If competition limits Argo Group’s ability to write new business at adequate rates, Argo Group’s future results of operations would be adversely affected.
Argo Group’s bye-laws generally permit transfers of Argo Group common shares unless the board of directors determines a transfer may result in a non-de minimis adverse tax, legal or regulatory consequence to Argo Group, any Argo Group subsidiary or any direct or indirect shareholder of Argo Group or its affiliates. Argo Group may refuse to register on its share transfer records any transfer that does not comply with these share transfer restrictions. A transferee will be permitted to promptly dispose of any Argo Group shares purchased which violate the restrictions and as to the transfer of which registration is refused.
In the event that Argo Group becomes aware of a U.S. Person (that owns Argo Group shares directly or indirectly through non-U.S. entities) owning more than the permitted 9.5% level of voting power of the outstanding shares of Argo Group after a transfer of shares has been registered, Argo Group’s bye-laws provide that, subject to certain exceptions and waiver procedures, the voting rights with respect to the shares of Argo Group owned by any such shareholder will be limited to the permitted level of voting power, subject only to the further limitation that no other shareholder allocated any such voting rights may exceed the permitted level of voting power as a result of such limitation.
In addition, Argo Group’s ownership of U.S. subsidiaries can, under applicable state insurance company laws and regulations, delay or impede a change of control of Argo Group. Under applicable insurance regulations, any proposed purchase of 10% or more of the voting securities of Argo Group would require the prior approval of the relevant insurance regulatory authorities.
Argo Group’s bye-laws provide for a classified board of directors. The directors of the class elected at each annual general meeting hold office for a term of three years, with the term of each class expiring at successive annual general meetings of shareholders. Under Argo Group’s bye-laws, the vote of two-thirds of the outstanding shares entitled to vote and the approval of a majority of the board are required to amend bye-laws regarding appointment and removal of directors, indemnification of directors and officers, directors’ interests and the procedures for amending bye-laws.
The provisions described above may have the effect of making more difficult or discouraging unsolicited takeover bids from third parties. To the extent that these effects occur, shareholders could be deprived of opportunities to realize takeover premiums for their shares and the market price of their shares could be depressed. In addition, these provisions could also result in the entrenchment of incumbent management.
Except as provided below, shareholders have one vote for each common share held by them and are entitled to vote at all meetings of shareholders. However, for so long as the shares of a shareholder are treated as “controlled shares” (as determined under section 958 of the Internal Revenue Code (“the Code”)) of any U.S. Person (that owns shares directly or indirectly through non-U.S. entities) and such controlled shares constitute 9.5% or more of the votes conferred by Argo Group’s issued shares, the voting rights with respect to the controlled shares of such U.S. Person, which we refer to as a 9.5% U.S. Shareholder, will be limited, in the aggregate, to a voting power of less than 9.5%, under a formula specified in Argo Group’s bye-laws. The formula is applied repeatedly until the voting power of all 9.5% U.S. Shareholders has been reduced to less than 9.5%. In addition, the board of Argo Group may limit a shareholder’s voting rights where it deems it appropriate to do so to (i) avoid the existence of any 9.5% U.S. Shareholder; and (ii) avoid certain material adverse tax, legal or regulatory consequences to Argo Group, any subsidiary of Argo Group or any direct or indirect shareholder or its affiliates. “Controlled shares” include, among other things, all shares of Argo Group that such U.S. Person is deemed to own directly, indirectly or constructively (within the meaning of section 958 of the Code).
Under these provisions, certain shareholders may have their voting rights limited, while other shareholders may have voting rights in excess of one vote per share. Moreover, these provisions could have the effect of reducing the votes of certain shareholders who would not otherwise be subject to the 9.5% limitation by virtue of their direct share ownership.
Argo Group also has the authority under its bye-laws to request information from any shareholder for the purpose of determining whether a shareholder’s voting rights are to be reallocated under the bye-laws. If a shareholder fails to respond to such a request for information or submits incomplete or inaccurate information in response to such a request, Argo Group may, in its sole discretion, eliminate such shareholder’s voting rights.
The effects of emerging claim and coverage issues on Argo Group’s business are uncertain.
As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may adversely affect Argo Group’s business by either extending coverage beyond its underwriting intent or by increasing the number or size of claims.
In some instances, these changes may not become apparent until some time after Argo Group has issued insurance or reinsurance contracts that are affected by the changes. As a result, the full extent of liability under Argo Group’s insurance or reinsurance contracts may not be known for many years after a contract is issued, and its financial position and results of operations may be adversely affected.
Argo Group has exposure to unpredictable catastrophes, which can materially and adversely affect its business, results of operations and/or financial condition.
Argo Group is subject to claims arising out of catastrophes that may have a significant effect on its business, results of operations, and/or financial condition. Catastrophes can be caused by various events, including hurricanes, windstorms, earthquakes, hailstorms, explosions, power outages, severe winter weather, fires and intentional man-made events, such as terrorist attacks. The incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Insurance companies are not permitted to reserve for catastrophes until such event takes place. Therefore, although Argo Group will actively manage its exposure to catastrophes through its underwriting process and the purchase of reinsurance protection, an especially severe catastrophe or series of catastrophes could exceed its reinsurance protection and may have a material adverse impact on Argo Group’s business, results of operations and/or financial condition.
As a primary insurer, Argo Group may have significant exposure for terrorist acts.
Argo Group may have exposure to losses resulting from acts of terrorism. Even if reinsurers are able to exclude coverage for terrorist acts or price that coverage at rates that Argo Group considers unattractive, direct insurers, like Argo Group’s insurance company subsidiaries, might not be able to likewise exclude terrorist acts because of regulatory constraints. If this does occur, Argo Group, in its capacity as a primary insurer, would have a significant gap in its reinsurance protection and would be exposed to potential losses as a result of any terrorist acts. These events are inherently unpredictable, although recent events may lead to their increased frequency and severity. It is difficult to predict occurrence of such events with statistical certainty or to estimate the amount of loss per occurrence they will generate.
The Terrorism Risk Insurance Act of 2002 (as amended by the Terrorism Risk Insurance Extension Act of 2005), which we refer to as TRIA, was enacted to ensure availability of insurance coverage for defined terrorist acts in the United States. This law requires insurers writing certain lines of property and casualty insurance, including Argo Group, to offer coverage against certified acts of terrorism causing damage within the United States or to U.S. flagged vessels or aircraft. In return, the law requires the federal government, should an insurer comply with the procedures of the law, to indemnify the insurer for 85% of covered losses, exceeding a deductible, based on a percentage of direct earned premiums for the previous calendar year, up to an industry limit of $100 billion resulting from covered acts of terrorism. This law does not apply to acts of domestic terrorism or acts that might otherwise be considered acts of terrorism that are not certified by the Secretary of the Treasury to be acts of terrorism under this law. Argo Group continues to attempt to exclude acts of terrorism not covered under the federal act, subject to state approvals.
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Given the retention limits imposed under this law and that some or many of Argo Group’s policies may not include an exclusion for terrorism, future terrorist attacks may result in losses that have a material adverse effect on Argo Group’s business, results of operations and/or financial condition. The federal terrorism risk assistance provided by TRIA will expire at the end of 2007 and it is not currently clear whether that assistance will renewed. Any renewal may be on substantially less favorable terms.
Litigation and legal proceedings against Argo Group’s insurance and reinsurance subsidiaries could have an adverse effect on Argo Group’s business, results of operations and/or financial condition.
In the normal course of business, insurance and reinsurance companies may be sued in a class action lawsuit and other major litigation as a result of their insurance and reinsurance operations. Argo Group’s insurance and reinsurance companies have been and may become involved in such lawsuits, including a number of class action lawsuits and other major litigation. Argo Group’s insurance and reinsurance companies have responded to the lawsuits and believe that there are meritorious defenses and intend to vigorously contest these claims. The plaintiffs in certain of these lawsuits have not quantified the amounts they ultimately will seek to recover. In addition, in the case of class actions, it is uncertain whether a class will be certified, the number of persons included in any class, and the amount of damages that are ultimately sought by the class members. As a result, Argo Group is unable, with any degree of certainty, to determine a range of any potential loss, or whether such an outcome is probable or remote. An adverse judgment in one or more of such lawsuits could have a material adverse effect on Argo Group’s business, results of operation and/or financial condition.
Several class action lawsuits have been filed against Argo Group and certain of Argo Group’s former officers on behalf of a putative class consisting of investors who purchased Argo Group’s (formerly PXRE) publicly traded securities between July 28, 2005 and February 16, 2006. The complaints allege, among other things, that Argo Group made false and misleading statements regarding loss estimates in violation of the federal securities laws. Pursuant to an opinion and order of the United States District Court for the Southern District of New York dated March 30, 2007, these lawsuits have been consolidated into one proceeding. It is possible that additional lawsuits relating to the recent decline in Argo Group’s (formerly PXRE) share price may be filed against Argo Group and/or certain of Argo Group’s current and former officers and directors in the future. It is also possible that regulators may institute administrative or regulatory proceedings against Argo Group in the future.
On February 15, 2007, PXRE entered into a Tolling and Standstill Agreement with certain institutional investors in connection with potential claims arising out of the Private Placement of Series D Perpetual Non-voting Preferred Shares of PXRE that were sold pursuant to the Private Placement Memorandum dated on or about September 28, 2005. The parties have agreed to extend the term of the tolling agreement to December 3, 2007.
The pending securities litigation is currently at a very early stage and Argo Group has very little information as to the course it will take. This litigation, which could continue for a significant period, and any future proceedings could be expensive and could divert management’s attention and other resources away from other matters. Any such diversion of management’s attention or other resources could negatively and materially impact Argo Group’s business. Argo Group cannot predict the timing of any trials with respect to the pending securities litigation or any future proceedings. Argo Group is not currently able to estimate legal defense costs or the amount of any damages that Argo Group may be required to pay in connection with the pending securities litigation or any future proceedings. In view of the inherent difficulty of predicting the outcome of litigation, particularly where there are many claimants and the claimants seek indeterminate damages, Argo Group is unable to predict the outcome of these matters and at this time cannot reasonably estimate the possible loss or range of loss with respect to the pending securities litigation or any future proceedings.
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Argo Group faces a risk of non-availability of reinsurance, which could materially and adversely affect Argo Group’s ability to write business and its results of operations and financial condition.
Market conditions beyond Argo Group’s control, such as the amount of capital in the reinsurance market and natural and man-made catastrophes, determine the availability and cost of the reinsurance protection Argo Group can purchase. Argo Group cannot be assured that reinsurance will remain continuously available to the same extent and on the same terms and rates as are currently available. If Argo Group is unable to maintain its current level of reinsurance or purchase new reinsurance protection in amounts that are considered sufficient, Argo Group would either have to be willing to accept an increase in its net exposures or reduce its insurance writings. Either of these potential developments could have a material adverse effect on its financial position, results of operations and cash flows.
Argo Group faces a risk of non-collectibility of reinsurance, which could materially and adversely affect its business, results of operations and/or financial condition.
As is common practice within the insurance industry, Argo Group transfers a portion of the risks insured under its policies to other companies through the purchase of reinsurance. This reinsurance is maintained to protect the insurance subsidiaries against the severity of losses on individual claims, unusually serious occurrences in which a number of claims produce an aggregate extraordinary loss and catastrophic events. Although reinsurance does not discharge Argo Group’s subsidiaries from their primary obligation to pay for losses insured under the policies they issue, reinsurance does make the assuming reinsurer liable to the insurance subsidiaries for the reinsured portion of the risk. A credit exposure exists with respect to ceded losses to the extent that any reinsurer is unable or unwilling to meet the obligations assumed under the reinsurance contracts. The collectibility of reinsurance is subject to the solvency of the reinsurers, interpretation and application of contract language and other factors. Argo Group is selective in regard to its reinsurers, placing reinsurance with those reinsurers with strong financial strength ratings from A.M. Best, S&P, or a combination thereof, although the financial condition of a reinsurer may change based on market conditions. Argo Group performs credit reviews on its reinsurers, focusing on, among other things, financial condition, stability, trends and commitment to the reinsurance business. Argo Group also requires assets in trust, letters of credit or other acceptable collateral to support balances due from reinsurers not authorized to transact business in the applicable jurisdictions. It has not always been standard business practice to require security for balances due; therefore, certain balances are not collateralized. A reinsurer’s insolvency or inability to make payments under the terms of a reinsurance contract could have a material adverse effect on Argo Group’s business, results of operations and/or financial condition.
The failure of the risk mitigation strategies Argo Group utilizes could have a material adverse effect on its financial condition or results of operations.
We utilize a number of strategies to mitigate our risk exposure including:
- engaging in vigorous underwriting;
- carefully evaluating terms and conditions of our policies;
- focusing on our risk aggregations by geographic zones, industry type, credit exposure and other bases; and
- ceding insurance risk to reinsurance companies.
However, there are inherent limitations in all of these tactics. No assurance can be given that an event or series of unanticipated events will not result in loss levels which could have a material adverse effect on Argo Group’s financial condition or results of operations.
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Argo Group may be unable to attract and retain qualified employees.
We depend on our ability to attract and retain experienced underwriting talent and other skilled employees who are knowledgeable about our business. If the quality of our underwriting team and other personnel decreases, we may be unable to maintain our current competitive position in the specialized markets in which we operate and be unable to expand our operations into new markets, which could adversely affect our results.
Argo Group’s information technology systems may fail or suffer a loss of security which could adversely affect our business.
Argo Group’s business is highly dependent upon the successful and uninterrupted functioning of our computer and data processing systems. We rely on these systems to perform actuarial and other modeling functions necessary for writing business, as well as to process and make claims payments. We have a highly trained staff that is committed to the development and maintenance of these systems. The failure of these systems could interrupt our operations. This could result in a material adverse effect on our business results.
In addition, a security breach of our computer systems could damage our reputation or result in liability. We retain confidential information regarding our business dealings in our computer systems. We may be required to spend significant capital and other resources to protect against security breaches or to alleviate problems caused by such breaches. It is critical that these facilities and infrastructure remain secure. Despite the implementation of security measures, this infrastructure may be vulnerable to physical break-ins, computer viruses, programming errors, attacks by third parties or similar disruptive problems. In addition, we could be subject to liability if hackers were able to penetrate our network security or otherwise misappropriate confidential information.
Because Argo Group gives a select group of wholesale agents limited quoting and binding authority, their failure to comply with our pre-established guidelines could cause our results to be adversely affected.
Argo Group markets and distributes some of our insurance products through a select group of wholesale agents who have limited quoting and binding authority and who, in turn, sell our insurance products to insureds through retail insurance brokers. These agencies can bind certain risks that meet our pre-established guidelines without our initial approval. If these agents failed to comply with our underwriting guidelines and the terms of their appointment, we could be bound on a particular risk or number of risks that were not anticipated when we developed the insurance products. Such actions could adversely affect our results of operations.
Argo Group’s merger and acquisition strategy may not succeed.
Argo Group’s strategy for growth may include merger and acquisition transactions. This strategy presents risks that could have a material adverse effect on the Argo Group’s business and financial performance, including: (i) the diversion of management’s attention, (ii) the ability of Argo Group to execute a transaction effectively, including the integration of operations and the retention of employees, and (iii) the contingent and latent risks associated with the past operations of and other unanticipated problems arising from a transaction partner. Argo Group cannot predict whether it will be able to identify and complete a future transaction on terms favorable to it. Argo Group cannot know if it will realize the anticipated benefits of a completed transaction or if there will be substantial unanticipated costs associated with the transaction. In addition, a future transaction by Argo Group may result in tax consequences at either or both the shareholder and Argo Group level, potentially dilutive issuances of our equity securities, the incurrence of additional debt and the recognition of potential impairment of goodwill and other intangible assets. Each of these factors could adversely affect Argo Group’s financial position and results of operations.
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Argo Group may incur significant additional indebtedness.
As of September 30, 2007, Argo Group had outstanding $58.0 million of debt incurred pursuant to Argonaut Group’s credit facility, in addition to an aggregate of $311.4 million of subordinated debt. Argo Group may seek to incur additional indebtedness either through the issuance of public or private debt or through bank or other financing. The funds raised by the incurrence of such additional indebtedness may be used to repay existing indebtedness of the parties, including amounts borrowed under Argonaut Group’s credit facility and Argo Group’s outstanding subordinated debt, or for general corporate purposes of Argo Group, including additions to working capital, capital expenditures, investments in subsidiaries or acquisitions.
This additional indebtedness, particularly if not used to repay existing indebtedness, could limit Argo Group’s financial and operating flexibility, including as a result of the need to dedicate a greater portion of its cash flows from operations to interest and principal payments. It may also be more difficult for Argo Group to obtain additional financing on favorable terms, limiting Argo Group’s ability to capitalize on significant business opportunities and making Argo Group more vulnerable to economic downturns.
