EVEREST GROUP, LTD. - Quarter Report: 2009 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

EVEREST RE GROUP, LTD.

(Exact name of registrant as specified in its charter)

Wessex House – 2^nd Floor

45 Reid Street

PO Box HM 845

Hamilton HM DX, Bermuda

441-295-0006

(Address, including zip code, and telephone number, including area code,

of registrant’s principal executive office)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES

X

NO

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or shorter period that the registrant was required to submit and post such files).

YES

NO

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES

NO

X

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

  EVEREST RE GROUP, LTD

           Table of Contents               

    Form 10-Q

      PART I

              FINANCIAL INFORMATION

  PART II

  OTHER INFORMATION

PART I

ITEM 1. FINANCIAL STATEMENTS

EVEREST RE GROUP, LTD.

CONSOLIDATED BALANCE SHEETS

EVEREST RE GROUP, LTD.

CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

EVEREST RE GROUP, LTD.

CONSOLIDATED STATEMENTS OF

CHANGES IN SHAREHOLDERS’ EQUITY

EVEREST RE GROUP, LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS

NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)

For the Three and Six Months Ended June 30, 2009 and 2008

1. General

Everest Re Group, Ltd. (“Group”), a Bermuda company, through its subsidiaries, principally provides reinsurance and insurance in the U.S., Bermuda and international markets. As used in this document, “Company” means Group and its subsidiaries. On December 30, 2008, Group contributed Everest Reinsurance Holdings, Inc. and its subsidiaries (“Holdings”) to its recently established Irish holding company, Everest Underwriting Group (Ireland), Limited.

The unaudited consolidated financial statements of the Company for the three and six months ended June 30, 2009 and 2008 include all adjustments, consisting of normal recurring accruals, which, in the opinion of management, are necessary for a fair statement of the results on an interim basis. Certain financial information, which is normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), has been omitted since it is not required for interim reporting purposes. The year end consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. The results for the three and six months ended June 30, 2009 and 2008 are not necessarily indicative of the results for a full year. These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the years ended December 31, 2008, 2007 and 2006 included in the Company’s most recent Form 10-K filing.

2. New Accounting Pronouncements

In March 2008, the Financial Accounting Standards Board (“FASB”) issued Financial Accounting Standards (“FAS”) No. 161 “Disclosures about Derivative Instruments and Hedging Activities - an amendment of FASB Statement No. 133” (“FAS 161”). FAS 161 requires entities to provide additional disclosures on derivative and hedging activities regarding their effect on financial position, financial performance and cash flows. This statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company adopted FAS 161 on January 1, 2009.

In June, 2008, the FASB issued FASB Staff Position (“FSP”) Emerging Issues Task Force (“EITF”) 03-6-1 “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“FSP EITF 03-6-1”). FSP EITF 03-6-1 requires nonvested restricted stock awards that contain rights to nonforfeitable dividends to be considered in the determination of earnings per share. FSP EITF 03-6-1 is effective for fiscal years beginning after December 31, 2008 and interim periods within those years. All prior period earnings per share data presented shall be adjusted retrospectively. The Company adopted FSP EITF 03-6-1 on January 1, 2009.

In December 2008, the FASB issued FASB Staff Position FAS 132(R)-1 “Employers’ Disclosures about Postretirement Benefit Plan Assets” (“FAS 132(R)-1”). FAS 132(R)-1 requires additional disclosures about plan assets. Additional disclosures include investment policies and strategies, fair value of each major plan asset category, inputs and valuation techniques used to develop fair value and any significant concentrations of risk. This FASB Staff Position is effective for fiscal years ending after December 15, 2009. The Company will adopt FAS 132(R)-1 for the reporting period ending December 31, 2009.

