UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005
Commission file number 001-31721
AXIS CAPITAL HOLDINGS LIMITED
(Exact name of registrant as specified in its charter)
Bermuda | 98-0395986 |
(State or other jurisdiction of | (I.R.S. Employer Identification No.) |
106 Pitts Bay Road, Pembroke HM 08, Bermuda
(Address of principal executive offices and zip code)
(441) 296-2600
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý No o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
As of November 2, 2005, there were 143,202,425 Common Shares, $0.0125 par value per share, of the registrant outstanding.
AXIS CAPITAL HOLDINGS LIMITED
INDEX TO FORM 10-Q
i
PART 1 — FINANCIAL INFORMATION
AXIS CAPITAL HOLDINGS LIMITED
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
As at September 30, 2005 and December 31, 2004
(Expressed in thousands of U.S. dollars, except share and per share amounts)
|
| September 30, 2005 |
| December 31, 2004 |
| ||
Assets |
|
|
|
|
| ||
Cash and cash equivalents |
| $ | 862,184 |
| $ | 632,329 |
|
Fixed maturity investments at fair market value |
| 5,562,593 |
| 5,128,345 |
| ||
Other investments |
| 514,221 |
| 271,344 |
| ||
Accrued interest receivable |
| 47,800 |
| 47,487 |
| ||
Securities lending collateral |
| 1,045,144 |
| 865,311 |
| ||
Insurance and reinsurance premium balances receivable |
| 1,145,471 |
| 914,562 |
| ||
Deferred acquisition costs |
| 242,478 |
| 211,082 |
| ||
Prepaid reinsurance premiums |
| 300,872 |
| 271,187 |
| ||
Reinsurance recoverable balances |
| 1,308,253 |
| 588,649 |
| ||
Reinsurance recoverable balances on paid losses |
| 28,767 |
| 7,650 |
| ||
Intangible assets |
| 37,969 |
| 31,734 |
| ||
Other assets |
| 344,794 |
| 68,605 |
| ||
Total Assets |
| $ | 11,440,546 |
| $ | 9,038,285 |
|
|
|
|
|
|
| ||
Liabilities |
|
|
|
|
| ||
Reserve for losses and loss expenses |
| $ | 4,514,277 |
| $ | 2,404,560 |
|
Unearned premiums |
| 2,003,223 |
| 1,644,771 |
| ||
Insurance and reinsurance balances payable |
| 325,924 |
| 247,940 |
| ||
Accounts payable and accrued expenses |
| 92,099 |
| 89,804 |
| ||
Securities lending payable |
| 1,041,124 |
| 864,354 |
| ||
Net payable for investments purchased |
| 93,268 |
| 49,854 |
| ||
Debt |
| 499,019 |
| 498,938 |
| ||
Total Liabilities |
| 8,568,934 |
| 5,800,221 |
| ||
|
|
|
|
|
| ||
Shareholders’ Equity |
|
|
|
|
| ||
Share Capital |
|
|
|
|
| ||
Series A Preferred shares |
| $ | 125 |
| $ | — |
|
Common shares |
| 1,769 |
| 1,910 |
| ||
Additional paid-in capital |
| 1,931,807 |
| 2,017,144 |
| ||
Accumulated other comprehensive (loss) income |
| (54,806 | ) | 12,915 |
| ||
Retained earnings |
| 992,717 |
| 1,206,095 |
| ||
Total Shareholders’ Equity |
| 2,871,612 |
| 3,238,064 |
| ||
|
|
|
|
|
| ||
Total Liabilities & Shareholders’ Equity |
| $ | 11,440,546 |
| $ | 9,038,285 |
|
|
|
|
|
|
|
See accompanying notes to Unaudited Condensed Consolidated Financial Statements
2
AXIS CAPITAL HOLDINGS LIMITED
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
For the Quarters and Nine Months ended September 30, 2005 and 2004
(Expressed in thousands of U.S. dollars, except share and per share amounts)
|
| Quarter ended |
| Nine Months ended |
| ||||||||
|
| September 30, 2005 |
| September 30, 2004 |
| September 30, 2005 |
| September 30, 2004 |
| ||||
Revenues |
|
|
|
|
|
|
|
|
| ||||
Gross premiums written |
| $ | 794,571 |
| $ | 687,700 |
| $ | 2,760,563 |
| $ | 2,361,142 |
|
Premiums ceded |
| (276,854 | ) | (125,688 | ) | (564,979 | ) | (412,063 | ) | ||||
Change in unearned premiums |
| 99,097 |
| (40,214 | ) | (328,767 | ) | (469,630 | ) | ||||
Net premiums earned |
| 616,814 |
| 521,798 |
| 1,866,817 |
| 1,479,449 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Net investment income |
| 67,015 |
| 40,017 |
| 177,774 |
| 104,621 |
| ||||
Net realized (losses) gains |
| (6,435 | ) | 3,732 |
| (5,997 | ) | 9,418 |
| ||||
Other insurance related income (loss) |
| 236 |
| 7,206 |
| (5,283 | ) | 7,650 |
| ||||
Total revenues |
| $ | 677,630 |
| $ | 572,753 |
| $ | 2,033,311 |
| $ | 1,601,138 |
|
|
|
|
|
|
|
|
|
|
| ||||
Expenses |
|
|
|
|
|
|
|
|
| ||||
Net losses and loss expenses |
| $ | 1,035,270 |
| $ | 445,575 |
| $ | 1,702,413 |
| $ | 946,025 |
|
Acquisition costs |
| 64,436 |
| 79,222 |
| 241,208 |
| 201,674 |
| ||||
General and administrative expenses |
| 44,237 |
| 47,068 |
| 155,335 |
| 131,360 |
| ||||
Foreign exchange losses (gains) |
| 1,727 |
| (3,459 | ) | 52,371 |
| 4,099 |
| ||||
Interest expense |
| 8,360 |
| 469 |
| 24,257 |
| 688 |
| ||||
Total expenses |
| $ | 1,154,030 |
| $ | 568,875 |
| $ | 2,175,584 |
| $ | 1,283,846 |
|
|
|
|
|
|
|
|
|
|
| ||||
(Loss) Income before income taxes |
| (476,400 | ) | 3,878 |
| (142,273 | ) | 317,292 |
| ||||
Income tax recovery (expense) |
| 8,325 |
| 2,401 |
| (1,158 | ) | (3,369 | ) | ||||
Net (Loss) Income |
| $ | (468,075 | ) | $ | 6,279 |
| $ | (143,431 | ) | $ | 313,923 |
|
|
|
|
|
|
|
|
|
|
| ||||
Other comprehensive (loss) income, net of tax |
|
|
|
|
|
|
|
|
| ||||
Unrealized (losses) gains arising during the period |
| (44,847 | ) | 53,176 |
| (52,214 | ) | 5,707 |
| ||||
Adjustment for re-classification of (losses) gains realized in income |
| (9,704 | ) | 1,014 |
| (15,507 | ) | (7,874 | ) | ||||
Comprehensive (loss) income |
| $ | (522,626 | ) | $ | 60,469 |
| $ | (211,152 | ) | $ | 311,756 |
|
|
|
|
|
|
|
|
|
|
| ||||
Weighted average common shares outstanding — basic |
| 140,995,298 |
| 152,534,495 |
| 142,711,852 |
| 152,523,144 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
Weighted average common shares and common share equivalents outstanding - diluted |
| 140,995,298 |
| 166,128,928 |
| 142,711,852 |
| 166,401,498 |
| ||||
|
|
|
|
|
|
|
|
|
| ||||
(Loss) Earnings per share — basic |
| $ | (3.32 | ) | $ | 0.04 |
| $ | (1.01 | ) | $ | 2.06 |
|
|
|
|
|
|
|
|
|
|
| ||||
(Loss) Earnings per share — diluted |
| $ | (3.32 | ) | $ | 0.04 |
| $ | (1.01 | ) | $ | 1.89 |
|
See accompanying notes to Unaudited Condensed Consolidated Financial Statements
3
AXIS CAPITAL HOLDINGS LIMITED
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
For the Nine Months ended September 30, 2005 and 2004
(Expressed in thousands of U.S. dollars)
|
| Nine Months ended |
| ||||
|
| September 30, 2005 |
| September 30, 2004 |
| ||
Series A Preferred shares |
|
|
|
|
| ||
Shares issued during period and balance at end of period |
| $ | 125 |
| $ | — |
|
|
|
|
|
|
| ||
Common shares |
|
|
|
|
| ||
Balance at beginning of period |
| $ | 1,910 |
| $ | 1,906 |
|
Shares issued during period |
| 19 |
| — |
| ||
Repurchased during period |
| (160 | ) | — |
| ||
Balance at end of period |
| $ | 1,769 |
| $ | 1,906 |
|
|
|
|
|
|
| ||
Additional paid-in capital |
|
|
|
|
| ||
Balance at beginning of period |
| $ | 2,017,144 |
| $ | 2,000,731 |
|
Shares issued during period, net of expenses |
| 240,097 |
| (797 | ) | ||
Repurchased during period |
| (349,840 | ) | — |
| ||
Stock options exercised |
| 3,301 |
| — |
| ||
Stock option expense |
| 6,423 |
| 2,317 |
| ||
Stock compensation expense |
| 14,682 |
| 11,074 |
| ||
Balance at end of period |
| $ | 1,931,807 |
| $ | 2,013,325 |
|
|
|
|
|
|
| ||
Accumulated other comprehensive (loss) income |
|
|
|
|
| ||
Balance at beginning of period |
| $ | 12,915 |
| $ | 25,164 |
|
Change in unrealized losses |
| (72,944 | ) | (1,385 | ) | ||
Change in deferred taxes |
| 5,223 |
| (782 | ) | ||
Balance at end of period |
| $ | (54,806 | ) | $ | 22,997 |
|
|
|
|
|
|
| ||
Retained earnings |
|
|
|
|
| ||
Balance at beginning of period |
| $ | 1,206,095 |
| $ | 789,347 |
|
Common share dividends paid |
| (69,947 | ) | (56,506 | ) | ||
Net (loss) income for period |
| (143,431 | ) | 313,923 |
| ||
Balance at end of period |
| $ | 992,717 |
| $ | 1,046,764 |
|
|
|
|
|
|
| ||
Total Shareholders’ Equity |
| $ | 2,871,612 |
| $ | 3,084,992 |
|
See accompanying notes to Unaudited Condensed Consolidated Financial Statements
4
AXIS CAPITAL HOLDINGS LIMITED
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months ended September 30, 2005 and 2004
(Expressed in thousands of U.S. dollars)
|
| Nine Months ended |
| ||||
|
| September 30, 2005 |
| September 30, 2004 |
| ||
Cash flows provided by operating activities: |
|
|
|
|
| ||
Net (loss) income |
| $ | (143,431 | ) | $ | 313,923 |
|
Adjustments to reconcile net income to net cash provided by (used in) operating activities: |
|
|
|
|
| ||
Net realized loss (gain) on sales of investments |
| 5,997 |
| (9,418 | ) | ||
Net amortization on fixed maturities |
| 23,763 |
| 25,912 |
| ||
Amortization of deferred compensation and option expense |
| 17,984 |
| 13,391 |
| ||
Amortization of intangible assets |
| 2,743 |
| 1,178 |
| ||
Amortization of deferred debt expenses |
| 340 |
| — |
| ||
Accrued interest receivable |
| (92 | ) | (4,058 | ) | ||
Insurance and reinsurance premium balances receivable |
| (230,909 | ) | (264,045 | ) | ||
Deferred acquisition costs |
| (31,396 | ) | (92,821 | ) | ||
Prepaid reinsurance premiums |
| (29,648 | ) | (69,183 | ) | ||
Reinsurance recoverable balances |
| (696,687 | ) | (426,265 | ) | ||
Reinsurance recoverable balances on paid losses |
| (21,117 | ) | — |
| ||
Intangible assets |
| 0 |
| (135 | ) | ||
Other assets |
| (271,225 | ) | (26,165 | ) | ||
Reserve for losses and loss expenses |
| 2,086,800 |
| 1,230,388 |
| ||
Unearned premiums |
| 358,415 |
| 538,672 |
| ||
Insurance and reinsurance balances payable |
| 77,984 |
| 38,814 |
| ||
Accounts payable and accrued expenses |
| (768 | ) | (7,434 | ) | ||
Total adjustments |
| 1,292,184 |
| 948,831 |
| ||
Net cash provided by operating activities |
| 1,148,753 |
| 1,262,754 |
| ||
Cash flows provided by (used in) investing activities: |
|
|
|
|
| ||
Net cash paid in acquisition of subsidiaries |
| (27,772 | ) | — |
| ||
Purchases of other investments |
| (247,606 | ) | (83,143 | ) | ||
Purchases of available-for-sale securities |
| (4,847,830 | ) | (5,006,227 | ) | ||
Sales and maturities of available-for-sale securities |
| 4,377,594 |
| 4,214,075 |
| ||
Net cash used in investing activities |
| (745,614 | ) | (875,295 | ) | ||
Cash flows provided by (used in) financing activities: |
|
|
|
|
| ||
Common share dividends |
| (69,947 | ) | (56,506 | ) | ||
Repurchase of shares, net |
| (350,000 | ) | — |
| ||
Issue of shares, net |
| 246,663 |
| (797 | ) | ||
Net cash used in financing activities |
| (173,284 | ) | (57,303 | ) | ||
Increase in cash and cash equivalents |
| 229,855 |
| 330,156 |
| ||
Cash and cash equivalents — beginning of period |
| 632,329 |
| 605,175 |
| ||
Cash and cash equivalents — end of period |
| $ | 862,184 |
| $ | 935,331 |
|
Supplemental disclosures of cash flow information: |
|
|
|
|
| ||
Income taxes paid |
| $ | 23,864 |
| $ | 13,684 |
|
Interest paid |
| $ | 15,677 |
| $ | 4 |
|
See accompanying notes to Unaudited Condensed Consolidated Financial Statements
5
AXIS CAPITAL HOLDINGS LIMITED
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands of U.S. dollars, except share and per share amounts)
1. Basis of Preparation and Consolidation
These unaudited condensed consolidated financial statements include the accounts of AXIS Capital Holdings Limited (“AXIS Capital”) and its subsidiaries (together, the “Company”) and have been prepared in accordance with U.S. Generally Accepted Accounting Principles (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, these unaudited condensed consolidated financial statements reflect all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of financial position and results of operations as at the end of and for the periods presented. The results of operations for any interim period are not necessarily indicative of the results for a full year. All significant intercompany accounts and transactions have been eliminated. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. The major estimates reflected in the Company’s condensed consolidated financial statements include the reserve for losses and loss expenses, premium estimates for business written on a line slip or proportional basis, the estimation of accruals for amounts due under incentive commission agreements and the estimation of fair values for derivative contracts. The terms “FAS” and “FASB” used in these notes refer to Statements of Financial Accounting Standards issued by the United States Financial Accounting Standards Board. To facilitate period-to-period comparisons and to conform to current period presentation, a reclassification from general and administrative expenses to interest expense has been made for the quarter and nine months ended September 30, 2004. There was no effect on net income from this change in presentation.
