UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q | ||||||||||||||||
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QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||||||||||||||
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FOR THE QUARTERLY PERIOD ENDED: June 30, 2007 |
| Commission file number: 1-15731 | ||||||||||||||
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EVEREST RE GROUP, LTD. (Exact name of registrant as specified in its charter) | ||||||||||||||||
Bermuda |
| 98-0365432 | ||||||||||||||
(State or other jurisdiction of incorporation or organization) |
| (I.R.S. Employer Identification No.) | ||||||||||||||
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Wessex House – 2nd Floor 45 Reid Street PO Box HM 845 Hamilton HM DX, Bermuda 441-295-0006 | ||||||||||||||||
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(Address, including zip code, and telephone number, including area code, of registrant’s principal executive office) | ||||||||||||||||
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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. | ||||||||||||||||
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Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. | ||||||||||||||||
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| Large accelerated filer | X | Accelerated filer |
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) | ||||||||||||||||
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Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: | ||||||||
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Class |
| Number of Shares Outstanding at August 1, 2007 | ||||||
Common Shares, $0.1 par value |
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Index To Form 10-Q | |||||||
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PART I | |||||||
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FINANCIAL INFORMATION | |||||||
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Item 1. |
| Financial Statements |
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| Consolidated Balance Sheets at June 30, 2007 (unaudited) |
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| and December 31, 2006 | 3 | |||
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| Consolidated Statements of Operations and Comprehensive Income for the |
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| three and six months ended June 30, 2007 and 2006 (unaudited) | 4 | |||
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| Consolidated Statements of Changes in Shareholders’ Equity for the |
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| three and six months ended June 30, 2007 and 2006 (unaudited) | 5 | |||
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| Consolidated Statements of Cash Flows for the three and six months |
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| ended June 30, 2007 and 2006 (unaudited) | 6 | |||
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| Notes to Consolidated Interim Financial Statements (unaudited) | 7 | ||||
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Item 2. |
| Management’s Discussion and Analysis of Financial Condition |
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| and Results of Operation | 21 | ||||
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Item 3. |
| Quantitative and Qualitative Disclosures About Market Risk | 51 | ||||
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Item 4. |
| Controls and Procedures | 52 | ||||
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PART II | |||||||
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OTHER INFORMATION | |||||||
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Item 1. |
| Legal Proceedings | 53 | ||||
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Item 1A. |
| Risk Factors | 53 | ||||
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Item 2. |
| Unregistered Sales of Equity Securities and Use of Proceeds | 54 | ||||
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Item 3. |
| Defaults Upon Senior Securities | 54 | ||||
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Item 4. |
| Submission of Matters to a Vote of Security Holders | 55 | ||||
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Item 5. |
| Other Information | 55 | ||||
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Item 6. |
| Exhibits | 56 | ||||
EVEREST RE GROUP, LTD.
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
(Dollars in thousands, except par value per share) 2007 2006
---------------- ----------------
(unaudited)
ASSETS:
Fixed maturities - available for sale, at market value
(amortized cost: 2007, $9,676,029; 2006, $10,210,165) $ 9,624,885 $ 10,319,850
Equity securities - available for sale, at market value
(cost: 2007, $16,393; 2006, $1,252,595) 16,393 1,613,678
Equity securities, at fair value 1,551,240 -
Short-term investments 2,436,747 1,306,498
Other invested assets (cost: 2007, $587,990; 2006, $466,232) 590,657 467,193
Cash 187,790 249,868
---------------- ----------------
Total investments and cash 14,407,712 13,957,087
Accrued investment income 146,150 141,951
Premiums receivable 1,091,841 1,136,787
Reinsurance receivables 724,219 772,813
Funds held by reinsureds 287,735 284,809
Deferred acquisition costs 368,420 388,117
Prepaid reinsurance premiums 51,856 67,757
Deferred tax asset 227,957 220,047
Federal income taxes recoverable 15,998 -
Other assets 162,565 138,202
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TOTAL ASSETS $ 17,484,453 $ 17,107,570
---------------- ----------------
LIABILITIES:
Reserve for losses and loss adjustment expenses $ 8,743,833 $ 8,840,140
Future policy benefit reserve 93,537 100,962
Unearned premium reserve 1,505,558 1,612,250
Funds held under reinsurance treaties 73,695 70,982
Losses in the course of payment 75,733 55,290
Commission reserves 36,908 23,665
Other net payable to reinsurers 30,618 47,483
Current federal income taxes payable - 43,002
8.75% Senior notes due 3/15/2010 199,621 199,560
5.4% Senior notes due 10/15/2014 249,670 249,652
6.6% Long term notes due 5/1/2067 399,637 -
Junior subordinated debt securities payable 546,393 546,393
Accrued interest on debt and borrowings 14,368 10,041
Other liabilities 176,957 200,463
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Total liabilities 12,146,528 11,999,883
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Commitment and Contingencies (Note 6)
SHAREHOLDERS' EQUITY:
Preferred shares, par value: $0.01; 50 million shares authorized;
no shares issued and outstanding - -
Common shares, par value: $0.01; 200 million shares authorized;
(2007) 63.2 million and (2006) 65.0 million issued and outstanding 653 650
Additional paid-in capital 1,791,220 1,770,496
Accumulated other comprehensive income, net of deferred income taxes of
$30.4 million at 2007 and $175.0 million at 2006 (12,170) 348,543
Treasury shares, at cost; (2007) 2.1 million shares and (2006) 0.0 million shares (200,080) -
Retained earnings 3,758,302 2,987,998
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Total shareholders' equity 5,337,925 5,107,687
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TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 17,484,453 $ 17,107,570
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The accompanying notes are an integral part of the consolidated financial statements
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EVEREST RE GROUP, LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
Three Months Ended Six Months Ended
June 30, June 30,
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(Dollars in thousands, except per share amounts) 2007 2006 2007 2006
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(unaudited) (unaudited)
REVENUES:
Premiums earned $ 999,320 $ 893,332 $ 2,004,049 $ 1,915,122
Net investment income 179,693 153,333 335,489 298,359
Net realized capital gains 91,774 2,472 132,666 16,073
Net derivative income 5,995 1,316 3,227 5,195
Other (expense) income (8,044) 2,275 (4,379) (4,332)
---------------------------- ----------------------------
Total revenues 1,268,738 1,052,728 2,471,052 2,230,417
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CLAIMS AND EXPENSES:
Incurred losses and loss adjustment expenses 619,114 543,637 1,184,882 1,242,580
Commission, brokerage, taxes and fees 234,423 206,403 460,078 443,905
Other underwriting expenses 37,541 33,645 73,601 62,659
Interest expense on senior notes 7,790 7,787 15,579 15,573
Interest expense on long term notes 4,327 - 4,327 -
Interest expense on junior subordinated debt 9,362 9,362 18,724 18,724
Amortization of bond issue costs 2,687 234 2,922 469
Interest and fee expense on credit facilities 77 98 154 195
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Total claims and expenses 915,321 801,166 1,760,267 1,784,105
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INCOME BEFORE TAXES 353,417 251,562 710,785 446,312
Income tax expense 70,549 31,159 130,335 57,513
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NET INCOME $ 282,868 $ 220,403 $ 580,450 $ 388,799
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Other comprehensive loss, net of tax (106,716) (105,324) (109,898) (158,617)
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COMPREHENSIVE INCOME $ 176,152 $ 115,079 $ 470,552 $ 230,182
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PER SHARE DATA:
Average shares outstanding (000's) 62,901 64,708 63,533 64,665
Net income per common share - basic $ 4.50 $ 3.41 $ 9.14 $ 6.01
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Average diluted shares outstanding (000's) 63,518 65,258 64,137 65,264
Net income per common share - diluted $ 4.45 $ 3.38 $ 9.05 $ 5.96
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The accompanying notes are an integral part of the consolidated financial statements
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EVEREST RE GROUP, LTD.
CONSOLIDATED STATEMENTS OF
CHANGES IN SHAREHOLDERS' EQUITY
Three Months Ended Six Months Ended
June 30, June 30,
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(Dollars in thousands, except share amounts) 2007 2006 2007 2006
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(unaudited) (unaudited)
COMMON SHARES (shares outstanding):
Balance, beginning of period 63,240,705 64,909,902 65,043,976 64,643,338
Issued during the period, net 156,935 38,139 253,664 304,703
Treasury shares aquired (199,000) - (2,099,000) -
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Balance, end of period 63,198,640 64,948,041 63,198,640 64,948,041
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COMMON SHARES (par value):
Balance, beginning of period $ 651 $ 649 $ 650 $ 646
Issued during the period, net 2 - 3 3
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Balance, end of period 653 649 653 649
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ADDITIONAL PAID-IN CAPITAL:
Balance, beginning of period 1,777,070 1,750,845 1,770,496 1,731,746
Share-based compensation plans 14,094 5,629 20,631 24,683
Other 56 37 93 82
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Balance, end of period 1,791,220 1,756,511 1,791,220 1,756,511
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ACCUMULATED OTHER COMPREHENSIVE INCOME,
NET OF DEFERRED INCOME TAXES:
Balance, beginning of period 94,546 167,853 348,543 221,146
Cumulative effect to adopt FAS 159, net of tax - - (250,815) -
Net decrease during the period (106,716) (105,324) (109,898) (158,617)
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Balance, end of period (12,170) 62,529 (12,170) 62,529
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RETAINED EARNINGS:
Balance, beginning of period 3,505,657 2,346,765 2,987,998 2,186,156
Cumulative effect to adopt FAS 159, net of tax - - 250,815 -
Net income 282,868 220,403 580,450 388,799
Dividends declared ($0.48 and $0.96 per share in 2007
and $0.12 and $0.24 per share in 2006) (30,223) (7,792) (60,961) (15,579)
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Balance, end of period 3,758,302 2,559,376 3,758,302 2,559,376
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TREASURY SHARES AT COST:
Balance, beginning of period (181,041) - - -
Purchase of treasury shares (19,039) - (200,080) -
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Balance, end of period (200,080) - (200,080) -
---------------------------- ---------------------------
TOTAL SHAREHOLDERS' EQUITY, END OF PERIOD $ 5,337,925 $ 4,379,065 $ 5,337,925 $ 4,379,065
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The accompanying notes are an integral part of the consolidated financial statements
5
EVEREST RE GROUP, LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended Six Months Ended
June 30, June 30,
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(Dollars in thousands) 2007 2006 2007 2006
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(unaudited) (unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 282,868 $ 220,403 $ 580,450 $ 388,799
Adjustments to reconcile net income to net cash provided by
operating activities:
Decrease in premiums receivable 45,724 83,688 48,290 69,062
(Increase) decrease in funds held by reinsureds, net (94) (4,325) 981 (42,609)
Decrease in reinsurance receivables 67,870 55,661 54,498 103,201
Decrease (increase) in deferred tax asset 7,337 (292) 26,405 (4,985)
Decrease in reserve for losses and loss adjustment expenses (33,499) (167,385) (134,010) (177,511)
Decrease in future policy benefit reserve (4,065) (11,254) (7,425) (16,352)
Decrease in unearned premiums (91,315) (22,797) (111,347) (24,381)
Change in other assets and liabilities, net (84,979) (8,559) (70,989) 14,476
Non-cash compensation expense 4,437 3,007 9,287 6,350
Amortization of bond premium (2,124) 5,911 (826) 13,215
Amortization of underwriting discount on senior notes 41 37 80 73
Realized capital gains (91,774) (2,472) (132,666) (16,073)
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Net cash provided by operating activities 100,427 151,623 262,728 313,265
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CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from fixed maturities matured/called - available for sale 305,278 192,648 617,195 359,089
Proceeds from fixed maturities sold - available for sale 169,549 48,298 204,035 152,375
Proceeds from equity securities - available for sale - 92,573 - 120,222
Proceeds from equity securities - fair value 1,027,955 - 1,318,561 -
Proceeds from other invested assets sold 5,572 21,141 27,383 26,703
Cost of fixed maturities acquired - available for sale (155,618) (79,224) (255,487) (842,907)
Cost of equity securities acquired - available for sale - (261,659) - (377,770)
Cost of equity securities acquired - fair value (816,891) - (1,138,408) -
Cost of other invested assets acquired (78,004) (30,254) (119,765) (58,952)
Net (purchases) sales of short-term securities (873,100) (108,943) (1,103,090) 353,864
Net increase in unsettled securities transactions (3,992) (24,378) (4,412) (1,200)
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Net cash used in investing activities (419,251) (149,798) (453,988) (268,576)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Common shares issued during the period 9,715 2,659 11,440 18,418
Purchase of treasury stock (19,039) - (200,080) -
Net proceeds from issuance of long term notes 395,637 - 395,637 -
Dividends paid to shareholders (30,223) (7,792) (60,961) (15,579)
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Net cash provided by (used in) financing activities 356,090 (5,133) 146,036 2,839
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EFFECT OF EXCHANGE RATE CHANGES ON CASH (9,685) 12,367 (16,854) 20,620
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Net increase (decrease) in cash 27,581 9,059 (62,078) 68,148
Cash, beginning of period 160,209 166,364 249,868 107,275
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Cash, end of period $ 187,790 $ 175,423 $ 187,790 $ 175,423
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SUPPLEMENTAL CASH FLOW INFORMATION
Cash transactions:
Income taxes paid (recovered) $ 135,022 $ 26,232 $ 160,306 $ (25,086)
Interest paid $ 16,189 $ 16,210 $ 34,378 $ 34,518
The accompanying notes are an integral part of the consolidated financial statements
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EVEREST RE GROUP, LTD.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)
For the Three and Six Months Ended June 30, 2007 and 2006
1. General
As used in this document, “Group” means Everest Re Group, Ltd.; “Holdings” means Everest Reinsurance Holdings, Inc.; “Everest Re” means Everest Reinsurance Company and its subsidiaries (unless the context otherwise requires); and the “Company” means Everest Re Group, Ltd. and its subsidiaries.
The unaudited consolidated financial statements of the Company for the three and six months ended June 30, 2007 and 2006 include all adjustments, consisting of normal recurring accruals, which, in the opinion of management, are necessary for a fair statement of the results on an interim basis. Certain financial information, which is normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), has been omitted since it is not required for interim reporting purposes. The year end consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. The results for the three and six months ended June 30, 2007 and 2006 are not necessarily indicative of the results for a full year. These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the years ended December 31, 2006, 2005 and 2004 included in the Company’s most recent Form 10-K filing.
2. New Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board (“FASB”) released FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN 48”), which is effective for fiscal years beginning after December 15, 2006. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes” (“FAS 109”). FIN 48 prescribes the recognition and measurement criteria for the financial statements for tax positions taken or expected to be taken in a tax return. Further, FIN 48 expands the required disclosures associated with uncertain tax positions. As a result of the implementation of FIN 48, the Company recorded no adjustment in the liability for unrecognized income tax benefits and no adjustment to beginning retained earnings.
In September 2006, the FASB issued Statement of Financial Accounting Standards (“FAS”) No. 157 “Fair Value Measurements” (“FAS 157”), which is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. FAS 157 defines fair value, establishes a framework for measuring fair value consistently in GAAP and expands disclosures about fair value measurements. As early adoption is an option, the Company adopted FAS 157 as of January 1, 2007.
In September 2006, the FASB issued FAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“FAS 158”), which is effective for employers with publicly traded equity securities as of the end of the fiscal year ending after December 15, 2006. FAS 158 requires an employer to (a) recognize in its financial statements an asset for a plan’s over funded status or a liability for a plan’s under funded status, (b) measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year and (c) recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur as other comprehensive income. The Company adopted FAS 158 for the reporting period ended December 31, 2006.
In February 2007, the FASB issued FAS No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities — including an amendment to FASB Statement No. 115” (“FAS 159”), which is effective for employers with publicly traded equity securities as of the end of the fiscal year ending after November 15, 2007. FAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The
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objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The Company adopted FAS 159 as of January 1, 2007.
3. Investments, Fair Value
Effective January 1, 2007, the Company adopted and implemented FAS 159 and FAS 157 for its available for sale publicly traded equity securities. In conjunction with the Company implementing more active management strategy for these specific investments, FAS 159 and FAS 157 provided an appropriate accounting and presentation of these investments in the Company’s consolidated financial statements. The Company did not elect FAS 159 for those equity investments in affiliated non-consolidated special purpose vehicles. Upon adoption, the Company recognized a $250.8 million cumulative-effect adjustment to retained earnings, net of $110.3 million of tax. The Company recorded a $109.8 million realized gain in net realized capital gains in the consolidated statements of operations and comprehensive income due to fair value re-measurement for the six months ended June 30, 2007.