In April 2009, the FASB issued FSP No. FAS 157-4 “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP FAS 157-4”). FSP FAS 157-4 provides additional guidance for estimating fair value in accordance with FAS No. 157 “Fair Value Measurements” (“FAS 157”) when the volume and level of activity

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for the asset or liability have significantly decreased and to identify circumstances that indicate a transaction is not orderly. In addition, FSP FAS 157-4 emphasizes that the objective of the fair value measurement remains the same, to arrive at a price received to sell an asset or paid to transfer a liability in an orderly transaction. FSP FAS 157-4 is effective for interim and annual reporting periods ending after June 15, 2009, and is applied prospectively. The Company adopted FSP FAS 157-4 effective April 1, 2009. There was no impact to the Company’s financial statements as a result of adopting FAS 157-4 for the second quarter of 2009.

In April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2 “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP FAS 115-2”). FSP FAS 115-2 amends the other-than-temporary guidance in U.S. GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. FSP FAS 115-2 is effective for interim and annual reporting periods ending after June 15, 2009, and is applied prospectively with an adjustment to reclassify the non-credit portion of any other-than-temporary payments previously recorded through earnings to accumulated other comprehensive income. The Company adopted FSP FAS 115-2 effective April 1, 2009. Upon adoption of FSP FAS 115-2, the Company recognized a $57.3 million cumulative-effect adjustment from retained earnings, net of $8.3 million of tax.

In April 2009, the FASB issued FSP FAS 107-1 and FSP APB 28-1 “Interim Disclosures about Fair Value of Financial Instruments” (“FSP FAS 107-1 and APB 28-1”). FSP FAS 107-1 and APB 28-1 amends FASB Statement No. 107 “Disclosures about Fair Value of Financial Instruments” and APB Opinion No. 28 “Interim Financial Reporting” to require complete disclosures in both the interim and annual financial reporting. FSP FAS 107-1 and APB 28-1 is effective for interim and annual reporting periods ending after June 15, 2009, and is applied prospectively. The Company adopted FSP FAS 107-1 and APB 28-1 effective April 1, 2009.

In May 2009, the FASB issued FAS 165 “Subsequent Events” (“FAS 165”). FAS 165 establishes principles and requirements for the recognition, nonrecognition and disclosure of subsequent events that occur after the balance sheet date but before financial statements are issued or are available to be issued. FAS 165 is effective for interim or annual financial periods ending after June 15, 2009, and shall be applied prospectively.

3. Investments

The amortized cost, market value and gross unrealized appreciation and depreciation of available for sale, fixed maturity and equity security investments, carried at market value, are as follows for the periods indicated:

In accordance with FSP FAS 115-2, the Company reclassified previously other-than-temporary impairments from retained earnings into accumulated other comprehensive income. The pre-tax amount of the reclassification was $65.7 million with $65.4 million related to corporate securities and $0.3 million related to foreign corporate securities. At June 30, 2009, the cumulative unrealized depreciation on these securities had improved and the remaining unrealized depreciation for the corporate securities was $27.2 million and the foreign securities were virtually at amortized cost.

The changes in net unrealized appreciation (depreciation) for the Company’s investments are derived from the following sources for the periods indicated:

The Company frequently reviews its investment portfolio for declines in market value and focuses its attention on securities whose fair value has fallen below 80% of their amortized value at the time of review. The Company then assesses whether the decline in value is temporary or other-than-temporary. In making its assessment, the Company evaluates the current market and interest rate environment as well as specific issuer information. Generally, a change in a security’s value caused by a change in the market or interest rate environment does not constitute an other-than-temporary impairment, but rather a temporary decline in market value. Temporary declines in market value are recorded as unrealized losses in accumulated other comprehensive income. If the Company determines that the decline is other-than-temporary and the Company does not have the intent to sell the security; and it is more likely than not the Company will not have to sell the security before recovery of its cost basis, the carrying value of the investment is written down to fair value. The fair value adjustment that is credit related is recorded in net realized capital gains (losses) in the Company’s consolidated statements of operations and comprehensive income. The fair value adjustment that is non-credit related is recorded as a component of other comprehensive income, net of tax, and is included in accumulated other comprehensive income in the Company’s consolidated balance sheets. The Company’s assessments are based on the issuers current and expected future financial position,

timeliness with respect to interest and/or principal payments, speed of repayments and any applicable credit enhancements or breakeven constant default rates on mortgage and asset backed securities, as well as relevant information provided by rating agencies, investment advisors and analysts.