This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 filed with the Securities and Exchange Commission (the “SEC”) on March 1, 2005.
2. New Accounting Pronouncements
In June 2005, the FASB directed the staff to issue the proposed FSP EITF Issue 03-1-a as final and it will be retitled FSP FAS 115-1 “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments”. It replaces existing guidance and clarifies that an impairment should be recognized as a loss at a date no later than the impairment is deemed other-than-temporary, even if the decision to sell has not been made. FSP FAS 115-1 is effective for other-than-temporary impairment analysis conducted in periods beginning after September 15, 2005. The Company believes that its current policy on other-than-temporary impairments complies with FSP FAS 115-1. Accordingly, the adoption of this standard has no impact on the Company’s results of operations or financial condition.
In December 2004, the FASB issued Statement No 123 (revised 2004), Share-Based Payment (“FAS 123R”). FAS 123R replaces FASB Statement No. 123 “Accounting for Stock-Based Compensation” and supersedes APB opinion No.25 “Accounting for Stock Issued to Employees”. The statement requires all entities to recognize compensation expense in an amount equal to the fair value of share-based payments granted to employees and is effective for the first quarter of 2006. The Company already records compensation expense for awards of stock options and restricted stock to employees based on the fair value of the awards; consequently, this statement is not expected to have a material impact on the Company’s results of operations or financial condition.
6
3. Stock-Based Compensation
The Company accounts for stock compensation in accordance with FAS No. 123, “Accounting for Stock-Based Compensation.” Compensation expense for stock options and for restricted stock awards granted to employees is recorded over the vesting period using the fair value method. The Company adopted FAS No. 123 effective January 1, 2003 by applying the prospective method permitted under FAS No. 148 “Accounting for Stock Based Compensation — Transition and Disclosure”. Prior to 2003, the Company followed Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” and related interpretations in accounting for its employee stock compensation. The following table illustrates the effect on net (loss) income and earnings per share if the Company had applied the fair value recognition provisions of FAS 123 to stock-based compensation prior to January 1, 2003.
|
| Quarter ended |
| Nine Months ended |
| |||||||||
|
| September 30, 2005 |
| September 30, 2004 |
| September 30, 2005 |
| September 30, 2004 |
| |||||
Net (loss) income as reported |
| $ | (468,075 | ) | $ | 6,279 |
| $ | (143,431 | ) | $ | 313,923 |
| |
Add: | Stock-based employee compensation expense included in net (loss) income, net of related tax effects |
| 5,552 |
| 3,511 |
| 16,057 |
| 11,598 |
| ||||
Deduct: | Total stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax effects |
| (5,731 | ) | (4,276 | ) | (16,593 | ) | (13,729 | ) | ||||
|
|
|
|
|
|
|
|
|
| |||||
Pro-forma net (loss) income |
| $ | (468,254 | ) | $ | 5,514 |
| $ | (143,967 | ) | $ | 311,792 |
| |
(Loss) earnings per share: |
|
|
|
|
|
|
|
|
| |||||
Basic — as reported |
| $ | (3.32 | ) | $ | 0.04 |
| $ | (1.01 | ) | $ | 2.06 |
| |
Basic — pro forma |
| $ | (3.32 | ) | $ | 0.04 |
| $ | (1.01 | ) | $ | 2.04 |
| |
Diluted — as reported |
| $ | (3.32 | ) | $ | 0.04 |
| $ | (1.01 | ) | $ | 1.89 |
| |
Diluted — pro forma |
| $ | (3.32 | ) | $ | 0.03 |
| $ | (1.01 | ) | $ | 1.87 |
|
4. Segment Information
Through December 31, 2004, the Company’s business consisted of five reportable operating segments: global insurance; global reinsurance; U.S. insurance; U.S. reinsurance; and corporate. Effective January 1, 2005, the Company created two distinct global underwriting platforms, AXIS Insurance and AXIS Re. Following this strategic realignment of its organizational structure, the Company has re-evaluated its operating and reportable segments and determined that it has three reportable operating segments: insurance, reinsurance and corporate. The Company’s insurance segment is further divided into two sub-segments: global insurance and U.S. insurance. The Company’s segments and sub-segments have been determined on the basis of underlying information reviewed by the Company’s chief decision maker, the Chief Executive Officer.
The Company evaluates the performance of its insurance and reinsurance segments based on underwriting results. The Company writes business that has loss experience generally characterized as low frequency and high severity. This may result in volatility in both the Company’s and an individual segment’s operating results and cash flows. The Company does not allocate its assets by segment as it evaluates the underwriting results of each segment separately from the results of its investment portfolio.
7
Insurance
The Company’s insurance segment provides insurance coverage on a worldwide basis and is divided into two sub-segments: global insurance and U.S. insurance.
Global insurance provides specialty lines coverage, predominantly through the London broker network. The product lines in this segment are property, marine, terrorism and war risk, aviation and aerospace, political risk and professional lines and other specialty.
U.S. insurance provides specialty lines coverage through a variety of channels in the U.S. and covers exposures predominantly in the U.S. The product lines in this segment are property, professional lines, liability and other specialty and are offered through wholesale brokers, retail brokers and managing general underwriters. Many of its property and casualty insurance products are for non-standard and complex risks. U.S. insurance also writes risks that are unique and difficult to place in the standard market, but which must remain with an admitted insurance company for marketing and regulatory purposes.
Reinsurance
The Company’s reinsurance segment provides treaty property and casualty reinsurance to insurance companies on a worldwide basis. Treaty reinsurance contracts are contractual arrangements that provide for automatic reinsuring of a type or category of risk underwritten by our clients. Contracts can be written on an excess of loss basis or a pro rata basis, also known as proportional. The product lines in this segment are catastrophe, property, professional liability, credit and bond, motor, liability and other.
The following tables summarize the underwriting results, income (loss) before income taxes, ratios and the reserves for losses and loss expenses for the Company’s reportable operating segments for the quarters and nine months ended September 30, 2005 and 2004.
8
Quarter ended September 30, 2005
|
| Global Insurance |
| U.S. Insurance |
| Total Insurance |
| Reinsurance |
| Corporate |
| Total |
| ||||||
Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Gross premiums written |
| $ | 191,616 |
| $ | 268,967 |
| $ | 460,583 |
| $ | 333,988 |
| $ | — |
| $ | 794,571 |
|
Net premiums written |
| 63,813 |
| 124,061 |
| 187,874 |
| 329,843 |
| — |
| 517,717 |
| ||||||
Net premiums earned |
| 141,359 |
| 107,174 |
| 248,533 |
| 368,281 |
| — |
| 616,814 |
| ||||||
Other insurance related income |
| — |
| 236 |
| 236 |
| — |
| — |
| 236 |
| ||||||
Expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Net losses and loss expenses |
| (308,024 | ) | (130,500 | ) | (438,524 | ) | (596,746 | ) | — |
| (1,035,270 | ) | ||||||
Acquisition costs |
| (13,293 | ) | 1,722 |
| (11,571 | ) | (52,865 | ) | — |
| (64,436 | ) | ||||||
General and administrative expenses |
| (9,039 | ) | (19,716 | ) | (28,755 | ) | (12,187 | ) | — |
| (40,942 | ) | ||||||
Underwriting loss(a) |
| (188,997 | ) | (41,084 | ) | (230,081 | ) | (293,517 | ) | — |
| (523,598 | ) | ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Corporate expenses |
|
|
|
|
|
|
|
|
| (3,295 | ) | (3,295 | ) | ||||||
Net investment income |
|
|
|
|
|
|
|
|
| 67,015 |
| 67,015 |
| ||||||
Realized losses on investments |
|
|
|
|
|
|
|
|
| (6,435 | ) | (6,435 | ) | ||||||
Foreign exchange losses |
|
|
|
|
|
|
|
|
| (1,727 | ) | (1,727 | ) | ||||||
Interest expense |
|
|
|
|
|
|
|
|
| (8,360 | ) | (8,360 | ) | ||||||
Loss before income taxes |
|
|
|
|
|
|
|
|
|
|
| $ | (476,400 | ) | |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Net loss and loss expense ratio |
| 217.9 | % | 121.8 | % | 176.4 | % | 162.0 | % |
|
| 167.8 | % | ||||||
Acquisition cost ratio |
| 9.4 | % | (1.6 | )% | 4.7 | % | 14.4 | % |
|
| 10.4 | % | ||||||
General and administrative expense ratio |
| 6.4 | % | 18.4 | % | 11.6 | % | 3.3 | % | 0.6 | % | 7.2 | % | ||||||
Combined ratio |
| 233.7 | % | 138.6 | % | 192.7 | % | 179.7 | % |
|
| 185.4 | % | ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Reserve for losses and loss expenses |
| $ | 1,513,221 |
| $ | 1,379,010 |
| $ | 2,892,231 |
| $ | 1,622,046 |
| n/a |
| $ | 4,514,277 |
| |
(a) The Company utilizes underwriting income (loss) as a measure of underwriting profitability as it evaluates profitability solely on underwriting related revenues and costs. Items not considered to be part of underwriting income (loss) include: corporate expenses, investment income, realized losses and gains on the sale of investments, foreign exchange and interest expense. These items are evaluated separately from our underwriting results. Underwriting income (loss) takes into account net premiums earned and other insurance related income as revenue and net losses and loss expenses, acquisition costs and underwriting related general and administrative expenses as expenses. Underwriting income (loss) is the difference between the revenue and expense items.
9
Quarter ended September 30, 2004
|
| Global Insurance |
| U.S. Insurance |
| Total Insurance |
| Reinsurance |
| Corporate |
| Total |
| ||||||
Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Gross premiums written |
| $ | 214,282 |
| $ | 227,380 |
| $ | 441,662 |
| $ | 246,038 |
|
| — |
| $ | 687,700 |
|
Net premiums written |
| 203,469 |
| 124,812 |
| 328,281 |
| 233,731 |
| — |
| 562,012 |
| ||||||
Net premiums earned |
| 199,477 |
| 90,266 |
| 289,743 |
| 232,055 |
| — |
| 521,798 |
| ||||||
Other insurance related income |
| 7,106 |
| — |
| 7,106 |
| 100 |
| — |
| 7,206 |
| ||||||
Expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Net losses and loss expenses |
| (152,333 | ) | (85,531 | ) | (237,864 | ) | (207,711 | ) | — |
| (445,575 | ) | ||||||
Acquisition costs |
| (33,067 | ) | (4,941 | ) | (38,008 | ) | (41,214 | ) | — |
| (79,222 | ) | ||||||
General and administrative expenses |
| (8,592 | ) | (18,222 | ) | (26,814 | ) | (10,530 | ) | — |
| (37,344 | ) | ||||||
Underwriting income (loss)(a) |
| 12,591 |
| (18,428 | ) | (5,837 | ) | (27,300 | ) | — |
| (33,137 | ) | ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Corporate expenses |
|
|
|
|
|
|
|
|
| (9,724 | ) | (9,724 | ) | ||||||
Net investment income |
|
|
|
|
|
|
|
|
| 40,017 |
| 40,017 |
| ||||||
Realized gains on investments |
|
|
|
|
|
|
|
|
| 3,732 |
| 3,732 |
| ||||||
Foreign exchange gains |
|
|
|
|
|
|
|
|
| 3,459 |
| 3,459 |
| ||||||
Interest expense |
|
|
|
|
|
|
|
|
| (469 | ) | (469 | ) | ||||||
Income before income taxes |
|
|
|
|
|
|
|
|
|
|
| $ | 3,878 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Net loss and loss expense ratio |
| 76.4 | % | 94.7 | % | 82.1 | % | 89.5 | % |
|
| 85.4 | % | ||||||
Acquisition cost ratio |
| 16.5 | % | 5.5 | % | 13.1 | % | 17.8 | % |
|
| 15.2 | % | ||||||
General and administrative expense ratio |
| 4.3 | % | 20.2 | % | 9.3 | % | 4.5 | % | 1.9 | % | 9.0 | % | ||||||
Combined ratio |
| 97.2 | % | 120.4 | % | 104.5 | % | 111.8 | % |
|
| 109.6 | % | ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Reserve for losses and loss expenses |
| $ | 805,364 |
| $ | 711,181 |
| $ | 1,516,545 |
| $ | 706,689 |
| n/a |
| $ | 2,223,234 |
| |
(a) The Company utilizes underwriting income (loss) as a measure of underwriting profitability as it evaluates profitability solely on underwriting related revenues and costs. Items not considered to be part of underwriting income (loss) include: corporate expenses, investment income, realized losses and gains on the sale of investments, foreign exchange and interest expense. These items are evaluated separately from our underwriting results. Underwriting income (loss) takes into account net premiums earned and other insurance related income as revenue and net losses and loss expenses, acquisition costs and underwriting related general and administrative expenses as expenses. Underwriting income (loss) is the difference between the revenue and expense items.