The following table presents the equity securities fair value measurements as of June 30, 2007:
Fair Value Measurement Using:
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Quoted Prices
in Active Significant
Markets for Other Significant
Identical Observable Unobservable
Assets Inputs Inputs
(Dollars in thousands) June 30, 2007 (Level 1) (Level 2) (Level 3)
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Equity securities $ 1,551,240 $ 1,551,240 $ - $ -
4. Capital Transactions
On December 1, 2005, the Company filed a shelf registration statement on Form S-3ASR with the Securities and Exchange Commission (“SEC”), as a Well Known Seasoned Issuer under the new registration and offering revisions to the Securities Act of 1933. Generally, under this shelf registration statement, Group is authorized to issue common shares, preferred shares, debt securities, warrants and hybrid securities, Holdings is authorized to issue debt securities and Everest Re Capital Trust III (“Capital Trust III”) is authorized to issue trust preferred securities.
| • | On December 1, 2005, the Company issued 2,298,000 of its common shares at a price of $102.89 per share, which resulted in $236.4 million of proceeds before expenses and Holdings sold Group shares it acquired in 2002 at a price of $102.89 per share, which resulted in $46.5 million of proceeds before expenses. Expenses incurred for this transaction were approximately $0.3 million. |
| • | On April 26, 2007, Holdings completed a public offering of $400.0 million principal amount of 6.6% fixed to floating rate long term subordinated notes with a scheduled maturity date of May 15, 2037 and a final maturity date of May 1, 2067. The net proceeds from the offering are expected to be used to redeem all of the outstanding 7.85% junior subordinated debt securities as soon as possible after November 14, 2007 and for general corporate purposes. |
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5. Earnings Per Common Share
Net income per common share has been computed below, based upon weighted average common and diluted shares outstanding.
Three Months Ended Six Months Ended
June 30, June 30,
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(Dollars in thousands, except per share amounts) 2007 2006 2007 2006
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Net income (numerator) $ 282,868 $ 220,403 $ 580,450 $ 388,799
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Weighted average common and effect of
dilutive shares used in the computation
of net income per share:
Weighted average shares
outstanding - basic (denominator) 62,901 64,708 63,533 64,665
Effect of dilutive shares 617 550 604 599
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Weighted average shares
outstanding - diluted (denominator) 63,518 65,258 64,137 65,264
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Net income per common share:
Basic $ 4.50 $ 3.41 $ 9.14 $ 6.01
Diluted $ 4.45 $ 3.38 $ 9.05 $ 5.96
Options to purchase 4,000 and 10,000 common shares at prices ranging from $99.98 to $106.275 were outstanding for the three and six months ended June 30, 2007, respectively, but were not included in the computation of earnings per diluted share as the options’ exercise price was greater than the average market price of the common shares for the period. Options to purchase 323,500 and 318,500 common shares at prices ranging from $91.41 to $99.98 were outstanding for the three and six months ended June 30, 2006, respectively, but were not included in the computation of earnings per diluted share as the options’ exercise price was greater than the average market price of the common shares for the relevant periods. All outstanding options expire on or between September 26, 2007 and May 29, 2017.
6. Contingencies
In the ordinary course of business, the Company is involved in lawsuits, arbitrations and other formal and informal dispute resolution procedures, the outcomes of which will determine the Company’s rights and obligations under insurance, reinsurance and other contractual agreements. In some disputes, the Company seeks to enforce its rights under an agreement or to collect funds owing to it. In other matters, the Company is resisting attempts by others to collect funds or enforce alleged rights. These disputes arise from time to time and are ultimately resolved through both informal and formal means, including negotiated resolution, arbitration and litigation. In all such matters, the Company believes that its positions are legally and commercially reasonable. While the final outcome of these matters cannot be predicted with certainty, the Company does not believe that any of these matters, when finally resolved, will have a material adverse effect on the Company’s financial position or liquidity. However, an adverse resolution of one or more of these items in any one quarter or fiscal year could have a material adverse effect on the Company’s results of operations in that period.
In 1993 and prior, the Company had a business arrangement with The Prudential Insurance Company of America (“The Prudential”) wherein, for a fee, the Company accepted settled claim payment obligations of certain property and casualty insurers, and, concurrently, became the owner of the annuity or assignee of the annuity proceeds funded by the property and casualty insurers specifically to fulfill these fully settled obligations. In
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these circumstances, the Company would be liable if The Prudential, which has an A+ (Superior) financial strength rating from A.M. Best Company (“A.M. Best”), were unable to make the annuity payments. The estimated cost to replace all such annuities for which the Company was contingently liable at June 30, 2007 was $151.4 million.
Prior to its 1995 initial public offering, the Company purchased annuities from an unaffiliated life insurance company with an A+ (Superior) financial strength rating from A.M. Best to settle certain claim liabilities of the company. Should the life insurance company become unable to make the annuity payments, the Company would be liable for those claim liabilities. The estimated cost to replace such annuities at June 30, 2007 was $20.8 million.
7. Other Comprehensive Loss
The following table presents the components of other comprehensive loss for the periods indicated:
Three Months Ended Six Months Ended
June 30, June 30,
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(Dollars in thousands) 2007 2006 2007 2006
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Net unrealized depreciation of
investments, net of deferred income taxes $ (121,232) $ (124,857) $ (119,488) $ (188,011)
Currency translation adjustments, net of
deferred income taxes 14,516 19,533 9,590 29,394
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Other comprehensive loss,
net of deferred income taxes $ (106,716) $ (105,324) $ (109,898) $ (158,617)
------------- ------------- ------------- -------------
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8. Letters of Credit
The Company has arrangements available for the issuance of letters of credit, which letters are generally collateralized by the Company’s cash and investments. The Company’s agreement with Citibank is a bilateral letter of credit agreement only, while the Company’s other facility, the Wachovia Syndicated Facility, involves a syndicate of lenders (see Note 13, tranche two of the Group Credit Facility), with Wachovia acting as administrative agent. At June 30, 2007 and December 31, 2006, letters of credit for $390.6 million and $460.0 million, respectively, were issued and outstanding, generally supporting reinsurance provided by the Company’s non-U.S. operations. The following table summarizes the Company’s letters of credit as of June 30, 2007.
(Dollars in thousands)
Bank Commitment In Use Date of Expiry
- ------------------------------------------------------------------------------------------------------------
Citibank $ 350,000 $ 11,216 08/31/2007
28,916 12/31/2007
1,290 12/31/2008
121,568 12/31/2009
22,077 12/31/2011
-------------- --------------
Total Citibank Agreement $ 350,000 $ 185,067
-------------- --------------
Wachovia Syndicated Facility Tranche One $ 250,000 $ - -
Tranche Two 500,000 961 11/03/2007
48,075 11/13/2007
142,483 12/31/2007
13,986 05/09/2008
-------------- --------------
Total Wachovia Syndicated Facility $ 750,000 $ 205,505
-------------- --------------
Total letters of credit $ 1,100,000 $ 390,572
-------------- --------------
9. Trust Agreements
Certain subsidiaries of Group, principally Everest Reinsurance (Bermuda), Ltd. (“Bermuda Re”), a Bermuda insurance company and direct subsidiary of Group, have established trust agreements as security for assumed losses payable to certain non-affiliated ceding companies, which effectively use Company investments as collateral. At June 30, 2007, the total amount on deposit in trust accounts was $125.2 million.
10. Senior Notes
On October 12, 2004, Holdings completed a public offering of $250.0 million principal amount of 5.40% senior notes due October 15, 2014. On March 14, 2000, Holdings completed a public offering of $200.0 million principal amount of 8.75% senior notes due March 15, 2010.
Interest expense incurred in connection with these senior notes was $7.8 million for the three months ended June 30, 2007 and 2006 and $15.6 million for the six months ended June 30, 2007 and 2006. Market value, which is based on quoted market price at June 30, 2007 and December 31, 2006, was $239.6 million and $248.1 million, respectively, for the 5.40% senior notes and $214.5 million and $219.8 million, respectively, for the 8.75% senior notes.
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11. Long Term Subordinated Notes
On April 26, 2007, Holdings completed a public offering of $400.0 million principal amount of 6.6% fixed to floating rate long term subordinated notes with a scheduled maturity date of May 15, 2037 and a final maturity date of May 1, 2067. During the fixed rate interest period from May 3, 2007 through May 14, 2017, interest will be at the annual rate of 6.6%, payable semi-annually in arrears on November 15 and May 15 of each year, commencing on November 15, 2007, subject to Holdings’ right to defer interest on one or more occasions for up to ten consecutive years. During the floating rate interest period from May 15, 2017 through maturity, interest will be based on the 3 month London Interbank Offered Rate (“LIBOR”) plus 238.5 basis points, reset quarterly, payable quarterly in arrears on February 15, May 15, August 15 and November 15 of each year, subject to Holdings’ right to defer interest on one or more occasions for up to ten consecutive years. Deferred interest will accumulate interest at the applicable rate compounded semi-annually to the period prior to May 15, 2017, and compounded quarterly with respect to the period from and including May 15, 2017.
Holdings can redeem the long term subordinated notes prior to May 15, 2017, in whole but not in part at the applicable redemption price, which will equal the greater of (a) 100% of the principal amount being redeemed and (b) the present value of the principal payment on May 15, 2017 and scheduled payments of interest that would have accrued from the redemption date to May 15, 2017 on the long term subordinated notes being redeemed, discounted to the redemption date on a semi-annual basis at a discount rate equal to the treasury rate plus an applicable spread of either 0.25% or 0.50%, in each case plus accrued and unpaid interest. Holdings may redeem the long term subordinated notes on or after May 15, 2017, in whole or in part at 100% of the principal amount plus accrued and unpaid interest; however, redemption on or after the scheduled maturity date and prior to May 1, 2047 are subject to a replacement capital covenant. This covenant is for the benefit of certain senior note holders such that these notes cannot be redeemed except to the extent that Holdings has received proceeds from the sale of replacement capital securities.
Interest expense incurred in connection with these long term notes was $4.3 million for the three and six months ended June 30, 2007. Market value, which is based on quoted market price at June 30, 2007, was $381.8 million for the 6.6% long term subordinated notes.
12. Junior Subordinated Debt Securities Payable
On March 29, 2004, Holdings issued $329.9 million of 6.20% junior subordinated debt securities due March 29, 2034 to Everest Re Capital Trust II (“Capital Trust II”). Holdings can redeem the junior subordinated debt securities before their maturity at 100% of their principal amount plus accrued interest as of the date of redemption, in whole or in part, on one or more occasions at any time on or after March 30, 2009; or at any time, in whole, but not in part, within 90 days of the occurrence and continuation of a determination that the Trust may become subject to tax or the Investment Company Act.
On November 14, 2002, Holdings issued $216.5 million of 7.85% junior subordinated debt securities due November 15, 2032 to Everest Re Capital Trust (“Capital Trust”). Holdings can redeem the junior subordinated debt securities before their maturity at 100% of their principal amount plus accrued interest as of the date of redemption, in whole or in part, on one or more occasions at any time on or after November 14, 2007; or at any time, in whole, but not in part, within 90 days of the occurrence and continuation of a determination that the Trust may become subject to tax or the Investment Company Act.
Fair value, which is primarily based on quoted market price of the related trust preferred securities at June 30, 2007 and December 31, 2006, was $302.4 million and $316.3 million, respectively, for the 6.20% junior subordinated debt securities and $220.4 million and $221.2 million, respectively, for the 7.85% junior subordinated debt securities.
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Interest expense incurred in connection with these junior subordinated notes was $9.4 million for the three months ended June 30, 2007 and 2006 and $18.7 million for the six months ended June 30, 2007 and 2006.
Capital Trust and Capital Trust II are wholly owned finance subsidiaries of Holdings.
Holdings considers that the mechanisms and obligations relating to the trust preferred securities, taken together, constitute a full and unconditional guarantee by Holdings of Capital Trust and Capital Trust II’s payment obligations with respect to their respective trust preferred securities.
Capital Trust and Capital Trust II will redeem all of the outstanding trust preferred securities when the junior subordinated debt securities are paid at maturity on November 15, 2032 and March 29, 2034, respectively. The Company may elect to redeem the junior subordinated debt securities, in whole or in part, at any time on or after November 14, 2007 and March 30, 2009, respectively. If such an early redemption occurs, the outstanding trust preferred securities would also be proportionately redeemed.
There are certain regulatory and contractual restrictions on the ability of Holdings’ operating subsidiaries to transfer funds to Holdings in the form of cash dividends, loans or advances. The insurance laws of the State of Delaware, where Holdings’ direct insurance subsidiaries are domiciled, require regulatory approval before those subsidiaries can pay dividends or make loans or advances to Holdings that exceed certain statutory thresholds. In addition, the terms of Holdings’ Credit Facility (discussed in Note 13) require Everest Re, Holdings’ principal insurance subsidiary, to maintain a certain statutory surplus level as measured at the end of each fiscal year. At December 31, 2006, $2,451.4 million of the $3,102.6 million in net assets of Holdings’ consolidated subsidiaries were subject to the foregoing regulatory restrictions.
13. Credit Line
Effective December 8, 2004, Group, Bermuda Re and Everest International Reinsurance, Ltd. (“Everest International”) entered into a three year, $750.0 million senior credit facility with a syndicate of lenders (the “Group Credit Facility”). Wachovia Bank is the administrative agent for the Group Credit Facility. The Group Credit Facility consists of two tranches. Tranche one provides up to $250.0 million of revolving credit for liquidity and general corporate purposes, and for the issuance of standby letters of credit. The interest on the revolving loans shall, at the option of each of the borrowers, be either (1) the Base Rate (as defined below) or (2) an adjusted LIBOR plus a margin. The Base Rate is the higher of the rate of interest established by Wachovia Bank from time to time as its prime rate or the Federal Funds rate, in each case plus 0.5% per annum. The amount of margin and the fees payable for the Group Credit Facility depends on Group’s senior unsecured debt rating. Tranche two exclusively provides up to $500.0 million for the issuance of standby letters of credit on a collateralized basis.
The Group Credit Facility requires Group to maintain a debt to capital ratio of not greater than 0.35 to 1 and to maintain a minimum net worth amount. Minimum net worth is an amount equal to the sum of (i) $3,575.4 million (base amount) plus (ii) (A) 25% of consolidated net income for each of Group’s fiscal quarters and (B) 25% of any increase in consolidated net worth attributable to the issuance of ordinary and preferred shares. The base amount is reset at the end of each fiscal year to be the greater of 70% of Group’s consolidated net worth as of the last day of the fiscal year or the calculated minimum amount of net worth prior to the last day of the fiscal year. As of June 30, 2007, the Company was in compliance with these covenants.
For the three and six months ended June 30, 2007 and 2006, there were no outstanding borrowings under tranche one of the Group Credit Facility. At June 30, 2007, there was $205.5 million used of the $500.0 million available for tranche two standby letters of credit.
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Effective July 27, 2007, Group entered into a new five year, $850.0 million senior credit facility replacing the December 8, 2004, Group Credit Facility. Tranche one will provide up to $350.0 million of revolving credit and for issuance of unsecured standby letters of credit and Tranche two will provide up to $500.0 million for the issuance of secured standby letters of credit. The covenants will basically remain the same as the previous Group Credit Facility.
Effective August 23, 2006, Holdings entered into a new five year, $150.0 million senior revolving credit facility with a syndicate of lenders, replacing the October 10, 2003 three year senior revolving credit facility, which expired on October 10, 2006. Both the August 23, 2006 and October 10, 2003 senior revolving credit agreements, which have similar terms, are referred to as the “Holdings Credit Facility”. Citibank N.A. is the administrative agent for the Holdings Credit Facility. The Holdings Credit Facility is used for liquidity and general corporate purposes. The Holdings Credit Facility provides for the borrowing of up to $150.0 million with interest at a rate selected by Holdings equal to either, (1) the Base Rate (as defined below) or (2) a periodic fixed rate equal to the Eurodollar Rate plus an applicable margin. The Base Rate means a fluctuating interest rate per annum in effect from time to time to be equal to the higher of (a) the rate of interest publicly announced by Citibank as its prime rate or 0.5% per annum above the Federal Funds Rate, in each case plus the applicable margin. The amount of margin and the fees payable for the Holdings Credit Facility depends upon Holdings’ senior unsecured debt rating.
The Holdings Credit Facility requires Holdings to maintain a debt to capital ratio of not greater than 0.35 to 1 and Everest Re to maintain its statutory surplus at $1.5 billion plus 25% of future aggregate net income and 25% of future aggregate capital contributions after December 31, 2005. As of June 30, 2007, Holdings was in compliance with these covenants.
For the three and six months ended June 30, 2007 and 2006, there were no outstanding borrowings under the Holdings Credit Facility.
Interest expense and fees incurred in connection with the Group Credit Facility and the Holdings Credit Facility were $0.1 million and $0.2 million for the three and six months ended June 30, 2007 and 2006.