The tables below display the aggregate market value and gross unrealized depreciation of fixed maturity securities, by security type and maturity type, in each case subdivided according to length of time that individual securities had been in a continuous unrealized loss position for the periods indicated:

The aggregate market value and gross unrealized losses related to investments in an unrealized loss position as of June 30, 2009 were $3,442.4 million and $373.2 million, respectively. There were no unrealized losses on a single security that exceeded 0.20% of the market value of the fixed maturities at June 30, 2009. In addition, there was no significant concentration of unrealized losses in any one market sector. The $53.4 million of unrealized losses related to fixed maturity securities that have been in an unrealized loss position for less than one year were generally comprised of highly rated government, municipal, corporate bonds and mortgage-backed securities. Of these unrealized losses, $51.6 million were related to securities that were rated investment grade or better by at least one nationally recognized statistical rating organization. The $319.9 million of unrealized losses related to fixed maturity securities in an unrealized loss position for more than one year also related primarily to highly rated government, municipal, corporate bonds and mortgage-backed securities. Of these unrealized losses, $264.6 million related to securities that were rated investment grade or better by at least one nationally recognized statistical rating organization. The non-investment grade securities with unrealized losses are mainly comprised of non-credit other-than-

temporary impaired securities and non-agency residential mortgage-backed securities. In all instances, there were no projected cash flow shortfalls to recover the full book value of the investments and the related interest obligations. The mortgage-backed securities still have excess credit coverage and are current on interest and principal payments. Unrealized losses have decreased since year end as a result of improved conditions in the overall financial market.

The Company, given the size of its investment portfolio and capital position, does not have the intent to sell these securities; and it is more likely than not the Company will not have to sell the security before recovery of its cost basis. In addition, all securities currently in an unrealized loss position are current with respect to principal and interest payments.

The tables below display the aggregate market value and gross unrealized depreciation of fixed maturity securities, by security type and maturity type, in each case subdivided according to the length of time that individual securities had been in a continuous unrealized loss position for the period indicated:

The aggregate market value and gross unrealized losses related to investments in an unrealized loss position as of December 31, 2008 were $4,561.8 million and $604.2 million, respectively. There were no unrealized losses on a single security that exceeded 0.25% of the market value of the fixed maturities at December 31, 2008. In addition, there was no significant concentration of unrealized losses in any one market sector. The $352.7 million of unrealized losses related to fixed maturity securities that have been in an unrealized loss position for less than one year were generally comprised of highly rated government, municipal, corporate

bonds and mortgage-backed securities with the losses primarily the result of widening credit spreads from the financial markets crisis during the latter part of the year. Of these unrealized losses, $346.6 million were related to securities that were rated investment grade or better by at least one nationally recognized statistical rating organization. The $251.5 million of unrealized losses related to fixed maturity securities in an unrealized loss position for more than one year also related primarily to highly rated government, municipal, corporate bonds and mortgage-backed securities and were also the result of widening credit spreads during the latter part of the year. Of these unrealized losses, $224.5 million related to securities that were rated investment grade or better by at least one nationally recognized statistical rating organization. The gross unrealized depreciation greater than 12 months for mortgage-backed securities includes only $4.7 million related to sub-prime and alt-A loans.

The components of net investment income are presented in the table below for the periods indicated:

The Company reports results from limited partnership investments on the equity basis of accounting with changes in value reported through net investment income. Due to the timing of receiving financial information from these partnerships, the results are generally reported on a one month or quarter lag. If the Company determines there has been a significant decline in value of a limited partnership during this lag period, a loss will be recorded in the period in which the Company indentifies the decline.

The Company had contractual commitments to invest up to an additional $239.4 million in limited partnerships at June 30, 2009. These commitments will be funded when called in accordance with the partnership agreements, which have investment periods that expire, unless extended, through 2014.