10
Nine Months ended September 30, 2005
|
| Global Insurance |
| U.S. Insurance |
| Total Insurance |
| Reinsurance |
| Corporate |
| Total |
| |||||
Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Gross premiums written |
| $ | 671,451 |
| $ | 731,363 |
| $ | 1,402,814 |
| $ | 1,357,749 |
| — |
| $ | 2,760,563 |
|
Net premiums written |
| 481,248 |
| 366,391 |
| 847,639 |
| 1,347,945 |
| — |
| 2,195,584 |
| |||||
Net premiums earned |
| 562,934 |
| 321,996 |
| 884,930 |
| 981,887 |
| — |
| 1,866,817 |
| |||||
Other insurance related (loss) income |
| (5,865 | ) | 582 |
| (5,283 | ) | — |
| — |
| (5,283 | ) | |||||
Expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Net losses and loss expenses |
| (451,958 | ) | (272,876 | ) | (724,834 | ) | (977,579 | ) | — |
| (1,702,413 | ) | |||||
Acquisition costs |
| (72,830 | ) | (5,017 | ) | (77,847 | ) | (163,361 | ) | — |
| (241,208 | ) | |||||
General and administrative expenses |
| (28,523 | ) | (60,804 | ) | (89,327 | ) | (36,818 | ) | — |
| (126,145 | ) | |||||
Underwriting income (loss)(a) |
| 3,758 |
| (16,119 | ) | (12,361 | ) | (195,871 | ) | — |
| (208,232 | ) | |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Corporate expenses |
|
|
|
|
|
|
|
|
| (29,190 | ) | (29,190 | ) | |||||
Net investment income |
|
|
|
|
|
|
|
|
| 177,774 |
| 177,774 |
| |||||
Realized losses on investments |
|
|
|
|
|
|
|
|
| (5,997 | ) | (5,997 | ) | |||||
Foreign exchange losses |
|
|
|
|
|
|
|
|
| (52,371 | ) | (52,371 | ) | |||||
Interest expense |
|
|
|
|
|
|
|
|
| (24,257 | ) | (24,257 | ) | |||||
Loss before income taxes |
|
|
|
|
|
|
|
|
|
|
| $ | (142,273 | ) | ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Ratios: |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Net loss and loss expense ratio |
| 80.3 | % | 84.7 | % | 81.9 | % | 99.6 | % |
|
| 91.2 | % | |||||
Acquisition cost ratio |
| 12.9 | % | 1.6 | % | 8.8 | % | 16.6 | % |
|
| 12.9 | % | |||||
General and administrative expense ratio |
| 5.1 | % | 18.9 | % | 10.1 | % | 3.7 | % | 1.5 | % | 8.3 | % | |||||
Combined ratio |
| 98.3 | % | 105.2 | % | 100.8 | % | 119.9 | % |
|
| 112.4 | % | |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserve for loss and loss expenses |
| $ | 1,513,221 |
| $ | 1,379,010 |
| $ | 2,892,231 |
| $ | 1,622,046 |
| n/a |
| $ | 4,514,277 |
|
(a) The Company utilizes underwriting income (loss) as a measure of underwriting profitability as it evaluates profitability solely on underwriting related revenues and costs. Items not considered to be part of underwriting income (loss) include: corporate expenses, investment income, realized losses and gains on the sale of investments, foreign exchange and interest expense. These items are evaluated separately from our underwriting results. Underwriting income (loss) takes into account net premiums earned and other insurance related income as revenue and net losses and loss expenses, acquisition costs and underwriting related general and administrative expenses as expenses. Underwriting income (loss) is the difference between the revenue and expense items.
11
Nine Months ended September 30, 2004
|
| Global Insurance |
| U.S. Insurance |
| Total Insurance |
| Reinsurance |
| Corporate |
| Total |
| |||||
Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Gross premiums written |
| $ | 730,878 |
| $ | 595,637 |
| $ | 1,326,515 |
| $ | 1,034,627 |
| — |
| $ | 2,361,142 |
|
Net premiums written |
| 619,248 |
| 323,241 |
| 942,489 |
| 1,006,590 |
| — |
| 1, 949,079 |
| |||||
Net premiums earned |
| 595,761 |
| 247,837 |
| 843,598 |
| 635,851 |
| — |
| 1,479,449 |
| |||||
Other insurance related income |
| 6,887 |
| — |
| 6,887 |
| 763 |
| — |
| 7,650 |
| |||||
Expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Net losses and loss expenses |
| (368,476 | ) | (182,271 | ) | (550,747 | ) | (395,278 | ) | — |
| (946,025 | ) | |||||
Acquisition costs |
| (89,530 | ) | (7,477 | ) | (97,007 | ) | (104,667 | ) | — |
| (201,674 | ) | |||||
General and administrative expenses |
| (24,047 | ) | (49,927 | ) | (73,974 | ) | (29,058 | ) | — |
| (103,032 | ) | |||||
Underwriting income(a) |
| 120,595 |
| 8,162 |
| 128,757 |
| 107,611 |
| — |
| 236,368 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Corporate expenses |
|
|
|
|
|
|
|
|
| (28,328 | ) | (28,328 | ) | |||||
Net investment income |
|
|
|
|
|
|
|
|
| 104,621 |
| 104,621 |
| |||||
Realized gains on investments |
|
|
|
|
|
|
|
|
| 9,418 |
| 9,418 |
| |||||
Foreign exchange losses |
|
|
|
|
|
|
|
|
| (4,099 | ) | (4,099 | ) | |||||
Interest expense |
|
|
|
|
|
|
|
|
| (688 | ) | (688 | ) | |||||
Income before income taxes |
|
|
|
|
|
|
|
|
|
|
| $ | 317,292 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Ratios: |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Net loss and loss expense ratio |
| 61.8 | % | 73.5 | % | 65.3 | % | 62.1 | % |
|
| 63.9 | % | |||||
Acquisition cost ratio |
| 15.0 | % | 3.0 | % | 11.5 | % | 16.5 | % |
|
| 13.6 | % | |||||
General and administrative expense ratio |
| 4.0 | % | 20.1 | % | 8.8 | % | 4.6 | % | 1.9 | % | 8.9 | % | |||||
Combined ratio |
| 80.8 | % | 96.6 | % | 85.6 | % | 83.2 | % |
|
| 86.4 | % | |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserve for losses and loss expenses |
| $ | 805,364 |
| $ | 711,181 |
| $ | 1,516,545 |
| $ | 706,689 |
| n/a |
| $ | 2,223,234 |
|
(a) The Company utilizes underwriting income as a measure of underwriting profitability as it evaluates profitability solely on underwriting related revenues and costs. Items not considered to be part of underwriting income include: corporate expenses, investment income, realized losses and gains on the sale of investments, foreign exchange and interest expense. These items are evaluated separately from our underwriting results. Underwriting income takes into account net premiums earned and other insurance related income as revenue and net losses and loss expenses, acquisition costs and underwriting related general and administrative expenses as expenses. Underwriting income is the difference between the revenue and expense items.
12
5. Business Combinations
On August 1, 2005, the Company completed the purchase of Fireman’s Fund Insurance Company of Wisconsin, which is licensed in 46 states of the United States and the District of Columbia. Fireman’s Fund Insurance Company of Wisconsin was subsequently redomiciled to the state of Illinois and renamed AXIS Insurance Company. The Company paid a purchase price of $28.5 million. The purchase of AXIS Insurance Company was made to expand the Company’s ability to write insurance on an admitted basis within the U.S.
At the date of acquisition, Fireman’s Fund Insurance Company assumed all known, unknown and contingent liabilities relating to events occurring on or before the acquisition date. In addition, Fireman’s Fund Insurance Company entered into a reinsurance agreement to fully assume $22.9 million of outstanding loss reserves on the acquisition date. These loss reserves and a reinsurance recoverable of the same amount were recorded on the date of acquisition. To the extent Fireman’s Fund Insurance Company does not meet its obligation under these agreements, AXIS Insurance Company remains liable for these liabilities.
In addition to the loss reserves and related reinsurance recoverable, the assets of AXIS Insurance Company included fixed income securities and accrued interest of $18.8 million, cash equivalents of $0.7 million and licenses of $9.0 million. These assets were recorded at their fair values on the date of acquisition. The purchase price has been fully allocated against the fair values of the assets and liabilities; consequently, no goodwill was recorded.
6. Benefit Plans
The following table shows the components of expense for the quarters and nine months ended September 30, 2005 and 2004 and the amounts included in the Company’s Condensed Consolidated Balance Sheet as of September 30, 2005 and December 31, 2004 for the Company’s supplemental retirement plans established for the benefit of the Company’s Chairman and its Chief Executive Officer and President:
|
| Quarter ended |
| Nine Months ended |
| ||||||||
|
| September 30, 2005 |
| September 30, 2004 |
| September 30, 2005 |
| September 30, 2004 |
| ||||
Components of pension expense |
|
|
|
|
|
|
|
|
| ||||
Amortization of prior service cost |
| $ | 537 |
| $ | 536 |
| $ | 1,610 |
| $ | 1,608 |
|
Interest cost |
| 171 |
| 161 |
| 513 |
| 483 |
| ||||
Amortization of prior service cost |
| $ | 708 |
| $ | 697 |
| $ | 2,123 |
| $ | 2,091 |
|
The weighted-average assumptions used to determine net periodic pension cost and benefit obligations for the quarters and nine months ended September 30, 2005 and 2004 were:
|
| September 30, 2005 |
| September 30, 2004 |
| ||
Discount rate |
| 6.0 | % | 6.0 | % | ||
Expected return on plan assets |
|
| 6.0 | % |
| 6.0 | % |
13
|
| September 30, 2005 |
| December 31, 2004 |
| ||
Components of benefit obligation |
|
|
|
|
| ||
Benefit obligation amendment |
| $ | 11,371 |
| $ | 10,728 |
|
Interest cost |
| 513 |
| 643 |
| ||
Benefit obligation at end of period |
| $ | 11,884 |
| $ | 11,371 |
|
Reconciliation of Funded Status |
|
|
|
|
| ||
Funded Status |
| $ | (11,884 | ) | $ | (11,371 | ) |
Unrecognized prior service cost |
| 6,972 |
| 8,582 |
| ||
Accrued benefit cost |
| $ | (4,912 | ) | $ | (2,789 | ) |
7. Debt and Financing Arrangements
a) Senior Notes
On November 15, 2004, the Company issued $500.0 million of senior unsecured debt (“Senior Notes”) at an issue price of 99.785%, generating net proceeds of $495.7 million. The Senior Notes bear interest at a rate of 5.75% payable semi-annually in arrears on June 1 and December 1 of each year, beginning on June 1, 2005. Unless previously redeemed, the Senior Notes will mature on December 1, 2014. The Company may redeem the Senior Notes at any time, in whole or in part, at a “make-whole” redemption price, however, the Company has no current intention of calling the Senior Notes. The Senior Note indenture contains various covenants, including limitations on liens on the stock of restricted subsidiaries, restrictions as to the disposition of the stock of restricted subsidiaries, and limitations on mergers and consolidations. The Company was in compliance with all covenants contained in the Senior Note indenture at September 30, 2005. The market value of the Senior Notes at September 30, 2005 was $497.3 million. For the quarter ended September 30, 2005, the Company incurred interest expense of $7.2 million for the Senior Notes.
b) Credit Facilities
On August 25, 2005, the Company entered into a $1.5 billion credit agreement with a syndicate of lenders replacing its existing $750 million credit facility. The credit agreement is an unsecured five-year facility that allows the Company and its operating subsidiaries to issue letters of credit up to the full amount of the facility and to borrow up to $500 million for general corporate purposes, with total usage not to exceed $1.5 billion. The credit agreement contains various loan covenants, including limitations on the incurrence of future indebtedness, future liens, fundamental changes, investments and certain transactions with affiliates. The facility also requires that the Company maintain 1) a minimum consolidated net worth of $2.0 billion plus (A) 25% of consolidated net income (if positive) of AXIS Capital for each semi-annual fiscal period ending on or after December 31, 2005 plus (B) an amount equal to 25% of the net cash proceeds received by AXIS Capital from the issuance of its capital stock during each such semi-annual fiscal period; and 2) a maximum debt to total capitalization ratio of 0.35:1.0. The Company was in compliance with all covenants contained in the credit agreement at September 30, 2005. As at September 30, 2005, the Company had letters of credit of $436.1 million (2004: $421.7 million) outstanding. There was no debt outstanding under the credit agreements as at September 30, 2005 or December 31, 2004.
8. Share Transactions
On September 28, 2005, the Company announced that it had agreed to offer to the public $250.0 million of 7.25% Series A preferred shares, par value $0.0125 per share, with a liquidation preference of $25.00 per share. The Company may redeem the shares on and after October 15, 2010 at a redemption price
14
of $25.00 per share. Included within other assets at September 30, 2005 was net proceeds of $242.3 million, which the Company received following the completion of the offering on October 5, 2005.
On February 16, 2005, the Company repurchased 12,783,094 common shares owned by initial investors at the formation of the Company pursuant to its repurchase program. The average purchase price was $27.38 per common share and the aggregate price was $350.0 million.
9. Earnings Per Share
The following table sets forth the calculation of basic and diluted earnings per share:
|
| Quarter ended |
| Nine Months ended |
| ||||||||
|
| September 30, 2005 |
| September30, 2004 |
| September 30, 2005 |
| September 30, 2004 |
| ||||
Basic earnings (loss) per share |
|
|
|
|
|
|
|
|
| ||||
Net (loss) income |
| $ | (468,075 | ) | $ | 6,279 |
| $ | (143,431 | ) | $ | 313,923 |
|
Weighted average common shares outstanding |
| 140,995,298 |
| 152,534,495 |
| 142,711,852 |
| 152,523,144 |
| ||||
(Loss) earnings per share - basic |
| $ | (3.32 | ) | $ | 0.04 |
| $ | (1.01 | ) | $ | 2.06 |
|
|
|
|
|
|
|
|
|
|
| ||||
Diluted earnings per share |
|
|
|
|
|
|
|
|
| ||||
Net (loss) income |
| $ | (468,075 | ) | $ | 6,279 |
| $ | (143,431 | ) | $ | 313,923 |
|
Weighted average common shares outstanding |
| 140,995,298 |
| 152,534,495 |
| 142,711,852 |
| 152,523,144 |
| ||||
Share equivalents |
|
|
|
|
|
|
|
|
| ||||
Warrants |
| — |
| 10,545,184 |
| — |
| 10,755,132 |
| ||||
Options |
| — |
| 2,220,416 |
| — |
| 2,270,654 |
| ||||
Restricted stock |
| — |
| 828,833 |
| — |
| 852,568 |
| ||||
Weighted average common shares and common share equivalents outstanding — diluted |
| 140,995,298 |
| 166,128,928 |
| 142,711,852 |
| 166,401,498 |
| ||||
(Loss) earnings per share- diluted |
| $ | (3.32 | ) | $ | 0.04 |
| $ | (1.01 | ) | $ | 1.89 |
|
The following securities that will result in the issuance of common shares were not included in the computation of diluted earnings per share because the effect would be antidilutive: 16,570,771 and 1,671,875 for the quarters ended September 30, 2005 and 2004, respectively, and 17,186,868 and 1,735,875 for the nine months ended September 30, 2005 and 2004, respectively.
10. Subsequent Event
In October 2005, Hurricane Wilma caused significant damage in Mexico and Florida. While the Company has exposure to losses from Hurricane Wilma, no reasonable estimate of losses can be made at this time.
15
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
As used in this quarterly report, references to “we,” “us” or “our” refer to the consolidated operations of AXIS Capital and its direct and indirect subsidiaries and branches, unless the context suggests otherwise.
Business Overview
The following is a discussion of the Company’s financial condition, liquidity and results of operations. This discussion should be read in conjunction with the Management’s Discussion and Analysis of Financial Condition and Results of Operations and the audited Consolidated Financial Statements and notes thereto presented under Item 7 and Item 8, respectively, of the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 filed with the SEC on March 1, 2005.
The markets in which we operate have historically been cyclical. During periods of excess underwriting capacity, as defined by availability of capital, competition can result in lower pricing and less favorable policy terms and conditions for insurers and reinsurers. During periods of reduced underwriting capacity, pricing and policy terms and conditions are generally more favorable for insurers and reinsurers. Historically, underwriting capacity has been impacted by several factors, including industry losses, catastrophes, changes in legal and regulatory guidelines, investment results and the ratings and financial strength of competitors.
We believe that we are currently operating in a marketplace that, with appropriate risk selection, can offer favorable pricing and/or terms and conditions in our business segments. In general, pricing in our insurance segment has been stable to declining for many classes of business. Terms and conditions remain relatively attractive. In our reinsurance segment, we have experienced moderate price softening, particularly in short-tail lines of business, with the exception of Florida catastrophe-exposed business. Terms and conditions have remained firm across most lines of business. Following the catastrophic events of the third quarter of 2005, we anticipate substantial contraction of underwriting capacity in catastrophe-exposed short-tail lines of business. We expect this contraction of capacity, coupled with stricter underwriting discipline and risk management within the industry, will lead to increased pricing and firming of terms and conditions in these lines globally. We believe that this contraction of capacity may impact market conditions more broadly. Despite the catastrophic events of the third quarter, the aviation line of business is experiencing severe pricing competition. This competition has resulted in our declining a substantial amount of aviation renewal business. This business is largely incepted in the fourth quarter of each year and subsequently earned over the course of the following year.
We derive our revenues primarily from the sale of our insurance policies and reinsurance contracts. Insurance and reinsurance premiums are a function of the number and type of contracts we write, as well as prevailing market prices. Our expenses primarily consist of net losses and loss expenses, acquisition costs, general and administrative expenses and interest expense.
Financial Measures
Our objective as an insurance and reinsurance company is to generate superior returns on capital that appropriately reward us for the risks we assume and to grow revenue only when we deem the returns meet or exceed our requirements. To achieve this objective, we must be able to accurately assess the potential losses associated with the risks that we insure and reinsure, to manage our investment portfolio risk appropriately, and to control acquisition costs and infrastructure throughout the organization. Three financial measures that are meaningful in analyzing our performance are return on equity, combined ratio and underwriting income. Our return on equity calculation is based on the level of net income generated from the average of the opening and closing shareholders’ equity during the period. The combined ratio is a formula used by insurance and reinsurance companies to relate net premiums earned during a period to
16
net losses and loss expenses, acquisition costs and general and administrative expenses during a period. A combined ratio above 100% indicates that a company is incurring more in net losses and loss expenses, acquisition costs and general and administrative expenses than it is earning in net premiums. We consider the combined ratio an appropriate indicator of our underwriting performance, particularly given the relatively short-tail orientation of our overall portfolio of risks. Underwriting income is a measure of underwriting profitability that takes into account net premiums earned and other insurance related income as revenue and net losses and loss expenses, acquisition costs and underwriting related general and administrative expenses as expenses. Underwriting income is the difference between these revenue and expense items.
The following table details our key performance indicators for the periods indicated:
|
| Quarter ended |
| Nine months ended |
| ||||||||
|
| September 30, 2005 |
| September 30, 2004 |
| September 30, 2005 |
| September 30, 2004 |
| ||||
|
| ($in thousands, except share and per share amounts) |
| ||||||||||
Gross premiums written |
| $ | 794,571 |
| $ | 687,700 |
| $ | 2,760,563 |
| $ | 2,361,142 |
|
Net premiums earned |
| 616,814 |
| 521,798 |
| 1,866,817 |
| 1,479,449 |
| ||||
Underwriting (loss) income |
| (523,598 | ) | (33,137 | ) | (208,232 | ) | 236,368 |
| ||||
Net (loss) income |
| (468,075 | ) | 6,279 |
| (143,431 | ) | 313,923 |
| ||||
Net loss and loss expense ratio |
| 167.8 | % | 85.4 | % | 91.2 | % | 63.9 | % | ||||
Acquisition cost ratio |
| 10.4 | % | 15.2 | % | 12.9 | % | 13.6 | % | ||||
General and administrative expense ratio |
| 7.2 | % | 9.0 | % | 8.3 | % | 8.9 | % | ||||
Combined ratio |
| 185.4 | % | 109.6 | % | 112.4 | % | 86.4 | % | ||||
Return on average equity |
| (64.7 | )% | 0.8 | % | (6.5 | )% | 14.2 | % | ||||
Because we have a limited operating history and are exposed to volatility in our results of operations, period-to-period comparisons of our results of operations may not be meaningful. In addition, the amount of premiums written with respect to any particular segment or line of business may vary from quarter to quarter as a result of changes in market conditions and our view of the long-term profit potential of individual lines of business.
Critical Accounting Policies
The Company’s critical accounting policies are discussed in Managements’ Discussion and Analysis of Results of Operations and Financial Condition contained in our Annual Report on Form 10-K for the year ended December 31, 2004 filed with the SEC on March 1, 2005.
Results of Operations
Quarters ended September 30, 2005 and 2004
Premiums. The $106.9 million increase in gross written premium was generated primarily by our reinsurance segment, which experienced an increase in gross premiums written of $88.0 million. This was largely due to an increase in reinstatement premiums following losses incurred from Hurricane Katrina.
The increase of $151.2 million in premiums ceded was largely due to an increase in the level of reinsurance purchased by our insurance segment. This was primarily a result of reinstatement premiums ceded by global insurance following reinsurance recoveries from Hurricanes Katrina and Rita.
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The $95.0 million increase in net premiums earned was primarily generated by our reinsurance segment, which reported an increase of $136.2 million in net premiums earned. Premiums are earned over the term of the policies in proportion to the risks to which they relate. As the level of net premiums written increases, the level of net premiums earned also increases. As we experienced an increase in net premiums written over the rolling twelve-month period ended September 30, 2005 compared to the rolling twelve-month period ended September 30, 2004, our net premiums earned increased.
Net Investment Income. Net investment income increased by $27.0 million due to a combination of higher investment balances and higher investment yields. Net investment income consisted of $59.4 million of interest on cash and fixed maturity investments and $9.3 million of income from other investments, offset by $1.7 million of net investment expenses. Included in net investment income was $4.2 million of unrealized gains from other investments. Net investment income for the quarter ended September 30, 2004 consisted of $41.0 million of interest on cash and fixed maturity investments, $0.7 million of income from other investments, offset by $1.7 million of net investment expenses.
The annualized effective yield (calculated by dividing the net investment income generated from invested assets by the average balance of the assets managed by our portfolio managers) increased by 0.8% to 4.3%. The increase in the effective yield was primarily due to higher U.S. interest rates at the short end of the yield curve. The yield may vary significantly from period to period due primarily to the timing of cash flows, changes in interest rates and changes in asset allocation.
Net Realized Losses/Gains. Net realized losses increased by $10.2 million. The increase was generated by a movement in net realized gains (losses) of $10.0 million and net realized and unrealized losses of $0.2 million from investment derivatives that we use to hedge foreign exchange risk in our investment portfolio. We invest our portfolio to produce a total return. In assessing returns under this approach, we include investment income, realized gains and losses and unrealized gains and losses generated by the investment portfolio. As a result, there can be significant changes in the levels of our net realized gains (losses) from quarter to quarter.
The total return for our investment portfolio for the quarter ended September 30, 2005 (calculated using beginning and ending market portfolio values, adjusted for external cash flows) was (0.2)% versus 2.4% for the quarter ended September 30, 2004. The total return for an investment portfolio consists of price and income return. These components are primarily affected by the timing of cash flows, changes in interest rates and changes in asset allocation. Our total return was lower during the quarter ended September 30, 2005 as higher investment yields obtained during the quarter versus the comparable prior period were offset by an increase in intermediate U.S. interest rates that negatively impacted the price of fixed income securities.
Other Insurance Related Income/Loss. The decrease of $7.0 million in other insurance related income/loss was due to the expiration in the second quarter of 2005 of the principal contract that was accounted for as a derivative.
Net Losses and Loss Expenses. The increase of $589.7 million in net losses and loss expenses was primarily generated by an increase in the level of hurricane related net incurred losses and loss expenses.
In late August 2005, Hurricane Katrina caused widespread damage to homes and businesses in six states: Louisiana, Mississippi, Alabama, Florida, Tennessee and Georgia. Estimates as to the size of the industry loss from this hurricane vary significantly due primarily to the extent of damage, the interpretation of coverage under insurance contracts and the delay in adjusting losses in the affected areas. Most policies do not cover flood damage, or substantially limit flood damage; however, they may cover water damage caused by wind, such as storm surge. Difficulties will arise in estimating a loss when a
18
combination of insured and uninsured perils have caused the damage. Of the industry losses estimated by risk modeling agencies, only Risk Management Solutions attempted at an early stage to explicitly estimate insured losses from flooding in its industry loss estimate, which currently stands at $40 billion to $60 billion.
Our estimate of net losses and loss expenses from Hurricane Katrina was $723.6 million and was derived from our insurance and reinsurance segments. This estimate of net losses and loss expenses is based upon industry loss predictions of $60 billion and includes wind-related damages, flood-related damages, offshore energy and marine losses and business interruption. Our estimate of net losses and loss expenses was derived from a combination of the output of industry models, market share analyses, a review of in-force contracts and preliminary loss information from our clients, brokers and loss adjusters.
In late September 2005, Hurricane Rita struck Texas and Louisiana causing significant destruction in those areas. We incurred estimated net losses and loss expenses of $80.9 million in our insurance and reinsurance segments. Our estimate of net losses and loss expenses is based upon industry loss predictions of $2.5 billion to $7.0 billion and was derived from a combination of the output of industry models, market share analyses and a preliminary review of in-force contracts.
Our actual losses from both of these hurricanes may differ materially from our estimates of net losses and loss expenses.
During the quarter ended September 30, 2004, we incurred estimated net losses and loss expenses of $227.4 million from Hurricanes Charley, Frances, Ivan and Jeanne, which swept across the Caribbean and Southeastern United States in August and September 2004.
The net loss and loss expense ratio for the quarter ended September 30, 2005 was 167.8% compared to 85.4% for the quarter ended September 30, 2004. During the quarter ended September 30, 2005, we experienced favorable prior period development of $95.8 million, or 15.5 percentage points, compared with $49.6 million, or 9.5 percentage points, for the quarter ended September 30, 2004.
Acquisition Costs. The acquisition cost ratio for the quarter ended September 30, 2005 was 10.4% compared to 15.2% for the quarter ended September 30, 2004. The decrease was principally the result of a reduction of $39.6 million in the amounts expensed under incentive commission arrangements with brokers from 2004, following agreement as to the amounts due under such arrangements. Excluding incentive commissions, the acquisition cost ratio for the quarter ended September 30, 2005 was 15.0% compared to 12.9% for the quarter ended September 30, 2004. The increase in the ratio was primarily due to a change in business mix with a higher percentage of net premiums generated by our reinsurance segment, which has a higher acquisition cost ratio. For the quarter ended September 30, 2005, 59.7% of our net premiums earned was derived from our reinsurance segment compared to 44.5% for the quarter ended September 30, 2004.
At September 30, 2005, we had two remaining incentive commission arrangements with brokers from 2004 that had yet to be resolved. Although we have accrued our best estimate of the amounts due under these arrangements, given the uncertainties that exist surrounding the calculation and payment of these incentive commissions, our estimates are subject to change. Any changes in the estimates are recorded during the period in which the change is identified. We have not entered into any incentive commission arrangements with brokers for 2005 and, therefore, have not accrued any fees regarding these arrangements for the quarter ended September 30, 2005. To date, the level of commissions charged in 2005 by brokers has generally remained consistent with prior periods.
General and Administrative Expenses. The general and administrative expense ratio for the quarter ended September 30, 2005 decreased to 7.2% from 9.0% for the quarter ended September 30,
19
2004. This decrease was primarily due to a reduction in accrued compensation costs caused by the significant level of loss activity during the quarter together with an increase in net premiums earned.
Foreign Exchange. Our functional currency is the U.S. dollar; however, some of our business is written in other currencies. For the quarter ended September 30, 2005, we experienced a foreign exchange loss of $1.7 million compared to a foreign exchange gain of $3.5 million for the quarter ended September 30, 2004.
Interest Expense. The increase of $7.9 million was primarily due to the issuance of senior unsecured debt in November 2004, which bears interest at 5.75% per annum. Interest expense consists of interest due on outstanding debt, the amortization of debt offering expenses and offering discounts, and fees relating to our credit facility.
Income Tax. For the quarter ended September 30, 2005, we experienced an income tax recovery of $8.3 million compared to $2.4 million for the quarter ended September 30, 2004.The increase was primarily attributable to the generation of taxable losses by our U.S. and European subsidiaries, following an increase in the level of hurricane-related net losses and loss expenses.
Net (Loss) Income. Net loss consisted of a net underwriting loss of $523.6 million, net investment income and net realized losses of $60.6 million, corporate expenses of $3.3 million, foreign exchange losses of $1.7 million, interest expense of $8.4 million and tax recovery of $8.3 million. Net income for the quarter ended September 30, 2004 consisted of net underwriting loss of $33.1 million, net investment income and net realized gains of $43.7 million, corporate expenses of $9.7 million, foreign exchange gains of $3.5 million and a tax recovery of $2.4 million.
Comprehensive (Loss) Income. Comprehensive loss decreased $583.1 million and represents net (loss) income adjusted for changes in the unrealized position in our investment portfolio.
Nine months ended September 30, 2005 and 2004
Premiums. We experienced an increase in gross written premium of $399.4 million, which was primarily generated by an increase in gross premiums written of $323.1 million by our reinsurance segment. This was largely due to an increase in reinstatement premiums, following incurred losses from Hurricane Katrina, greater market penetration in Continental Europe and new opportunities within our property book.
The $152.9 million increase in premium ceded was largely due to an increase in the level of reinsurance purchased by our insurance segment. This was primarily a result of reinstatement premiums ceded by global insurance following reinsurance recoveries from Hurricanes Katrina and Rita.
The $387.4 million increase in net premiums earned resulted primarily from our reinsurance segment, which reported an increase in net premiums earned of $346.0 million. Premiums are earned over the term of the policies in proportion to the risks to which they relate. As the level of net premiums written increases, the level of net premiums earned also increases. As we experienced an increase in net premiums written over the rolling twelve-month period ended September 30, 2005 compared to the rolling twelve-month period ended September 30, 2004, our net premiums earned increased.
Net Investment Income. Net investment income increased by $73.2 million due to a combination of higher investment balances and higher investment yields. Net investment income consisted of $165.5 million of interest on cash and fixed maturity investments and $17.2 million of income from other investments, offset by $4.9 million of net investment expenses. Included in net investment income was $5.1 million of unrealized gains from other investments. Net investment income for the nine months
20
ended September 30, 2004 consisted of $108.4 million of interest on cash and fixed maturity investments and $1.2 million of income from other investments, offset by $5.0 million of net investment expenses.
The annualized effective yield (calculated by dividing the net investment income generated from invested assets by the average balance of the assets managed by our portfolio managers) increased by 0.7%. The increase in the effective yield was primarily due to higher U.S. interest rates at the short end of the yield curve. The yield may vary significantly from period to period due primarily to the timing of cash flows, changes in interest rates and changes in asset allocation.
Net Realized Losses/Gains. Net realized losses increased by $15.4 million. The increase was generated by a movement in net realized gains (losses) of $21.0 million offset by net realized and unrealized gains of $5.6 million from investment derivatives that we use to hedge foreign exchange risk in our investment portfolio. We invest our portfolio to produce a total return. In assessing returns under this approach, we include investment income, realized gains and losses and unrealized gains and losses generated by the investment portfolio. As a result, there can be significant changes in the levels of our net realized gains (losses) from quarter to quarter.
The total return for our investment portfolio for the nine months ended September 30, 2005 (calculated using beginning and ending market portfolio values, adjusted for external cash flows) was 1.7% versus 2.7% for the nine months ended September 30, 2004. The decrease was due to an increase in intermediate U.S. interest rates that negatively impacted the price of fixed income securities. The total return for an investment portfolio consists of price and income return. These components are primarily affected by the timing of cash flows, changes in interest rates and changes in asset allocation.
Other Insurance Related Income/Loss. The decrease of $12.9 million in other insurance related income/loss was primarily due to the movement in the fair value of insurance contracts that meet the definition of derivatives. During the second quarter of 2005, the principal contract that was accounted for as a derivative expired.
Net Losses and Loss Expenses. The increase of $756.4 million in net losses and loss expenses was primarily generated by an increase in the level of hurricane related net incurred losses and loss expenses.
�� In late August 2005, Hurricane Katrina caused widespread damage to homes and businesses in six states: Louisiana, Mississippi, Alabama, Florida, Tennessee and Georgia. Estimates as to the size of the industry loss from this hurricane vary significantly due primarily to the extent of damage, to the interpretation of coverage under insurance contracts and the delay in adjusting losses in the affected areas. Most policies do not cover flood damage, or substantially limit flood damage; however, they may cover water damage caused by wind, such as storm surge. Difficulties will arise in estimating a loss when a combination of insured and uninsured perils have caused the damage. Of the industry losses estimated by risk modeling agencies, only Risk Management Solutions attempted at an early stage to explicitly estimate insured losses from flooding in its industry loss estimate, which currently stands at $40 billion to $60 billion.
Our estimate of net losses and loss expenses for Hurricane Katrina was $723.6 million and was derived from our insurance and reinsurance segments. Our estimate of net losses and loss expenses is based upon industry loss predictions of $60 billion and includes wind-related damages, flood-related damages, offshore energy and marine losses and business interruption. Our estimate of net losses and loss expenses was derived from a combination of the output of industry models, market share analyses, a review of in-force contracts and preliminary loss information from our clients, brokers and loss adjusters.
21
In late September 2005, Hurricane Rita struck Texas and Louisiana causing significant destruction in those areas. We incurred estimated net losses and loss expenses of $80.9 million in our insurance and reinsurance segments. Our estimate of net losses and loss expenses is based upon industry loss predictions of $2.5 billion to $7.0 billion and was derived from a combination of the output of industry models, market share analyses and a preliminary review of in-force contracts.
Our actual losses from these hurricanes may differ materially from our estimates of net losses and loss expenses.
During the nine months ended September 30, 2004, we incurred estimated net losses and loss expenses of $227.4 million from Hurricanes Charley, Frances, Ivan and Jeanne, which swept across the Caribbean and Southeastern United States in August and September 2004.
The net loss and loss expense ratio for the nine months ended September 30, 2005 was 91.2% compared to 63.9% for the nine months ended September 30, 2004. During the nine months ended September 30, 2005, we experienced favorable prior period development of $236.5 million, or 12.7 percentage points, compared with $141.4 million, or 9.6 percentage points, for the nine months ended September 30, 2004.
Acquisition Costs. The increase of $39.5 million in acquisition costs primarily resulted from an increase in the volume of gross premiums earned. The acquisition cost ratio for the nine months ended September 30, 2005 was 12.9% compared to 13.6% for the nine months ended September 30, 2004. The decrease was principally the result of a reduction of $40.6 million in the amounts expensed under our incentive commission arrangements with brokers from 2004, following agreement as to the amounts due under such arrangements. Excluding incentive commissions, the acquisition cost ratio for the nine months ended September 30, 2005 was 13.6% compared to 11.8% for the nine months ended September 30, 2004. The increase in the ratio was principally the result of two factors. First, the acquisition cost ratio within our reinsurance segment increased from 16.5% for the nine months ended September 30, 2004 to 16.6% for the nine months ended September 30, 2005. Second, we experienced a change in our business mix with a higher percentage of net earned premiums generated by our reinsurance segment. For the nine months ended September 30, 2005, 52.5% of our net earned premiums was generated by our reinsurance segment compared to 43.0% for the nine months ended September 30, 2004.
At September 30, 2005, we had two remaining incentive arrangements with brokers from 2004 that had yet to be resolved. Although we have accrued our best estimate of the amounts due under these arrangements, given the uncertainties that exist surrounding the calculation and payment of these incentive commissions, our estimates are subject to change. Any changes in the estimate are recorded during the period in which the change is identified. We have not entered into any incentive commission arrangements with brokers for business underwritten in 2005 and, therefore, have not accrued any fees regarding these arrangements for the quarter ended September 30, 2005. To date, the level of commissions charged in 2005 by brokers has generally remained consistent with prior periods.
General and Administrative Expenses. The $24.0 million increase in general and administration expenses was generated principally by an increase in compensation costs due primarily to an increase in headcount from the expansion of operations in the U.S. and Continental Europe. The general and administrative expense ratio for the nine months ended September 30, 2005 was 8.3% compared to 8.9% for the nine months ended September 30, 2004.
Foreign Exchange. Our functional currency is the U.S. dollar; however, some of our business is written in other currencies. For the nine months ended September 30, 2005, we experienced a foreign exchange loss of $52.4 million, compared to an exchange loss of $4.1 million for the nine months ended September 30, 2004. The loss was principally attributable to the decline of the Euro against the U.S.
22
dollar and an increase in our asset balances denominated in Euros following an increase in the level of gross premiums written in this currency in our reinsurance segment.
Interest Expense. The increase of $23.6 million was primarily due to the issuance of senior unsecured debt in November 2004, which bears interest at 5.75% per annum. Interest expense consists of interest due on outstanding debt, the amortization of debt offering expenses and offering discounts, and fees relating to our credit facility.
Income Tax. The decrease of $2.2 million in the income tax expense was attributable to the generation of taxable losses by our U.S. and European subsidiaries following an increase in the level of hurricane-related net losses and loss expenses.
Net (Loss) Income. Net loss consisted of a net underwriting loss of $208.2 million, net investment income and net realized losses of $171.8 million, corporate expenses of $29.2 million, foreign exchange losses of $52.4 million, interest expense of $24.2 million and tax expense of $1.2 million. Net income for the nine months ended September 30, 2004 consisted of net underwriting income of $236.4 million, net investment income and net realized gains of $114.0 million, corporate expenses of $28.3 million, foreign exchange losses of $4.1 million, interest expense of $0.7 million and tax expense of $3.4 million.
Comprehensive (Loss) Income. Comprehensive loss decreased by $522.9 million and represents net (loss) income adjusted for changes in the unrealized position in our investment portfolio.
Underwriting Results by Segment
Our business consists of two underwriting segments: insurance and reinsurance. Our insurance segment is further divided into two sub-segments: global insurance and U.S. insurance.
We evaluate the performance of each underwriting segment based on underwriting results. We allocate all of our general and administrative costs, except our corporate expenses, to our underwriting segments. Our corporate expenses include holding company costs necessary to support our worldwide insurance and reinsurance operations and costs associated with operating as a publicly-traded company. We do not allocate our assets by segment as we evaluate the underwriting results of each segment separately from the results of our investment portfolio.
Insurance
Our insurance segment provides specialty lines of business on a worldwide basis.
Global insurance provides specialty lines coverage predominantly through the London broker network with product lines comprising property, marine, terrorism and war risk, aviation and aerospace, political risk and professional lines and other specialty risks.
The property line of business provides physical damage and business interruption coverage for industrial properties and physical damage, business interruption and liability coverage for onshore energy property and operations. Coverage relates to both catastrophic and non-catastrophic events.
The marine line of business provides coverage for hull, liability, cargo and specie and recreational marine risks. These risks include property damage to ships, pollution damage caused by vessels on a sudden and accidental basis and protection for general cargo and the contents of armored cars, vaults, exhibitions and museums. This line of business also provides physical damage, business interruption and liability coverage for offshore energy property and operations.
23
The terrorism and war risk line of business includes coverage for physical damage and associated business interruption of an insured following an act of terrorism and specific war coverage for the interests otherwise covered in our aviation and marine hull and liability business.
The aviation and aerospace line of business includes hull and liability coverage for passenger and cargo airlines and privately owned aircraft, select aviation product liability coverage, physical damage coverage on satellite launches and satellite liability.
The political risk line of business generally provides protection against sovereign default or other sovereign actions resulting in impairment of cross-border investments for banks and major corporations in industries such as energy and mining.
The professional lines and other specialty line of business primarily consist of directors’ and officers’ liability coverage.
U.S. insurance provides coverage through a variety of channels in the U.S. and covers exposures predominantly in the U.S. The product lines are property, professional lines, liability and other specialty and are offered through wholesale brokers, retail brokers and managing general underwriters. Many of its property and casualty insurance products are for nonstandard and complex risks. U.S. insurance also writes risks that are unique and difficult to place in the standard market, but must remain with an admitted insurance company for marketing and regulatory purposes.
The property line of business provides coverage for physical damage and business interruption primarily with respect to commercial properties. The book consists of both primary and excess risks, some of which are catastrophe-exposed.
The professional lines business primarily consists of coverage for directors’ and officers’ liability, errors and omission liability and employment practices liability.
The liability line of business primarily targets casualty risks in the U.S. excess and surplus lines markets. Target classes include mercantile, manufacturing and building/premises, with particular emphasis on commercial and consumer products, commercial construction and miscellaneous general liability.
The other specialty book currently consists of a product that indemnifies self-insured, small and medium sized employers for losses in excess of a retention associated with employee medical coverage.
Quarters ended September 30, 2005 and September 30, 2004
The following table summarizes the underwriting results and ratios for the insurance segment for the quarters ended September 30, 2005 and 2004:
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|
| Quarter ended |
|
|
| ||||||||
|
| September 30, 2005 |
| September 30, 2004 |
| Change |
| % Change |
| ||||
|
|
|
| ($ in thousands) |
|
|
|
|
| ||||
Revenues: |
|
|
|
|
|
|
|
|
| ||||
Gross premiums written |
| $ | 460,583 |
| $ | 441,662 |
| $ | 18,921 |
|
| 4.3 | % |
Net premiums written |
| 187,874 |
| 328,281 |
| (140,407 | ) | (42.8 | )% | ||||
Net premiums earned |
| 248,533 |
| 289,743 |
| (41,210 | ) | (14.2 | )% | ||||
Other insurance related income |
| 236 |
| 7,106 |
| (6,870 | ) | (96.7 | )% | ||||
Expenses: |
|
|
|
|
|
|
|
|
| ||||
Net losses and loss expenses |
| (438,524 | ) | (237,864 | ) | (200,660 | ) | (84.4 | )% | ||||
Acquisition costs |
| (11,571 | ) | (38,008 | ) | 26,437 |
| 69.6 | % | ||||
General and administrative expenses |
| (28,755 | ) | (26,814 | ) | (1,941 | ) | (7.2 | )% | ||||
Underwriting loss |
| $ | (230,081 | ) | $ | (5,837 | ) | $ | (224,244 | ) | nm |
| |
Ratios: |
|
|
|
|
|
|
|
|
| ||||
Net loss and loss expense ratio |
| 176.4 | % | 82.1 | % | (94.3 | )% |
|
| ||||
Acquisition cost ratio |
| 4.7 | % | 13.1 | % | 8.4 | % |
|
| ||||
General and administrative expense ratio |
| 11.6 | % | 9.3 | % | (2.3 | )% |
|
| ||||
Combined ratio |
| 192.7 | % | 104.5 | % | (88.2 | )% |
|
| ||||
nm — not meaningful
Premiums. The increase in gross premiums written was principally due to an increase of $41.6 million in gross premiums written in U.S. insurance that offset a $22.7 million decrease in gross written premiums in global insurance.
The table below shows gross premiums written in global insurance by line of business for the quarters ended September 30, 2005 and 2004:
|
| Quarter ended |
|
|
| ||||||||
|
| September 30, 2005 |
| September 30, 2004 |
| Change |
| % Change |
| ||||
|
|
|
| ($ in thousands) |
|
|
|
|
| ||||
Property |
| $ | 49,136 |
| $ | 57,960 |
| $ | (8,824 | ) |
| (15.2 | )% |
Marine |
| 23,671 |
| 39,732 |
| (16,061 | ) | (40.4 | )% | ||||
Terrorism and War Risk |
| 23,919 |
| 34,026 |
| (10,107 | ) | (29.7 | )% | ||||
Aviation and Aerospace |
| 28,037 |
| 38,645 |
| (10,608 | ) | (27.4 | )% | ||||
Political Risk |
| 45,743 |
| 31,018 |
| 14,725 |
| 47.5 | % | ||||
Professional Lines and Other Specialty |
| 21,110 |
| 12,901 |
| 8,209 |
| 63.6 | % | ||||
Total |
| $ | 191,616 |
| $ | 214,282 |
| $ | (22,666 | ) |
| (10.6 | )% |
The decrease in gross premiums written was partially due to rate reductions in several lines of business, which resulted in fewer risks meeting our underwriting criteria. This deterioration in the pricing environment primarily accounted for the reduction in premiums written in our property and aviation and aerospace lines of business and to a lesser extent the decrease experienced in our marine and terrorism and war risk lines. The decrease in gross premiums written was also driven by two other factors. First, we experienced a $12.3 million decrease in premiums written on our energy offshore business. This was primarily the result of additional gross premiums written in the third quarter of 2004 relating to one-off
25
construction business. Second, our terrorism and war risk lines included a $4.0 million decrease in gross written premium on our aviation war business primarily as a result of adjustments on business written in prior quarters on a line slip basis following a review of estimated premium and the development of actual premium data. Our political risk book is not characterized by predictable renewal patterns, as it is largely dependent upon the levels of foreign direct investment and, consequently, there can be some variability in the level of our gross premium writings for comparable periods. The growth in our professional lines and other specialty gross premiums written was due to the addition of a London market-based professional lines underwriting team in early 2004, which is focused on European risks. Consequently, only a small amount of business was written in the quarter ended September 30, 2004.
The table below shows gross premiums written in U.S. insurance by line of business for the quarters ended September 30, 2005 and 2004:
|
| Quarter ended |
|
|
| |||||||
|
| September 30, 2005 |
| September 30, 2004 |
| Change |
| % Change |
| |||
|
|
|
| ($ in thousands) |
|
|
|
|
| |||
Property |
| $ | 116,250 |
| $ | 103,517 |
| $ | 12,733 |
| 12.3 | % |
Liability |
| 64,977 |
| 58,962 |
| 6,015 |
| 10.2 | % | |||
Professional Lines |
| 84,665 |
| 64,901 |
| 19,764 |
| 30.4 | % | |||
Other Specialty |
| 3,075 |
| — |
| 3,075 |
| nm |
| |||
Total |
| $ | 268,967 |
| $ | 227,380 |
| $ | 41,587 |
| 18.3 | % |
The increase in gross premiums written in our professional lines business was driven primarily by an increase of $17.9 million in errors and omissions insurance following the appointment of a managing general underwriter effective January 1, 2005. The increase in gross premiums written in our property account was primarily driven by an increase of $9.2 million in premiums generated by our specialty program business, which includes coverages such as property, builders risk insurance and earthquake risk. We experienced growth in our inland marine business of $3.1 million due to an increase in the number of dedicated underwriters. The increase in our liability gross premiums written was largely driven by an additional $7.5 million of umbrella and excess liability insurance following our decision to target this class of business and increase the number of dedicated underwriters. In addition, we generated $5.9 million of new specialty program business, which primarily covers recreational marine watercraft risk. These increases were offset by a $7.3 million decrease on our primary casualty account, primarily as the result of an increasingly competitive pricing environment.
Premiums ceded increased by $159.3 million, primarily due to reinstatement premiums. We recorded $612.9 million of reinsurance recoveries on our gross losses from Hurricanes Katrina and Rita and ceded $93.5 million for the reinstatement of our reinsurance protections.
The following table shows the derivation of net premiums earned in our insurance segment for the quarters ended September 30, 2005 and 2004:
26
|
| Quarter ended |
|
|
| |||||||
|
| September 30, 2005 |
| September 30, 2004 |
| Change |
| % Change |
| |||
|
|
|
| ($ in thousands) |
|
|
|
|
| |||
Gross premiums earned |
| $ | 486,194 |
| $ | 405,971 |
| $ | 80,223 |
| 19.8 | % |
Ceded premiums amortized |
| (237,661 | ) | (116,228 | ) | (121,433 | ) | (104.5 | )% | |||
Net premiums earned |
| $ | 248,533 |
| $ | 289,743 |
| $ | (41,210 | ) | (14.2 | )% |
Gross premiums are earned over the period of the insured risk. As the level of net premiums written increases, the level of net premiums earned also increases. As we experienced an increase in gross premiums written over the rolling twelve-month period ended September 30, 2005 compared to the rolling twelve-month period ended September 30, 2004, our gross premiums earned increased.
Ceded premiums are amortized over the contract term. Consequently, the level of amortized ceded premium has increased in 2005 as premiums ceded in 2004 continue to be amortized in 2005. In addition, following the exhaustion of reinsurance protection on some contracts due to losses recovered from Hurricanes Katrina and Rita, some of our ceded premiums were fully amortized during the quarter.
Other Insurance Related Income. The decrease of $6.9 million in other insurance related income/loss was primarily due to the movement in the fair value of insurance contracts that meet the definition of derivatives. During the second quarter of 2005, the principal contract that was accounted for as a derivative expired.
Net Losses and Loss Expenses. The increase in net loss and loss expenses of $200.7 million and the net loss and loss expense ratio of 94.3 percentage points was primarily due to an increase in the level of net loss and loss expenses due to significant hurricane activity during the quarter.
The net loss and loss expense ratio for global insurance was 217.9% for the quarter ended September 30, 2005 compared to 76.4% for the quarter ended September 30, 2004. The increase was due to Hurricanes Katrina and Rita from which we incurred estimated net loss and loss expenses of $248.5 million, or 175.8 percentage points. During the quarter ended September 30, 2004, we incurred estimated net loss and loss expenses of $61.1 million, or 30.6 percentage points, in respect of Hurricanes Charley, Frances, Ivan and Jeanne.
Our losses with respect to Hurricane Katrina were primarily derived from our onshore property and offshore energy business within our property and marine books of business, following property damage and business interruption claims. Our estimate of our gross loss and loss expenses of $428.2 million is based upon industry loss predictions of $60 billion and is derived from a review of contracts potentially affected by the hurricane and preliminary loss information from our clients, brokers and loss adjustors. Actual losses from this hurricane may differ materially from our estimates of loss and loss expenses. Our gross loss and loss expense estimate was reduced by $237.4 million of reinsurance recoveries, primarily from excess of loss reinsurance contracts.
Our losses with respect to Hurricane Rita were primarily derived from our offshore energy book as Hurricane Rita tracked through a densely populated offshore oil rig area. Our estimate of our gross loss and loss expenses of $134.2 million was derived from a review of contracts potentially affected by the hurricane and preliminary loss information received from our clients, brokers and loss adjustors. Actual losses from this hurricane may differ materially from our estimates of loss and loss expenses. Our gross loss and loss expense estimate was reduced by $76.6 million of excess of loss reinsurance recoveries.
27
During the quarter ended September 30, 2005, we experienced favorable development in prior year loss and loss reserves of $59.2 million, or 41.9 percentage points, compared to $16.6 million, or 8.3 percentage points, for the quarter ended September 30, 2004. In estimating the ultimate cost of losses, we primarily use the Bornhuetter-Ferguson method. This method takes as a starting point an initial expected loss and loss expense ratio and blends in the loss and loss expense ratio implied by our experience to date. Given our limited operating history, the initial expected loss and loss expense ratio was primarily based on industry data. As our favorable loss experience has emerged, the expected ultimate loss has been reduced and, therefore, has generated favorable prior period loss development.
The net loss and loss expense ratio for U.S. insurance was 121.8% for the quarter ended September 30, 2005 compared to 94.7% for the quarter ended September 30, 2004. The increase was due to the impact of Hurricanes Katrina and Rita from which we incurred estimated net loss and loss expenses of $61.0 million, or 56.9 percentage points. During the quarter ended September 30, 2004, we incurred estimated net loss and loss expenses of $47.6 million, or 52.7 percentage points, in respect of Hurricanes Charley, Frances, Ivan and Jeanne.
The losses from these hurricanes were generated from our property book of business. Our estimates of gross loss and loss expenses were $350.0 million and $10.0 million for Hurricanes Katrina and Rita, respectively. Our estimate of our gross loss and loss expenses is based upon industry loss predictions of $60 billion for Hurricane Katrina and $2.5 billion to $7.0 billion for Hurricane Rita and is derived from a review of contracts potentially affected by the hurricanes and preliminary loss information from clients, brokers and loss adjustors. Actual losses from these hurricanes may differ materially from our estimates of losses and loss expenses. U.S. insurance purchases significant reinsurance protections on a per risk and excess of loss basis, which reduced our gross losses by $294.0 million in respect of Hurricane Katrina and $5.0 million in respect of Hurricane Rita.
During the quarter ended September 30, 2005, we experienced favorable prior year development of $6.9 million, or 6.4 percentage points, compared to $4.6 million, or 5.0 percentage points, during the quarter ended September 30, 2004.
Acquisition Costs. The decrease in the acquisition cost ratio was primarily driven by a decrease in the acquisition cost ratio of global insurance.
Acquisition costs in global insurance were $13.3 million, or 9.4% of net premiums earned, for the quarter ended September 30, 2005 compared to $33.1 million, or 16.5%, of net premiums earned, for the quarter ended September 30, 2004. The decrease in the acquisition cost ratio was primarily the result of a reduction of $18.7 million in the amounts expensed under incentive commission arrangements with brokers from 2004. Excluding incentive commissions, the acquisition cost ratio was 17.9% for the quarter ended September 30, 2005 compared to 13.2% for the quarter ended September 30, 2004. The increase was due to the impact of higher amortized reinsurance costs.
U.S. insurance acquisition costs were $(1.7) million, or (1.6%) of net premiums earned, for the quarter ended September 30, 2005 compared to $4.9 million, or 5.5% of net premiums earned, for the quarter ended September 30, 2004. This decrease in the acquisition cost ratio was primarily the result of a reduction of $11.1 million in the amounts expensed under incentive commission arrangements with brokers from 2004. Excluding the incentive commissions, the acquisition cost ratio was 5.1% for the quarter ended September 30, 2005 compared to 1.2% for the quarter ended September 30, 2004. The increase was due to the impact of higher amortized reinsurance costs and a change of business mix with a higher percentage of premiums derived from our specialty program business, which has higher acquisition costs.
28
General and Administrative Expenses. The 2.3 percentage point increase in our general and administrative expenses ratio was primarily due to an increase in U.S. insurance business, which has a higher general and administrative ratio.
Nine months ended September 30, 2005 and September 30, 2004
The following table summarizes the underwriting results and ratios for the insurance segment for the nine months ended September 30, 2005 and 2004:
|
| Nine months ended |
|
|
| |||||||
|
| September 30, 2005 |
| September 30, 2004 |
| Change |
| % Change |
| |||
|
|
|
| ($ in thousands) |
|
|
|
|
| |||
Revenues: |
|
|
|
|
|
|
|
|
| |||
Gross premiums written |
| $ | 1,402,814 |
| $ | 1,326,515 |
| $ | 76,299 |
| 5.7 | % |
Net premiums written |
| 847,639 |
| 942,489 |
| (94,850 | ) | (10.1 | )% | |||
Net premiums earned |
| 884,930 |
| 843,598 |
| 41,332 |
| 4.9 | % | |||
Other insurance related (loss) income |
| (5,283 | ) | 6,887 |
| (12,170 | ) | nm |
| |||
Expenses: |
|
|
|
|
|
|
|
|
| |||
Net losses and loss expenses |
| (724,834 | ) | (550,747 | ) | (174,087 | ) | (31.6 | )% | |||
Acquisition costs |
| (77,847 | ) | (97,007 | ) | 19,160 |
| 19.8 | % | |||
General and administrative expenses |
| (89,327 | ) | (73,974 | ) | (15,353 | ) | (20.7 | )% | |||
Underwriting (loss) income |
| $ | (12,361 | ) | $ | 128,757 |
| $ | (141,118 | ) | (109.6 | )% |
Ratios: |
|
|
|
|
|
|
|
|
| |||
Net loss and loss expense ratio |
| 81.9 | % | 65.3 | % | (16.6 | )% |
|
| |||
Acquisition cost ratio |
| 8.8 | % | 11.5 | % | 2.7 | % |
|
| |||
General and administrative expense ratio |
| 10.1 | % | 8.8 | % | (1.3 | )% |
|
| |||
Combined ratio |
| 100.8 | % | 85.6 | % | (15.2 | )% |
|
|
nm — not meaningful
Premiums. The increase in gross premiums written was principally due to an increase of $135.7 million in gross premiums written in U.S. insurance that partially offset a decrease of $59.4 million in gross written premiums in global insurance.
The table below shows gross premiums written in global insurance by line of business for the nine months ended September 30, 2005 and 2004:
29
|
| Nine months ended |
|
|
| |||||||
|
| September 30, 2005 |
| September 30, 2004 |
| Change |
| % Change |
| |||
|
|
|
| ($ in thousands) |
|
|
|
|
| |||
Property |
| $ | 160,340 |
| $ | 192,512 |
| $ | (32,172 | ) | (16.7 | )% |
Marine |
| 143,436 |
| 157,493 |
| (14,057 | ) | (8.9 | )% | |||
Terrorism and War Risk |
| 128,450 |
| 156,788 |
| (28,338 | ) | (18.1 | )% | |||
Aviation and Aerospace |
| 72,409 |
| 93,217 |
| (20,808 | ) | (22.3 | )% | |||
Political Risk |
| 107,532 |
| 104,132 |
| 3,400 |
| 3.3 | % | |||
Professional Lines and Other Specialty |
| 59,284 |
| 26,736 |
| 32,548 |
| 121.7 | % | |||
Total |
| $ | 671,451 |
| $ | 730,878 |
| $ | (59,427 | ) | (8.1 | )% |
The decrease in gross premiums written was partially due to rate reductions in several lines of business, which resulted in fewer risks meeting our underwriting criteria. This deterioration in the pricing environment primarily accounted for the reduction in premiums written in our property book and to a lesser extent the decrease experienced in our marine, terrorism and war risk and aviation and aerospace lines. The decrease in gross premiums written was also driven by three other factors. First, we experienced a decrease in gross premiums written as a result of the timing of certain renewals on our terrorism and war risk lines. Some terrorism contracts written in 2004 were not renewed in 2005 due to the non-recurring nature of events covered by this line of business and to the fact that some policies provided coverage for a period of up to two years. Also, on our aviation and aerospace line of business the vast majority of aviation business is renewed in the last calendar quarter; however, some policies can take longer to place, which results in the binding of risks in the first calendar quarter. Second, we experienced a $6.9 million decrease in gross written premiums on our satellite business following a decision to reduce our exposure to this class of business. Third, we experienced a $12.3 million decrease in premiums written on our energy offshore business. This decrease was primarily the result of additional gross premiums written in the third quarter of 2004 relating to one-off construction. The increase in gross premiums written in our professional lines and other specialty book of business was due to the addition of a London market-based professional lines underwriting team in early 2004 focused on European risks. Consequently, only a small amount of business was written in the nine months ended September 30, 2004.
The table below shows gross premiums written in U.S. insurance by line of business for the nine months ended September 30, 2005 and 2004:
|
| Nine months ended |
|
|
| |||||||
|
| September 30, 2005 |
| September 30, 2004 |
| Change |
| % Change |
| |||
|
|
|
| ($ in thousands) |
|
|
|
|
| |||
Property |
| $ | 275,610 |
| $ | 241,671 |
| $ | 33,939 |
| 14.0 | % |
Liability |
| 207,508 |
| 164,817 |
| 42,691 |
| 25.9 | % | |||
Professional Lines |
| 242,195 |
| 189,149 |
| 53,046 |
| 28.0 | % | |||
Other Specialty |
| 6,050 |
| — |
| 6,050 |
| nm |
| |||
Total |
| $ | 731,363 |
| $ | 595,637 |
| $ | 135,726 |
| 22.7 | % |
The increase in gross premiums written was driven by growth across all lines of business.
The increase in gross premiums written in our professional lines business was driven primarily by an increase of $45.7 million in errors and omissions insurance following the appointment of a managing
30
general underwriter effective January 1, 2005. The increase in our liability account was primarily due to an additional $39.7 million of umbrella and excess liability insurance following our decision to target this class of business and increase the number of dedicated underwriters. We wrote $13.2 million of new specialty business, which primarily covers recreational marine watercraft risk. These increases were offset by a $10.3 million decrease on our primary casualty account, primarily as the result of an increasingly competitive pricing environment. The increase in our property account was largely driven by an increase of $19.9 million in premiums generated by our specialty program business, which includes coverages such as property, builders risk insurance and earthquake risk. In addition, we experienced growth in our excess and surplus line business due to greater market penetration and wrote additional gross written premiums on our inland marine business due to an increase in the number of dedicated underwriters.
Premiums ceded increased by $171.2 million. Premiums ceded for U.S. insurance increased by $92.6 million. The ratio of premiums ceded to gross premiums written in U.S. insurance was 49.9% for the nine months ended September 30, 2005 and 45.7% for the nine months ended September 30, 2004. Although we increased our net retention on our professional lines book, during the nine months ended September 30, 2005 this impact was offset by an increase in the reinsurance ceded on our property book. This was due to two factors: first, an increase in the cost following the renewal of our reinsurance in May 2005; and second, reinstatement premiums due on hurricane losses ceded to reinsurers. Premiums ceded in global insurance increased by $78.6 million due to reinstatement premiums due on hurricane losses ceded to reinsurers.
The following table shows the derivation of net premiums earned in our insurance segment for the nine months ended September 30, 2005 and 2004:
|
| Nine months ended |
|
|
| |||||||
|
| September 30, 2005 |
| September 30, 2004 |
| Change |
| % Change |
| |||
|
|
|
| ($ in thousands) |
|
|
|
|
| |||
Gross premiums earned |
| $ | 1,403,868 |
| $ | 1,164,639 |
| $ | 239,229 |
| 20.5 | % |
Ceded premiums amortized |
| (518,938 | ) | (321,041 | ) | (197,897 | ) | (61.6 | )% | |||
Net premiums earned |
| $ | 884,930 |
| $ | 843,598 |
| $ | 41,332 |
| 4.9 | % |
Gross premiums are earned over the period of the insured risk. As the level of net premiums written increases, the level of net premiums earned also increases. As we experienced an increase in gross premiums written over the rolling twelve-month period ended September 30, 2005 compared to the rolling twelve-month period ended September 30, 2004, our gross premiums earned increased.
Ceded premiums are amortized over the contract term. Consequently, the level of amortized ceded premium has increased in 2005 as premiums ceded in 2004 continue to be amortized in 2005. In addition, following the exhaustion of reinsurance protection on some contracts due to losses recovered from Hurricanes Katrina and Rita, a portion of our ceded premiums were fully amortized during the quarter.
Other Insurance Related Income. Other insurance related income primarily related to the movement in the fair value of our insurance contracts that meet the definition of derivatives. These contracts typically insure a portfolio of sovereign debt securities against the risk of default. During the nine months ended September 30, 2005, the principal contract that was accounted for as a derivative expired.
Net Losses and Loss Expenses. The net loss and loss expense ratio for the nine months ended September 30, 2005 was 81.9% compared to 65.3% for the nine months ended September 30, 2004, an
31
increase of 16.6 percentage points. The increase in net loss and loss expenses and the net loss and loss expense ratio was primarily due to an increase in the level of net loss and loss expenses due to significant hurricane activity.
The net loss and loss expense ratio for global insurance was 80.3% for the nine months ended September 30, 2005 compared to 61.8% for the nine months ended September 30, 2004. The increase was due to the impact of Hurricanes Katrina and Rita from which we incurred estimated net loss and loss expenses of $248.5 million, or 44.1 percentage points. During the nine months ended September 30, 2004, we incurred estimated net loss and loss expenses of $61.1 million, or 10.3 percentage points, in respect of Hurricanes Charley, Frances, Ivan and Jeanne.
Our losses with respect to Hurricane Katrina were primarily derived from our onshore property and offshore energy business within our property and marine books of business following property damage and business interruption claims. Our estimate of our gross loss and loss expenses of $428.2 million is based on industry loss predictions of $60 billion and is derived from a review of contracts potentially affected by the hurricane and preliminary loss information from our clients, brokers and loss adjusters. Actual losses from this hurricane may differ materially from our estimates of loss and loss expenses. Our gross loss and loss expense estimate was reduced by $237.4 million of reinsurance recoveries, primarily from excess of loss reinsurance contracts.
Our losses with respect to Hurricane Rita were primarily derived from our offshore energy book as Hurricane Rita tracked through a densely populated offshore oil rig area. Our estimate of our gross loss and loss expenses of $134.2 million was derived from a review of contracts potentially affected by the hurricane and preliminary loss information from our clients, brokers and loss adjusters. Actual losses from this hurricane may differ materially from our estimated loss and loss expenses. Our estimate of gross loss and loss expenses was reduced by $76.6 million of excess of loss reinsurance recoveries.
During the nine months ended September 30, 2005, we experienced favorable development in prior year loss and loss reserves of $165.2 million, or 29.3 percentage points, compared to $68.6 million, or 11.5 percentage points, for the nine months ended September 30, 2004. In estimating the ultimate cost of losses, we primarily use the Bornhuetter-Ferguson method. This method takes as a starting point an initial expected loss and loss expense ratio and blends in the loss and loss expense ratio implied by our experience to date. Given our limited operating history, the initial expected loss and loss expense ratio was primarily based on industry data. As our favorable loss experience has emerged, the expected ultimate loss has been reduced and, therefore, has generated favorable prior period loss development.
The net loss and loss expense ratio for U.S. insurance was 84.7% for the nine months ended September 30, 2005 compared to 73.5% for the nine months ended September 30, 2004. The increase was due to the impact of Hurricanes Katrina and Rita from which we incurred net loss and loss expenses of $61.0 million, or 18.9 percentage points. During the nine months ended September 30, 2004, we incurred net loss and loss expenses of $47.6 million, or 19.2 percentage points, in respect of Hurricanes Charley, Frances, Ivan and Jeanne.
The losses from these hurricanes were generated from our property book of business. Our estimates of gross loss and loss expenses were $350.0 million and $10.0 million for Hurricanes Katrina and Rita, respectively. Our estimate of our gross loss and loss expenses is based upon industry loss predictions of $60 billion for Hurricane Katrina and $2.5 billion to $7.0 billion for Hurricane Rita and is derived from a review of contracts potentially affected by the hurricanes and preliminary loss information from our clients, brokers and loss adjusters. Actual losses from these hurricanes may differ materially from our estimates of loss and loss expenses. U.S. insurance purchases significant reinsurance protections on a per risk and excess of loss basis, which has reduced our gross losses by $294.0 million in respect of Hurricane Katrina and $5.0 million in respect of Hurricane Rita.
32
During the nine months ended September 30, 2005, we experienced favorable prior year development of $7.4 million, or 2.3 percentage points, compared to favorable development of $10.9 million, or 4.4 percentage points, during the nine months ended September 30, 2004.
Acquisition Costs. The decrease in the acquisition cost ratio was driven by a decrease in the acquisition cost ratio of global insurance.
Acquisition costs in global insurance were $72.8 million, or 12.9% of net premiums earned, for the nine months ended September 30, 2005 compared to $89.5 million, or 15.0% of net premiums earned, for the nine months ended September 30, 2004. This decrease in the acquisition cost ratio was primarily caused by a reduction of $19.0 million in the amounts expensed under incentive commission arrangements with brokers for 2004. Excluding incentive commissions, the acquisition cost ratio was 13.5% for the nine months ended September 30, 2005 compared to 12.4% for the nine months ended September 30, 2004. The increase was primarily the result of higher amortized reinsurance costs.
U.S. insurance acquisition costs were $5.0 million, or 1.6% of net premiums earned, for the nine months ended September 30, 2005 compared to $7.5 million, or 3.0% of net premiums earned, for the nine months ended September 30, 2004. This decrease in the acquisition cost ratio was primarily caused by a reduction of $13.6 million in the amounts expensed under incentive commission arrangements with brokers for 2004. Excluding the incentive commissions, the acquisition cost ratio was 2.7% for the nine months ended September 30, 2005 compared to (0.9%) for the nine months ended September 30, 2004. The increase of 3.6 percentage points was due to the impact of higher amortized reinsurance costs and a change of business mix within our property book with a higher percentage of premiums derived from our specialty program business, which has a higher level of acquisition costs.
General and Administrative Expenses. The 1.3 percentage point increase in our general and administrative expenses ratio was primarily due to an increase in U.S. insurance business, which has a higher general and administrative expense ratio.
Reinsurance
Our reinsurance segment provides treaty property and casualty reinsurance to insurance companies on a worldwide basis. Treaty reinsurance contracts are contractual arrangements that provide for automatic reinsuring of a type of category of risk underwritten by our clients. Contracts can be written on an excess of loss basis or a pro rata basis, also known as proportional. The product lines in this segment are catastrophe, property, professional liability, credit and bond, motor, liability and other.
The catastrophe reinsurance line of business provides protection for most catastrophic losses that are covered in the underlying insurance policies written by our ceding company clients. The underlying insurance policies in the catastrophe reinsurance line of business primarily cover property exposures. This business also consists of contracts covering non-property exposures, including workers compensation, personal accident and life. The principal perils in this portfolio are hurricane and windstorm, earthquake, flood, tornado, hail and fire. In some instances, terrorism may be a covered peril or the only peril.
The property reinsurance line of business includes treaty reinsurance written on both a pro rata and a per risk basis and covers underlying personal lines and commercial property exposures. Property pro rata treaty reinsurance covers a cedent’s aggregate losses from all events in the covered period on a proportional basis. Property per risk treaty reinsurance business reinsures a portfolio of particular property risks of ceding companies on an excess of loss basis.
The professional liability treaty reinsurance book covers directors’ and officers’ liability, employment practices liability, medical malpractice and miscellaneous errors and omissions insurance risks.
33
The credit and bond treaty reinsurance book consists principally of reinsurance of trade credit insurance products and includes both proportional and excess-of loss structures. The underlying insurance indemnifies sellers of goods and services against a payment default by the buyer of those goods and services. Also included in this book is coverage for ceding insurers against losses arising from a broad array of surety bonds issued by bond insurers principally to satisfy regulatory demands in a variety of jurisdictions around the world, but predominantly in Europe.
The motor liability reinsurance line of business provides coverage to insurers for motor liability losses arising out of any one occurrence. The occurrence can involve one or many claimants where the ceding insurer aggregates the claims from the occurrence.
The liability reinsurance line of business provides coverage to insurers of standard casualty lines, including auto liability, general liability, personal and commercial umbrella and workers compensation.
The other reinsurance line of business currently covers claims arising from aviation, marine and crop reinsurance.