Argo Group’s investment portfolio is subject to significant market and credit risks which could result in an adverse impact on Argo Group’s financial position or results.
Argo Group holds a diversified portfolio of investments in common stocks representing U.S. firms in industries and market segments ranging from small market capitalization stocks to the Standard & Poor’s 500 stocks. The marketable equity securities are carried on the balance sheet at fair market value and are subject to the risk of potential loss in market value resulting from adverse changes in prices. Equity price risk is managed primarily through the daily monitoring of funds committed to the various types of securities owned and by limiting the exposure in any one investment or type of investment. No issuer (exclusive of the U.S. government and U.S. governmental agencies) of fixed income or equity securities represents more than 1.8% of shareholders’ equity as of September 30, 2007. Argo Group’s invested assets also consist of debt instruments with fixed maturities, short-term investments and, to a lesser extent, hedge funds and interests in mezzanine bond and equity limited partnerships.
Argo Group’s primary exposure to interest rate risk relates to its fixed maturity investments including redeemable preferred stock, as well as its junior subordinated debentures. Changes in market interest rates directly impact the market value of the fixed maturity securities, redeemable preferred stock and debt service requirements. Some fixed income securities have call or prepayment options. This subjects Argo Group to reinvestment risk if issuers call their securities and Argo Group reinvests the proceeds at lower interest rates.
Argo Group’s invested assets are subject to market-wide risks and fluctuations as well as to risks inherent in particular securities. Although Argo Group seeks to preserve its capital, Argo Group has invested in a portfolio of hedge funds and other privately held securities. These investments were designed to provide diversification of risk; however, such investments entail substantial risks. There can be no assurance that Argo Group’s investment objectives will be achieved, and results may vary substantially over time. In addition, although Argo Group seeks to employ investment strategies that are not correlated with its insurance and reinsurance exposures, losses in Argo Group’s investment portfolio may occur at the same time as underwriting losses and, therefore, exacerbate such losses’ adverse effect on Argo Group. While Argo Group’s primary objective is capital preservation, all Argo Group portfolios have a degree of risk.
Argo Group has exited the finite reinsurance business, but claims in respect of finite reinsurance could have an adverse effect on Argo Group’s operating results.
Finite risk reinsurance contracts are highly customized and typically involve complicated structural elements. Generally accepted accounting principles in the United States, which we refer to as GAAP, govern whether or not a contract should be accounted for as reinsurance. Contracts that do not meet these GAAP requirements may not be accounted for as reinsurance and are required to be accounted for as deposits. In the past few years, certain finite insurance and reinsurance arrangements are coming under scrutiny by the New York Attorney General’s Office, the SEC and other governmental authorities. According to the press, investigators have asserted that the contracts in question were accounted for in an improper or fraudulent manner.
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PXRE sold finite reinsurance prior to June 30, 2004, and from time to time, has purchased finite reinsurance. Although Argo Group has received no request for information or documents in connection with the investigations with respect to any finite reinsurance PXRE sold or purchased from time to time, certain of its customers or reinsurers have been asked to provide or have provided documents and information in the framework of these investigations with respect to reinsurance contracts to which Argo Group is a party. Any claim challenging the appropriateness of the accounting treatment of the finite contracts PXRE underwrote or purchased could result in negative publicity, costs and, in the event of any regulatory or judicial decision being entered against Argo Group, ultimately fines and penalties, all of which could have a material adverse effect on Argo Group’s business and operating results.
Argo Group has exhausted its retrocessional coverage with respect to Hurricane Katrina, leaving it exposed to further losses.
Based on Argo Group’s current estimate of losses related to Hurricane Katrina, Argo Group has exhausted its retrocessional protection with respect to this event, meaning that Argo Group has no retrocessional coverage available should Argo Group’s Hurricane Katrina losses prove to be greater than currently estimated. Argo Group cannot be sure that retrocessional coverage will be available to it on acceptable terms, or at all, in the future. Argo Group’s business, financial condition and operating results could be materially adversely impacted by additional losses related to Hurricane Katrina.
Argo Group may be adversely affected by foreign currency fluctuations.
Although Argo Group’s functional currency is the U.S. dollar, premium receivables and loss reserves include business denominated in currencies other than U.S. dollars. Argo Group is exposed to the possibility of significant claims in currencies other than U.S. dollars. Argo Group may, from time to time, experience losses resulting from fluctuations in the values of these non-U.S. currencies, which could adversely affect its operating results. While Argo Group holds positions denominated in foreign currencies to mitigate, in part, the effects of currency fluctuations on its operating results, Argo Group currently does not hedge its currency exposures before a catastrophic event that may produce a claim.
Argo Group has an exposure to foreign currency risks under the International Directors and Officers Liability Quota Share reinsurance agreement with HCC Insurance Holdings Inc. Accounts under this program may settle in any of the following currencies: U.S. dollars, British pounds, Canadian dollars or Euros. Remittances are due within 60 days of quarter end, one quarter in arrears. Due to the extended time frame for settling the accounts plus the fluctuation in currency exchange rates, the potential exists for Argo Group to realize gains and/or losses related to the exchange rates. For the nine months ended September 30, 2007, Argo Group (which includes only Argonaut Group through August 7, 2007) has recognized a foreign currency gain of $0.7 million related to this program. Management is unable at this time to estimate the future gains or losses, if any.
Reinsurance prices may decline, which could affect Peleus Re’s profitability.
Demand for reinsurance depends on numerous factors, including the frequency and severity of catastrophic events, levels of capacity, general economic conditions and underwriting results of primary property insurers. The supply of reinsurance is related to prevailing prices, recent loss experience and levels of surplus capacity. All of these factors fluctuate and may contribute to price declines generally in the reinsurance industry. Premium rates or other terms and conditions of trade may vary in the future. If any of these factors were to cause the demand for reinsurance to fall or the supply to rise, Peleus Re’s profitability could be adversely affected.
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Because of potential exposure to catastrophes in the future, Peleus Re’s financial results may vary significantly from period to period.
As a reinsurer of property catastrophe-type coverages in the worldwide marketplace, Peleus Re’s operating results in any given period will depend to some extent on the number and magnitude of natural and man-made catastrophes such as hurricanes, windstorms, hailstorms, earthquakes, volcanic eruptions, fires, industrial explosions, freezes, riots and floods. While Peleus Re may, depending on market conditions, purchase catastrophe retrocessional coverage for its own protection, the occurrence of one or more major catastrophes in any given period could nevertheless have a material adverse impact on Peleus Re’s operating results and financial condition and result in substantial liquidation of investments and outflows of cash as losses are paid.
Peleus Re operates in a highly competitive environment and no assurance can be given that Peleus Re will be able to compete effectively in this environment.
Peleus Re competes with numerous companies, many of whom have credit ratings and substantially greater financial, marketing and management resources. No assurance can be given that Peleus Re will be able to compete successfully in the reinsurance markets in which Argo Group has historically operated.
Peleus Re competes with reinsurers that provide property-based lines of reinsurance, such as ACE Tempest Reinsurance Ltd., Arch Reinsurance Ltd., Aspen Insurance Holdings Limited, AXIS Reinsurance Company, Endurance Specialty Insurance Ltd., Everest Reinsurance Company, IPC Re Limited, Lloyd’s of London syndicates, Montpelier Reinsurance Ltd., Munich Reinsurance Company, Partner Reinsurance Company Ltd., Platinum Underwriters Holdings, Ltd., Renaissance Reinsurance Ltd., Swiss Reinsurance Company and XL Re Ltd. A number of reinsurers were also formed in Bermuda in the wake of Hurricanes Katrina, Rita and Wilma in 2005 that are providing additional competition.
Peleus Re’s inability to provide the necessary collateral could affect Peleus Re’s ability to offer reinsurance in certain markets.
Peleus Re is not licensed or admitted as an insurer in any jurisdiction other than Bermuda. Because many jurisdictions do not permit insurance companies to take credit for reinsurance obtained from unlicensed or non-admitted insurers on their statutory financial statements unless appropriate security mechanisms are in place, Peleus Re anticipates that its reinsurance clients will typically require it to post a letter of credit or other collateral. If Peleus Re is unable to arrange for security on commercially reasonable terms, Peleus Re could be limited in its ability to write business for certain of its clients.
As of September 30, 2007, Peleus Re had no committed letter of credit facility and Argo Group had $310.0 million of committed letter of credit facilities and an uncommitted facility that allows for letters of credit to be issued subject to satisfactory collateral being provided to the issuing bank.
At September 30, 2007, Argo Group had issued letters of credit in the amount of $194.4 million which are secured by cash and securities with a fair value of $244.3 million.
Regulatory constraints may restrict Argo Group’s ability to operate its business.
General. Argo Group’s insurance and reinsurance subsidiaries may not be able to obtain or maintain necessary licenses, permits, authorizations or may be able to do so only at significant cost. In addition, Argo Group may not be able to comply with, or obtain appropriate exemptions from, the wide variety of laws and regulations applicable to insurance or reinsurance companies or holding companies. Failure to comply with or to obtain appropriate authorizations and/or exemptions under any applicable laws could result in restrictions on Argo Group’s ability to do business or certain activities that are regulated in one or more of the jurisdictions and could subject Argo Group to fines and other sanctions, which could have a material adverse effect on Argo Group’s business.
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Argo Group’s Bermuda Subsidiaries.PXRE Bermuda is registered as a Class 4 Bermuda insurance and reinsurance company and Peleus Re is registered as a Class 3 Bermuda insurance and reinsurance company. Among other matters, Bermuda statutes, regulations and policies of the Bermuda Monetary Authority (“BMA”) require PXRE Bermuda and Peleus Re to maintain minimum levels of statutory capital, surplus and liquidity, to meet solvency standards, to obtain prior approval of ownership and transfer of shares and to submit to certain periodic examinations of its financial condition. These statutes and regulations may, in effect, restrict the ability of PXRE Bermuda and Peleus Re to write insurance and reinsurance policies, to make certain investments and to distribute funds. By agreement with the BMA, PXRE Bermuda may not underwrite any new reinsurance business without the prior consent of the BMA, other than reinsurance of business written by Peleus Re.
The offshore insurance and reinsurance regulatory environment has become subject to increased scrutiny in many jurisdictions, including the United States and various states within the United States. Compliance with any new laws or regulations regulating offshore insurers or reinsurers could have a material adverse effect on Argo Group’s business. In addition, although neither PXRE Bermuda nor Peleus Re believes it is or will be in violation of insurance laws or regulations of any jurisdiction outside Bermuda, inquiries or challenges to the insurance or reinsurance activities of PXRE Bermuda or Peleus Re may still be raised in the future.
Argo Group’s U.S. Subsidiaries.Argo Group’s U.S. insurance subsidiaries are subject to extensive regulation which may reduce our profitability or inhibit our growth. Moreover, if we fail to comply with these regulations, we may be subject to penalties, including fines and suspensions, which may adversely affect our financial condition and results of operations.
The U.S. insurance industry is highly regulated and supervised. Our insurance subsidiaries are subject to the supervision and regulation of the states in which they are domiciled and the states in which they do business. Such supervision and regulation is designed to protect our policyholders rather than our shareholders. These regulations are generally administered by a department of insurance in each state and relate to, among other things:
- approval of policy forms and premium rates;
- standards of solvency, including risk-based capital measurements;
- licensing of insurers and their producers;
- restrictions on the nature, quality and concentration of investments;
- restrictions on the ability of our insurance company subsidiaries to pay dividends to us;
- restrictions on transactions between insurance company subsidiaries and their affiliates;
- restrictions on the size of risks insurable under a single policy;
- requiring deposits for the benefit of policyholders;
- requiring certain methods of accounting;
- periodic examinations of our operations and finances;
- prescribing the form and content of records of financial condition required to be filed; and
- requiring additional reserves as required by statutory accounting rules.
State insurance departments also conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to financial condition, holding company issues and other matters. These regulatory requirements may adversely affect or inhibit our ability to achieve some or all of our business objectives.
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In addition, regulatory authorities have relatively broad discretion to deny or revoke licenses for various reasons, including the violation of regulations. In some instances, we follow practices based on our interpretations of regulations or practices that we believe may be generally followed by the industry. These practices may turn out to be different from the interpretations of regulatory authorities. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or otherwise penalize us. This could adversely affect our ability to operate our business.
Finally, changes in the level of regulation of the insurance industry or changes in laws or regulations themselves or interpretations by regulatory authorities could adversely affect our ability to operate our business.
Argo Group’s U.S. insurance subsidiaries are subject to the risk-based capital provisions under The Insurers Model Act.
The risk-based capital system is designed to measure whether the amount of available capital is adequate to support the inherent specific risks of each insurer. Risk-based capital is calculated annually. State regulatory authorities use the risk-based capital formula to identify insurance companies that may be undercapitalized and thus may require further regulatory attention. The formula prescribes a series of risk measurements to determine a minimum capital amount for an insurance company, based on the profile of the individual company. The ratio of a company’s actual policyholder surplus to its minimum capital requirements will determine whether any state regulatory action is required.
The risk-based capital system in The Insurers Model Act provides four levels of regulatory activity if the risk-based capital ratio yielded by the calculation falls below specified minimums. At each of four successively lower risk-based capital ratios specified by statute, increasing regulatory remedies become available, some of which are mandatory. The four levels are: (i) Company Action Level Event, (ii) Regulatory Action Level Event, (iii) Authorized Control Level Event, and (iv) Mandatory Control Level Event. As of December 31, 2006, all of Argonaut Group’s insurance subsidiaries had risk-based capital ratios that exceed specified minimums. If we fall below the minimum acceptable risk-based capital level, we would be subject to additional regulation.
Argo Group’s U.S. subsidiaries affiliated company transactions are subject to regulation by certain states.
All states have enacted legislation that regulates transactions with related companies. Such regulation generally provides that transactions between related companies must be fair and equitable. Transfers of assets among such affiliated companies, certain dividend payments from insurance subsidiaries and certain material transactions between companies within the system may be subject to prior notice to, or prior approval by, state regulatory authorities. If Argo Group is unable to obtain the requisite prior approval for a specific transaction, we would be precluded from taking the action which could adversely affect our operations.
If PXRE Bermuda or Peleus Re becomes subject to insurance statutes and regulations in jurisdictions other than Bermuda or there are changes in Bermuda law or regulations or the application of Bermuda law or regulations, there could be a significant and negative impact on their businesses.
PXRE Bermuda, as a registered Bermuda Class 4 insurer, and Peleus Re, as a registered Bermuda Class 3 insurer, are subject to regulation and supervision in Bermuda. Bermuda insurance statutes, regulations and policies of the BMA require PXRE Bermuda and Peleus Re to, among other things:
- maintain a minimum level of capital, surplus and liquidity;
- satisfy solvency standards;
- restrict dividends and distributions;
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- obtain prior approval of ownership and transfer of shares;
- appoint an approved loss reserve specialist;
- maintain a principal office and appoint and maintain a principal representative in Bermuda; and
- provide for the performance of certain periodic examinations of PXRE Bermuda and Peleus Re and their financial condition.
In addition to the above, PXRE Bermuda has agreed to submit to additional regulatory oversight by the BMA effective March 12, 2007.
These statutes and regulations may, in effect, restrict Argo Group’s ability to write reinsurance policies, to distribute funds and to pursue its investment strategy.
Argo Group does not presently intend that either PXRE Bermuda or Peleus Re will be admitted to do business in any jurisdiction in the United States, the United Kingdom or elsewhere (other than Bermuda). However, Argo Group cannot assure you that insurance regulators in the United States, the United Kingdom or elsewhere will not review the activities of PXRE Bermuda or Peleus Re or related companies or their agents and claim that PXRE Bermuda or Peleus Re is subject to such jurisdiction’s licensing requirements. If any such claim is successful and PXRE Bermuda or Peleus Re must obtain a license, Argo Group may be subject to taxation in such jurisdiction. In certain circumstances, Argo Group may be subject to tax in a jurisdiction even if it is not licensed by such jurisdiction. In addition, PXRE Bermuda and Peleus Re are subject to indirect regulatory requirements imposed by jurisdictions that may limit their ability to provide insurance or reinsurance. For example, the ability of PXRE Bermuda and Peleus Re to write insurance or reinsurance may be subject, in certain cases, to arrangements satisfactory to applicable regulatory bodies. Proposed legislation and regulations may have the effect of imposing additional requirements upon, or restricting the market for, alien insurers or reinsurers with whom domestic companies place business.
Generally, Bermuda insurance statutes and regulations applicable to PXRE Bermuda and Peleus Re are less restrictive than those that would be applicable if it were governed by the laws of any state in the United States. In the past, there have been congressional and other initiatives in the United States regarding proposals to supervise and regulate insurers domiciled outside the United States. If in the future either PXRE Bermuda or Peleus Re becomes subject to any insurance laws of the United States or any state thereof or of any other jurisdiction, Argo Group cannot assure you that PXRE Bermuda or Peleus Re would be in compliance with those laws or that coming into compliance with those laws would not have a significant and negative effect on the business of PXRE Bermuda or Peleus Re.
The process of obtaining licenses is very time consuming and costly, and Argo Group may not be able to become licensed in a jurisdiction other than Bermuda, should it choose to do so. The modification of the conduct of Argo Group’s business resulting from its becoming licensed in certain jurisdictions could significantly and negatively affect Argo Group’s business. In addition, Argo Group’s inability to comply with insurance statutes and regulations could significantly and adversely affect its business by limiting Argo Group’s ability to conduct business as well as subjecting Argo Group to penalties and fines.
Because Argo Group is incorporated in Bermuda, Argo Group is subject to changes in Bermuda law and regulation that may have an adverse impact on its operations, including imposition of tax liability or increased regulatory supervision. In addition, Argo Group will be exposed to changes in the political environment in Bermuda. The Bermuda insurance and reinsurance regulatory framework recently has become subject to increased scrutiny in many jurisdictions, including in the United States and in various states within the United States. Argo Group cannot predict the future impact on its operations of changes in the laws and regulations to which Argo Group is or may become subject.
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Argo Group may be unable to obtain extensions of work permits for its employees, which may cause its business to be adversely affected.
Under Bermuda law, non-Bermudians (other than spouses of Bermudians or holders of permanent residence certificates) may not engage in any gainful occupation in Bermuda without the specific permission of the appropriate government authority. The Bermuda government will issue a work permit for a specific period of time, which may be extended upon showing that, after proper public advertisements, no Bermudian (or spouse of a Bermudian or holder of a permanent residence certificate) is available who meets the minimum standards for the advertised position. The Bermuda government has a policy that limits the duration of work permits to six years, subject to certain exemptions for key employees. The Bermuda government could refuse to extend these work permits. If any of Argo Group’s senior executive officers were not permitted to remain in Bermuda, Argo Group’s operations could be disrupted and its financial performance could be adversely affected.
Argo Group is a holding company and if its subsidiaries do not make dividend payments to Argo Group, Argo Group may not be able to pay dividends or other obligations.
Argo Group is a holding company with no operations or significant assets other than the share capital of its subsidiaries.
PXRE effected an internal reorganization of its subsidiaries on March 15, 2005. The purpose of the reorganization was to consolidate all of PXRE’s non-Bermudian subsidiaries under a newly formed holding company established in Ireland, PXRE Holding (Ireland) Limited (“PXRE Ireland”). PXRE Ireland is a wholly owned subsidiary of PXRE Bermuda. In the reorganization, PXRE Reinsurance (Barbados) Ltd. distributed all of the common shares of PXRE Corporation (“PXRE Delaware”) to PXRE Bermuda. PXRE Bermuda then contributed the common shares of PXRE Delaware and the common shares of PXRE Solutions, S.A. (“PXRE Europe”) to PXRE Ireland.
Argo Group will rely primarily on cash dividends from its subsidiaries to pay its operating expenses, including debt service payments, shareholder dividends, if any, income taxes and other obligations that may arise from time to time. Argo Group expects future dividends and other permitted payments from these subsidiaries to be its principal source of funds to pay expenses and dividends. The payment of dividends by Argo Group’s insurance and reinsurance subsidiaries to Argo Group is limited under Bermuda law, Irish law and under certain insurance statutes of various U.S. states in which they are licensed to transact business, including Illinois and Virginia insurance law, which are the states of domicile for Argonaut Insurance Company and Colony Insurance Company, Argonaut Group’s immediate insurance subsidiaries. Argo Group’s U.S. insurance subsidiaries are subject to state regulatory restrictions that limit the maximum amount of annual dividends or other distributions, including loans or cash advances, available to shareholders without prior approval of the state regulatory authorities. During 2007, Argonaut Insurance Company may be permitted to pay dividends of up to $46.6 million in cash to Argonaut Group without approval from the Illinois Department of Insurance, while Colony Insurance Company may be permitted to pay dividends of up to $28.2 in cash without approval from the Virginia Department of Insurance. As of January 1, 2007, PXRE Reinsurance cannot pay any dividends without the prior approval of the Insurance Commissioner of the State of Connecticut.
Bermuda insurance laws require PXRE Bermuda and Peleus Re to maintain certain measures of solvency and liquidity, and further limit the amount by which PXRE can reduce capital and surplus without prior regulatory approval. Moreover, as a precondition to the licensing of Peleus Re, PXRE Bermuda has agreed to submit to additional regulatory oversight by the BMA. PXRE agreed that effective March 12, 2007 PXRE Bermuda will not write any insurance business without the approval of the BMA other than reinsurance of business written by Peleus Re.
PXRE also agreed with the BMA that effective March 12, 2007, PXRE Bermuda, before reducing its total statutory capital by 10% or more, in the aggregate, as set out in its previous year’s financial statements, in any calendar year, shall obtain the BMA’s approval. PXRE Bermuda may reduce its total statutory capital, as set out in its previous year’s financial statements, by less than 10% in the aggregate in any calendar year, provided that at least fourteen days before payment of such distribution it files with the BMA a certificate signed by the insurer’s principal representative and two of its directors which states that, in the opinion of those signing the certificate, the return and reduction of statutory capital will not cause the insurer to fail to meet its relevant margins.
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Additionally, PXRE Bermuda, before declaring a dividend in respect of any financial year which would exceed 20% of its total statutory capital and surplus as shown on its statutory balance sheet in relation to the previous financial year, must obtain the BMA’s approval. PXRE Bermuda may declare and pay dividends in respect of any financial year which would not exceed 20% of its total statutory capital and surplus as shown on its statutory balance sheet in relation to the previous financial year, provided that at least fourteen days before payment of such dividend it files with the BMA a certificate signed by its principal representative and two of its directors which states that, in the opinion of those signing the certificate, the payment of such dividend will not cause PXRE Bermuda to fail to meet its relevant margins.
PXRE Bermuda is prohibited from declaring or paying any dividends during any financial year it is in breach of its minimum solvency margin or minimum liquidity ratio or if the declaration or payment of such dividends would cause it to fail to meet such margin or ratio. If it fails to meet its minimum solvency margin or minimum liquidity ratio on the last day of any financial year, the insurer will be prohibited, without the approval of the BMA, from declaring or paying any dividends during the next financial year. If its total statutory capital and surplus falls to $75.0 million or less, it will have to comply with additional reporting requirements as mandated by the BMA.
U.S. persons who own Argo Group’s common shares may have more difficulty in protecting their interests than U.S. persons who are shareholders of a U.S. corporation.
The Companies Act 1981 of Bermuda, which we refer to as the Companies Act, which applies to Argo Group, differs in certain material respects from laws generally applicable to U.S. corporations and their shareholders. Set forth below is a summary of certain significant provisions of the Companies Act applicable to Argo Group which includes, where relevant, information which differs in certain respects from provisions of Delaware corporate law. Because the following statements are summaries, they do not discuss all aspects of Bermuda law that may be relevant to Argo Group and its shareholders.
Interested Directors.Under Bermuda law and Argo Group’s bye-laws, a transaction entered into by Argo Group in which a director has an interest will not be voidable by Argo Group, and such director will not be liable to Argo Group for any profit realized pursuant to such transaction, provided the nature of the interest is disclosed at the first opportunity at a meeting of directors, or in writing to the directors. In addition, Argo Group’s bye-laws allow an interested director to be taken into account in determining whether a quorum is present and to vote on a transaction in which that director has an interest following a declaration of the interest pursuant to the Companies Act, provided that the director is not disqualified from doing so by the chairman of the meeting. Under Delaware law, a transaction with an interested director would not be voidable if:
- the material facts as to the interested director’s relationship or interests were disclosed or were known to the board of directors and the board of directors in good faith authorized the transaction by the affirmative vote of a majority of the disinterested directors;
- such material facts were disclosed or were known to the shareholders entitled to vote on such transaction and the transaction was specifically approved in good faith by vote of the majority of shares entitled to vote thereon; or
- the transaction was fair as to the corporation as of the time it was authorized, approved or ratified.
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Under Delaware law, an interested director could be held liable for a transaction in which such director derived an improper personal benefit.
Certain Transactions with Significant Shareholders.As a Bermuda company, upon the approval of Argo Group’s board of directors, Argo Group may enter into certain business transactions with its significant shareholders, including asset sales, in which a significant shareholder receives, or could receive, a financial benefit that is greater than that received, or to be received, by other shareholders without obtaining prior approval from Argo Group shareholders. Amalgamations, including amalgamations with an interested shareholder, require the approval of the board of directors and a resolution of shareholders approved by the affirmative vote of three-fourths of those voting at such meeting and the quorum shall be two persons holding or represented by proxy of more than one-third of the issued shares of Argo Group. If Argo Group was a Delaware corporation, a business combination (which, for this purpose, includes mergers and asset sales of greater than 10% of Argo Group’s assets that would otherwise be considered transactions in the ordinary course of business) with an interested shareholder, would require, subject to certain exceptions, prior approval from shareholders holding at least two-thirds of its outstanding common shares not owned by such interested shareholder for a period of three years from the time the person became an interested shareholder, unless Argo Group opted out of the relevant Delaware statute.
Shareholders’ Suits.The rights of shareholders under Bermuda law are not as extensive as the rights of shareholders in many U.S. jurisdictions. Class actions and derivative actions are generally not available to shareholders under the laws of Bermuda. However, the Bermuda courts ordinarily would be expected to follow English case law precedent, which would permit a shareholder to commence an action in Argo Group’s name to remedy a wrong done to Argo Group where an act is alleged to be beyond Argo Group’s corporate power, is illegal or would result in the violation of Argo Group’s memorandum of association or bye-laws. Furthermore, consideration would be given by the court to acts that are alleged to constitute a fraud against the minority shareholders or where an act requires the approval of a greater percentage of Argo Group’s shareholders than actually approved it. The winning party in such an action generally would be able to recover a portion of attorneys’ fees incurred in connection with such action. Argo Group’s bye-laws provide that shareholders waive all claims or rights of action that they might have, individually or in Argo Group’s right, against any director or officer for any act or failure to act in the performance of such director’s or officer’s duties, except with respect to any fraud or dishonesty of such director or officer. Class actions and derivative actions generally are available to shareholders under Delaware law for, among other things, breach of fiduciary duty, corporate waste and actions not taken in accordance with applicable law. In such actions, the court has discretion to permit the winning party to recover attorneys’ fees incurred in connection with such action.
Indemnification of Directors and Officers. Under Bermuda law and Argo Group’s bye-laws, Argo Group may indemnify Argo Group directors, officers or any other person appointed to a committee of the board of directors (and their respective heirs, executors or administrators) to the full extent permitted by law against all actions, costs, charges, liabilities, loss, damage or expense incurred or sustained by such person by reason of any act done, concurred in or omitted in the conduct of Argo Group’s business or in the discharge of his/her duties; provided that such indemnification shall not extend to any matter in which any of such persons is found, in a final judgment or decree not subject to appeal, to have committed fraud or dishonesty. Under Delaware law, a corporation may indemnify a director or officer of the corporation against expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement actually and reasonably incurred in defense of an action, suit or proceeding by reason of such position if (i) such director or officer acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation and (ii) with respect to any criminal action or proceeding, such director or officer had no reasonable cause to believe his conduct was unlawful.
Committees of the Board of Directors.Argo Group’s bye-laws provide, as permitted by Bermuda law, that the board of directors may delegate any of its powers to committees that the board appoints, and those committees may consist partly or entirely of non-directors. Delaware law allows the board of directors of a corporation to delegate many of its powers to committees, but those committees may consist only of directors.
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Argo Group’s shareholders may have difficulty effecting service of process on Argo Group or enforcing judgments against Argo Group in the United States.
Argo Group is organized under the laws of Bermuda and Argo Group’s business will be based in Bermuda. In addition, certain of Argo Group’s directors and officers reside outside the United States, and all or a substantial portion of Argo Group’s assets and the assets of such persons are located in jurisdictions outside the United States. As such, Argo Group has been advised that there is doubt as to whether:
a holder of Argo Group’s common shares would be able to enforce, in the courts of Bermuda,judgments of United States courts against persons who reside in Bermuda based upon the civil liability provisions of the United States federal securities laws;
a holder of Argo Group’s common shares would be able to enforce, in the courts of Bermuda,judgments of United States courts based upon the civil liability provisions of the United States federal securities laws; and
a holder of Argo Group’s common shares would be able to bring an original action in the Bermudacourts to enforce liabilities against Argo Group or Argo Group’s directors or officers, as well as Argo Group’s independent accountants, who reside outside the United States based solely uponUnited States federal securities laws.
Further, Argo Group has been advised that there is no treaty in effect between the United States and Bermuda providing for the enforcement of judgments of United States courts, and there are grounds upon which Bermuda courts may not enforce judgments of United States courts. Because judgments of United States courts are not automatically enforceable in Bermuda, it may be difficult for Argo Group’s shareholders to recover against Argo Group based on such judgments.
Risks Related to Taxation
Argo Group and Argo Group’s Bermuda subsidiaries may become subject to Bermuda taxes after 2016.
Bermuda currently imposes no income tax on corporations. Argo Group has obtained an assurance from the Bermuda Minister of Finance, under The Exempted Undertakings Tax Protection Act 1966 of Bermuda, that if any legislation is enacted in Bermuda that would impose tax computed on profits or income, or computed on any capital asset, gain or appreciation, or any tax in the nature of estate duty or inheritance tax, then the imposition of any such tax will not be applicable to Argo Group or Argo Group’s Bermuda subsidiaries, until March 28, 2016. Argo Group cannot assure you that Argo Group or its Bermuda subsidiaries will not be subject to any Bermuda tax after that date.
Argo Group and Argo Group’s non-U.S. subsidiaries may be subject to U.S. tax, which may have a material adverse effect on Argo Group’s financial condition and operating results.
Argo Group and Argo Group’s non-U.S. subsidiaries have operated and intend to continue to operate in a manner that should not cause them to be treated as engaged in a trade or business in the United States (and, in the case of those non-U.S. companies qualifying for treaty protection, in a manner that should not cause any of such non-U.S. subsidiaries to be doing business through a permanent establishment in the United States) and, thus, Argo Group believes that it and its non-U.S. subsidiaries should not be subject to U.S. federal income taxes or branch profits tax (other than withholding taxes on certain U.S. source investment income and excise taxes on insurance or reinsurance premiums). However, because there is uncertainty as to the activities that constitute being engaged in a trade or business within the United States, and what constitutes a permanent establishment under the applicable tax treaties, there can be no assurances that the United States Internal Revenue Service, which we refer to as the IRS, will not contend successfully that one of the non-U.S. subsidiaries is engaged in a trade or business, or carrying on business through a permanent establishment, in the United States.
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Dividends paid by Argo Group’s U.S. subsidiaries to PXRE Ireland may not be eligible for benefits under the U.S.-Ireland income tax treaty.
Under U.S. federal income tax law, dividends paid by a U.S. corporation to a non-U.S. shareholder are generally subject to a 30% withholding tax, unless reduced by treaty. The income tax treaty between the Republic of Ireland and the United States, which we refer to as the Irish Treaty, reduces the rate of withholding tax on certain dividends to 5%. Were the IRS to contend successfully that PXRE Ireland is not eligible for benefits under the Irish Treaty, any dividends paid by Argo Group’s U.S. subsidiaries to PXRE Ireland would be subject to the 30% withholding tax. Such a result could have a material adverse effect on Argo Group’s financial condition and operating results.
If you are a U.S. non-corporate shareholder, dividends you receive from Argo Group will not be eligible for reduced rates of tax upon enactment of certain legislative proposals or after 2010 if legislation is not enacted extending the “qualified dividend” income provisions.
Dividends are generally considered to be ordinary income subject, in the case of individuals, to rates of tax up to 35%. However, dividends paid by a qualified foreign corporation, such as Argo Group will be, to U.S. non-corporate holders of its common shares are eligible for reduced rates of taxation (based on the long-term capital gain rates) up to a maximum of 15%. The application of these reduced rates is, however, set to expire in 2011. Argo Group, therefore, cannot assure you that any dividends paid by Argo Group after 2010 would continue to qualify for reduced rates of tax.
Moreover, legislation has been introduced in the U.S. Congress that would, if enacted, deny the applicability of reduced rates to dividends paid by any corporation organized under the laws of a foreign country which does not have a comprehensive income tax system, such as Bermuda. It is possible that this legislative proposal could become law before 2011 or that it could apply retroactively. Therefore, depending on whether, when and in what form this legislative proposal is enacted, Argo Group cannot assure you that any dividends paid by Argo Group in the future would qualify for reduced rates of tax.
If you acquire 10% or more of Argo Group’s shares and Argo Group or one or more of its non-U.S. subsidiaries is classified as a controlled foreign corporation, which we refer to as a CFC, your taxes could increase.
Each United States person (as defined in Section 957(c) of the Code) who (i) owns (directly, indirectly through non-U.S. persons, or constructively by application of certain attribution rules, which we refer to as constructively) 10% or more of the total combined voting power of all classes of shares of a non-U.S. corporation at any time during a taxable year, which we refer to as a 10% U.S. Shareholder, and (ii) owns (directly or indirectly through non-U.S. persons) shares of such non-U.S. corporation on the last day of such taxable year, must include in its gross income for U.S. federal income tax purposes itspro ratashare of the CFC’s “subpart F income,” even if the subpart F income is not distributed, if such non-U.S. corporation has been a CFC for an uninterrupted period of 30 days or more during such taxable year. A non-U.S. corporation is considered a CFC if 10% U.S. Shareholders own (directly, indirectly through non-U.S. entities, or constructively) more than 50% of the total combined voting power of all classes of voting shares of such non-U.S. corporation or more than 50% of the total value of all shares of such corporation. For purposes of taking into account insurance income, a CFC also includes a non-U.S. insurance company in which more than 25% of the total combined voting power of all classes of shares (or more than 25% of the total value of the shares) is owned (directly, indirectly through non-U.S. persons or constructively) by 10% U.S. Shareholders, on any day during the taxable year of such corporation, if the gross amount of premiums or other consideration for the reinsurance or the issuing of insurance or annuity contracts (other than certain insurance or reinsurance related to same country risks written by certain insurance companies not applicable here) exceeds 75% of the gross amount of all premiums or other consideration in respect of all risks. Argo Group cannot assure you that Argo Group or its non-U.S. subsidiaries will not be classified as CFCs. Argo Group believes that because of the anticipated dispersion of its common share ownership, provisions in Argo Group’s organizational documents that limit voting power and other factors, no United States person who (i) owns Argo Group’s shares directly or indirectly through one or more non-U.S. entities and (ii) has not received a waiver from Argo Group’s board of directors of provisions in Argo Group’s organizational documents that limit voting power, should be treated as owning (directly, indirectly through non-U.S. entities or constructively) 10% or more of the total voting power of all classes of the shares of Argo Group or any of its non-U.S. subsidiaries.
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Due to the attribution provisions of the Code regarding determination of beneficial ownership, there is a risk that the IRS could assert that Argo Group or one or more of its non-U.S. subsidiaries are CFCs and that U.S. holders of Argo Group’s shares who own 10% or more of the value of Argo Group’s shares should be treated as owning 10% or more of the total voting power of Argo Group, and/or its non-U.S. subsidiaries, notwithstanding the reduction of voting power discussed above.
If one or more of Argo Group’s non-U.S. subsidiaries is determined to have related person insurance income, which we refer to as RPII, you may be subject to U.S. taxation on your pro rata share of such income.
If the RPII of any of Argo Group’s non-U.S. insurance subsidiaries were to equal or exceed 20% of such company’s gross insurance income in any taxable year and direct or indirect insureds (and persons related to such insureds) own, directly or indirectly through entities, 20% or more of Argo Group’s voting power or value, then a U.S. person who owns Argo Group’s shares (directly or indirectly through non-U.S. entities) on the last day of the taxable year would be required to include in its income for U.S. federal income tax purposes such person’spro ratashare of such non-U.S. insurance subsidiary’s RPII for the entire taxable year, determined as if such RPII were distributed proportionately only to U.S. persons at that date regardless of whether such income is distributed. In addition, any RPII that is includible in the income of a U.S. tax-exempt organization may be treated as unrelated business taxable income. The amount of RPII earned by the non-U.S. insurance subsidiaries (generally, premium and related investment income from the direct or indirect insurance or reinsurance of any direct or indirect U.S. holder of common shares or any person related to such holder) will depend on a number of factors, including the identity of persons directly or indirectly insured or reinsured by the non-U.S. insurance subsidiaries. Argo Group believes that the gross RPII of each non-U.S. insurance subsidiary did not in prior years of operation and is not expected in the foreseeable future to equal or exceed 20% of such subsidiary’s gross insurance income. Additionally, Argo Group does not expect the direct or indirect insureds of its non-U.S. insurance subsidiaries (and persons related to such insureds) to directly or indirectly own 20% or more of either the voting power or value of its shares. No assurance can be given that this will be the case because some of the factors that determine the existence or extent of RPII may be beyond Argo Group’s knowledge and/or control.
The RPII rules provide that if a U.S. person disposes of shares in a non-U.S. insurance corporation in which U.S. persons own 25% or more of the shares (even if the amount of RPII is less than 20% of the corporation’s gross insurance income and the ownership of its shares by direct or indirect insureds and related persons is less than the 20% threshold), any gain from the disposition will generally be treated as ordinary income to the extent of the U.S. person’s share of the corporation’s undistributed earnings and profits that were accumulated during the period that the U.S. person owned the shares (whether or not such earnings and profits are attributable to RPII). In addition, such U.S. person will be required to comply with certain reporting requirements, regardless of the amount of shares owned by the U.S. person. These RPII rules should not apply to dispositions of Argo Group’s shares because Argo Group will not itself be directly engaged in the insurance business. The RPII provisions, however, have never been interpreted by the courts or the U.S. Treasury Department in final regulations, and regulations interpreting the RPII provisions of the Code exist only in proposed form. It is not certain whether these regulations will be adopted in their proposed form or what changes or clarifications might ultimately be made thereto or whether any such changes, as well as any interpretation or application of RPII by the IRS, the courts or otherwise, might have retroactive effect. The U.S. Treasury Department has authority to impose, among other things, additional reporting requirements with respect to RPII. Accordingly, the meaning of the RPII provisions and the application of those provisions to Argo Group and its non-U.S. subsidiaries are uncertain.
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If Argo Group is classified as a passive foreign investment company, which we refer to as PFIC, your taxes would increase.
If Argo Group is classified as a PFIC, it would have material adverse tax consequences for U.S. persons that directly or indirectly own Argo Group’s shares, including subjecting such U.S. persons to a greater tax liability than might otherwise apply and subjecting such U.S. persons to tax on amounts in advance of when tax would otherwise be imposed. Argo Group believes that it should not be, and currently does not expect to become, a PFIC for U.S. federal income tax purposes; however, Argo Group cannot assure you that it will not be deemed a PFIC by the IRS based, in part, on Argo Group’s recent limited operations. There are currently no regulations regarding the application of the PFIC provisions to an insurance company. New regulations or pronouncements interpreting or clarifying these rules may be forthcoming. Argo Group cannot predict what impact, if any, such guidance would have on persons subject to U.S. federal income tax that directly or indirectly own Argo Group’s shares.
The reinsurance agreements between Argo Group and Argo Group’s U.S. subsidiaries may be subject to recharacterization or other adjustment for U.S. federal income tax purposes, which may have a material adverse effect on Argo Group’s financial condition and operating results.
Under Section 845 of the Code, the IRS may allocate income, deductions, assets, reserves, credits and any other items related to a reinsurance agreement among certain related parties to the reinsurance agreement, recharacterize such items, or make any other adjustment, in order to reflect the proper source, character or amount of the items for each party. No regulations have been issued under Section 845 of the Code. Accordingly, the application of such provisions is uncertain and Argo Group cannot predict what impact, if any, such provisions may have on it and its subsidiaries either before or after completion of the merger.
U.S. tax-exempt organizations that own Argo Group’s shares may recognize unrelated business taxable income.
A U.S. tax-exempt organization may recognize unrelated business taxable income if a portion of Argo Group’s insurance income is allocated to the organization. In general, insurance income will be allocated to a U.S. tax-exempt organization if either Argo Group is a CFC and the tax-exempt shareholder is a 10% U.S. Shareholder or there is RPII and certain exceptions do not apply. Although Argo Group does not believe that any U.S. persons should be allocated such insurance income, Argo Group cannot be certain that this will be the case. U.S. tax-exempt investors should consult their tax advisors as to the U.S. tax consequences of any allocation of Argo Group’s insurance income.
The payment of the special cash dividend to Argonaut Group shareholders made in July 2007 could result in adverse U.S. federal income tax consequences to shareholders and to Argo Group under certain circumstances.
Argonaut Group intends to take the position that the amount paid as the special cash dividend is treated as a distribution with respect to the Argonaut Group common stock, and not as consideration in the Merger. Although Argo Group believes its position with respect to the special cash dividend is correct, the IRS may take a contrary position, and to the extent the IRS were to prevail, the amount paid as the special cash dividend would be treated as additional cash received in connection with the Merger and not as a distribution for U.S. federal income tax purposes. If the special cash dividend were to be treated as Merger consideration, it is possible that the special cash dividend would be deemed to be paid from Argonaut Group to Argo Group, in which case a U.S. 30% withholding tax would be imposed on such payment.
The Merger may have adverse U.S. federal income tax consequences on Argo Group under certain circumstances.
Section 7874 of the Code was added in 2004 by the American Jobs Creation Act of 2004 to address inversion transactions, which refer in relevant part to transactions where a U.S. corporation becomes a subsidiary of a foreign corporation. This provision provides that in certain instances a foreign corporation may be treated as a domestic corporation for U.S. federal income tax purposes.
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Because the former holders of Argonaut Group common stock did not own 80 percent or more of the stock (by vote or value) of Argo Group immediately after the Merger, Argo Group believes that neither Argo Group nor any of its non-U.S. affiliates should be treated as a domestic corporation subject to U.S. taxation under Section 7874 of the Code. Moreover, although the former holders of Argonaut Group common stock held more than 60 percent of the stock (by vote and value) of Argo Group immediately after the inversion transaction, Argo Group believes that it should not recognize current gain under Section 7874 of the Code or otherwise as a result of the Merger of Argonaut Group and PXRE. It is possible that, as a result of certain transfers or licenses of stock or other property, as the case may be, during the applicable period (including the transfer of any income received or accrued during the applicable period by reason of a license of any property by Argonaut Group), Argonaut Group could recognize inversion gain during the applicable period. However, Argo Group does not anticipate such transfers taking place and thus do not expect to recognize any inversion gain during the applicable period.
Changes in U.S. federal income tax law could be retroactive and may subject Argo Group or its non-U.S. subsidiaries to U.S. federal income taxation.
Legislation has been introduced in the U.S. Congress intended to eliminate certain perceived tax advantages of companies (including insurance companies) that have legal domiciles outside the United States but have certain U.S. connections. There are currently pending legislative proposals which, if enacted, could have a material adverse effect on Argo Group or its shareholders. It is possible that broader-based or new legislative proposals could emerge in the future that could have an adverse effect on Argo Group or its shareholders.
The tax laws and interpretations regarding whether a company is engaged in a U.S. trade or business or whether a company is a CFC or PFIC or has RPII or subject to the inversion tax rules are subject to change, possibly on a retroactive basis. There are currently no regulations regarding the application of the PFIC rules to an insurance company. Additionally, the regulations regarding RPII are still in proposed form and the regulations regarding inversion transactions are in temporary form. New regulations or pronouncements interpreting or clarifying such rules will likely be forthcoming from the IRS. Argo Group is not able to predict if, when or in what form such guidance will be provided and whether such guidance will be applied on a retroactive basis.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchase of Equity Securities
For the three months ended September 30, 2007, the Company did not purchase shares of our common stock on the open market. Employees are allowed to surrender shares to settle the tax liability incurred upon the vesting of shares under the various employees equity compensation plans. The following table provides information with respect to shares of the Company’s common stock that were surrendered during the three months ended September 30, 2007:
| | | | | | | | | Maximum Number (or |
| | | | | | | Total Number of | | Approximate Dollar |
| | | | | | | Shares Purchased | | Value) of Shares |
| | | Total Number | | Average | | as Part of Publicly | | That May Yet Be |
| | | of Shares | | Price Paid | | Announced Plan | | Purchased Under the |
| Period | | Purchased | | per Share | | or Program | | Plan or Program |
| July 1 through July 31, 2007 | | - | | $ | - | | - | | - |
| August 1 through August 31, 2007 | | 1,729 | | $ | 42.26 | | - | | - |
| September 1 through September 30, 2007 | | 311 | | $ | 43.90 | | - | | - |
| Total | | 2,040 | | $ | 42.51 | | - | | - |
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Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
We held a special general meeting of our shareholders on July 25, 2007. At the meeting, nine proposals were voted upon by our shareholders as follows:
Proposal 1:To approve the issuance of our common shares of PXRE pursuant to the Agreement and Plan of Merger with Argonaut.
| For | Against | Abstain | Broker Non-votes |
| 54,741,812 | 1,704,539 | 195,810 | 0 |
Proposal 2:To approve the reverse split of our common shares at a ratio of one share of PXRE for each ten shares held or entitled to be received in the Merger.
| For | Against | Abstain | Broker Non-votes |
| 54,792,313 | 1,731,113 | 118,735 | 0 |
Proposal 3:To approve the change of name of “PXRE Group Ltd.” to “Argo Group International Holdings, Ltd.”
| For | Against | Abstain | Broker Non-votes |
| 54,831,441 | 1,688,935 | 121,785 | 0 |
Proposal 4:To approve an increase in our authorized share capital from $380 million to $530 million.
| For | Against | Abstain | Broker Non-votes |
| 54,800,536 | 1,721,895 | 119,730 | 0 |
Proposal 5:To increase the maximum number of our directors from 11 directors to 13 directors (if the affirmative vote of 66 2/3% of the voting power of the outstanding shares is obtained) or to 12 directors.
| For | Against | Abstain | Broker Non-votes |
| 54,770,134 | 1,748,742 | 123,285 | 0 |
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Proposal 6:To approve an amendment and restatement of our memorandum of association.
| For | Against | Abstain | Broker Non-votes |
| 48,105,603 | 8,405,083 | 131,475 | 0 |
Proposal 7:To approve an amendment and restatement of our bye-laws (some of which amendments require the affirmative vote of 66 2/3% of the voting power of the outstanding shares).
| For | Against | Abstain | Broker Non-votes |
| 54,722,221 | 1,721,415 | 198,525 | 0 |
Proposal 8:To approve adjournments of our special general meeting to a later date, if necessary, to permit further solicitation of proxies if there are not sufficient votes at the time of the special general meeting to approve the above proposals.
| For | Against | Abstain | Broker Non-votes |
| 54,602,878 | 1,846,348 | 192,935 | 0 |
Proposal 9:To approve actions upon any other business that may properly come before the special general meeting or any reconvened meeting, following an adjournment of the special general meeting.
| For | Against | Abstain | Broker Non-votes |
| (1) | (1) | (1) | (1) |
(1) No additional business was brought before the special general meeting.
Item 5. Other Information
None
Item 6. Exhibits
A list of exhibits required to be filed as part of this report is set forth in the Exhibit Index of this Form 10-Q, which immediately precedes such exhibits, and is incorporated herein by reference.
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| EXHIBIT INDEX |
| |
| Exhibit Number | | Description | |
| 10.1 | | Employment Agreement between Argo Group International Holdings, Ltd. and Mark E. Watson III, incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K filed August 8, 2007. |
| 10.2 | | Letter Agreement, dated August 17, 2007, between Argo Group International Holdings, Ltd. and Barbara Bufkin, incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K filed August 23, 2007. |
| 12.1 | | Statement of Computation of Ratio of Earnings to Fixed Charges and Preferred Share Dividends. |
| 31.1 | | Rule 13(a) - 14(a)/15(d) – 14(a) Certification of Chief Executive Officer |
| 31.2 | | Rule 13(a) - 14(a)/15(d) – 14(a) Certification of Chief Financial Officer |
| 32.1 | | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| 32.2 | | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report or amendment thereto to be signed on its behalf by the undersigned thereunto duly authorized.
ARGO GROUP INTERNATIONAL HOLDINGS, LTD.
| November 9, 2007 | By: | /s/ Mark E. Watson III | |
| | Mark E. Watson III | |
| | President and | |
| | Chief Executive Officer | |
| | |
| November 9, 2007 | By: | /s/ Mark W. Haushill | |
| | Mark W. Haushill | |
| | Interim Chief Financial Officer | |
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