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Scottish Re Losses Soar

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Poor financial results have increased uncertainty over the future of Scottish Re Group Ltd., Hamilton, Bermuda.

The reinsurer’s fourth quarter and full-year 2006 financial report prompted an amendment of an agreement with investors who are bailing out the life reinsurer as well as a downgrade from Fitch Ratings, Chicago.

Commenting on the results, John Nadel, an analyst with Fox-Pitt, Kelton, said, “While we expected a lot of noise this quarter, what we got was still an eye opener–enough so that we don’t think investors can or should ignore results.”

Much of the decline was posted in the second half of 2006. On July 31, 2006, Scottish announced a $130 million loss, resulting in a tumble in stock price and ratings.

For the 3 months ending Dec. 31, 2006, Scottish reported a net loss available to ordinary shareholders of $233.8 million, compared to net income available to ordinary shareholders of $58.5 million for the same 2005 time frame.

The net loss for full-year 2006 totaled $376.7 million, compared to net income of $125.4 million for 2005.

The results prompted MassMutual Capital and Cerberus, investors who on Nov. 26 agreed to each purchase 500,000 of the company’s convertible cumulative participating preferred stock for $600 million, to request a second amendment to a securities purchase agreement. Scottish had already agreed to an amendment on Jan. 9, 2007, that changed the certificates of designation for the convertible shares.

The second amendment, dated Feb. 20, 2007, provides additional indemnity to investors up to an aggregate $68.5 million if actual claims of in-force individual life reinsurance business acquired from ING America Insurance Holdings Inc. exceed expected claims of the block. The ING business was written by Security Life of Denver Co. and Security Life of Denver International Ltd. prior to it being assumed by Scottish.

An extraordinary general meeting originally planned for Feb. 23 has been postponed until March 2 in order to give shareholders an opportunity to consider the amendment, according to Scottish.

In a statement, Paul Goldean, Scottish Re’s CEO, said, “I can affirmatively state that MassMutual Capital and Cerberus remain committed to closing the transaction, and the amendment noted above is not expected to have any impact on the timing of the closing.”

Scottish Re’s losses were attributed to reduced earned premiums and higher expenses. Premiums earned declined to $494.5 million in fourth quarter 2006, a 12% decline from fourth quarter 2005′s $563.3 million. For full-year 2006, premiums earned totaled $1.84 billion, down 4.8% from full-year 2005′s $1.93 billion.

Total revenues for fourth quarter 2006 declined to $668.2 million, a 1% drop from $675 million in the same 2005 time period. Full-year 2006 total revenue was $2.45 billion, up 6.7% from full-year 2005′s $2.3 billion in revenue.

Revenue was helped by net investment income, which grew a respective quarterly and annual percentage of 78% and 73%.

The company attributed the operating loss for the fourth quarter to:

–A 5% higher-than-expected mortality in Scottish’s North America segment totaling approximately $11 million.

–The reversal of an expected recovery from a specific client of approximately $15 million due to corrected client data.

–The write-off of goodwill and unrecoverable deferred acquisition costs of approximately $34 million and $12 million, respectively, related to Scottish’s international segment.

–A $118.2 million tax expense related to a $91 million valuation allowance on deferred tax assets.

–Higher operating expenses, including $14 million in relocation costs and approximately $54.5 million in collateral finance facilities expenses.

“The business and operating challenges and uncertainties that SCT continues to face” prompted Fitch Ratings to downgrade the company’s insurer financial strength ratings of its operating subsidiaries to ‘BB+’ from ‘BBB.’ SCT’s issuer default rating was reduced to ‘B+’ from ‘BB,’ and its preferred stock rating to ‘B-’ from ‘B+’. All ratings remain on Rating Watch Evolving.

The run-rate operating earnings capacity is “significantly below Fitch’s ratings expectations,” the rating agency says.

The ratings changes also reflect “heightened concern” that the pending investor agreement will be called off. Fitch cautioned that if the transaction does not close, the ratings of the holding company will be downgraded to a level “no higher than ‘CC’ and the insurance financial strength ratings to a level of “no higher than ‘CCC.’”

Standard & Poor’s Corp., New York, said the ‘B/Watch Dev.’ rating assigned Scottish would not be affected because it “incorporated the expectation of continued sub-par performance.” However, S&P also notes that the earnings were below the rating agency’s expectations.

S&P says that if the investor transaction closes, it would expect to raise the counterparty credit and financial strength ratings of Scottish’s operating companies to levels “not likely to exceed ‘BBB-.’ But, if the deal is not completed, the current ratings would likely be lowered by 3 or more notches.

“Without the deal, it would be difficult for Scottish Re to proceed with an orderly run-off or manage as an operating company.”

If all investor indemnifications, according to Nadel of Fox-Pitt, Kelton, are realized, the $4 per share investment would be reduced to about $3, given the increase in the stock conversion rate.


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