The components of net realized capital losses are presented in the table below for the periods indicated:

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Proceeds from sales of fixed maturity securities for the three months ended June 30, 2009 and 2008 were $53.2 million and $82.7 million, respectively. Gross gains of $5.6 million and $0.5 million and gross losses of $2.0 million and $0.9 million were realized on those fixed maturity securities sales for the three months ended June 30, 2009 and 2008, respectively. Proceeds from sales of equity securities for the three months ended June 30, 2009 and 2008 were $10.6 million and $66.9 million, respectively. Gross gains of $5.7 million and $4.9 million and gross losses of $0.0 million and $1.9 million were realized on those equity sales for the three months ended June 30, 2009 and 2008, respectively.

Proceeds from sales of fixed maturity securities for the six months ended June 30, 2009 and 2008 were $137.7 million and $129.9 million, respectively. Gross gains of $8.3 million and $1.9 million and gross losses of $44.3 million and $2.4 million were realized on those fixed maturity securities sales for the six months ended June 30, 2009 and 2008, respectively. Proceeds from sales of equity securities for the six months ended June 30, 2009 and 2008 were $13.3 million and $329.2 million, respectively. Gross gains of $5.9 million and $7.6 million and gross losses of $0.7 million and $18.5 million were realized on those equity sales for the six months ended June 30, 2009 and 2008, respectively.

Included in net realized capital losses was $4.9 million and $5.6 million for the three months ended June 30, 2009 and 2008, respectively, and $13.2 million and $6.5 million for the six months ended June 30, 2009 and 2008, respectively, of write-downs in the value of securities deemed to be impaired on an other-than-temporary basis.

At June 30, 2009, the Company had no other-than-temporary impaired securities where the impairment had both a credit and non-credit component.

4. Derivatives

The Company sold seven equity index put options based on two indices in 2001 and in 2005. The Company sold these equity index put options as insurance products with the intent of achieving a profit. These equity index put options meet the definition of a derivative under FAS 133 and the Company’s position in these contracts is unhedged. These equity index put options are not used for risk management purposes.

The Company sold six equity index put options based on the Standard & Poor’s 500 (“S&P 500”) index for total consideration, net of commissions, of $22.5 million. At June 30, 2009, fair value for these equity put options was $52.1 million. These contracts each have a single exercise date, with maturities ranging from 12 to 30 years and strike prices ranging from $1,141.21 to $1,540.63. No amounts will be payable under these contracts if the S&P 500 index is at or above the strike prices on the exercise dates, which fall between June 2017 and March 2031. If the S&P 500 index is lower than the strike price on the applicable exercise date, the amount due would vary proportionately with the percentage by which the index is below the strike price. Based on historical index volatilities and trends and the June 30, 2009 index value, the Company estimates the probability for each contract of the S&P 500 index falling below the strike price on the exercise date to be less than 52%. The theoretical maximum payouts under the contracts would occur if on each of the exercise dates the S&P 500 index value were zero. At June 30, 2009, the present value of these theoretical maximum payouts using a 6% discount factor was $246.6 million.

The Company sold one equity index put option based on the FTSE 100 index for total consideration, net of commissions, of $6.7 million. At June 30, 2009, fair value for this equity put option was $6.8 million. This contract has an exercise date of July 2020 and a strike price of £5,989.75. No amount will be payable under this contract if the FTSE 100 index is at or above the strike price on the exercise date. If the FTSE 100 index is lower than the strike price on the exercise date, the amount due will vary proportionately with the percentage by which the index is below the strike price. Based on historical index volatilities and trends and the June 30, 2009 index value, the Company estimates the probability that the FTSE 100 index contract will fall below the strike price on the exercise date to be less than 55%. The theoretical maximum payout under

the contract would occur if on the exercise date the FTSE 100 index value was zero. At June 30, 2009, the present value of the theoretical maximum payout using a 6% discount factor and current exchange rate was $28.3 million.