14. Segment Results
The Company, through its subsidiaries, operates in five segments: U.S. Reinsurance, U.S. Insurance, Specialty Underwriting, International and Bermuda. The U.S. Reinsurance operation writes property and casualty reinsurance, on both a treaty and facultative basis, through reinsurance brokers, as well as directly with ceding companies within the U.S. The U.S. Insurance operation writes property and casualty insurance primarily through general agents and surplus lines brokers within the U.S. The Specialty Underwriting operation writes accident and health (“A&H”), marine, aviation and surety business within the U.S. and worldwide through brokers and directly with ceding companies. The International operation writes non-U.S. property and casualty reinsurance through Everest Re’s branches in Canada and Singapore and offices in Miami and New Jersey. The Bermuda operation provides reinsurance and insurance to worldwide property and casualty markets and reinsurance to life insurers through brokers and directly with ceding companies from its Bermuda office and reinsurance to the United Kingdom and European markets through its UK branch.
These segments are managed in a coordinated fashion with respect to pricing, risk management, control of aggregate catastrophe exposures, capital, investments and support operations. Management generally monitors and evaluates the financial performance of these operating segments based upon their underwriting results.
Underwriting results include earned premium less losses and loss adjustment expenses (“LAE”) incurred, commission and brokerage expenses and other underwriting expenses. Underwriting results are measured using
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ratios, in particular loss, commission and brokerage and other underwriting expense ratios, which, respectively, divide incurred losses, commissions and brokerage and other underwriting expenses by earned premium. The Company utilizes inter-affiliate reinsurance, although such reinsurance does not materially impact segment results.
The Company does not maintain separate balance sheet data for its operating segments. Accordingly, the Company does not review and evaluate the financial results of its operating segments based upon balance sheet data.
The following tables represent the relevant underwriting results for the operating segments for the periods indicated:
U.S. Reinsurance
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
(Dollars in thousands) 2007 2006 2007 2006
---------------------- ----------------------
Gross written premiums $ 271,670 $ 262,018 $ 626,022 $ 656,415
Net written premiums 271,566 260,396 620,475 652,030
Premiums earned $ 314,293 $ 258,759 $ 667,534 $ 638,421
Incurred losses and loss adjustment expenses 110,169 175,790 232,544 443,801
Commission and brokerage 81,328 66,015 157,602 163,511
Other underwriting expenses 7,320 6,364 13,814 11,140
---------- ---------- ---------- ----------
Underwriting gain $ 115,476 $ 10,590 $ 263,574 $ 19,969
---------- ---------- ---------- ----------
U.S. Insurance
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
(Dollars in thousands) 2007 2006 2007 2006
---------------------- ----------------------
Gross written premiums $ 161,637 $ 195,390 $ 379,010 $ 413,396
Net written premiums 145,392 169,466 342,777 358,939
Premiums earned $ 178,080 $ 179,692 $ 371,053 $ 365,300
Incurred losses and loss adjustment expenses 125,251 121,644 304,719 246,523
Commission and brokerage 35,420 25,263 68,636 54,997
Other underwriting expenses 12,014 11,389 24,379 22,094
---------- ---------- ---------- ----------
Underwriting gain (loss) $ 5,395 $ 21,396 $ (26,681) $ 41,686
---------- ---------- ---------- ----------
15
Specialty Underwriting
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
(Dollars in thousands) 2007 2006 2007 2006
---------------------- ----------------------
Gross written premiums $ 76,377 $ 53,087 $ 131,058 $ 117,113
Net written premiums 75,852 50,166 129,128 113,798
Premiums earned $ 77,111 $ 49,890 $ 132,842 $ 118,090
Incurred losses and loss adjustment expenses 54,620 10,994 95,749 81,571
Commission and brokerage 15,432 13,314 31,272 33,498
Other underwriting expenses 1,775 1,637 3,364 2,942
---------- ---------- ---------- ----------
Underwriting gain $ 5,284 $ 23,945 $ 2,457 $ 79
---------- ---------- ---------- ----------
International
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
(Dollars in thousands) 2007 2006 2007 2006
---------------------- ----------------------
Gross written premiums $ 202,626 $ 179,835 $ 375,970 $ 355,357
Net written premiums 202,621 179,597 376,498 355,216
Premiums earned $ 208,895 $ 181,535 $ 388,653 $ 355,842
Incurred losses and loss adjustment expenses 162,432 94,385 258,143 212,642
Commission and brokerage 53,052 46,088 96,589 86,876
Other underwriting expenses 4,332 3,685 8,050 6,363
---------- ---------- ---------- ----------
Underwriting (loss) gain $ (10,921) $ 37,377 $ 25,871 $ 49,961
---------- ---------- ---------- ----------
Bermuda
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
(Dollars in thousands) 2007 2006 2007 2006
---------------------- ----------------------
Gross written premiums $ 223,153 $ 220,043 $ 440,170 $ 423,111
Net written premiums 223,105 220,348 439,535 422,328
Premiums earned $ 220,941 $ 223,456 $ 443,967 $ 437,469
Incurred losses and loss adjustment expenses 166,642 140,824 293,727 258,043
Commission and brokerage 49,191 55,723 105,979 105,023
Other underwriting expenses 4,299 3,798 9,187 7,511
---------- ---------- ---------- ----------
Underwriting gain $ 809 $ 23,111 $ 35,074 $ 66,892
---------- ---------- ---------- ----------
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The following table reconciles the underwriting results for the operating segments to income before tax as reported in the consolidated statements of operations and comprehensive income for the periods indicated:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
(Dollars in thousands) 2007 2006 2007 2006
---------------------- ----------------------
Underwriting gain $ 116,043 $ 116,419 $ 300,295 $ 178,587
Net investment income 179,693 153,333 335,489 298,359
Net realized capital gains 91,774 2,472 132,666 16,073
Net derivative income 5,995 1,316 3,227 5,195
Corporate expenses (7,801) (6,772) (14,807) (12,609)
Interest, fee and bond issue cost
amortization expense (24,243) (17,481) (41,706) (34,961)
Other (expense) income (8,044) 2,275 (4,379) (4,332)
---------- ---------- ---------- ----------
Income before taxes $ 353,417 $ 251,562 $ 710,785 $ 446,312
---------- ---------- ---------- ----------
The Company produces business in the U.S., Bermuda and internationally. The net income deriving from and assets residing in the individual foreign countries in which the Company writes business are not identifiable in the Company’s financial records. Based on written premium, the largest country, other than the U.S., in which the Company writes business is the United Kingdom, with $89.8 million and $217.8 million of written premium for the three and six months ended June 30, 2007, respectively. No other country represented more than 5% of the Company’s revenues.
15. Derivatives
The Company has sold seven equity put options in its product portfolio, which are outstanding. These products meet the definition of a derivative under FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS 133”). The Company’s position in these contracts is unhedged and is accounted for as a derivative in accordance with FAS 133. Accordingly, these contracts are carried at fair value and are recorded in “Other liabilities” in the consolidated balance sheets and changes in fair value are recorded in the consolidated statements of operations and comprehensive income. The Company recorded net derivative income of $6.0 million and $1.3 million for three months ended June 30, 2007 and 2006, respectively, and $3.2 million and $5.2 million for the six months ended June 30, 2007 and 2006, respectively.
The following table presents the derivative fair value measurements as of June 30, 2007:
Fair Value Measurement Using:
---------------------------------------------------------------
Quoted Prices
in Active Significant
Markets for Other Significant
Identical Observable Unobservable
Liabilities Inputs Inputs
(Dollars in thousands) June 30, 2007 (Level 1) (Level 2) (Level 3)
---------------------------------------------------------------
Equity Put Options $ 34,377 $ - $ 34,377 $ -
17
As there is no active market for these instruments, the determination of their fair value is calculated using an industry accepted option pricing model, Black-Scholes, which uses the following inputs:
Contract
Contracts based on
based on FTSE 100
S & P 500 Index Index
------------------------------------------
Equity index at June 30, 2007 1,503.0 6,607.9
Interest rate 5.66% to 5.78% 5.75%
Time to maturity 9.95 to 23.7 yrs 13.1 yrs
Volatility 24.6% to 26.9% 33.2%
16. Share-Based Compensation Plans
Share-based compensation awards granted were 4,000 options for the three months ended June 30, 2007. The grant exercise price was $106.275 per share. The fair value of $23.82 per option award was estimated on the date of the grant using the Black-Scholes option valuation model. The following assumptions were used in calculating the fair value of the options granted for the three months ended June 30, 2007:
Weighted-average volatility 26.22% Weighted-average dividend yield 3.75% Weighted-average expected term 6.3 years Weighted-average risk-free rate 4.83% Weighted-average forfeiture 11.66%
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17. Retirement Benefits
The Company maintains both qualified and non-qualified defined benefit pension plans for its U.S. employees. In addition, the Company has a retiree health plan for eligible retired employees.
Net periodic benefit cost for U.S. employees included the following components for the three and six months ended June 30 as indicated:
Pension Benefits
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
(Dollars in thousands) 2007 2006 2007 2006
--------------------- ---------------------
Service cost $ 1,225 $ 1,505 $ 2,450 $ 2,546
Interest cost 1,352 1,429 2,704 2,444
Expected return on plan assets (1,386) (1,352) (2,772) (2,269)
Amortization of prior service cost 32 31 64 63
Amortization of net loss 467 771 934 1,325
--------- --------- --------- ---------
Net periodic benefit cost $ 1,690 $ 2,384 $ 3,380 $ 4,109
--------- --------- --------- ---------
Other Benefits
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
(Dollars in thousands) 2007 2006 2007 2006
--------------------- ---------------------
Service cost $ 158 $ 185 $ 316 $ 315
Interest cost 129 130 258 232
Amortization of net loss - 12 - 25
--------- --------- --------- ---------
Net periodic benefit cost $ 287 $ 327 $ 574 $ 572
--------- --------- --------- ---------
The Company contributed $3.4 million to the pension benefit plans for the three and six months ended June 30, 2007. The Company did not make any contributions to the pension benefit plans for the three and six months ended June 30, 2006.
18. Related-Party Transactions
During the normal course of business, the Company, through its affiliates, engages in reinsurance and brokerage and commission business transactions, which management believes to be at arm’s-length, with companies controlled by or affiliated with its outside directors. Such transactions, individually and in the aggregate, are not material to the Company’s financial condition, results of operations and cash flows.
19. Income Taxes
The Company uses a projected annual effective tax rate in accordance with FAS 109 to calculate its quarterly tax expense. Under this methodology, when an interim quarter’s pre-tax income (loss) varies significantly from a full year’s income (loss) projection, the tax impact resulting from the income (loss) variance is effectively spread between the impacted quarter and the remaining quarters of the year, except for discreet items impacting an individual quarter.
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The Company adopted the provisions of FIN 48 as of January 1, 2007. As a result of the implementation of FIN 48, the Company recorded no adjustment in the liability for unrecognized income tax benefits and no adjustment to beginning retained earnings.
The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. At the date of adoption, January 1, 2007, the Company had $1.3 million of accrued interest related to uncertain tax positions.
Tax years 2003-2006 remain open to examination by the major taxing jurisdictions to which the Company is subject.
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PART I — Item 2
EVEREST RE GROUP, LTD.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION
RESULTS OF OPERATIONS
Industry Conditions
The worldwide reinsurance and insurance businesses are highly competitive, as well as cyclical by product and market. As a result, financial results tend to fluctuate with periods of constrained availability, high rates and strong profits followed by periods of abundant capacity, low rates and constrained profitability. Competition in the types of reinsurance and insurance business that we underwrite is based on many factors, including the perceived overall financial strength of the reinsurer or insurer, ratings of the reinsurer or insurer by A.M. Best Company (“A.M. Best”) and/or Standard & Poor’s Rating Services (“Standard & Poor’s”), underwriting expertise, the jurisdictions where the reinsurer or insurer is licensed or otherwise authorized, capacity and coverages offered, premiums charged, other terms and conditions of the reinsurance and insurance business offered, services offered, speed of claims payment and reputation and experience in lines written. Furthermore, the market impact from these competitive factors related to reinsurance and insurance is generally not consistent across lines of business, domestic and international geographical areas and distribution channels.
We compete in the U.S., Bermuda and international reinsurance and insurance markets with numerous global competitors. Our competitors include independent reinsurance and insurance companies, subsidiaries or affiliates of established worldwide insurance companies, reinsurance departments of certain insurance companies and domestic and international underwriting operations, including underwriting syndicates at Lloyd’s. Some of these competitors have greater financial resources than we do and have established long-term and continuing business relationships, which can be a significant competitive advantage. In addition, the lack of strong barriers to entry into the reinsurance business and the potential for securitization of reinsurance and insurance risks through capital markets provide additional sources of potential reinsurance and insurance capacity and competition.
Through the second quarter of 2007, we observed increased competition with slightly reduced premiums, higher commissions and demands by cedants for improved terms and conditions. The extent of the increased competition and its affect on rates, terms and conditions varied widely by market and coverage types. One of the lesser impacted markets was property catastrophe retrocession coverage in regions that were most affected by the catastrophe events of 2005, principally Hurricanes Katrina, Rita and Wilma. Reinsurance capacity in areas including southeastern U.S. exposures and energy lines continued to be constrained. In January 2007, the state of Florida passed legislation that increased coverage provided by the Florida Hurricane Catastrophe Fund, thus potentially reducing the amount of reinsurance that Florida companies will purchase from the private reinsurance market. In addition, the legislature broadened the mandate of the state sponsored homeowners’ insurance company to render it a fully competitive market participant. Although we are unable to predict the impact on future market conditions from the increased competition and legislative developments, we believe that our clients continue to write profitable business in Florida and will continue to purchase both quota share and catastrophe coverage, although at likely lower volumes. The balance of the U.S. and international property lines experienced mostly modest price declines but are still adequately priced.
Our U.S. and international casualty lines experienced weaker market conditions led by the medical stop loss and D&O reinsurance classes, as well as the California workers’ compensation insurance line. We believe that U.S. casualty reinsurance generally remains adequately priced. We also believe that increased primary price competition and cedants’ increased appetite for retaining more profitable business net, following several years of hard-market conditions, has resulted in modestly softer, but profitable, reinsurance pricing. Our U.S. insurance
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operation was also affected, although somewhat less so, by these primary casualty insurance market conditions given the specialty nature of its program orientated business.
We are unable to predict the impact on future market conditions from the increased competition and legislative initiatives. In addition to these market forces, reinsurers continue to reassess their risk appetites and rebalance their property portfolios to obtain a better spread of risk against the backdrop of: (i) recent revisions to the industry’s catastrophe loss projection models, which are indicating significantly higher loss potentials and consequently higher pricing requirements and (ii) elevated rating agency scrutiny and capital requirements for many catastrophe exposed companies.
In light of our 2005 catastrophe experience, we have re-examined our risk management practices and concluded that its control framework operated generally as intended. We rebalanced our property portfolio, particularly within peak catastrophe zones, including the Southeast U.S., Mexico and Gulf of Mexico. This effort has enabled us to benefit from market dislocations by carefully shifting the mix of its writings toward the most profitable classes, lines, customers and territories and by enhancing its portfolio balance and diversification.
Overall, we believe that current marketplace conditions offer solid opportunities for us given our strong ratings, distribution system, reputation and expertise. We continue to employ our strategy of targeting business that offers the greatest profit potential, while maintaining balance and diversification in our overall portfolio.
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Consolidated Financial Results
We monitor and evaluate our overall performance based upon financial results. The following table displays a summary of the consolidated net income, ratios and shareholders’ equity for the periods indicated:
Three Months Ended Six Months Ended
June 30, Percentage June 30, Percentage
------------------------- Increase/ ------------------------ Increase/
(Dollars in thousands) 2007 2006 (Decrease) 2007 2006 (Decrease)
------------------------ ---------- ------------------------ ----------
Gross written premiums $ 935,463 $ 910,373 2.8% $1,952,230 $1,965,392 -0.7%
Net written premiums 918,536 879,973 4.4% 1,908,413 1,902,311 0.3%
REVENUES:
Premiums earned $ 999,320 $ 893,332 11.9% $2,004,049 $1,915,122 4.6%
Net investment income 179,693 153,333 17.2% 335,489 298,359 12.4%
Net realized capital gains 91,774 2,472 NM 132,666 16,073 NM
Net derivative income 5,995 1,316 NM 3,227 5,195 -37.9%
Other (expense) income (8,044) 2,275 NM (4,379) (4,332) -1.1%
---------- ---------- ---------- ----------
Total revenues 1,268,738 1,052,728 20.5% 2,471,052 2,230,417 10.8%
---------- ---------- ---------- ----------
CLAIMS AND EXPENSES:
Incurred losses and LAE 619,114 543,637 13.9% 1,184,882 1,242,580 -4.6%
Commission, brokerage, taxes and fees 234,423 206,403 13.6% 460,078 443,905 3.6%
Other underwriting expenses 37,541 33,645 11.6% 73,601 62,659 17.5%
Interest expense 24,243 17,481 38.7% 41,706 34,961 19.3%
----------- ---------- ---------- ----------
Total claims and expenses 915,321 801,166 14.2% 1,760,267 1,784,105 -1.3%
----------- ---------- ---------- ----------
INCOME BEFORE TAXES 353,417 251,562 40.5% 710,785 446,312 59.3%
Income tax expense 70,549 31,159 126.4% 130,335 57,513 126.6%
----------- ---------- ----------- ----------
NET INCOME $ 282,868 $ 220,403 28.3% $ 580,450 $ 388,799 49.3%
----------- ---------- ----------- ----------
RATIOS: Point Point
Change Change
--------- ---------
Loss ratio 62.0% 60.9% 1.1 59.1% 64.9% (5.8)
Commission and brokerage ratio 23.5% 23.1% 0.4 23.0% 23.2% (0.2)
Other underwriting expense ratio 3.7% 3.7% 0.0 3.7% 3.2% 0.5
----------- ---------- --------- ----------- ---------- ---------
Combined ratio 89.2% 87.7% 1.5 85.8% 91.3% (5.5)
----------- ---------- --------- ----------- ---------- ---------
As of As of Percentage
June 30, December 31, Increase/
(Dollars in millions, except per share amounts) 2007 2006 (Decrease)
----------- ---------- ---------
Balance sheet data:
Total investments and cash $ 14,407.7 $ 13,957.1 3.2%
Total assets 17,484.5 17,107.6 2.2%
Loss and LAE reserves 8,743.8 8,840.1 -1.1%
Total debt 1,395.3 995.6 40.1%
Total liabilites 12,146.5 11,999.9 1.2%
Shareholders' equity 5,337.9 5,107.7 4.5%
Book value per share 84.46 78.53
(NM, not meaningful)
23
Revenues.
Premiums. Gross written premiums increased $25.1 million, or 2.8%, for the three months ended June 30, 2007 compared to the three months ended June 30, 2006, reflecting $58.8 million of growth in the worldwide reinsurance business, partially offset by a $33.8 million decline in the U.S. insurance business. Net written premiums increased $38.6 million, or 4.4%, for the three months ended June 30, 2007 compared to the three months ended June 30, 2006, which exceeded the growth in gross written premiums because we purchased less reinsurance on our program business. Net earned premium increased $106.0 million, or 11.9%, for the three months ended June 30, 2007 compared to the three months ended June 30, 2006, principally due to the growth in the worldwide reinsurance gross written premiums, particularly in the treaty property, marine and aviation and international reinsurance classes of business.
Net Investment Income. Net investment income increased 17.2% for the three months ended June 30, 2007 compared to the three months ended June 30, 2006, primarily due to $14.8 million of additional investment income from our limited partnership investments. Investment income from equity investments in limited partnerships fluctuates period over period depending on the performance of the individual investments made by the partnerships as well as movements in the equity markets. In addition, investment income increased due to the growth in invested assets from the net proceeds of the $400.0 million long term note issuance and the positive cash flow from operations. The average investment portfolio yields for the three months ended June 30, 2007 were 5.2% pre-tax and 4.4% after-tax compared to the three months ended June 30, 2006 average investment portfolio yields of 4.7% pre-tax and 4.1% after-tax.
Net Realized Capital Gains. Net realized capital gains were $91.8 million and $2.5 million for the three months ended June 30, 2007 and 2006, respectively, and $132.7 million and $16.1 million for the six months ended June 30, 2007 and 2006, respectively. The increase in 2007 is primarily attributable to our adoption of Statement of Financial Accounting Standards (“FAS”) No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities – including an amendment to FASB statement No. 115” (“FAS 159”) for our publicly traded equity securities investment portfolio. For the three and six months ended June 30, 2007, we recorded $69.3 million and $109.8 million, respectively, of net realized capital gains due to fair value adjustments. Because we reported our realized gains and losses in accordance with FAS No. 115 “Accounting for Certain Investments in Debt and Equity Securities” in 2006, we did not record any fair value adjustments in 2006.
Net Derivative Income. We have issued seven equity put options in our product portfolio which are outstanding. These products meet the definition of a derivative under FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS 133”). We recognized net derivative income of $6.0 million for the three months ended June 30, 2007 as compared to $1.3 million for the three months ended June 30, 2006, reflecting changes in the fair value of these equity put options.
Other (Expense) Income. Other expense for the three months ended June 30, 2007 was $8.0 million compared to other income of $2.3 million for the three months ended June 30, 2006. The change, period over period, was principally due to the fluctuation in foreign currency exchange rates.
24
Claims and Expenses.
Incurred Losses and Loss Adjustment Expenses. The following table presents our incurred losses and LAE for the three and six months ended June 30, 2007 and 2006.
Incurred Losses and LAE
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------------------- ---------------------------------------------------
2007 2006 2007 2006
-------------------------------------------------- ---------------------------------------------------
(Dollars in Current Prior Total Current Prior Total Current Prior Total Current Prior Total
millions) Year Years Incurred Year Years Incurred Year Years Incurred Year Years Incurred
------------------------ ------------------------ ------------------------- -------------------------
All Segments
Attritional (a) $538.1 $(37.4) $500.8 $502.4 $(64.9) $437.5 $1,077.9 $(45.4) $1,032.5 $1,120.9 $(61.6) $1,059.3
Catastrophes 78.6 1.7 80.3 5.4 94.3 99.7 112.5 1.9 114.4 5.4 162.8 168.2
A&E - 38.0 38.0 - 6.4 6.4 - 38.0 38.0 - 15.1 15.1
------------------------ ------------------------ ------------------------- -------------------------
Total All segments $616.8 $ 2.4 $619.1 $507.8 $ 35.9 $543.6 $1,190.4 $ (5.5) $1,184.9 $1,126.3 $116.3 $1,242.6
------------------------ ------------------------ ------------------------- -------------------------
Loss Ratio 61.7% 0.2% 62.0% 56.8% 4.0% 60.9% 59.4% -0.3% 59.1% 58.8% 6.1% 64.9%
------------------------ ------------------------ ------------------------- -------------------------
(a) Attritional losses exclude catastrophe and A&E losses.
(Some amounts may not reconcile due to rounding.)
Incurred losses and loss adjustment expenses (“LAE”) increased $75.5 million, or 13.9%, for the three months ended June 30, 2007 as compared to the same period in 2006. This increase period over period was principally due to $63.3 million increase in attritional losses, of which $35.7 million was from the current year losses and a $27.6 million change was from prior years’ losses and a $31.6 million increase from asbestos and environmental (“A&E”) losses, partially offset by a $19.4 million decrease in catastrophe losses, primarily from a decrease in prior years’ loss development.
Commission, Brokerage, Taxes and Fees. Commission, brokerage, and tax expenses increased $28.0 million, or 13.6%, for the three months ended June 30, 2007 compared to the same period in 2006. The increase in net earned premiums was the principal driver of the increase in this directly variable expense.
Other Underwriting Expenses. Other underwriting expenses for the three months ended June 30, 2007 increased $3.9 million, or 11.6%, compared to the same period in 2006, primarily due to growth in salaries and benefits from an increase in staff. Included in other underwriting expenses were corporate underwriting expenses, which are expenses that are not allocated to segments, of $7.8 million for the three months ended June 30, 2007 compared to $6.8 million for the three months ended June 30, 2006. This increase was primarily due to higher share-based compensation expense.
Interest expense. Interest expense was $24.2 million and $17.5 million for the three months ended June 30, 2007 and 2006. Interest expense for the three months ended June 30, 2007 included $9.3 million related to junior subordinated debt, $7.8 million related to senior notes, $4.3 million related to long term notes, $2.7 million related to bond issue costs and $0.08 million related to the credit line under the credit facilities. The increase is primarily due to the new long term notes and the acceleration of the bond amortization costs associated with the expected early retirement of a portion of the junior subordinated debt.
Income Tax Expense. Our income tax expense was $70.5 million (20.0% effective tax rate) for three months ended June 30, 2007 compared to $31.2 million (12.4% effective tax rate) for the three months ended June 30, 2006. The increase is due to higher taxable income in jurisdictions with higher relative tax rates, particularly related to net realized capital gains, which had an effective tax rate of 24.2% for the second quarter of 2007. Our
25
income tax expense is primarily a function of the statutory tax rates and corresponding pre-tax income in the jurisdictions where we operate, coupled with the impact from tax preferenced investment income. Variations in our effective tax rate generally result from changes in the relative levels of pre-tax income among jurisdictions with different tax rates.
Net Income.
Net income increased 28.3% to $282.9 million for the three months ended June 30, 2007 from $220.4 million for the three months ended June 30, 2006, primarily due to the increased net realized capital gains and net investment income, partially offset by an increase in income taxes.
Ratios.
Our loss ratio increased by 1.1 points for the three months ended June 30, 2007 compared to the three months ended June 30, 2006, reflective of the changes in attritional, current year catastrophe and A&E losses. The combined ratio increased by 1.5 points to 89.2% due to a 0.4% increase in the commission and brokerage ratio and the loss ratio increase discussed above.
Shareholders’ Equity.
Shareholders’ equity increased by $0.2 billion to $5.3 billion at June 30, 2007 from $5.1 billion at December 31, 2006, principally as a result of the $580.5 million of net income generated for the period, partially offset by the repurchase of 2.1 million shares at a cost of $200.1 million and the payment of $61.0 million of shareholder dividends.
Consolidated Investment Results
Net Investment Income.
Net investment income increased 17.2% to $179.7 million for the three months ended June 30, 2007 from $153.3 million for the three months ended June 30, 2006, primarily reflecting growth in limited partnership income, growth in invested assets to $14.4 billion at June 30, 2007 and a reduction in interest credited on funds held.
The following table shows the components of net investment income for the three and six months ended June 30 as indicated:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
(Dollars in thousands) 2007 2006 2007 2006
-------------------- --------------------
Fixed maturities $ 125,061 $ 129,645 $ 251,581 $ 255,668
Equity securities 4,907 3,236 8,772 6,181
Short-term investments 23,717 12,611 40,332 24,928
Other investment income 27,765 12,578 39,031 22,210
--------- --------- --------- ---------
Total gross investment income 181,450 158,070 339,716 308,987
Interest credited and other expense (1,757) (4,737) (4,227) (10,628)
--------- --------- --------- ---------
Total net investment income $ 179,693 $ 153,333 $ 335,489 $ 298,359
--------- --------- --------- ---------
26
The following tables show a comparison of various investment yields for the periods indicated:
----------------
2007 2006
----------------
Imbedded pre-tax yield of cash and invested assets at June 30 and December 31 4.6% 4.6%
Imbedded after-tax yield of cash and invested assets at June 30 and December 31 3.9% 4.0%
Three Months Ended Six Months Ended
June 30, June 30,
------------------- -------------------
2007 2006 2007 2006
------------------- -------------------
Annualized pre-tax yield on average cash and invested assets 5.2% 4.7% 4.8% 4.6%
Annualized after-tax yield on average cash and invested assets 4.4% 4.1% 4.1% 4.0%
Net Realized Capital Gains.
Net realized capital gains of $91.8 million and $132.7 million for the three and six months ended June 30, 2007, respectively, reflected gross realized capital gains on our investments of $33.9 million and $39.5 million, resulting principally from gains on the sale of equity securities of $33.2 million and $37.5 million and fixed maturities of $0.6 million and $2.0 million, partially offset by $11.4 million and $16.6 million of realized capital losses on the sale of equity securities and fixed maturities. In addition, $69.3 million and $109.8 million of fair value adjustment for equity securities added to realized gains for the three and six months ended June 30, 2007, respectively. Net realized capital gains of $2.5 million for the three months ended June 30, 2006 reflected $7.2 million of realized capital gains on our investments, resulting principally from gains on the sale of fixed maturities of $0.6 million and equity securities of $6.6 million, partially offset by $4.7 million of realized capital losses. Net realized capital gains of $16.1 million for the six months ended June 30, 2006 reflected $21.3 million of realized capital gains on our investments, resulting principally from gains on the sale of fixed maturities of $9.8 million and equity securities of $11.5 million, partially offset by $5.2 million of realized capital losses.
Segment Results
Through our subsidiaries, we operate in five segments: U.S. Reinsurance, U.S. Insurance, Specialty Underwriting, International and Bermuda. The U.S. Reinsurance operation writes property and casualty reinsurance, on both a treaty and facultative basis, through reinsurance brokers, as well as directly with ceding companies within the U.S. The U.S. Insurance operation writes property and casualty insurance primarily through general agents and surplus lines brokers within the U.S. The Specialty Underwriting operation writes accident and health (“A&H”), marine, aviation and surety business within the U.S. and worldwide through brokers and directly with ceding companies. The International operation writes non-U.S. property and casualty reinsurance through Everest Re’s branches in Canada and Singapore and offices in Miami and New Jersey. The Bermuda operation provides insurance and reinsurance to worldwide property and casualty markets and reinsurance to the United Kingdom and European markets through its UK branch.
We coordinate the operations of our segments with respect to pricing, risk management, control of catastrophe exposures, capital, investments and support operations. Management generally monitors and evaluates the financial performance of these operating segments based upon their underwriting results.
Underwriting results include earned premium less losses and LAE incurred, commission and brokerage expenses and other underwriting expenses. We measure our underwriting results using ratios, in particular loss, commission and brokerage and other underwriting expense ratios, which respectively, divide incurred losses, commissions and brokerage and other underwriting expenses by earned premium. We utilize inter-affiliate reinsurance, although such reinsurance does not materially impact segment results.
27
Our loss and LAE reserves represent our best estimate of our ultimate liability for unpaid claims. We re-evaluate our estimates on an ongoing basis, including re-estimates of prior period reserves, taking into consideration all available information and, in particular, recently reported loss and claim experience related to prior periods. Such re-evaluations are recorded in incurred losses in the period in which the re-evaluation is made.
The following discusses the underwriting results for each of our segments for the periods indicated:
U.S. Reinsurance
The following table presents the underwriting results and ratios for the U.S. Reinsurance segment for the three and six months ended June 30, 2007 and 2006.
Underwriting Results and Ratios
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------- --------------------------------------
(Dollars in thousands) 2007 2006 Variance %Change 2007 2006 Variance %Change
-------------------------------------- --------------------------------------
Gross written premiums $271,670 $262,018 $ 9,652 3.7% $626,022 $656,415 $(30,393) -4.6%
Net written premiums 271,566 260,396 11,170 4.3% 620,475 652,030 (31,555) -4.8%
Premiums earned $314,293 $258,759 $ 55,534 21.5% $667,534 $638,421 $ 29,113 4.6%
Incurred losses and LAE 110,169 175,790 (65,621) -37.3% 232,544 443,801 (211,257) -47.6%
Commission and brokerage 81,328 66,015 15,313 23.2% 157,602 163,511 (5,909) -3.6%
Other underwriting expenses 7,320 6,364 956 15.0% 13,814 11,140 2,674 24.0%
-------- -------- ------------------ -------- -------- ------------------
Underwriting gain $115,476 $ 10,590 $104,886 NM $263,574 $ 19,969 $243,605 NM
-------- -------- ------------------ -------- -------- ------------------
Point Chg Point Chg
--------- ---------
Loss ratio 35.1% 67.9% (32.8) 34.8% 69.5% (34.7)
Commission and brokerage ratio 25.9% 25.5% 0.4 23.6% 25.6% (2.0)
Other underwriting expense ratio 2.3% 2.5% (0.2) 2.1% 1.8% 0.3
-------- -------- --------- -------- -------- ---------
Combined ratio 63.3% 95.9% (32.6) 60.5% 96.9% (36.4)
-------- -------- --------- -------- -------- ---------
(NM, not meaningful)
Premiums. Gross written premiums increased 3.7% to $271.7 million for the three months ended June 30, 2007 from $262.0 million for the three months ended June 30, 2006, primarily due to an $82.0 million (101.7%) increase in written treaty property business, partially offset by a $57.0 million (44.8%) decrease in written treaty casualty business and a $15.7 million (29.1%) decrease in written facultative business. The increase in treaty property writings was the result of new quota share treaties. The more competitive environment for U.S. casualty business is resulting in reduced opportunities to write this business at what we deem to be adequate rates.
Net written premiums increased 4.3% to $271.6 million for the three months ended June 30, 2007 compared to $260.4 million for the three months ended June 30, 2006, primarily due to the $9.7 million increase in gross written premiums, discussed above, and a $1.5 million decrease in ceded premiums.
Net earned premiums increased 21.5% to $314.3 million for the three months ended June 30, 2007 compared to $258.8 million for the three months ended June 30, 2006. The greater growth in net earned premiums relative to net written premiums is the result of timing; premiums are earned ratably over the coverage period whereas written premiums are reflected at the initiation of the coverage period.
28
Incurred Losses and LAE. The following table presents the incurred losses and LAE for the U.S. Reinsurance segment for the three and six months ended June 30, 2007 and 2006.
Incurred Losses and LAE
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------------------- ---------------------------------------------------
2007 2006 2007 2006
-------------------------------------------------- ---------------------------------------------------
(Dollars in Current Prior Total Current Prior Total Current Prior Total Current Prior Total
millions) Year Years Incurred Year Years Incurred Year Years Incurred Year Years Incurred
------------------------ ------------------------ ------------------------- -------------------------
Attritional $ 139.0 $(36.5) $102.5 $112.4 $(26.3) $ 86.1 $298.5 $(63.3) $235.3 $328.1 $ 4.8 $332.9
Catastrophes - (8.8) (8.8) - 89.0 89.0 - (19.2) (19.2) - 109.7 109.7
A&E - 16.5 16.5 - 0.6 0.6 - 16.5 16.5 - 1.2 1.2
------------------------ ------------------------ ------------------------- -------------------------
Total segment $ 139.0 $(28.9) $110.2 $112.4 $ 63.4 $175.8 $298.5 $(66.0) $232.5 $328.1 $115.7 $443.8
------------------------ ------------------------ ------------------------- -------------------------
Loss Ratio 44.2% -9.2% 35.1% 43.5% 24.5% 67.9% 44.7% -9.9% 34.8% 51.4% 18.1% 69.5%
------------------------ ------------------------ ------------------------- -------------------------
(Some amounts may not reconcile due to rounding.)
Incurred losses and LAE decreased 37.3% to $110.2 million for the three months ended June 30, 2007, compared to $175.8 million for the three months ended June 30, 2006. The segment loss ratio for the three months ended June 30, 2007, improved by 32.8 points. Compared to the second quarter of 2006, the current accident year attritional loss ratio was little changed, at 44.2%. The largest factor driving the improvement in the reported loss ratio was unfavorable development in last year’s second quarter, principally caused by upward movement in the reserves for prior years’ catastrophe losses, which added 34.4 points to last year’s reported loss ratio compared to 2.8 points of favorable development in this year’s second quarter.
Segment Expenses. Underwriting expenses increased 22.5% to $88.6 million for the three months ended June 30, 2007 from $72.4 million for the three months ended June 30, 2006. Commission and brokerage increased by $15.3 million, principally due to increased earned premium volume. Segment other underwriting expenses for the three months ended June 30, 2007 increased to $7.3 million from $6.4 million for the three months ended June 30, 2006, also driven by the growth in earned premiums.
29
U.S. Insurance
The following table presents the underwriting results and ratios for the U.S. Insurance segment for the three and six months ended June 30, 2007 and 2006.
Underwriting Results and Ratios
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------- --------------------------------------
(Dollars in thousands) 2007 2006 Variance %Change 2007 2006 Variance %Change
-------------------------------------- --------------------------------------
Gross written premiums $161,637 $195,390 $(33,753) -17.3% $379,010 $413,396 $(34,386) -8.3%
Net written premiums 145,392 169,466 (24,074) -14.2% 342,777 358,939 (16,162) -4.5%
Premiums earned $178,080 $179,692 $ (1,612) -0.9% $371,053 $365,300 $ 5,753 1.6%
Incurred losses and LAE 125,251 121,644 3,607 3.0% 304,719 246,523 58,196 23.6%
Commission and brokerage 35,420 25,263 10,157 40.2% 68,636 54,997 13,639 24.8%
Other underwriting expenses 12,014 11,389 625 5.5% 24,379 22,094 2,285 10.3%
-------- -------- ------------------ -------- -------- ------------------
Underwriting gain (loss) $ 5,395 $ 21,396 $(16,001) -74.8% $(26,681) $ 41,686 $(68,367) -164.0%
-------- -------- ------------------ -------- -------- ------------------
Point Chg Point Chg
--------- ---------
Loss ratio 70.3% 67.7% 2.6 82.1% 67.5% 14.6
Commission and brokerage ratio 19.9% 14.1% 5.8 18.5% 15.1% 3.4
Other underwriting expense ratio 6.8% 6.3% 0.5 6.6% 6.0% 0.6
-------- -------- --------- -------- -------- ---------
Combined ratio 97.0% 88.1% 8.9 107.2% 88.6% 18.6
-------- -------- --------- -------- -------- ---------
Premiums. Gross written premiums decreased 17.3% to $161.6 million for the three months ended June 30, 2007 from $195.4 million for the three months ended June 30, 2006. The decrease is primarily the result of continued decline in our workers’ compensation writings in response to increased competition and lower rates.
Net written premiums decreased 14.2% to $145.4 million for the three months ended June 30, 2007 compared to $169.5 million for the three months ended June 30, 2006, primarily due to a $33.8 million decrease in gross written premiums and a $9.7 million decrease in ceded premiums, reflective of the change in program mix.
Net earned premiums decreased 0.9% to $178.1 million for the three months ended June 30, 2007 from $179.7 million for the three months ended June 30, 2006.
30
Incurred Losses and LAE. The following table presents the incurred losses and LAE for the U.S. Insurance segment for the three and six months ended June 30, 2007 and 2006.
Incurred Losses and LAE
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------------------- ---------------------------------------------------
2007 2006 2007 2006
-------------------------------------------------- ---------------------------------------------------
(Dollars in Current Prior Total Current Prior Total Current Prior Total Current Prior Total
millions) Year Years Incurred Year Years Incurred Year Years Incurred Year Years Incurred
------------------------ ------------------------ ------------------------- -------------------------
Attritional $130.3 $ (4.7) $125.6 $134.5 $(13.1) $121.4 $266.1 $ 39.0 $305.1 $270.4 $(24.5) $245.9
Catastrophes - (0.3) (0.3) - 0.2 0.2 - (0.4) (0.4) - 0.6 0.6
------------------------ ------------------------ ------------------------- -------------------------
Total segment $130.3 $ (5.0) $125.3 $134.5 $(12.9) $121.6 $266.1 $ 38.6 $304.7 $270.4 $(23.9) $246.5
------------------------ ------------------------ ------------------------- -------------------------
Loss Ratio 73.1% -2.8% 70.3% 74.9% -7.2% 67.7% 71.7% 10.4% 82.1% 74.0% -6.5% 67.5%
------------------------ ------------------------ ------------------------- -------------------------
(Some amounts may not reconcile due to rounding.)
Incurred losses and LAE increased 3.0% to $125.3 million for the three months ended June 30, 2007 from $121.6 million for the three months ended June 30, 2006, primarily because we experienced less favorable loss development on workers’ compensation reserves in this year’s second quarter.
Segment Expenses. Underwriting expenses increased 29.4% to $47.4 million for the three months ended June 30, 2007 from $36.7 million for the three months ended June 30, 2006. Commission and brokerage increased by $10.2 million for the three months ended June 30, 2007, principally due to an increase in profit commissions. Segment other underwriting expenses for the three months ended June 30, 2007 increased to $12.0 million as compared to $11.4 million for the three months ended June 30, 2006, primarily due to an increase in compensation costs associated with an increase in staff.
31
Specialty Underwriting
The following table presents the underwriting results and ratios for the Specialty Underwriting segment for the three and six months ended June 30, 2007 and 2006.
Underwriting Results and Ratios
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------- --------------------------------------
(Dollars in thousands) 2007 2006 Variance %Change 2007 2006 Variance %Change
-------------------------------------- --------------------------------------
Gross written premiums $ 76,377 $ 53,087 $ 23,290 43.9% $131,058 $117,113 $ 13,945 11.9%
Net written premiums 75,852 50,166 25,686 51.2% 129,128 113,798 15,330 13.5%
Premiums earned $ 77,111 $ 49,890 $ 27,221 54.6% $132,842 $118,090 $ 14,752 12.5%
Incurred losses and LAE 54,620 10,994 43,626 396.8% 95,749 81,571 14,178 17.4%
Commission and brokerage 15,432 13,314 2,118 15.9% 31,272 33,498 (2,226) -6.6%
Other underwriting expenses 1,775 1,637 138 8.4% 3,364 2,942 422 14.3%
-------- -------- ------------------ -------- -------- ------------------
Underwriting gain $ 5,284 $ 23,945 $(18,661) -77.9% $ 2,457 $ 79 $ 2,378 NM
-------- -------- ------------------ -------- -------- ------------------
Point Chg Point Chg
--------- ---------
Loss ratio 70.8% 22.0% 48.8 72.1% 69.1% 3.0
Commission and brokerage ratio 20.0% 26.7% (6.7) 23.6% 28.3% (4.7)
Other underwriting expense ratio 2.3% 3.3% (1.0) 2.5% 2.5% 0.0
-------- -------- --------- -------- -------- ---------
Combined ratio 93.1% 52.0% 41.1 98.2% 99.9% (1.7)
-------- -------- --------- -------- -------- ---------
(NM, not meaningful)
Premiums. Gross written premiums increased 43.9% to $76.4 million for the three months ended June 30, 2007 from $53.1 million for the three months ended June 30, 2006. Contributing to this growth was an increase of $22.5 million (117.1%) in marine writings and $7.5 million (39.6%) in accident and health writings, partially offset by a $6.8 million (45.6%) decrease in surety writings. The marine premium growth emanated from increases on existing quota share business as well as new quota share business. We continue to decrease our surety writings, in response to much tougher market conditions.
Net written premiums increased 51.2% to $75.9 million for the three months ended June 30, 2007 compared to $50.2 million for the three months ended June 30, 2006, due to the $23.3 million increase in gross written premiums and the $2.4 million decrease in ceded premiums.
Net earned premiums increased 54.6% to $77.1 million for the three months ended June 30, 2007 compared to $49.9 million for the three months ended June 30, 2006, due to a $21.5 million (109.6%) increase in marine and aviation business and $9.9 million (58.4%) in A&H business, partially offset by $4.1 million (30.5%) decrease in surety business.
32
Incurred Losses and LAE. The following table presents the incurred losses and LAE for the Specialty Underwriting segment for the three and six months ended June 30, 2007 and 2006.
Incurred Losses and LAE
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------------------- ---------------------------------------------------
2007 2006 2007 2006
-------------------------------------------------- ---------------------------------------------------
(Dollars in Current Prior Total Current Prior Total Current Prior Total Current Prior Total
millions) Year Years Incurred Year Years Incurred Year Years Incurred Year Years Incurred
------------------------ ------------------------ ------------------------- -------------------------
Attritional $ 42.8 $ 3.6 $ 46.4 $ 29.8 $(20.5) 9.3 $ 75.1 $ 3.6 $ 78.7 $ 71.8 $(23.1) $ 48.7
Catastrophes - 8.3 8.3 - 1.7 1.7 - 17.1 17.1 - 32.9 32.9
------------------------ ------------------------ ------------------------- -------------------------
Total segment $ 42.8 $ 11.8 $ 54.6 $ 29.8 $(18.8) $ 11.0 $ 75.1 $ 20.6 $ 95.7 $ 71.8 $ 9.8 $ 81.6
------------------------ ------------------------ ------------------------- -------------------------
Loss Ratio 55.5% 15.4% 70.8% 59.7% -37.7% 22.0% 56.5% 15.5% 72.1% 60.8% 8.3% 69.1%
------------------------ ------------------------ ------------------------- -------------------------
(Some amounts may not reconcile due to rounding.)
Incurred losses and LAE increased to $54.6 million for the three months ended June 30, 2007, compared to $11.0 million for the three months ended June 30, 2006. The current accident year loss ratio was slightly lower in the second quarter 2007 compared to 2006. During last year’s second quarter, we experienced $20.5 million of favorable loss development, principally in the marine, aviation and A&H lines. However, during this year’s second quarter, we incurred $11.8 million of unfavorable development, most of which emanated from the 2005 catastrophes in the marine line.
Segment Expenses. Underwriting expenses increased 15.1% to $17.2 million for the three months ended June 30, 2007 from $15.0 million for the three months ended June 30, 2006. Commission and brokerage increased by $2.1 million for the three months ended June 30, 2007, respectively, principally due to the increase in premium volume and the direct expenses associated with that volume.
33
International
The following table presents the underwriting results and ratios for the International segment for the three and six months ended June 30, 2007 and 2006.
Underwriting Results and Ratios
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------- --------------------------------------
(Dollars in thousands) 2007 2006 Variance %Change 2007 2006 Variance %Change
-------------------------------------- --------------------------------------
Gross written premiums $202,626 $179,835 $ 22,791 12.7% $375,970 $355,357 $ 20,613 5.8%
Net written premiums 202,621 179,597 23,024 12.8% 376,498 355,216 21,282 6.0%
Premiums earned $208,895 $181,535 $ 27,360 15.1% $388,653 $355,842 $ 32,811 9.2%
Incurred losses and LAE 162,432 94,385 68,047 72.1% 258,143 212,642 45,501 21.4%
Commission and brokerage 53,052 46,088 6,964 15.1% 96,589 86,876 9,713 11.2%
Other underwriting expenses 4,332 3,685 647 17.6% 8,050 6,363 1,687 26.5%
-------- -------- ------------------ -------- -------- ------------------
Underwriting (loss) gain $(10,921) $ 37,377 $(48,298) -129.2% $ 25,871 $ 49,961 $(24,090) -48.2%
-------- -------- ------------------ -------- -------- ------------------
Point Chg Point Chg
--------- ---------
Loss ratio 77.8% 52.0% 25.8 66.4% 59.8% 6.6
Commission and brokerage ratio 25.4% 25.4% 0.0 24.9% 24.4% 0.5
Other underwriting expense ratio 2.0% 2.0% 0.0 2.0% 1.8% 0.2
-------- -------- --------- -------- -------- ---------
Combined ratio 105.2% 79.4% 25.8 93.3% 86.0% 7.3
-------- -------- --------- -------- -------- ---------
Premiums. Gross written premiums increased 12.7% to $202.6 million for the three months ended June 30, 2007 from $179.8 million for the three months ended June 30, 2006. Business written through the Miami and New Jersey offices increased $18.2 million (17.7%), in the Asian branch premiums increased $3.7 million (8.9%) and in the Canadian branch premiums increased $1.2 million (3.4%). We have seen more business opportunities in the international market as a result of industry consolidation and some competitors’ financial ratings downgrades.
Net written premiums increased 12.8% to $202.6 million for the three months ended June 30, 2007 compared to $179.6 million for the three months ended June 30, 2006, primarily due to the increase in gross written premiums.
Net earned premiums increased 15.1% to $208.9 million for the three months ended June 30, 2007 compared to $181.5 million for the three months ended June 30, 2006. This increase is consistent with the increase in net written premiums.
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Incurred Losses and LAE. The following table presents the incurred losses and LAE for the International segment for the three and six months ended June 30, 2007 and 2006.
Incurred Losses and LAE
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------------------- ---------------------------------------------------
2007 2006 2007 2006
-------------------------------------------------- ---------------------------------------------------
(Dollars in Current Prior Total Current Prior Total Current Prior Total Current Prior Total
millions) Year Years Incurred Year Years Incurred Year Years Incurred Year Years Incurred
------------------------ ------------------------ ------------------------- -------------------------
Attritional $110.3 $ 5.6 $115.8 $ 89.3 $ (2.9) $ 86.3 $208.3 $ (4.4) $203.9 $183.6 $ 5.6 $189.2
Catastrophes 44.3 2.3 46.6 5.4 2.6 8.0 50.0 4.3 54.3 5.4 18.0 23.4
------------------------ ------------------------ ------------------------- -------------------------
Total segment $154.6 $ 7.9 $162.4 $ 94.7 $ (0.3) $ 94.4 $258.2 $ (0.1) $258.1 $189.0 $ 23.6 $212.6
------------------------ ------------------------ ------------------------- -------------------------
Loss Ratio 74.0% 3.8% 77.8% 52.2% -0.2% 52.0% 66.4% 0.0% 66.4% 53.1% 6.6% 59.8%
------------------------ ------------------------ ------------------------- -------------------------
(Some amounts may not reconcile due to rounding.)
Incurred losses and LAE increased 72.1% to $162.4 million for the three months ended June 30, 2007, compared to $94.4 million for the three months ended June 30, 2006. The segment loss ratio increased by 25.8 points, due to increased catastrophe loss, principally emanating from Australia and Jakarta. As well, we incurred $7.9 million of unfavorable development, primarily on our loss reserves for Asian and Canadian business.
Segment Expenses. Underwriting expenses increased 15.3% to $57.4 million for the three months ended June 30, 2007 from $49.8 million for the three months ended June 30, 2006. Commission and brokerage increased by $7.0 million for the three months ended June 30, 2007, in line with the increase in premiums. Segment other underwriting expenses for the three months ended June 30, 2007 increased to $4.3 million compared to $3.7 million for the three months ended June 30, 2006, also in line with the growth in premium.
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Bermuda
The following table presents the underwriting results, ratios and incurred losses and LAE for the Bermuda segment for the three and six months ended June 30, 2007 and 2006.
Underwriting Results and Ratios
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------- --------------------------------------
(Dollars in thousands) 2007 2006 Variance %Change 2007 2006 Variance %Change
-------------------------------------- --------------------------------------
Gross written premiums $223,153 $220,043 $ 3,110 1.4% $440,170 $423,111 $ 17,059 4.0%
Net written premiums 223,105 220,348 2,757 1.3% 439,535 422,328 17,207 4.1%
Premiums earned $220,941 $223,456 $ (2,515) -1.1% $443,967 $437,469 $ 6,498 1.5%
Incurred losses and LAE 166,642 140,824 25,818 18.3% 293,727 258,043 35,684 13.8%
Commission and brokerage 49,191 55,723 (6,532) -11.7% 105,979 105,023 956 0.9%
Other underwriting expenses 4,299 3,798 501 13.2% 9,187 7,511 1,676 22.3%
-------- -------- ------------------ -------- -------- ------------------
Underwriting gain $ 809 $ 23,111 $(22,302) -96.5% $ 35,074 $ 66,892 $(31,818) -47.6%
-------- -------- ------------------ -------- -------- ------------------
Point Chg Point Chg
--------- ---------
Loss ratio 75.4% 63.0% 12.4 66.2% 59.0% 7.2
Commission and brokerage ratio 22.3% 25.0% (2.7) 23.8% 24.0% (0.2)
Other underwriting expense ratio 1.9% 1.7% 0.2 2.1% 1.7% 0.4
-------- -------- --------- -------- -------- ---------
Combined ratio 99.6% 89.7% 9.9 92.1% 84.7% 7.4
-------- -------- --------- -------- -------- ---------
Premiums. Gross written premiums increased 1.4% to $223.2 million for the three months ended June 30, 2007 compared to $220.0 million for the three months ended June 30, 2006. Premiums written from the Bermuda office increased 17.4%, primarily driven by treaty business, while premiums written from the UK office decreased.
Net written premiums increased 1.3% to $223.1 million for the three months ended June 30, 2007 compared to $220.3 million for the three months ended June 30, 2006, due to $3.1 million increase in gross written premiums and the $0.4 million increase in ceded premiums.
Net earned premiums decreased 1.1% to $220.9 million for the three months ended June 30, 2007 compared to $223.5 million for the three months ended June 30, 2006. The decline in premiums earned compared to net written premiums is primarily due to the inherent time difference in the earning of premiums over specific contract periods.
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Incurred Losses and LAE. The following table presents the incurred losses and LAE for the Bermuda segment for the three and six months ended June 30, 2007 and 2006.
Incurred Losses and LAE
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------------------- ---------------------------------------------------
2007 2006 2007 2006
-------------------------------------------------- ---------------------------------------------------
(Dollars in Current Prior Total Current Prior Total Current Prior Total Current Prior Total
millions) Year Years Incurred Year Years Incurred Year Years Incurred Year Years Incurred
------------------------ ------------------------ ------------------------- -------------------------
Attritional $115.8 $ (5.3) $110.5 $136.3 $ (2.0) $134.3 $229.8 $(20.2) $209.6 $266.9 $(24.4) $242.5
Catastrophes 34.3 0.3 34.6 - 0.8 0.8 62.5 0.1 62.6 - 1.6 1.6
A&E - 21.5 21.5 - 5.8 5.8 - 21.5 21.5 - 13.9 13.9
------------------------ ------------------------ ------------------------- -------------------------
Total segment $150.1 $ 16.5 $166.6 $136.3 $ 4.5 $140.8 $292.3 $ 1.4 $293.7 $266.9 $ (8.9) $258.0
------------------------ ------------------------ ------------------------- -------------------------
Loss Ratio 67.9% 7.5% 75.4% 61.0% 2.0% 63.0% 65.8% 0.3% 66.2% 61.0% -2.0% 59.0%
------------------------ ------------------------ ------------------------- -------------------------
(Some amounts may not reconcile due to rounding.)
Incurred losses and LAE increased 18.3% to $166.6 million for the three months ended June 30, 2007 compared to $140.8 million for the three months ended June 30, 2006. The segment loss ratio for Bermuda increased by 12.4 points, reflecting a 15.5 point increase in current year catastrophe losses, principally due to the winter storm Kyrill and the London floods, as well as 7.2 points due to reserve strengthening for asbestos and environmental losses, partially offset by a 10.1 point decrease in attritional losses.
Segment Expenses. Underwriting expenses decreased 10.1% to $53.5 million for the three months ended June 30, 2007 from $59.5 million for the three months ended June 30, 2006. Commission and brokerage decreased by $6.5 million for the three months ended June 30, 2007, principally due to decreases in premiums earned and changes in the mix of business. Segment other underwriting expenses for the three months ended June 30, 2007 increased to $4.3 million compared to $3.8 million for the three months ended June 30, 2006.
FINANCIAL CONDITION
Cash and Invested Assets. Aggregate invested assets, including cash and short-term investments, were $14,407.7 million at June 30, 2007 and $13,957.1 million at December 31, 2006. This increase in cash and invested assets resulted primarily from $395.4 million of net proceeds, net of $0.2 million of expenses, from the long term debt issuance, $262.7 million in cash flows from operations and $133.6 million of realized capital gains on FAS 159 equity securities, partially offset by the repurchase in the open market of 2.1 million shares for $200.1 million, $159.1 million of unrealized depreciation, primarily on fixed maturities as a result of rising interest rates and the payment of $61.0 million in dividends to shareholders.
Our principal investment objectives are to ensure funds are available to meet our insurance and reinsurance obligations and to maximize after-tax investment income while maintaining a high quality diversified investment portfolio. Considering these objectives, we view our investment portfolio as having two components; 1) the investments needed to satisfy outstanding liabilities and 2) investments funded by our shareholders’ equity.
For amounts deemed to be required to pay outstanding liabilities, we invest in taxable and tax-preferenced fixed income securities with an average credit quality of Aa, as rated by Moody’s Investors Service, Inc. (“Moody’s”). We adjust the mix of taxable and tax-preferenced investments periodically taking into account relative after-tax yields, current and projected operating results, market conditions and our tax position. The fixed maturity portfolio is externally managed by an independent, professional investment manager using portfolio guidelines developed and approved by us.
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Our fixed maturity portfolio at June 30, 2007 includes only $31.3 million of asset backed securities that have collateral with sub-prime mortgage loan exposure. Sub-prime mortgage loans generally represent loans made to borrowers with limited or blemished credit records. Nearly 100% of our asset backed securities with sub-prime exposure are investment grade and the market value of these investments at June 30, 2007 was $31.1 million. As of July 31, 2007, the book value of this portfolio declined to $30.5 million as a result of normal principal paydowns and the market value of this portfolio was $30.3 million.
Over the past few years, we have reallocated a portion of our investment portfolio to include 1) publicly traded equity securities (primarily exchange traded funds in 2006) and 2) private equity limited partnership investments. The objective of this portfolio diversification is to enhance the risk-adjusted total return of the investment portfolio by allocating a prudent portion of the portfolio to higher return asset classes. We have limited our allocation to these asset classes because of 1) the potential for volatility in their values and 2) the impact of these investment classes on required capital as measured by regulatory and rating agency capital models. At June 30, 2007, the value of investments in equity and limited partnership securities approximated 40% of shareholders’ equity.
The tables below summarize the composition and characteristics of our investment portfolio for the periods indicated:
As of As of
June 30, 2007 December 31, 2006
--------------------- ---------------------
Fixed maturities $ 9,624.9 66.8% $10,319.8 73.9%
Equity securities, market value 16.4 0.1% 1,613.7 11.6%
Equity securities, fair value 1,551.2 10.8% - -
Short-term investments 2,436.7 16.9% 1,306.5 9.4%
Other invested assets 590.7 4.1% 467.2 3.3%
Cash 187.8 1.3% 249.9 1.8%
--------------------- ---------------------
Total investments and cash $14,407.7 100.0% $13,957.1 100.0%
--------------------- ---------------------
As of As of
June 30, 2007 December 31, 2006
--------------------- ---------------------
Fixed income portfolio duration 3.8 years 4.1 years
Fixed income composite credit quality Aa2 Aa2
Imbedded end of period yield, pre-tax 4.6% 4.6%
Imbedded end of period yield, after-tax 3.9% 4.0%
The increase in other invested assets reflects routine funding of previous limited partnership commitments and an increase in undistributed earnings. We adopted and implemented the Statement of Financial Accounting Standards (“FAS”) No. 157 “Fair Value Measurements” (“FAS 157”) and FAS No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities — including an amendment to FASB statement No. 115” (“FAS 159”) for our publicly traded equity securities and as such, $250.8 million, which is net of $110.3 million of tax, was recorded as a cumulative-effect adjustment to retained earnings and a $109.8 million realized gain due to fair value remeasurement was recorded in the consolidated statements of operations and comprehensive income for the six months ended June 30, 2007.
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The following table provides a comparison of our total return by asset class to broadly accepted industry benchmarks for the periods indicated:
Six Months Ended Twelve Months Ended
June 30, 2007 December 31, 2006
--------------------- ---------------------
Company's fixed income portfolio total return 1.1% 4.6%
Lehman bond aggregate index 0.5% 4.3%
Company's common equity portfolio total return 10.5% 19.2%
S & P 500 index 7.0% 15.8%
Company's other invested asset portfolio total return 9.2% 19.8%
Reinsurance Receivables. Reinsurance receivables for both paid and unpaid losses were $724.2 million at June 30, 2007, a 6.3% decrease from the $772.8 million at December 31, 2006. At June 30, 2007, $173.5 million, or 24.0%, was receivable from Transatlantic Reinsurance Company (“Transatlantic”); $163.7 million, or 22.6%, was receivable from Founders Insurance Company Limited (“Founders”), which we have established a $131.1 million provision for uncollectible reinsurance with the balance collateralized by a trust; $100.0 million, or 13.8%, was receivable from Continental Insurance Company (“Continental”), which is partially collateralized by funds held arrangements; $72.0 million, or 9.9%, was receivable from LM Property and Casualty Insurance Company (“LM”), whose obligations are guaranteed by The Prudential Insurance Company of America (“The Prudential”); $49.9 million, or 6.9%, was receivable from Munich Reinsurance Company (“Munich Re”) and $38.4 million, or 5.3%, was receivable from Ace Property and Casualty Insurance Company (“Ace”). Continental is collateralized by a funds held arrangement under which the Company has retained the premium amounts otherwise due the retrocessionaire, recognized liabilities for such amounts and reduced such otherwise due liabilities as amounts became due from the retrocessionaire. No other retrocessionaire accounted for more than 5% of our receivables.
Loss and LAE Reserves. Gross loss and LAE reserves totaled $8,743.8 million at June 30, 2007 and $8,840.1 million at December 31, 2006. The decrease during the six months ended June 30, 2007 is primarily attributable to the payout of prior years’ catastrophe losses. Net prior period reserve adjustments and normal variability in claim settlements also impacted the period over period change.
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The following tables summarize gross outstanding loss and LAE reserves by segment, segregated into case reserves and incurred but not reported loss (“IBNR”) reserves which are managed on a combined basis for the periods indicated:
Gross Reserves By Segment
As of June 30, 2007
------------------------------------------------------
Case IBNR Total % of
(Dollars in thousands) Reserves Reserves Reserves Total
------------------------------------------------------
U.S. Reinsurance $ 1,475,173 $ 2,000,339 $ 3,475,512 39.8%
U.S. Insurance 573,448 1,072,762 1,646,210 18.8%
Specialty Underwriting 289,257 158,810 448,067 5.1%
International 557,682 458,109 1,015,791 11.6%
Bermuda 738,060 782,305 1,520,365 17.4%
------------------------------------------------------
Total excluding A&E 3,633,620 4,472,325 8,105,945 92.7%
A&E 484,996 152,892 637,888 7.3%
------------------------------------------------------
Total including A&E $ 4,118,616 $ 4,625,217 $ 8,743,833 100.0%
------------------------------------------------------
As of December 31, 2006
------------------------------------------------------
Case IBNR Total % of
(Dollars in thousands) Reserves Reserves Reserves Total
------------------------------------------------------
U.S. Reinsurance $ 1,641,661 $ 2,061,722 $ 3,703,383 41.9%
U.S. Insurance 591,384 1,010,998 1,602,382 18.1%
Specialty Underwriting 338,719 145,646 484,365 5.5%
International 535,135 380,208 915,343 10.3%
Bermuda 817,536 666,997 1,484,533 16.8%
------------------------------------------------------
Total excluding A&E 3,924,435 4,265,571 8,190,006 92.6%
A&E 501,387 148,747 650,134 7.4%
------------------------------------------------------
Total including A&E $ 4,425,822 $ 4,414,318 $ 8,840,140 100.0%
------------------------------------------------------
The changes by segment generally reflect changes in earned premium, changes in business mix, the impact of reserve re-estimations and changes in catastrophe loss reserves, together with claim settlement activity. The fluctuations for A&E reflect claim settlement activity.
Our loss and LAE reserves represent our best estimate of our ultimate liability for unpaid claims. We re-evaluate our estimates on an ongoing basis, and we re-estimate prior period reserves, taking into consideration all available information, in particular, recently reported loss and claim experience related to prior periods. We record the effect of such re-evaluations in incurred losses for the current period. We note that our analytical methods and processes operate at multiple levels including individual contracts, groupings of like contracts, classes and lines of business, internal business units, segments, legal entities, and in the aggregate. The complexities of our business and operations require analyses and adjustments, both qualitative and quantitative, at these various levels. Additionally, the attribution of reserves, change in reserves and incurred losses between accident year and underwriting year requires adjustments and allocations, both qualitative and quantitative, at these various levels. All of these processes, methods and practices appropriately balance actuarial science, business expertise and management judgment in a manner intended to assure the accuracy, precision and consistency of our reserving practices, which are fundamental to our operations. We note however, that the underlying reserves are estimates, which are subject to variation.
There can be no assurance that reserves for, and losses from, claim obligations will not increase in the future, possibly by a material amount. However, management believes that our existing reserves and reserving
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methodologies lessen the probability that any such increase would have a material adverse effect on our financial condition, results of operations or cash flows. In this context, we note that over the past 10 years, our past calendar year operations have been affected variably by effects from prior period reserve re-estimates, with such effects ranging from a favorable $62.1 million in 1997, representing 2.2% of the net prior period reserves for the year in which the adjustment was made, to an unfavorable $249.4 million in 2004, representing 3.7% of the net prior period reserves for the year in which the adjustment was made. We have noted that variability had increased for years 1999 to 2003 and have taken actions to attempt to reduce year to year variability prospectively. Our Annual Report on Form 10-K for the year ended December 31, 2006 discusses our past experience more fully in Part I, Item 1, “Changes in Historical Reserves”.
Asbestos and Environmental Exposures. We continue to receive claims under expired contracts, both insurance and reinsurance, asserting alleged injuries and/or damages relating to or resulting from environmental pollution and hazardous substances, including asbestos. Our environmental claims typically involve potential liability for (a) the mitigation or remediation of environmental contamination or (b) bodily injury or property damages caused by the release of hazardous substances into the land, air or water. Our asbestos claims typically involve potential liability for bodily injury from exposure to asbestos or for property damage resulting from asbestos or products containing asbestos.
Our reserves include an estimate of our ultimate liability for A&E claims. This estimate is made based on judgmental assessment of the underlying exposures as the result of: (1) long and variable reporting delays, both from insureds to insurance companies and from ceding companies to reinsurers; (2) historical data, which is more limited and variable on A&E losses than historical information on other types of casualty claims; and (3) unique aspects of A&E exposures for which ultimate value cannot be estimated using traditional reserving techniques. There are significant uncertainties in estimating the amount of our potential losses from A&E claims. Among the uncertainties are: (a) potentially long waiting periods between exposure and manifestation of any bodily injury or property damage; (b) difficulty in identifying sources of asbestos or environmental contamination; (c) difficulty in properly allocating responsibility and/or liability for asbestos or environmental damage; (d) changes in underlying laws and judicial interpretation of those laws; (e) the potential for an asbestos or environmental claim to involve many insurance providers over many policy periods; (f) questions concerning interpretation and application of insurance and reinsurance coverage; and (g) uncertainty regarding the number and identity of insureds with potential asbestos or environmental exposure.
With respect to asbestos claims in particular, several additional factors have emerged in recent years that further compound the difficulty in estimating our liability. These developments include: (a) continued growth in the number of claims filed, in part reflecting a much more aggressive plaintiff bar and including claims against defendants who may only have a “peripheral” connection to asbestos; (b) a disproportionate percentage of claims filed by individuals with no functional injury, which should have little to no financial value but that have increasingly been considered in jury verdicts and settlements; (c) the growth in the number and significance of bankruptcy filings by companies as a result of asbestos claims (including, more recently, bankruptcy filings in which companies attempt to resolve their asbestos liabilities in a manner that is prejudicial to insurers and forecloses insurers from participating in the negotiation of asbestos related bankruptcy reorganization plans); (d) the concentration of claims in a small number of states that favor plaintiffs; (e) the growth in the number of claims that might impact the general liability portion of insurance policies rather than the product liability portion; (f) measures adopted by specific courts to ameliorate the worst procedural abuses; (g) an increase in settlement values being paid to asbestos claimants, especially those with cancer or functional impairment; (h) legislation in some states to address asbestos litigation issues; and (i) the potential that other states or the U.S. Congress may adopt legislation on asbestos litigation. Anecdotal evidence suggests that new claims filing rates have decreased, that new filings of asbestos-driven bankruptcies have decreased and that various procedural and legislative reforms are beginning to diminish the potential ultimate liability for asbestos losses.
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We believe that these uncertainties and factors continue to render reserves for A&E and particularly asbestos losses significantly less subject to traditional actuarial analysis than reserves for other types of losses. Given these uncertainties, we believe that no meaningful range for such ultimate losses can be established. We establish reserves to the extent that, in the judgment of management, the facts and prevailing law reflect an exposure for us or our ceding companies. Our A&E liabilities stem from Mt. McKinley’s direct insurance business and Everest Re’s assumed reinsurance business.
In connection with the acquisition of Mt. McKinley, which has significant exposure to A&E claims, LM provided reinsurance to Mt. McKinley covering 80% ($160.0 million) of the first $200.0 million of any adverse development of Mt. McKinley’s reserves as of September 19, 2000 and The Prudential guaranteed LM’s obligations to Mt. McKinley. Cessions under this reinsurance agreement exhausted the limit available under the contract at December 31, 2003.
Due to the uncertainties discussed above, the ultimate losses attributable to A&E, and particularly asbestos, may be subject to more variability than are non-A&E reserves and such variation could have a material adverse effect on our financial condition, results of operations and/or cash flows.
With respect to Mt. McKinley, where we have a direct relationship with policyholders, our aggressive litigation posture and the uncertainties inherent in the asbestos coverage and bankruptcy litigation have provided an opportunity to actively engage in settlement negotiations with a number of those policyholders who have potentially significant asbestos liabilities. Those discussions are oriented towards achieving reasonable negotiated settlements that limit Mt. McKinley’s liability to a given policyholder to a sum certain. Because of uncertainties and risks inherent in litigation, we cannot be certain that in every instance this approach will lead to negotiated settlements in the range expected by us. Since 2004, we concluded such settlements or reached agreement in principle with 14 of our high profile policyholders. We currently have identified 8 policyholders based on their past claim activity and/or potential future liabilities as “High Profile Policyholders” and our settlement efforts are generally directed at such policyholders, in part because their exposures have developed to the point where both the policyholder and us have sufficient information to be motivated to settle. We believe that this active approach will ultimately result in a more cost-effective liquidation of Mt. McKinley’s liabilities than a passive approach, although it may also introduce additional variability in Mt. McKinley’s losses and cash flows as reserves are adjusted to reflect the development in litigation, negotiations and, ultimately, potential settlements.
There is less potential for similar settlements with respect to our reinsurance asbestos claims. Ceding companies, with their direct obligation to insureds and overall responsibility for claim settlements, are not consistently aggressive in developing claim settlement information and conveying this information to reinsurers, which can introduce significant and perhaps inappropriate delays in the reporting of asbestos claims/exposures to reinsurers. These delays not only extend the timing of reinsurance claim settlements, but also restrict the information available to estimate the reinsurers’ ultimate exposure. At June 30, 2007 we had gross asbestos loss reserves of $570.4 million, of which $310.1 million was for assumed business and $260.3 million was for direct excess business.
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The following table summarizes incurred losses with respect to A&E on both a gross and net of retrocessional basis for the periods indicated:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ ------------------------
(Dollars in thousands) 2007 2006 2007 2006
------------------------ ------------------------
Gross basis:
Beginning of period reserves $ 632,239 $ 639,635 $ 650,134 $ 649,460
Incurred losses 40,000 6,400 40,000 16,400
Paid losses (34,351) (26,156) (52,246) (45,981)
----------- ----------- ----------- -----------
End of period reserves $ 637,888 $ 619,879 $ 637,888 $ 619,879
----------- ----------- ----------- -----------
Net basis:
Beginning of period reserves $ 517,910 $ 461,235 $ 511,412 $ 450,350
Incurred losses 38,019 6,400 38,019 15,125
Paid losses (26,909) (27,620) (20,411) (25,460)
----------- ----------- ----------- -----------
End of period reserves $ 529,020 $ 440,015 $ 529,020 $ 440,015
----------- ----------- ----------- -----------
At June 30, 2007, the gross reserves for A&E losses were comprised of $132.6 million representing case reserves reported by ceding companies, $143.0 million representing additional case reserves established by us on assumed reinsurance claims, $209.4 million representing case reserves established by us on direct excess insurance claims, including Mt. McKinley, and $152.9 million representing IBNR reserves.
The gross incurred losses for A&E exposures increased by $40.0 million and $6.4 million for the three months ended June 30, 2007 and 2006, respectively, and $40.0 million and $16.4 million for the six months ended June 30, 2007 and 2006, respectively. These increases are the result of re-evaluations by management reflecting additional information received from insureds and ceding companies, ongoing litigation, additional claims received and settlement activity. We closely monitor this additional information and adjust reserves accordingly.
Industry analysts have developed a measurement, known as the survival ratio, to compare the A&E reserves among companies with such liabilities. The survival ratio is typically calculated by dividing a company’s current net reserves by the three year average of paid losses, and therefore measures the number of years that it would take to exhaust the current reserves based on historical payment patterns. Using this measurement, our net three year A&E survival ratio was 4.6 years at June 30, 2007. Adjusting for the effect of the reinsurance ceded under the reinsurance agreement with LM, this ratio rises to the equivalent of 5.2 years at June 30, 2007. The cession of $72.0 million to the stop loss reinsurance provided by LM in connection with the acquisition of Mt. McKinley results in unpaid proceeds that are not reflected in past net payments and effectively extend the funding available for future net payments.
Because the survival ratio was developed as a comparative measure of reserve strength and not of absolute reserve adequacy, we consider, but do not rely on, the survival ratio when evaluating its reserves. In particular, we note that loss payout variability, which can be material, due in part to our orientation to negotiated settlements, particularly on our Mt. McKinley exposures, significantly impairs the credibility and utility of this measure as an analytical tool.
Our net three year survival ratio on our asbestos exposures was 4.4 years for the period ended June 30, 2007. This three year survival ratio, when adjusted for the effect of the reinsurance ceded under the stop loss cover from LM, was 5.1 years and, when adjusted for settlements in place and structured settlements, which are either fully funded by reserves or subject to financial terms that substantially limit the potential variability in the liability, and the stop loss protection from LM, was 7.2 years.
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Shareholders’ Equity. Our shareholders’ equity increased to $5,337.9 million as of June 30, 2007 from $5,107.7 million as of December 31, 2006, principally due to $580.5 million of net income for the six months ended June 30, 2007 and a $20.7 million increase in net share-based compensation activity, partially offset by the repurchase of 2.1 million common shares for $200.1 million, $61.0 million of shareholder dividends and a net decrease of $109.8 million in accumulated other comprehensive income due to unrealized losses on securities, partially offset by currency translation gains.
LIQUIDITY AND CAPITAL RESOURCES
Capital. Our business operations are in part dependent on our financial strength, and the market’s perception thereof as measured by our shareholders’ equity noted above. We possess significant financial flexibility and access to the debt and equity markets as a result of its perceived financial strength, as evidence by the financial strength ratings as assigned by independent rating agencies. We continuously monitor our capital and financial position, as well as investment and security market conditions and responds accordingly.
From time to time, we have used open market share repurchases to effectively adjust our capital position. During the six months ended June 30, 2007, 2.1 million of our common shares were repurchased by Holdings at a cost of $200.1 million. At June 30, 2007, 2.9 million shares remained under the existing repurchase authorization.
On December 1, 2005 we filed a shelf registration statement on Form S-3ASR with the Securities and Exchange Commission (“SEC”), as a Well Known Seasoned Issuer under the new registration and offering revision to the Securities Act of 1933. Generally, under this shelf registration statement, Group is authorized to issue common shares, preferred shares, debt securities, warrants and hybrid securities, Holdings is authorized to issue debt securities and Everest Re Capital Trust III (“Capital Trust III”) is authorized to issue trust preferred securities.
| • | On December 1, 2005, we issued 2,298,000 of its common shares at a price of $102.89 per share, which resulted in $236.4 million of proceeds before expenses and Holdings sold Group shares it acquired in 2002 at a price of $102.89 per share, which resulted in $46.5 million of proceeds before expenses. Expenses incurred for this transaction were approximately $0.3 million. |
| • | On April 26, 2007, Holdings completed a public offering of $400.0 million principal amount of 6.6% fixed to floating rate long term subordinated notes with a scheduled maturity of May 15, 2037 and a final maturity of May 1, 2067. The net proceeds from the offering are expected to be used to redeem all of the outstanding 7.85% junior subordinated debt securities as soon as possible after November 14, 2007 and for general corporate purposes. |
Liquidity. The increase in other invested assets reflects routine funding of previous limited partnership commitments and an increase in undistributed earnings. We adopted and implemented FAS 157 and FAS 159, for our publicly traded equity securities and as such, $250.8 million net of $110.3 million of tax was recorded as a cumulative-effect adjustment to retained earnings and a $109.8 million realized gain due to fair value remeasurement was recorded in the consolidated statements of operations and comprehensive income.
For amounts deemed to be required to pay outstanding liabilities, we invest in taxable and tax-preferenced fixed income securities with an average credit quality of Aa, as rated by the independent investment rating service of Moody’s. Our mix of taxable and tax-preferenced investments is adjusted periodically, consistent with our current and projected operating results, market interest rates and our tax position. This fixed maturity portfolio is externally managed by an independent, professional investment manager using portfolio guidelines developed and approved by us.
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Over the past few years, we have reallocated a portion of our investment portfolio to include 1) publicly traded equity securities (primarily exchange traded funds in 2006) and 2) private equity limited partnership investments. The objective of this portfolio diversification is to enhance the risk-adjusted total return of the investment portfolio by allocating a prudent portion of the portfolio to higher return asset classes. We have limited our allocation to these asset classes because 1) the potential for volatility in their values and 2) the impact of these investments on regulatory and rating agency capital adequacy models. At June 30, 2007, the market value of investments in equity and limited partnership securities approximated 40% of shareholders’ equity.
Our liquidity requirements are generally met from positive cash flow from operations. Positive cash flow results from net income and from reinsurance and insurance premiums being collected prior to disbursements for claims, which disbursements generally take place over an extended period after the collection of premiums, sometimes a period of many years. Collected premiums are generally invested, prior to their use for such disbursements, and investment income provides additional funding for loss payments. Our net cash flows from operating activities were $258.7 million and $313.3 millionfor the six months ended June 30, 2007 and 2006, respectively. Additionally, these cash flows reflected a net tax payment of $160.3 million for the six months ended June 30, 2007 and a $25.1 million net tax refund for the six months ended June 30, 2006. Net catastrophe loss payments were $262.7 million and $506.0 million for the six months ended June 30, 2007 and 2006, respectively; and A&E loss payments were $20.4 million for the six months ended June 30, 2007 compared to $25.5 million for the six months ended June 30, 2006.
If disbursements for claims and benefits, policy acquisition costs and other operating expenses were to exceed premium inflows, cash flow from insurance operations would be negative. The effect on cash flow from operations would be partially offset by cash flow from investment income. Additionally, cash flow from investment maturities and dispositions, both short-term investments and longer term maturities, would be available.
As the timing of payments for claims and benefits cannot be predicted with certainty, we maintain portfolios of long term invested assets with varying maturities, along with short-term investments that provide additional liquidity for payment of claims. At June 30, 2007 and December 31, 2006 we held cash and short-term investments of $2,624.5 million and $1,556.4 million, respectively. In addition to these cash and short-term investments at June 30, 2007, we had $0.7 billion, at fair value, available for sale fixed maturity securities maturing within one year or less, $2.3 billion maturing within one to five years and $6.7 billion maturing after five years. Our $1.6 billion of equity securities are comprised primarily of publicly traded securities that can be easily liquidated. The fixed maturity and equity securities, in conjunction with the short-term investments and positive cash flow from operations, generally provide adequate sources of liquidity for the expected payment of losses in the near future. We do not anticipate selling securities or using available credit facilities to pay losses and LAE, but have the ability to do so. Sales may result in realized capital gains or losses and we note that at June 30, 2007 we had $48.5 million of net unrealized depreciation, comprised of $205.5 million of pre-tax depreciation and $157.0 million of pre-tax appreciation.
Management expects the trend of positive cash flow from operations, which in general reflects our core earnings strength, to persist over the near term despite the continuing underlying trend, which is negatively impacted by the payout of catastrophe loss reserves. In the intermediate and longer term, the trend will be impacted by the extent to which competitive pressures change overall pricing available in our markets and the extent to which we successfully maintain our strategy of emphasizing profitability over volume.
Effective December 8, 2004, Group, Bermuda Re and Everest International Reinsurance, Ltd. (“Everest International”) entered into a three year, $750.0 million senior credit facility with a syndicate of lenders (the “Group Credit Facility”). Wachovia Bank is the administrative agent for the Group Credit Facility. The Group Credit Facility consists of two tranches. Tranche one provides up to $250.0 million of revolving credit for liquidity and general corporate purposes, and for the issuance of standby letters of credit. The interest on the revolving loans shall, at the option of each of the borrowers, be either (1) the Base Rate (as defined below) or (2)
45
an adjusted LIBOR plus a margin. The Base Rate is the higher of the rate of interest established by Wachovia Bank from time to time as its prime rate or the Federal Funds rate, in each case plus 0.5% per annum. The amount of margin and the fees payable for the Group Credit Facility depends on Group’s senior unsecured debt rating. Tranche two exclusively provides up to $500.0 million for the issuance of standby letters of credit on a collateralized basis.
The Group Credit Facility requires Group to maintain a debt to capital ratio of not greater than 0.35 to 1 and to maintain a minimum net worth amount. Minimum net worth is an amount equal to the sum of (i) $3,575.4 million (base amount) plus (ii) (A) 25% of consolidated net income for each of Group’s fiscal quarters and (B) 25% of any increase in consolidated net worth attributable to the issuance of ordinary and preferred shares. The base amount is reset at the end of each fiscal year to be the greater of 70% of Group’s consolidated net worth as of the last day of the fiscal year or the calculated minimum amount of net worth prior to the last day of the fiscal year. As of June 30, 2007, the Company was in compliance with these covenants.
For the three and six months ended June 30, 2007 and 2006, there were no outstanding borrowings under tranche one of the Group Credit Facility. At June 30, 2007, there was $205.5 million used of the $500.0 million available for tranche two of standby letters of credit. In addition, we had $185.1 million in letters of credit outstanding at June 30, 2007 under a $350.0 million bilateral agreement with Citibank. All of these letters of credit are collateralized by our cash and investments. These letters of credit are generally used to collateralize reinsurance assumed by Bermuda Re from jurisdictions where collateralization is generally required for the ceding company to receive financial statement credit for such reinsurance recoverables from its principal regulator. Bermuda Re and Everest International also used trust arrangements to provide collateralization to ceding companies, including affiliates. We generally avoid providing collateral except where required for ceding companies to receive credit from their regulators. Additionally, at June 30, 2007, $125.2 million of assets were deposited in trust accounts, primarily on behalf of Bermuda Re, as security for assumed losses payable to certain non-affiliated ceding companies.
Effective July 27, 2007, Group entered into a new five year, $850.0 million senior credit facility replacing the December 8, 2004, Group Credit Facility. Tranche one will provide up to $350.0 million of revolving credit and for issuance of unsecured standby letters of credit and Tranche two will provide up to $500.0 million for the issuance of secured standby letters of credit. The covenants will basically remain the same as the previous Group Credit Facility.
Effective August 23, 2006, Holdings entered into a new five year, $150.0 million senior revolving credit facility with a syndicate of lenders, replacing the October 10, 2003 three year senior revolving credit facility, which expired on October 10, 2006. Both the August 23, 2006 and October 10, 2003 senior revolving credit agreements, which have similar terms, are referred to as the “Holdings Credit Facility”. Citibank N.A. is the administrative agent for the Holdings Credit Facility. The Holdings Credit Facility is used for liquidity and general corporate purposes. The Holdings Credit Facility provides for the borrowing of up to $150.0 million with interest at a rate selected by Holdings equal to either, (1) the Base Rate (as defined below) or (2) a periodic fixed rate equal to the Eurodollar Rate plus an applicable margin. The Base Rate means a fluctuating interest rate per annum in effect from time to time to be equal to the higher of (a) the rate of interest publicly announced by Citibank as its prime rate or 0.5% per annum above the Federal Funds Rate, in each case plus the applicable margin. The amount of margin and the fees payable for the Holdings Credit Facility depends upon Holdings’ senior unsecured debt rating.
The Holdings Credit Facility requires Holdings to maintain a debt to capital ratio of not greater than 0.35 to 1 and Everest Re to maintain its statutory surplus at $1.5 billion plus 25% of future aggregate net income and 25% of future aggregate capital contributions after December 31, 2005. As of June 30, 2007, Holdings was in compliance with these covenants.
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For the three and six months ended June 30, 2007 and 2006, there were no outstanding borrowings under the Holdings Credit Facility.
Interest expense and fees incurred in connection with the Group Credit Facility and the Holdings Credit Facility were $0.1 million and $0.2 million for the three and six months ended June 30, 2007 and 2006.
Market Sensitive Instruments. The SEC’s Financial Reporting Release #48 requires registrants to clarify and expand upon the existing financial statement disclosure requirements for derivative financial instruments, derivative commodity instruments and other financial instruments (collectively, “market sensitive instruments”). We do not generally enter into market sensitive instruments for trading purposes.
Our investment strategy seeks to maximize after-tax income through a high quality, diversified, taxable and tax-preferenced fixed maturity portfolio, while maintaining an adequate level of liquidity. Our mix of taxable and tax-preferenced investments is adjusted continuously, consistent with its current and projected operating results, market conditions and our tax position. The fixed maturities in the investment portfolio are comprised of available for sale securities. Additionally, we invest in equity securities, which we believe will enhance the risk-adjusted total return of the investment portfolio. We have also engaged in a small number of equity put options.
The overall investment strategy considers the scope of our present and anticipated operations. In particular, estimates of the financial impact resulting from non-investment asset and liability transactions, together with our capital structure and other factors, are used to develop a net liability analysis. This analysis includes estimated payout characteristics for which our investments provide liquidity. This analysis is considered in the development of specific investment strategies for asset allocation, duration and credit quality. The change in overall market sensitive risk exposure principally reflects the asset changes that took place during the period.
Interest Rate Risk. Our $14.4 billion investment portfolio at June 30, 2007 is principally comprised of fixed maturity securities, which are subject to interest rate risk and foreign currency rate risk, and equity securities, which are subject to price fluctuations. The impact of the foreign exchange risks on the investment portfolio is generally mitigated by changes in the dollar value of foreign currency denominated liabilities and their associated income statement impact.
Interest rate risk is the potential change in value of the fixed maturity portfolio, including short-term investments, from a change in market interest rates. In a declining interest rate environment, it includes prepayment risk on the $1,429.6 million of mortgage-backed securities. Prepayment risk results from potential accelerated principal payments that shorten the average life and thus the expected yield of the security.
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The table below displays the potential impact of market value fluctuations and after-tax unrealized appreciation on our fixed maturity portfolio (including $2.4 billion of short-term investments) as of June 30, 2007 based on upward and downward parallel and immediate 100 and 200 basis point shifts in interest rates. For legal entities with a U.S. dollar functional currency, this modeling was performed on each security individually. To generate appropriate price estimates on mortgage-backed securities, changes in prepayment expectations under different interest rate environments were taken into account. For legal entities with a non-U.S. dollar functional currency, the effective duration of the involved portfolio of securities was used as a proxy for the market value change under the various interest rate change scenarios. All amounts are in U.S. dollars and are presented in millions.
As of June 30, 2007
Interest Rate Shift in Basis Points
- ----------------------------------------------------------------------------------------------------
-200 -100 0 100 200
- ----------------------------------------------------------------------------------------------------
Total Market Value $ 13,008.5 $ 12,546.0 $ 12,061.6 $ 11,535.3 $ 10,998.8
Market Value Change from Base (%) 7.9% 4.0% 0.0% -4.4% -8.8%
Change in Unrealized Appreciation
After–tax from Base ($) $ 710.9 $ 363.4 $ - $ (390.8) $ (786.7)
We had $8,743.8 million and $8,840.1 million of reserves for losses and LAE as of June 30, 2007 and December 31, 2006, respectively. These amounts are recorded at their nominal value as opposed to fair value, which would reflect a discount adjustment to reflect the time value of money. Since losses are paid out over a period of time, the fair value of the reserves is less than the nominal value. As interest rates rise, the fair value of the reserves decreases and, conversely, as interest rates decline, the fair value increases. These movements are the opposite of the interest rate impacts on the fair value of investments. While the difference between fair value and nominal value is not reflected in our financial statements, our financial results will include investment income over time from the investment portfolio until the claims are paid. Our loss and loss reserve obligations have an expected duration of approximately 3.8 years, which is reasonably consistent with our fixed income portfolio. If we were to discount our loss and LAE reserves, net of $0.7 billion of reinsurance receivables on unpaid losses, the discount would be approximately $1.6 billion resulting in a discounted reserve balance of approximately $6.4 billion, representing approximately 51% of the market value of the fixed maturity investment portfolio funds.
Equity Risk. Equity risk is the potential change in market value of the common stock and preferred stock portfolios arising from changing equity prices. Our equity investments are mainly exchange traded and mutual funds, which invest principally in high quality common and preferred stocks that are traded on the major exchanges in the U.S. The primary investment objective of the equity portfolio is to obtain greater total return relative to bonds over time through market appreciation and income.
The table below displays the impact on market value and after-tax change in fair value of a 10% and 20% change in equity prices up and down for the period indicated. All amounts are in U.S. dollars and are presented in millions.
As of June 30, 2007
Change in Equity Fair Values in Percent
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-20% -10% 0% 10% 20%
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Fair Value of the Equity Portfolio $ 1,241.0 $ 1,396.1 $ 1,551.2 $ 1,706.4 $ 1,861.5
After–tax Change in Fair Value $ (252.4) $ (126.2) $ - $ 126.2 $ 252.4
Foreign currency risk is the potential change in value, income and cash flow arising from adverse changes in foreign currency exchange rates. Each of our non-U.S./Bermuda (“foreign”) operations maintains capital in the
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currency of the country of its geographic location consistent with local regulatory guidelines. Generally, we prefer to maintain the capital of its operations in U.S. dollar assets, although this varies by regulatory jurisdiction in accordance with market needs. Each foreign operation may conduct business in its local currency, as well as the currency of other countries in which it operates. The primary foreign currency exposures for these foreign operations are the Canadian Dollar, the British Pound Sterling and the Euro. We mitigate foreign exchange exposure by generally matching the currency and duration of its assets to its corresponding operating liabilities. In accordance with FAS No. 52, “Foreign Currency Translation”, we translate the assets, liabilities and income of non-U.S. dollar functional currency legal entities to the U.S. dollar. This translation amount is reported as a component of other comprehensive income. As of June 30, 2007, there has been no material change in exposure to foreign exchange rates as compared to December 31, 2006.
Although not considered material in the context of our aggregate exposure to market sensitive instruments, we have issued six equity put options based on the S&P 500 index and one equity put option based on the FTSE 100 index, that are market sensitive and sufficiently unique to warrant supplemental disclosure.
We have sold six equity put options based on the S&P 500 index for total consideration, net of commissions, of $22.5 million. These contracts each have a single exercise date, with original maturities ranging from 12 to 30 years and strike prices ranging from $1,141.21 to $1,540.63. As of June 30, 2007, the S&P 500 Index stood at $1,502.97. No amounts will be payable under these contracts if the S&P 500 index is at or above the strike price on the exercise dates, which currently fall between June 2017 and March 2031. If the S&P 500 index is lower than the strike price on the applicable exercise date, the amount due will vary proportionately with the percentage by which the index is below the strike price. Based on historical index volatilities and trends and the June 30, 2007 index value, we estimate the probability for each contract of the S&P 500 index falling below the strike price on the exercise date to be less than 3.3%. The theoretical maximum payouts under the contracts would occur if on each of the exercise dates the S&P 500 index value were zero. The present value of these theoretical maximum payouts using a 6% discount factor is $219.5 million.
We have sold one equity put option based on the FTSE 100 index for total consideration, net of commissions, of $6.7 million. This contract has an exercise date of July 2020 and a strike price of £5,989.75. As of June 30, 2007, the FTSE 100 Index stood at £6,607.90. No amount will be payable under this contract if the FTSE 100 index is at or above the strike price on the exercise date. If the FTSE 100 index is lower than the strike price on the applicable exercise date, the amount due will vary proportionately with the percentage by which the index is below the strike price. Based on historical index volatilities and trends and the June 30, 2007 index value, we estimate the probability that the FTSE 100 index contract will fall below the strike price on the exercise date to be less than 5.6%. The theoretical maximum payout under the contract would occur if on the exercise date the FTSE 100 index value was zero. The present value of the theoretical maximum payout using a 6.0% discount factor is $30.3 million.
Because the equity put options are derivatives within the framework of FAS 133, we report the fair value of these instruments in its balance sheet and record any changes to fair value in its consolidated statements of operations and comprehensive income. We have recorded fair values for its obligations on these equity put options at June 30, 2007 and December 31, 2006 of $34.4 million and $37.5 million, respectively; however, we do not believe that the ultimate settlement of these transactions is likely to require a payment that would exceed the initial consideration received or any payment at all.
As there is no active market for these instruments, the determination of their fair value is based on an industry accepted option pricing model, which requires estimates and assumptions, including those regarding volatility and expected rates of return.
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The table below estimates the impact of potential movements in interest rates and the equity indices, which are the principal factors affecting fair value of these instruments, looking forward from the fair value at June 30, 2007. These are estimates and there can be no assurance regarding future market performance. The asymmetrical results of the interest rate and S&P 500 and FTSE 100 indices shifts reflect that the liability cannot fall below zero whereas it can increase to its theoretical maximum.
As of June 30, 2007
Equity Indices Put Options Obligation — Sensitivity Analysis
(Dollars in millions)
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Interest Rate Shift in Basis Points: -100 -50 0 50 100
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Total Fair Value $ 48.0 $ 40.7 $ 34.4 $ 29.0 $ 24.4
Fair Value Change from Base (%) -39.8% -18.3% 0.0% 15.6% 28.9%
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Equity Indices Shift in Points: -200 -100 0 100 200
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Total Fair Value $ 40.9 $ 37.4 $ 34.4 $ 31.7 $ 29.4
Fair Value Change from Base (%) -19.0% -8.9% 0.0% 7.8% 14.6%
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Combined Interest Rate / Equity Indices Shift: -100/-200 -50/-100 0 / 0 50/100 100/200
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Total Fair Value $ 56.5 $ 44.1 $ 34.4 $ 26.7 $ 20.7
Fair Value Change from Base (%) -64.3% -28.4% 0.0% 22.4% 39.9%
Safe Harbor Disclosure. This report contains forward-looking statements within the meaning of the U.S. federal securities laws. We intend these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in the federal securities laws. In some cases, these statements can be identified by the use of forward-looking words such as “may”, “will”, “should”, “could”, “anticipate”, “estimate”, “expect”, “plan”, “believe”, “predict”, “potential” and “intend”. Forward-looking statements contained in this report include information regarding our reserves for losses and LAE, the adequacy of our provision for uncollectible balances, estimates of our catastrophe exposure, the effects of catastrophic events on our financial statements, the ability of Everest Re, Holdings and Bermuda Re to pay dividends and the settlement costs of our specialized equity put options. Forward-looking statements only reflect our expectations and are not guarantees of performance. These statements involve risks, uncertainties and assumptions. Actual events or results may differ materially from our expectations. Important factors that could cause our actual events or results to be materially different from our expectations include the uncertainties that surround the estimating of reserves for losses and LAE, those discussed in Note 6 of Notes to Consolidated Financial Statements (unaudited) included in this report and the risks described under the caption “Risk Factors” in our most recent Annual Report on Form 10-K, Part I, Item 1A. We undertake no obligation to update or revise publicly any forward looking statements, whether as a result of new information, future events or otherwise.
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PART I — Item 3
EVEREST RE GROUP, LTD.
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
Market Risk Instruments. See “Liquidity and Capital Resources — Market Sensitive Instruments” in PART I — Item 2.
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PART I – Item 4
EVEREST RE GROUP, LTD.
CONTROLS AND PROCEDURES
As of the end of the period covered by this report, our management carried out an evaluation, with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act��)). Based on their evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission’s rules and forms. Our management, with the participation of the Chief Executive Officer and Chief Financial Officer, also conducted an evaluation of our internal control over financial reporting to determine whether any changes occurred during the quarter covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on that evaluation, there has been no such change during the quarter covered by this report.
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EVEREST RE GROUP, LTD.
OTHER INFORMATION
PART II – Item 1. Legal Proceedings
In the ordinary course of business, we are involved in lawsuits, arbitrations and other formal and informal dispute resolution procedures, the outcomes of which will determine our rights and obligations under insurance, reinsurance and other contractual agreements. In some disputes, we seek to enforce our rights under an agreement or to collect funds owing to it. In other matters, we are resisting attempts by others to collect funds or enforce alleged rights. These disputes arise from time to time and are ultimately resolved through both informal and formal means, including negotiated resolution, arbitration and litigation. In all such matters, we believe that its positions are legally and commercially reasonable. While the final outcome of these matters cannot be predicted with certainty, we do not believe that any of these matters, when finally resolved, will have a material adverse effect on our financial position or liquidity. However, an adverse resolution of one or more of these items in any one quarter or fiscal year could have a material adverse effect on our results of operations in that period.
In May 2005, Holdings received and responded to a subpoena from the SEC seeking information regarding certain loss mitigation insurance products. We have stated that Holdings will fully cooperate with this and any future inquiries and that Holdings does not believe that it has engaged in any improper business practices with respect to loss mitigation insurance products.
Our insurance subsidiaries have also received and have responded to broadly distributed information requests by state regulators including among others, from Delaware and Georgia.
PART II – Item 1A. Risk Factors
No material changes.
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PART II – Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
IssuerPurchases of Equity Securities
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Issuer Purchases of Equity Securities
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(a) (b) (c) (d)
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Maximum
Number (or
Approximate
Total Number of Dollar Value) of
Shares (or Units) Shares (or Units)
Total Number Purchased as Part that May Yet Be
of Shares (or Average Price of Publicly Purchased Under
Units) Paid per Share Announced Plans the Plans or
Period Purchased (or Unit) or Programs Programs (2)
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April 1 - 30 0 N/A 199,000 2,901,000
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May 1 - 31 (1) 1,486 $ 106.425 0 2,901,000
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June 1 - 30 0 N/A 0 2,901,000
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Total 1,486 $ 106.425 199,000 2,901,000
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(1) The 1,486 shares were withheld as payment for taxes on restricted shares that became unrestricted in
the quarter
(2) On September 21, 2004, the Company's board of directors approved an amended share repurchase
program authorizing the Company and/or its subsidiary Holdings to purchase up to an aggregate of
5,000,000 of the Company's common shares through open market transactions, privately negotiated
transactions or both.
PART II – Item 3. Defaults Upon Senior Securities
None.
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PART II — Item 4. Submission of Matters to a Vote of Security Holders
(a) The Annual General Meeting of Shareholders of Everest Re Group, Ltd. was held on May 23, 2007.
(b) All director nominees were elected.
(c) Each matter voted upon at the meeting and the votes cast with respect to each such matter are as follows:
Votes Cast
-----------------
59,994,572
Against or Broker
For Withheld Abstain Non-votes
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Approval of the appointment
of an independent registered
public accounting firm for the
2007 audit 59,976,731 11,227 6,614 -
Election of directors for a term
expiring 2010:
Kenneth J. Duffy 59,640,950 353,622 N/A -
Joseph V. Taranto 59,183,297 811,275 N/A -
PART II – Item 5. Other Information
None.
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Part II – Item 6. Exhibits
Exhibit Index: Exhibit No. Description 31.1 Section 302 Certification of Joseph V. Taranto 31.2 Section 302 Certification of Craig Eisenacher 32.1 Section 906 Certification of Joseph V. Taranto and Craig Eisenacher
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