On Tuesday Annuity and Life Re announced that it has ceased writing new business, prompting questions about its future. John Burke, senior vice president and chief financial officer says that Annuity and Life Re (“Annuity”) has a challenging year ahead of it, but the present problems are manageable. He indicated that there are no imminent plans to release any employees and in fact the company is in the market for new staff with financial qualifications.

Mr. Burke said: “2003 will be a stabilising year. There is some risk, but there's also a book of business that will generate revenue and hopefully profit. It's important to emphasise that while we say there's no new business, there is still a significant revenue stream from our existing reinsurance agreements and potential new products.”

Annuity's share price fell yesterday amid analysts' frustration that Tuesday's release did not include a figure for projected losses expected in the fourth quarter.

Mr. Burke admitted that certain of the company's reinsurance agreements were not performing as expected and were contributing to the company's losses. He said that in the fourth quarter they increased reserves in its life reinsurance business to reflect higher than expected mortality and an increase in reported claim activity during the quarter.

He said that Annuity's financial problems becoming public may have contributed to a higher rate of reported claims:

“Life reinsurance claim reporting generally lags behind actual deaths and under usual circumstances, claims might not be reported to a reinsurer for months after a death, but ceding companies may have made an extra effort to report claims quickly during the fourth quarter. The company is still attempting to identify the underlying cause of the adverse mortality,” he explained.

However the most significant issue for Annuity is its current liquidity crisis.

In March 2002, the company filed with the SEC to issue debt through a shelf registration. (A shelf registration is an SEC filing which allows a listed company to issue debt or shares whenever it requires extra capital without having to go through all the formalities on each occasion.)

In the course of their due diligence, the SEC raised questions about certain reinsurance arrangements where the ceding reinsurer holds invested assets and the assuming reinsurer records a receivable from the ceding company, commonly referred to as modified coinsurance arrangements. The assuming reinsurer receives a return on its receivable that is tied to the performance of the underlying invested assets held and managed by the ceding company. The SEC concluded that these types of reinsurance agreements contain derivative like attributes, albeit embedded in the agreement, and required Annuity to restate its financial statements for the year 2001 and the first quarter of 2002 to separately account for these attributes.

In the present climate of corporate scandals, the mere whiff of any accounting irregularities can have an extremely dramatic effect on a company's financial condition, which may have caused further downside pressure on the company's stock and its ability to raise capital.

Mr. Burke said that the reinsurance agreements in question are standard in the industry and not specific to Annuity, but they are the first company to be required to apply this accounting concept to its modified coinsurance agreements. In February 2003, the Derivatives Implementation Group (the group tasked by the Financial Accounting Standards Board to interpret FAS 133 - Derivative Accounting), concluded that beginning in the third quarter of 2003 all reinsurance agreements of this type must separately accountant for their derivative attributes.

As a reinsurer, Annuity takes on a pro-rata portion of the primary insurer's policies and is required to post collateral for the benefit of the ceding company so that the ceding company can claim statutory reserve benefit.

While the SEC review was proceeding, Annuity was not able to raise capital in the public markets. However, its collateral requirements continued to grow and ultimately created a significant collateral funding shortfall.

In addition, the company reported losses on its largest annuity reinsurance agreement in the second and third quarters of 2002. The combination of these events triggered ratings down-grades from the company's rating agencies.

The share price fell dramatically and in November 2002 a class action law suit was filed by shareholders.

In order to address the collateral shortfall and meet the requirements of as many cedents as possible Annuity began unwinding reinsurance agreements with ceding companies that had high collateral requirements. The unwinding of these agreements in a compressed time frame produced losses in the fourth quarter of 2002.

The upshot of this chain of events is that Annuity, which was originally set up in 1998 to provide capital relief for mortality related risks, has itself experienced a liquidity/capital crisis.

Mr. Burke recalls: “Beginning in 2000 we attempted to capitalise on a new regulation in the US relating to term life insurance business which required US based life insurers to establish reserves far in excess of economic expectations, causing statutory surplus drains for those companies.”

At the moment, Annuity is unable to fulfill its collateral requirements for two major contracts. For one, a guaranteed minimum death benefit reinsurance agreement, the ceding company asserts a collateral shortfall of $59 million. Annuity and Life Re has yet to perform its own analysis of the ceding company's reserve computation to assess whether it agrees with the ceding company's computation. Mr. Burke indicated that the company was still trying to find a solution for this cedent. For the second, Annuity is discussing the appropriateness of the ceding company's reserve methodology. The company will likely continue to unwind certain other agreements in 2003 to free up capital. Mr. Burke has had prior experience in restructuring businesses and remains optimistic that Annuity and Life Re can turn things around. “In let's say a year, we can start to think about what our new strategic direction will be.”