The fair value of the equity put options can be found in the Company’s balance sheet as follows:

The loss on the equity index put options can be found in the Company’s statement of operations and comprehensive income as follows:

The Company’s derivative (equity index put options) contracts contain provisions that require collateralization of the fair value, as calculated by the counterparty, above a specified threshold, which are based on the Company’s financial strength ratings (Moody’s) and/or debt ratings (Standard & Poor’s). The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a liability position on June 30, 2009, was $58.9 million for which the Company had posted collateral of $27.9 million. If on June 30, 2009, the Company’s ratings were such that the collateral threshold was zero, the Company would be required to post an additional $60.0 million.

5. Fair Value

The Company records fair value re-measurements as net realized capital gains or losses in the consolidated statements of operations and comprehensive income. The Company recorded $19.3 million and $2.3 million in net realized capital gains due to fair value re-measurement on fixed maturity securities and equity securities at fair value for the three and six months ended June 30, 2009, respectively. The Company recorded $28.6 million and $150.0 million in net realized capital losses due to fair value re-measurement on fixed maturity securities and equity securities at fair value for the three and six months ended June 30, 2008, respectively.

The Company’s fixed maturity and equity securities are managed by third party investment asset managers. The investment asset managers obtain prices from nationally recognized pricing services. These services seek to utilize market data and observations in their evaluation process. They use pricing applications that vary by asset class and incorporate available market information and when fixed maturity securities do not trade on a daily basis the services will apply available information through processes such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. In addition, they use model processes, such as the Option Adjusted Spread model to develop prepayment and interest rate scenarios for securities that have prepayment features.

In limited instances where prices are not provided by pricing services or in rare instances when a manager may not agree with the pricing service, price quotes on a non-binding basis are obtained from investment

brokers. The investment asset managers do not make any changes to prices received from either the pricing services or the investment brokers. In addition, the investment asset managers have procedures in place to review the reasonableness of the prices from the service providers and may request verification of the prices. In addition, the Company tests the prices on a random basis to an independent pricing source. In limited situations, where financial markets are inactive or illiquid, the Company may use its own assumptions about future cash flows and risk-adjusted discount rates to determine fair value. The Company made no such adjustments at June 30, 2009.

Fixed maturity securities are categorized as Level 2, Significant Other Observable Inputs, since a particular security may not have traded but the pricing services are able to use valuation models with observable market inputs such as interest rate yield curves and prices for similar fixed maturity securities in terms of issuer, maturity and seniority. Valuations that are derived from techniques in which one or more of the significant inputs are unobservable (including assumptions about risk) are categorized as Level 3, Significant Unobservable Inputs. These securities include broker priced securities and valuation of less liquid securities such as commercial mortgage-backed securities and the Company’s equity index put options.

Equity securities in U.S. denominated currency are categorized as Level 1, Quoted Prices in Active Markets for Identical Assets, since the securities are actively traded on an exchange and prices are based on quoted prices from the exchange. Equity securities traded on foreign exchanges are categorized as Level 2 due to potential foreign exchange adjustments to fair or market value.

The Company sold seven equity index put options which meet the definition of a derivative under FAS 133. The Company’s position in these contracts is unhedged. The Company recorded the change in fair value of $21.4 million and $1.6 million as net derivative income for the three and six months ended June 30, 2009, respectively, in the consolidated statements of operations and comprehensive income (loss). The Company recorded the change in fair value of $2.1 million as net derivative income for the three months ended June 30, 2008 and $1.7 million as net derivative expense for the six months ended June 30, 2008 in the consolidated statements of operations and comprehensive income (loss).

The fair value was calculated using an industry accepted option pricing model, Black-Scholes, which used the following assumptions:

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The following tables present the fair value measurement levels for all assets and liabilities, which the Company has recorded at fair value as of the periods indicated:

The following table presents the activity under Level 3, fair value measurements using significant unobservable inputs for fixed maturity investments, for the periods indicated:

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The following table presents the activity under Level 3, fair value measurements using significant unobservable inputs for equity index put options for the periods indicated: