10-Q 1 lh10q_stirling.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition period from to --------------- --------------- COMMISSION FILE NUMBER 000-23427 STIRLING COOKE BROWN HOLDINGS LIMITED (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) BERMUDA NOT APPLICABLE (STATE OF OTHER JURISDICTION OF (IRS EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) VICTORIA HALL, 3RD FLOOR, 11 VICTORIA STREET, HAMILTON HM 11, BERMUDA (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) TELEPHONE NUMBER: (441) 295-7556 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) 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 |_| The number of outstanding shares of the registrant's Ordinary Stock, $0.25 par value, as of June 30, 2002 was 9,519,972. INDEX PART I - FINANCIAL INFORMATION PAGE ---- ITEM 1 UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Consolidated Balance Sheets at December 31, 2001 (Audited) and June 30, 2002 (Unaudited) .......................... 1 Unaudited Consolidated Statements of Income and Comprehensive Income for the three-month and six-month periods ended June 30, 2001 and 2002............................. 2 Unaudited Consolidated Statements of Changes in Shareholders' Equity for the three-month and six-month periods ended June 30, 2001 and 2002............................. 3 Unaudited Consolidated Statements of Cash Flows for the six-month periods ended June 30, 2001 and 2002................... 4 Notes to Unaudited Consolidated Financial Statements at June 30, 2001 and 2002........................................... 5 ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.............................. 7 ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...................................................... 13 PART II - OTHER INFORMATION ITEM 1 LEGAL PROCEEDINGS................................................ 14 ITEM 5 OTHER INFORMATION................................................ 17 ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K................................. 17 SIGNATURES....................................................... 18 EXHIBITS Exhibit 11 - Statement of Computation of Net Income Per Ordinary Share Exhibit 99 - Forward Looking Information STIRLING COOKE BROWN HOLDINGS LIMITED CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2001 (AUDITED) AND JUNE 30, 2002 (UNAUDITED) (EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS, EXCEPT PER-SHARE DATA)

STIRLING COOKE BROWN HOLDINGS LIMITED UNAUDITED CONSOLIDATED STATEMENTS OF INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS) THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2001 AND 2002 (EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS, EXCEPT PER SHARE DATA)

STIRLING COOKE BROWN HOLDINGS LIMITED UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2001 AND 2002 (EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS, EXCEPT PER SHARE DATA)

STIRLING COOKE BROWN HOLDINGS LIMITED UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS SIX MONTHS ENDED JUNE 30, 2001 AND 2002 (EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS)

STIRLING COOKE BROWN HOLDINGS LIMITED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2001 AND 2002 (EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS, EXCEPT SHARE DATA) 1. INTERIM ACCOUNTING POLICY In the opinion of management of Stirling Cooke Brown Holdings Limited ("the Company"), the accompanying unaudited consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position of the Company at December 31, 2001 and June 30, 2002, the results of operations for the three months and six months ended June 30, 2001 and 2002 and the cash flows for the six months ended June 30, 2001 and 2002. Although the Company believes that the disclosure in these financial statements is adequate to make the information presented not misleading, certain information and footnotes normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States has been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The interim financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2001. Results of operations for the three months and six months ended June 30, 2002 are not necessarily indicative of what operating results may be for the full year. 2. SIGNIFICANT ACCOUNTING POLICIES In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets." Under SFAS No. 142, amortization of goodwill is precluded; however, its fair value is periodically (at least annually) reviewed and tested for impairment. Goodwill must be tested for impairment in the year of adoption, including an initial test performed within six months. If the initial test indicates a potential impairment, then a more detailed analysis to determine the extent of impairment must be completed within twelve months. SFAS No. 142 requires that useful lives for intangibles, other than goodwill, be reassessed and remaining amortization periods be adjusted accordingly. The reassessment was completed prior to the first quarter of 2002. The provisions of SFAS No. 142 are effective for financial statements issued for fiscal years beginning after December 15, 2001. All provisions of SFAS No. 142 were applied beginning January 1, 2002 to goodwill and other intangible assets. Goodwill amortization totaled $58 in the second quarter of 2001 and $116 in the first six months of 2001, and the Company expects it would have approximated $35 in the second quarter and $70 in the first six months of 2002 before application of the non-amortization provisions of this statement. In August 2001, the FASB issued Statement No. 144, "Accounting for the Impairment or Disposal of Long Lived Assets," which updates and clarifies the accounting and reporting for impairment of assets held in use and to be disposed of. SFAS No. 144, among other things, will require the Company to classify the operations and cash flow of properties to be disposed of as discontinued operations. The provisions of SFAS No. 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, with early application encouraged. The provisions of SFAS No. 144 generally are to be applied prospectively. The Company adopted the provisions of SFAS No. 144 on January 1, 2002 The adoption did not have a significant impact on the Company's financial position or results of operations. 3. REVENUES AND NET INCOME (LOSS) BY SEGMENT

ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is Management's discussion and analysis of the results of operations of Stirling Cooke Brown Holdings Limited ("the Company") for the three months and six months ended June 30, 2001 and 2002 and financial condition as of June 30, 2002. This discussion and analysis should be read in conjunction with the attached unaudited consolidated financial statements and notes thereto of the Company and the audited consolidated financial statements and notes thereto of the Company contained in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2001. GENERAL The Company is a Bermuda holding company incorporated on December 12, 1995, which, through its subsidiaries, provides insurance services and products. The Company provides its range of services and products to insurance and reinsurance companies, insurance agents, and insureds. The Company is involved primarily in the workers' compensation, occupational accident and health and property/casualty insurance markets through its subsidiaries located in the United States, Bermuda and London. RESULTS OF OPERATIONS FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2001 AND 2002. REVENUES AND NET LOSS ---------------------

Basic net loss per share was $0.28 in the second quarter and $0.73 in the first six months of 2002, compared to basic net loss per share of $0.24 in the second quarter of 2001 and $0.44 in the first six months of 2001. Diluted net loss per share was $0.28 in the second quarter and $0.73 in the first six months of 2002, compared to basic net loss per share of $0.24 in the second quarter of 2001 and $0.44 in the first six months of 2001. Net loss from all operations for the second quarter of 2002 was $2.7 million, which was an increase of $0.4 million from net loss from all operations for the second quarter of 2001 of $2.3 million. Net loss from all operations for the first six months of 2002 was $7.0 million, compared to net loss from all operations for the first six months of 2001 of $4.2 million. The results for the year continued to be affected by adverse factors which impacted the Company's results last year. The program business segment suffered increased losses for the year, primarily due to a further charge of $4.0 million for estimated costs that the Company projects it will pay in connection with its indemnification of its major issuing company for losses in excess of a specific loss ratio on business produced by the program business segment during 2000. The Company also continued to incur costs pertaining to reinsurance-related disputes in which the Company and others are involved, including certain litigation in London, the unanticipated duration of which has placed a significant strain on the cash resources of the Company. Lastly, the Company benefited from the sale of its wholly owned reinsurance segment, which resulted in the elimination of $4.8 million of accumulated deficit in the second quarter. The Company understands that the trial currently under way in London is likely to conclude during the fourth quarter of 2002 and, in the interim, is pursuing efforts both to reduce the ongoing cash outlays required in order to fund the defense of the litigation, and to secure additional capital, possibly through the sale of certain assets of the Company. If successful, the Company believes that these efforts will prove sufficient to enable it to avoid serious constriction in its cash resources. The Company further remains cautiously optimistic that a successful result will be achieved in the litigation itself. In that event, the Company believes that, pursuant to U.K. law, it will secure a recovery of some portion of the costs and expenses incurred in the litigation and that it will be able to recognize significant income, the recognition of which thus far has been deferred pending developments both in the litigation and in the reinsurance disputes discussed below. The ability to recognize such income, together with the elimination of the significant cash demands necessitated by the London litigation, should help restore the Company to a more adequate cash position. No assurance can be given, however, as to the results of the Company's efforts to secure additional cash resources or as to the outcome of the litigation in London. Revenues from continuing operations of $11.8 million in the second quarter of 2002 were consistent with 2001 second quarter revenues from continuing operations of $11.8 million. Revenues from continuing operations of $22.3 million in the first six months of 2002 represented a $1.0 million decrease compared to revenues from continuing operations of $23.3 million for the first six months of 2001. Net loss from continuing operations of $6.9 million in the second quarter of 2002 represented an increase in net loss of $5.8 million from a net loss from continuing operations of $1.1 million in the second quarter of 2001. Net loss from continuing operations of $10.4 million in the first six months of 2002 represented an increase in net loss of $7.8 million from a net loss from continuing operations of $2.6 million in the first six months of 2001. The decline in revenues from continuing operations in 2002 reflected the difficult market conditions in the brokerage and program business segments. This decline was partially offset by increased net premiums earned in the insurance segment as the insurance segment retained more business by reducing the amount of reinsurance purchased for its programs. Expenses from continuing operations, including insurance costs, of $18.7 million in the second quarter of 2002 represent a $5.4 million increase from $13.3 million in the second quarter of 2001. Expenses from continuing operations, including insurance costs, of $33.1 million in the first six months of 2002 represent a $6.5 million increase from $26.6 million in the first six months of 2001. Insurance costs for the second quarter of 2002 increased to $7.8 million, compared to $5.8 million in the second quarter of 2001. Insurance costs for the first six months of 2002 increased to $13.8 million, compared to $10.1 million in the first six months of 2001. The increases in insurance costs, which include incurred losses, were primarily due to the increases in net premiums earned. This increase in expenses from continuing operations reflects a further charge of $4.0 million in the second quarter for future anticipated losses that the Company projects it will pay in connection with its indemnification of its major issuing company for losses in excess of a specific loss ratio on business produced by the program business segment during 2000. Total expenses from continuing operations excluding insurance costs for the second quarter of 2002 were $10.9 million, versus $7.5 million in the second quarter of 2001. Total expenses from continuing operations excluding insurance costs for the first six months of 2002 were $19.3 million, versus $16.5 million in the first six months of 2001. In addition, expenses from continuing operations continued to be impacted by costs and provisions pertaining to reinsurance-related disputes in which the Company is involved, including certain litigation. REVENUES AND NET INCOME (LOSS) BY SEGMENT

Insurance --------- The Company's insurance segment consists of its wholly owned U.S.-based insurance company, Realm National Insurance Company. Revenues of $8.1 million in the second quarter of 2002 represented an increase of $1.3 million from revenues of $6.8 million in the second quarter of 2001. Revenues of $14.7 million in the first six months of 2002 represented an increase of $2.6 million from revenues of $12.1 million in the first six months of 2001. Net premiums earned increased to $7.3 million in the second quarter of 2002 from $5.7 million in the second quarter of 2001. Net premiums earned increased to $13.6 million in the first six months of 2002 from $10.0 million in the first six months of 2001. The increase in insurance segment revenues reflects the increase in net premiums earned. Gross written premiums decreased due to the decision to discontinue certain loss-making programs in 2001. Despite the decrease in gross premiums, net premiums earned increased as a result of reduced reinsurance ceded. Segment loss of $0.5 million in the second quarter of 2002 represented a negative change of $0.7 million from segment income of $0.2 million in the second quarter of 2001. Segment loss of $1.6 million in the first six months of 2002 represented a decline of $1.1 million from segment loss of $0.5 million in the first six months of 2001. The increased loss before tax resulted from an increase in losses incurred on business written. In April, 2002, A.M. Best Company decreased Realm National Insurance Company's rating to C++ from B+. While there can be no assurance of an upgrade of Realm National's rating, the Company believes that the favorable resolution of certain reinsurance disputes should better position Realm National to seek reconsideration of its rating in the foreseeable future. Program Business ---------------- The Company's program business segment consists of subsidiaries that market insurance products and administer programs developed by the Company. Program business revenues of $3.1 million in the second quarter of 2002 represented a decrease of $0.1 million from revenues of $3.2 million in the second quarter of 2001. Program business revenues of $6.0 million in the first six months of 2002 represented a decrease of $0.3 million from revenues of $6.3 million in the first six months of 2001. This decrease was due to a reduction in program business volume due to management's decision to impose more selective underwriting conditions on continuing programs and to changes in the underwriting criteria of the Company's major issuing company. The program business segment's loss of $3.6 million in the second quarter of 2002 represented an increased loss of $2.8 million from segment loss of $0.8 million in the second quarter of 2001. The program business segment's loss of $3.8 million in the first six months of 2002 represented an increased loss of $2.0 million from segment loss of $1.8 million in the first six months of 2001. This increase in loss reflects a further charge of $4.0 million for estimated costs that the Company projects it will pay in connection with its indemnification of its major issuing company for losses in excess of a specific loss ratio on business produced by the program business segment during 2000. Brokerage --------- The Company's brokerage segment consists of subsidiaries that receive a fee or commission for brokering insurance and reinsurance contracts. Revenues of $0.5 million in the second quarter of 2002 represented a decrease of $1.2 million from revenues of $1.7 million in the second quarter of 2001. Revenues of $1.3 million in the first six months of 2002 represented a decrease of $2.0 million from revenues of $3.3 million in the first six months of 2001. The segment has been adversely affected by the disruption caused by widespread reinsurance market disputes and legal proceedings, including those involving the Company. The decrease in brokerage segment revenues was also the result of reduced business being brokered due to significantly diminished reinsurance capacity for workers' compensation business. The brokerage segment's loss of $1.7 million in the second quarter of 2002 represented a negative change of $1.5 million, from segment loss of $0.2 million in the second quarter of 2001. The brokerage segment's loss of $3.5 million in the first six months of 2002 represented a negative change of $2.9 million, from segment loss of $0.6 million in the first six months of 2001. The 2002 loss before tax reflects the decrease in revenues, which was partially offset by a decrease in brokerage segment expenses. Expenses for the segment continued to be impacted by significant costs and provisions associated with widespread reinsurance disputes involving the Company or its clients, including certain litigation. Other ----- Other revenues include primarily the Company's holding companies and other non-operating subsidiaries. Revenues of $0.1 million in the second quarter of 2002 were consistent with revenues of $0.1 million in the second quarter of 2001. Revenues of $0.3 million in the first six months of 2002 represented a decrease of $1.2 million from revenues of $1.5 million in the first six months of 2001. Segment loss of $1.1 million in the second quarter of 2002 represented a $0.4 increase in loss from segment loss of $0.7 million in 2001. Segment loss of $2.0 million in the first six months of 2002 represented a $1.6 increase in loss from the first six months of $0.4 million in 2001. The negative change in revenues and income from 2001 to 2002 was primarily the result of a gain of $1.1 million on the sale of an investment during 2001. The loss before tax for the quarter primarily reflects costs in respect of ongoing administrative expenses. Discontinued Operations ----------------------- On March 6, 2001, following a review of its operations, the Company decided to discontinue its loss-making reinsurance and underwriting management segments. The Company's discontinued underwriting management segment comprised companies that primarily underwrote and administered reinsurance business on behalf of independent reinsurance companies. Underwriting management segment loss of $0.6 million in the second quarter of 2002 represented an increased loss of $0.4 million from segment loss of $0.2 million in the second quarter of 2001. Underwriting management segment loss of $0.8 million in the first six months of 2002 represented an increase in loss of $0.5 million compared to $0.3 million in the first six months of 2001, reflecting the decrease in business being underwritten. The Company's discontinued reinsurance segment consisted of its Bermuda subsidiary, CIRCL Holdings Limited ("CIRCL") and its wholly owned reinsurance subsidiary, Comp Indemnity Reinsurance Company Limited. CIRCL's subsidiary primarily reinsured workers' compensation and property and general liability risks. CIRCL was sold effective June 27, 2002. Reinsurance segment income of $4.8 million in the second quarter of 2002 and $4.3 million in the first six months of 2002 represented the elimination of accumulated deficit. This elimination resulted from the sale of the segment in the second quarter. LIQUIDITY AND CAPITAL RESOURCES ------------------------------- At June 30, 2002, the Company held cash and marketable securities of $42.4 million, compared to $46.6 million at December 31, 2001. In addition, the Company held cash in fiduciary accounts relating to insurance client premiums amounting to $27.4 million at June 30, 2002, compared to $33.8 million at December 31, 2001. These decreased cash balances reflect the slow-down in the Company's business activities for 2002, the impact of delays in receiving outstanding reinsurance recoveries, and the net loss for the quarter. Of the $42.4 million of cash and marketable securities held by the Company at quarter end, $29.8 million (2001--$29.4 million) was held by subsidiaries whose payment of dividends to the Company was subject to regulatory restrictions or possible tax liabilities. In addition, $6.5 million of cash and marketable securities was pledged against letters of credit at June 30, 2002. At June 30, 2002, the Company's investment portfolio (at fair market value) totaled $28.7 million (2001--$30.1 million). The portfolio consisted primarily of U.S. Treasury obligations, short-term cash and A-rated corporate debt securities. During the first six months of 2002, the Company's operating activities used $4.5 million of net cash, compared to using $17.0 million of net cash during the first six months of 2001. The cash used by operating activities varies according to the Company's net loss and the timing of collections and payments of the Company's insurance and reinsurance balances. In light of continuing losses, the Company is continuing to review all operations and take steps to restructure those operations in an attempt to reduce cash usage. The Company anticipates that it will be able to make some reductions in the amount of cash required in connection with the defense of certain ongoing litigation prior to year-end 2002, the unanticipated duration of which has placed a significant strain on the cash resources of the Company. The Company understands that the trial currently under way in London is likely to conclude during the fourth quarter of 2002 and, in the interim, is pursuing efforts both to reduce the ongoing cash outlays required in order to fund the defense of the litigation, and to secure additional capital, possibly through the sale of certain assets of the Company. If successful, the Company believes that these efforts will prove sufficient to enable it to avoid serious constriction in its cash resources. The Company further remains cautiously optimistic that a successful result will be achieved in the litigation itself. In that event, the Company believes that, pursuant to U.K. law, it will secure a recovery of some portion of the costs and expenses incurred in the litigation and that it will be able to recognize significant income, the recognition of which thus far has been deferred pending developments both in the litigation and in the reinsurance disputes discussed below. The ability to recognize such income, together with the elimination of the significant cash demands necessitated by the London litigation, should help restore the Company to a more adequate cash position. No assurance can be given, however, as to the results of the Company's efforts to secure additional cash resources or as to the outcome of the litigation in London. The decrease of $64.3 million in insurance and reinsurance balances receivable during the first six months of 2002, along with the corresponding decrease of $75.4 million in insurance and reinsurance balances payable, primarily reflects the transfer of approximately $180 million of balances recorded by the Company's U.K. subsidiary to a third party ceding company. This decrease was partially offset by growth in clients' claims balances recorded in the Company's broking subsidiaries. As a result of various disputes between insurers and reinsurers on various reinsurance contracts, a number of the reinsurers have suspended paying claims due under the contracts. The Company's brokerage and underwriting management segment subsidiaries experienced a significant growth in client balances receivable and payable recorded during the six months ended June 30, 2002, reflecting this accumulation of claims due from one party to another. These balances are reflected as an asset or liability, as the case may be, on the Company's balance sheet. The Company has no direct liability for these balances. Shareholders' equity decreased by $6.6 million, to $28.9 million, at June 30, 2002 from $35.5 million at December 31, 2001, due primarily to the net loss incurred for the six months. On February 14, 2002, the Company was advised by the Nasdaq stock market that it was not in compliance with certain Nasdaq Marketplace Rules, specifically those relating to the minimum bid price of the Company's Ordinary Stock and the minimum market value of its publicly held shares. The Company was further advised that it would have until May 15, 2002 within which to regain compliance with the Marketplace Rules, failing which the Company would be provided with written notification that its securities would be delisted. The Company had the option, prior to May 15, 2002, to apply to transfer its securities to The Nasdaq SmallCap Market. The Company filed such an application to transfer its securities and this application was granted effective June 10, 2002. The Company's shares now trade on the Nasdaq SmallCap Market. The Company had no outstanding debt at June 30, 2002. Critical accounting policies and estimates ------------------------------------------ The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions for those transactions that are not yet complete or for which the ultimate effects cannot be precisely determined. Such estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The most significant estimates include those used in determining the liability for outstanding losses and loss expenses, uncollectible insurance and reinsurance balances receivable and recoverable, and potential losses from litigation. Although some variability is inherent in these estimates, management believes the amounts provided for are adequate. The Company has identified the following critical accounting policies and estimates utilized by management in the preparation of the Company's financial statements: losses and loss expenses, and premiums written, assumed and ceded. Losses and loss expenses: Losses and related loss adjustment expenses are charged to income as they are incurred and are net of losses recovered and recoverable. Amounts recoverable from reinsurers are estimated in a manner consistent with the underlying liability associated with the reinsured policy. Outstanding losses recoverable are shown separately on the consolidated balance sheets. The Company establishes reserves for losses and loss adjustment expenses related to reported claims on the basis of the evaluations of independent claims adjusters and the Company's own claims staff. In addition, reserves are established for losses which have occurred but have not yet been reported and for adverse development of reserves on reported losses. The Company's independent actuaries estimate claims and claims expenses arising for losses that have occurred but not yet been reported based upon the Company's and the insurance industry's experience, together with statistical information with respect to the probable number and nature of such claims. The Company established accruals in 2001 and 2002 in connection with an indemnification to its major issuing company. While the liability is not included in loss reserves, it is based on losses and is subject to the same estimation processes discussed above. The Company believes that the provision for outstanding losses and loss expenses is adequate to cover the ultimate net cost of losses and loss expenses incurred; however, such a provision is an estimate and may ultimately be significantly greater or less than the provision established. The Company has limited historical loss experience available to serve as a basis for the estimation of ultimate losses. It is possible that management will revise the estimate of outstanding losses and loss expenses in the future. Premiums written, assumed and ceded: Premiums written and assumed are recorded on an accrual basis and included in income on a pro-rata basis over the life of the policies or reinsurance agreements to which they relate, with the unearned portion deferred in the consolidated balance sheets. Adjustment premiums arising from premium audits are recorded in the period in which they are determined. Reinsurance premiums ceded are similarly pro-rated over the terms of the reinsurance contract, with the unearned portion being deferred in the consolidated balance sheets as deferred reinsurance premiums ceded. ACCOUNTING PRONOUNCEMENTS ------------------------- In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets." Under SFAS No. 142, amortization of goodwill is precluded; however, its fair value is periodically (at least annually) reviewed and tested for impairment. Goodwill must be tested for impairment in the year of adoption, including an initial test performed within six months. If the initial test indicates a potential impairment, then a more detailed analysis to determine the extent of impairment must be completed within twelve months. SFAS No. 142 requires that useful lives for intangibles, other than goodwill, be reassessed and remaining amortization periods be adjusted accordingly. The reassessment was completed prior to the first quarter of 2002. The provisions of SFAS No. 142 are effective for financial statements issued for fiscal years beginning after December 15, 2001. All provisions of SFAS No. 142 were applied beginning January 1, 2002 to goodwill and other intangible assets. Goodwill amortization totaled $58 in the second quarter of 2001 and $116 in the first six months of 2001, and the Company expects it would have approximated $35 in the second quarter and $70 in the first six months of 2002 before application of the non-amortization provisions of this statement. In August 2001, the FASB issued Statement No. 144, "Accounting for the Impairment or Disposal of Long Lived Assets," which updates and clarifies the accounting and reporting for impairment of assets held in use and to be disposed of. SFAS No. 144, among other things, will require the Company to classify the operations and cash flow of properties to be disposed of as discontinued operations. The provisions of SFAS No. 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, with early application encouraged. The provisions of SFAS No. 144 generally are to be applied prospectively. The Company adopted the provisions of SFAS 144 on January 1, 2002. The adoption did not have a significant impact on the Company's financial position or results of operations. NOTE ON FORWARD-LOOKING STATEMENTS The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. This Form 10-Q, or any oral or written statements made by or on behalf of the Company, may include forward-looking statements which reflect the Company's current views with respect to future events and financial performance. These forward-looking statements are identified by their use of such terms and phrases as "intends," "intend," "intended," "goal," "estimate," "estimates," "expects," "expect," "expected," "project," "projected," "projections," "plans," "anticipates," "anticipated," "should," "designed to," "foreseeable future," "believe," "believes" and "scheduled" and similar expressions. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statement was made. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Reference is made to the cautionary statements contained in Exhibit 99 to this Form 10-Q for a discussion of the factors that may cause actual results to differ from any results expressed or implied by these forward-looking statements. ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's investment portfolio is comprised of fixed-maturity investments, equity securities, and short-term investments. The Company's exposure to market risk is limited primarily to changing interest rates, primarily in the United States, as all fixed-maturity investments are denominated in U.S. dollars. The fair value of the fixed-maturity investments at June 30, 2002 was $25.5 million (December 31, 2001 - $26.5 million). A change in interest rates will affect the fair value of the Company's investments and will lead to fluctuations in "Accumulated Other Comprehensive Income" on the balance sheet. The Company does not use derivative financial instruments to manage market risk in its portfolio. PART II - OTHER INFORMATION ITEM 1 - LEGAL PROCEEDINGS (a) The trial in the proceedings which Sphere Drake Insurance Limited ("Sphere Drake") caused to be issued on February 29, 2001 in the London Commercial Court (equivalent to a civil complaint in U.S. jurisdictions) against two of the Company's U.K. subsidiaries, two former officers of those subsidiaries and others, is under way and currently is expected to conclude during the fourth quarter of 2002. Sphere Drake alleges, in substance, that each and every contract placed with it through its underwriting agent by the Company's U.K. broker subsidiary was commercially unreasonable. Sphere Drake further alleges that this was obvious to the broker and that, accordingly, the London Commercial Court should infer a conspiracy between the broker and the underwriting agent to defraud Sphere Drake, thereby allowing it to treat as void from the outset all of the inwards reinsurance contracts placed with Sphere Drake through its underwriting agent by the Company's broker subsidiary. While it remains the opinion of management that the claims described in Sphere Drake's action are without merit and the case is being and will be defended vigorously, the unexpected length of the trial of this action and the significant cost of maintaining such a defense represent a considerable strain on the cash resources of the Company and its subsidiaries. (b) On December 6, 2001, a jury returned a verdict dismissing all of the claims asserted against the Company, together with one of its London subsidiaries and a former employee of that subsidiary, in a third-party action in the New York State Supreme Court brought by AXA Reassurance S.A. ("AXA"). The verdict also encompassed all of the claims asserted against these same defendants by New Hampshire Insurance Company ("NHIC"). In that action, AXA had sought indemnity and damages resulting from its efforts to void reinsurance contracts entered into in connection with certain "reinsurance-backed gap film financing" arrangements ("Film Finance Covers") brokered by the Company's London subsidiary. A notice of appeal was filed by AXA on June 22, 2002. Although the specific grounds for appeal have not yet been disclosed, the defendants anticipate that the appeal will seek to overturn the jury verdict. The Company intends to oppose the appeal vigorously. On July 2, 2001, the third-party complaint filed by defendant AXA Corporate Solutions (U.K.) Ltd. ("ACS") against the Company, one of its London subsidiaries and a former employee of that subsidiary (the "SCB Defendants") in an existing action originally brought by the insured Silicon Valley Bank was dismissed without prejudice. The third party complaint had alleged fraudulent and/or wrongful inducement to contract, allegedly resulting in exposure to liability for claims under another Film Finance Cover brokered by the Company's London subsidiary. ACS filed a motion seeking reconsideration of that decision, which motion was denied by the Court on March 18, 2002. Two of the Company's London subsidiaries were served with a separate third-party complaint in this action alleging claims for fraudulent inducement, negligent misrepresentation and fraud and deceit by a different insurer defendant, NHIC. The London subsidiaries have entered into a tolling agreement with NHIC that will suspend for the time being the prosecution of NHIC's claims, as well as the running of the statute of limitations pertaining thereto. Two of the Company's London subsidiaries have been named as third party defendants in a federal court action instituted by Silicon Valley Bank in California involving a different Film Finance Cover. These subsidiaries also were named as defendants in a federal district court action by NHIC, which action has been dismissed without prejudice. The tolling agreement referred to above also applies to the claims in these two actions. Two of the Company's London subsidiaries, together with other unrelated parties, have been named as third-party defendants in an existing action in the New York State Supreme Court, filed on March 16, 2001 by NHIC. Each pleading alleges identical claims of fraudulent inducement and negligent misrepresentation against two of the Company's London subsidiaries in connection with another Film Finance Cover. A motion to dismiss has been made and is awaiting decision by the court. It is the opinion of management that the claims described in these actions are without merit and the cases are being and will be defended vigorously. Certain of the Company's subsidiaries acted as brokers in connection with other Film Finance Covers which either have become the subject of inquiry by one or more of the parties involved therein, or which have given rise to disputes not directly involving the Company or its subsidiaries. Although no assurances can be given as to the outcome of these disputes or of other potential proceedings related to the Film Finance Covers and their effect on the Company, the Company believes, based on the information presently available to it, that any such effect should not have a material adverse effect on the Company's financial condition. (c) Several arbitration proceedings currently are pending in England between reinsurers and ceding insurers relating to reinsurance transactions involving the personal accident excess of loss market in London ("LMX") for the account years 1993, 1994, 1995, 1996, 1997 and 1998. Although neither the Company nor any of its broker subsidiaries is a party to any of these arbitrations, certain of the Company's subsidiaries acted as a reinsurance broker for ceding insurer clients that are parties to certain of the arbitrations. In addition, the Company's reinsurance subsidiary is party to one of the LMX arbitrations. This particular arbitration has been dormant for some time. The Company understands that reinsurers generally have alleged that they sustained losses due to an "artificial" spiral in the LMX market, the existence of which, as well as other information, was not disclosed to them by the ceding insurers or their reinsurance brokers. In certain proceedings, there also are specific misrepresentation and non-disclosure allegations that are not of a generic nature. Relying on either or both types of allegations, these reinsurers have asserted that they are no longer obliged to honor their reinsurance agreements and have suspended payment of claims. During 1998 and 1999 certain of the reinsurers and reinsureds that are parties to the arbitrations described above issued proceedings in the English courts against one or more of the Company's brokerage subsidiaries and one underwriting management subsidiary, apparently for the primary purpose of tolling the statute of limitations pending the outcome of the arbitrations. In one proceeding against the same subsidiaries, three former officers of the subsidiaries were also named. In none of these proceedings did the complainant specify an amount of damages sought. If one or more reinsurers succeed in avoiding their contracts in the pending arbitrations, it is possible that ceding insurer clients, on whose behalf the Company's broker subsidiaries placed the reinsurance, may seek to pursue a claim for indemnification or other claims against one or more of those subsidiaries. Similarly, if one or more of the reinsurers fail to avoid their contracts in the pending arbitrations, it also is possible that those reinsurers may seek to pursue some type of claim against one or more of those subsidiaries. The Company understands that awards already have been made in favor of the reinsurer in three arbitrations. However, based on the Company's understanding of the reasons given by the arbitration panels for their awards in favor of the reinsurer in two of those cases, the Company does not believe there is any valid basis for its ceding insurer clients in those cases to assert a claim against the Company or its broker subsidiaries. The Company has insufficient information to make a valid assessment in relation to the third. With the exception of: (a) one inactive proceeding which the subsidiaries have been informed will be withdrawn; and (b) two related proceedings pending against certain subsidiaries of the Company and certain current and former officers of these subsidiaries, each of which is in an early procedural stage, all judicial proceedings against the Company's subsidiaries relating to these matters have been stayed or held in abeyance pursuant to standstill agreements or court order. One of the arbitration awards referenced above allowed a reinsurer to avoid certain of its reinsurance contracts with a Lloyd's syndicate. According to reports in the London press, that award may have caused the syndicate's liabilities to increase beyond the financial resources available to it and its Names, requiring the syndicate to avail itself of the Lloyd's Central Fund. Thereafter, Lloyd's initiated an investigation of that syndicate and all "market participants," including the Company's U.K. subsidiaries. The Company believes that the investigation is ongoing, but has no other information as to the progress of the investigation or when it will be completed. The Company understands that substantial progress has been and continues to be made by various market participants in settling ongoing reinsurance disputes, including many of the market participants that are parties to the arbitrations and other proceedings described above. The Company understands that a settlement by certain market participants of reinsurance disputes arising in the 1994 year of account (the "1994 Year of Account Settlement") has been executed. The Company further understands that working groups have been established to attempt to arrive at similar settlements in respect of the 1995 and 1996 years of account. A subsidiary of the Company has been notified of a potential claim by one of the parties to the 1994 Year of Account Settlement for the recovery of costs arising out of the settlement as well as for the costs and expenses incurred by the party in connection with its overall involvement in the LMX market. The subsidiary has denied any liability for this potential claim. Although no assurances can be given as to the outcome of the pending U.K. arbitrations or pending or potential arbitration or judicial proceedings related to the LMX spiral reinsurance arbitrations and their effect on the Company, the Company believes, based on the information presently available to it, that any such effect should not have a material adverse effect on the Company's financial condition, unless the Company is required to incur substantial legal fees in connection therewith. (d) Beginning in late 1998 and 1999, the reinsurance markets in which the Company historically has been involved experienced considerable disruption for a variety of reasons, including but not limited to the LMX market disputes described above and other disputes involving the North American workers' compensation reinsurance market. The effects of this disruption have continued up to the present time. One result of this market disruption has been that certain reinsurers with whom the Company's broker subsidiaries placed business on behalf of ceding insurer clients suspended claims payments to those clients, as well as to the Company's insurance and reinsurance subsidiaries, in certain instances also claiming a right to rescind the reinsurance contracts. As a result, a number of arbitrations were commenced between Company clients and their reinsurers. The Company has endeavored consistently to provide support to its clients in connection with these proceedings. In one ongoing arbitration involving the Company's insurer subsidiary, Realm National, that company succeeded in the second quarter in obtaining a decision from an arbitration panel which enforced various contracts of reinsurance and provided for the payment of certain balances thereunder, confirming Realm National's entitlement to $4.8 million in interim relief that previously had been awarded by the arbitration panel, and awarding additional amounts. In some instances, disputes or potential disputes have arisen concerning whether reinsurance was properly placed by the Company's broker subsidiaries. In other instances, the Company's ceding insurer clients have demanded indemnification by the Company if the client's reinsurance contracts ultimately are avoided by its reinsurers. Although no assurances can be given as to the effect on the Company of the various disputes in the worker's compensation reinsurance market, or related arbitrations, the Company believes, based on the information presently available to it, that any such effect should not have a material adverse effect on the Company's financial condition, unless the Company is required to incur substantial legal fees in connection therewith. (e) The Company is subject to other litigation and arbitration in the ordinary course of its business. While any of these proceedings contains an element of uncertainty, management presently believes the outcome of these currently pending proceedings will not have a material adverse effect on the Company's financial condition. ITEM 2 CHANGES IN SECURITES None. ITEM 3 DEFAULTS UPON SENIOR SECURITIES None. ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company held its Annual Meeting of Stockholders (the "Meeting") on May 23, 2002. A total of 9,519,972 of the Company's Ordinary Shares, with one vote each, were entitled to vote at the Meeting and holders of 7,869,250 Ordinary Shares voted in person or by proxy, constituting a quorum. The following directors were elected at the Meeting: Name of Director Votes For Votes Withheld ---------------- --------- -------------- Mr. Stephen A. Crane 7,855,900 13,350 Mr. Hadley C. Ford 7,854,400 14,850 Mr. David H. Elliott 7,855,900 13,350 The following additional directors continued to serve after the meeting: Mr. Peter S. Christie, Mr. George W. Jones, Mr. Patrick J. McDonough, Mr. Jean de Pourtales, and Mr. Len Quick. Other matters voted on during the Meeting were as follows: To appoint KPMG LLP as auditors of the Company to hold office until the close of the next Annual General Meeting: 7,843,609 affirmative, 13,641 negative, 12,000 abstained. ITEM 5 OTHER INFORMATION None. ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit No. Description ----------- ----------- 11. Statement of Computation of Net Income Per Ordinary Share 99. Forward Looking Information (b) Reports on Form 8-K A Form 8-K was filed on May 31, 2002, under Item 4, pursuant to which the Registrant disclosed the change in its Certifying Accountant to KPMG LLP. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Dated: August 14, 2002 STIRLING COOKE BROWN HOLDINGS LIMITED BY: /s/ Stephen A. Crane ---------------------------------------- Stephen A. Crane CHAIRMAN, PRESIDENT & CHIEF EXECUTIVE OFFICER BY: /s/ Anthony J. Del Tufo ---------------------------------------- Anthony J. Del Tufo ACTING CHIEF FINANCIAL OFFICER

STIRLING COOKE BROWN HOLDINGS LTD 10-Q