Quarters ended September 30, 2005 and September 30, 2004
The following table summarizes the underwriting results and ratios in our reinsurance segment for the quarters ended September 30, 2005 and 2004:
|
| Quarter ended |
|
|
| |||||||
|
| September 30, 2005 |
| September 30, 2004 |
| Change |
| % Change |
| |||
|
|
|
| ($ in thousands) |
|
|
|
|
| |||
Revenues: |
|
|
|
|
|
|
|
|
| |||
Gross premiums written |
| $ | 333,988 |
| $ | 246,038 |
| $ | 87,950 |
| 35.7 | % |
Net premiums written |
| 329,843 |
| 233,731 |
| 96,112 |
| 41.1 | % | |||
Net premiums earned |
| 368,281 |
| 232,055 |
| 136,226 |
| 58.7 | % | |||
Other insurance related income |
| — |
| 100 |
| (100 | ) | nm |
| |||
Expenses: |
|
|
|
|
|
|
|
|
| |||
Net losses and loss expenses |
| (596,746 | ) | (207,711 | ) | (389,035 | ) | (187.3 | )% | |||
Acquisition costs |
| (52,865 | ) | (41,214 | ) | (11,651 | ) | (28.3 | )% | |||
General and administrative expenses |
| (12,187 | ) | (10,530 | ) | (1,657 | ) | (15.7 | )% | |||
Underwriting loss |
| $ | (293,517 | ) | $ | (27,300 | ) | $ | (266,217 | ) | nm |
|
|
|
|
|
|
|
|
|
|
| |||
Ratios: |
|
|
|
|
|
|
|
|
| |||
Net loss and loss expense ratio |
| 162.0 | % | 89.5 | % | (72.5 | )% |
|
| |||
Acquisition cost ratio |
| 14.4 | % | 17.8 | % | 3.4 | % |
|
| |||
General and administrative expenses ratio |
| 3.3 | % | 4.5 | % | 1.2 | % |
|
| |||
Combined ratio |
| 179.7 | % | 111.8 | % | (67.9 | )% |
|
|
nm — not meaningful
Premiums. The table below shows gross premiums written by line of business in our reinsurance segment for the quarters ended September 30, 2005 and 2004:
34
|
| Quarter ended |
|
|
| |||||||
|
| September 30, 2005 |
| September 30, 2004 |
| Change |
| % Change |
| |||
|
|
|
| ($ in thousands) |
|
|
|
|
| |||
Catastrophe |
| $ | 106,627 |
| $ | 56,209 |
| $ | 50,418 |
| 89.7 | % |
Property |
| 121,962 |
| 108,234 |
| 13,728 |
| 12.7 | % | |||
Professional lines |
| 50,238 |
| 45,363 |
| 4,875 |
| 10.7 | % | |||
Credit and bond |
| 1,865 |
| 4,820 |
| (2,955 | ) | (61.3 | )% | |||
Motor |
| 1,809 |
| 5,788 |
| (3,979 | ) | (68.7 | )% | |||
Liability |
| 50,344 |
| 20,007 |
| 30,337 |
| 151.6 | % | |||
Other |
| 1,143 |
| 5,617 |
| (4,474 | ) | (79.6 | )% | |||
Total |
| $ | 333,988 |
| $ | 246,038 |
| $ | 87,950 |
| 35.7 | % |
The increase in our catastrophe account was primarily due to $42.0 million of reinstatement premiums related to this quarter’s hurricane losses, compared to $8.0 million for the quarter ended September 2004. In addition, we wrote several contracts that provided additional reinsurance protection for clients following the exhaustion of their reinsurance coverage as a result of Hurricane Katrina. The increase in our liability account primarily resulted from acquiring approved reinsurer status with some U.S. clients allowing us to write new business and from new market opportunities in our U.S. general liability umbrella excess reinsurance business. We also continued to achieve greater penetration on renewal business written in Continental Europe. The increase in our property account was primarily due to $15.6 million in reinstatement premiums related to this quarter’s hurricane losses. In addition, our gross written premiums increased due to adjustments on pro rata contracts written in prior quarters following a review of estimated premium and the development of actual premium data. However, this increase was offset by the timing of a large pro rata contract renewal that was written in the third calendar quarter of 2004 and will not renew until the fourth calendar quarter of 2005.
Premiums ceded for the quarter ended September 30, 2005 decreased by $8.2 million compared to the quarter ended September 30, 2004. The decrease was due to changes in the timing of the renewal of ceded reinsurance contracts. Following the losses generated by the hurricanes in September 2004, we exhausted our reinsurance coverage and purchased new protections during the quarter ended September 30, 2004.
The following table shows the derivation of net premiums earned in our reinsurance segment for the quarters ended September 30, 2005 and 2004:
|
| Quarter ended |
|
|
| |||||||
|
| September 30, 2005 |
| September 30, 2004 |
| Change |
| % Change |
| |||
|
|
|
| ($ in thousands) |
|
|
|
|
| |||
Gross premiums earned |
| $ | 376,265 |
| $ | 247,533 |
| $ | 128,732 |
| 52.0 | % |
Ceded premiums amortized |
| (7,984 | ) | (15,478 | ) | 7,494 |
| (48.4 | )% | |||
Net premiums earned |
| $ | 368,281 |
| $ | 232,055 |
| $ | 136,226 |
| 58.7 | % |
Gross premiums are earned over the period of the reinsured risk. Consequently, the level of gross premiums earned has increased as the level of gross premiums written has increased.
Ceded premiums are amortized over the contract term. During the quarter ended September 30, 2004, our ceded premiums amortized increased due to the exhaustion of reinsurance protections following
35
losses recovered from Hurricanes Charley, Frances, Ivan and Jeanne. This generated an increase in ceded premiums amortized as the ceded premiums were fully amortized during the quarter.
Net Losses and Loss Expenses. The increase in the net loss expense ratio was primarily driven by the impact of Hurricanes Katrina and Rita for which we incurred estimated net losses of $495.0 million, or 134.4 percentage points. During the quarter ended September 30, 2004, we incurred estimated net losses of $118.7 million, or 51.1 percentage points, from Hurricanes Charley, Frances, Ivan and Jeanne.
Our losses were primarily generated from our catastrophe and property lines of business as we write negligible amounts of offshore energy reinsurance. Our estimates for the losses incurred for Hurricanes Katrina and Rita were derived from the output of industry models, market analyses, a review of in-force contracts and preliminary loss information from clients and brokers. We have estimated our gross losses for Hurricane Katrina based on industry loss predictions of $60 billion and for Rita based on industry loss predictions of $2.5 billion to $7.0 billion. Actual losses from these hurricanes may differ materially from our estimates of loss and loss expenses. Our estimated gross losses were reduced by $30.0 million of reinsurance recoveries that were triggered by the occurrence of a series of large industry loss events. This reinsurance has predetermined industry loss triggers based on the number of events and size of industry losses calculated by independent third parties. Based on a combination of public information, our own assessment of each industry loss and historical industry loss development factors, we believe that these industry loss trigger points have been exceeded; however, these industry loss figures are only estimates and as such are subject to change. Consequently, our actual reinsurance recoveries could be materially reduced.
During the quarter ended September 30, 2005, we experienced favorable prior period development of $29.7 million, or 8.1 percentage points, compared to $28.4 million, or 12.2 percentage points, for the quarter ended September 30, 2004.
Acquisition Costs. Acquisition costs were $52.9 million, or 14.4% of net premiums earned, for the quarter ended September 30, 2005 compared to $41.2 million, or 17.8% of net premiums earned, for the quarter ended September 30, 2004. The decrease in the acquisition cost ratio was primarily the result of a reduction of $9.9 million in the amounts expensed under incentive commission arrangements with brokers for 2004. Excluding incentive commissions, the acquisition cost ratio was 16.7% for the quarter ended September 30, 2005 compared to 17.2% for the quarter ended September 30, 2004. The decrease was due to two factors: first, we experienced a lower acquisition cost ratio on the renewal of premiums in our professional lines book; and second, as a result of lower acquisition costs on reinstatement premiums, the acquisition cost ratio on our catastrophe book decreased.
General and Administrative Expenses. The 1.2 percentage point decrease in the general and administrative expense ratio was primarily due to an increase in the level of net premiums earned.
Nine months ended September 30, 2005 and September 30, 2004
The following table summarizes the underwriting results and ratios in our reinsurance segment for the nine months ended September 30, 2005 and 2004:
36
|
| Nine months ended |
|
|
| |||||||
|
| September 30, 2005 |
| September 30, 2004 |
| Change |
| % Change |
| |||
|
|
|
| ($ in thousands) |
|
|
|
|
| |||
Revenues: |
|
|
|
|
|
|
|
|
| |||
Gross premiums written |
| $ | 1,357,749 |
| $ | 1,034,627 |
| $ | 323,122 |
| 31.2 | % |
Net premiums written |
| 1,347,945 |
| 1,006,590 |
| 341,355 |
| 33.9 | % | |||
Net premiums earned |
| 981,887 |
| 635,851 |
| 346,036 |
| 54.4 | % | |||
Other insurance related income |
| — |
| 763 |
| (763 | ) | nm |
| |||
Expenses: |
|
|
|
|
|
|
|
|
| |||
Net losses and loss expenses |
| (977,579 | ) | (395,278 | ) | (582,301 | ) | (147.3 | )% | |||
Acquisition costs |
| (163,361 | ) | (104,667 | ) | (58,694 | ) | (56.0 | )% | |||
General and administrative expenses |
| (36,818 | ) | (29,058 | ) | (7,760 | ) | (26.7 | )% | |||
Underwriting (loss) income |
| $ | (195,871 | ) | $ | 107,611 |
| $ | (303,482 | ) | (282.0 | )% |
|
|
|
|
|
|
|
|
|
| |||
Ratios: |
|
|
|
|
|
|
|
|
| |||
Net loss and loss expense ratio |
| 99.6 | % | 62.1 | % | (37.5 | )% |
|
| |||
Acquisition cost ratio |
| 16.6 | % | 16.5 | % | (0.1 | )% |
|
| |||
General and administrative expenses ratio |
| 3.7 | % | 4.6 | % | 0.9 | % |
|
| |||
Combined ratio |
| 119.9 | % | 83.2 | % | (36.7 | )% |
|
|
nm — not meaningful
Premiums. The table below shows gross premiums written by line of business in our reinsurance segment for the nine months ended September 30, 2005 and 2004:
|
| Nine months ended |
|
|
| |||||||
|
| September 30, 2005 |
| September 30, 2004 |
| Change |
| % Change |
| |||
|
|
|
| ($ in thousands) |
|
|
|
|
| |||
Catastrophe |
| $ | 468,702 |
| $ | 394,916 |
| $ | 73,786 |
| 18.7 | % |
Property |
| 348,719 |
| 240,126 |
| 108,593 |
| 45.2 | % | |||
Professional lines |
| 176,354 |
| 190,320 |
| (13,966 | ) | (7.3 | )% | |||
Credit and bond |
| 103,915 |
| 72,660 |
| 31,255 |
| 43.0 | % | |||
Motor |
| 75,426 |
| 37,677 |
| 37,749 |
| 100.2 | % | |||
Liability |
| 161,659 |
| 82,111 |
| 79,548 |
| 96.9 | % | |||
Other |
| 22,974 |
| 16,817 |
| 6,157 |
| 36.6 | % | |||
Total |
| $ | 1,357,749 |
| $ | 1,034,627 |
| $ | 323,122 |
| 31.2 | % |
The increase in our property account was driven by four factors. First, we accrued additional reinstatement premiums relating to the hurricane losses in the current quarter. Second, we increased the level of pro rata reinsurance of U.S. homeowners’ business in select regions. Third, we obtained new business on targeted per risk programs. Fourth, we achieved greater market penetration in Continental Europe following an expansion into that marketplace in 2004. The increase in our liability account primarily resulted from acquiring approved reinsurer status with some U.S. clients that allowed us to write new business and from new market opportunities existing in our U.S. general liability umbrella excess reinsurance business. We also continued to achieve greater penetration on renewal business within Continental Europe. The increase in our catastrophe account was primarily due to $42.0 million in reinstatement premiums related to this quarter’s hurricane losses, compared to $8.0 million for the nine months ended September 30, 2004. We also wrote several contracts that provided additional reinsurance protection for clients following the exhaustion of their reinsurance coverage as a result of Hurricane
37
Katrina. We experienced rate decreases in our catastrophe book during 2005; however, we wrote more business focusing primarily on U.S. exposures where rate reductions were less severe than those for non-U.S. business. In addition, we experienced rate increases on some national clients who had suffered hurricane losses in 2004. Our motor account increased due to new business written primarily in the French and U.K. motor insurance markets. The increase in our credit and bond account resulted from our ability to increase our share on renewal business and our ability to penetrate new markets and accounts in Continental Europe. The decrease in our professional lines account was primarily driven by the non-renewal of a significant treaty where the client decided to retain the exposures.
Premiums ceded for the nine months ended September 30, 2005 decreased by $18.2 million compared to the nine months ended September 30, 2004. The decrease was due to changes in the timing of the renewal of ceded reinsurance contracts. Following the losses generated by the hurricanes in September 2004, we exhausted our reinsurance coverage and purchased new protections that will expire in the latter part of 2005.
The following table shows the derivation of net premiums earned in our reinsurance segment for the nine months ended September 30, 2005 and 2004:
|
| Nine months ended |
|
|
| |||||||
|
| September 30, 2005 |
| September 30, 2004 |
| Change |
| % Change |
| |||
|
|
|
| ($ in thousands) |
|
|
|
|
| |||
Gross premiums earned |
| $ | 998,281 |
| $ | 657,691 |
| $ | 340,590 |
| 51.8 | % |
Ceded premiums amortized |
| (16,394 | ) | (21,840 | ) | 5,446 |
| (24.9 | )% | |||
Net premiums earned |
| $ | 981,887 |
| $ | 635,851 |
| $ | 346,036 |
| 54.4 | % |
Gross premiums are earned over the period of the reinsured risk. During the quarter ended September 30, 2004, our ceded premiums amortized increased due to the exhaustion of reinsurance protections following losses recovered from Hurricanes Charley, Frances, Ivan and Jeanne. This generated an increase in ceded premiums amortized as the ceded premiums were fully amortized during the quarter.
Ceded premiums are amortized over the contract term. Consequently, the level of ceded premiums amortized increased in 2005 as premiums ceded in 2004 continued to be amortized in 2005.
Net Losses and Loss Expenses. The increase in the net loss expense ratio was primarily driven by the impact of Hurricanes Katrina and Rita for which we incurred estimated net losses of $495.0 million, or 50.4 percentage points. During the nine months ended September 30, 2004, we incurred estimated net losses of $118.7 million or 18.7 percentage points from Hurricanes Charley, Frances, Ivan and Jeanne.
Our losses were primarily generated from our catastrophe and property lines of business as we write negligible amounts of offshore energy reinsurance. Our estimates for the losses incurred from Hurricanes Katrina and Rita were derived from the output of industry models, market analyses, a review of in-force contracts and preliminary loss information from clients and brokers. We have estimated our gross losses for Hurricanes Katrina based on industry loss predictions of $60 billion and for Rita based on industry loss predictions of $2.5 billion to $7.0 billion. Actual losses from these hurricanes may differ materially from our estimates of loss and loss expenses. Our estimated gross losses were reduced by $30.0 million of reinsurance recoveries that were triggered by the occurrence of a series of large industry loss events. This reinsurance has predetermined industry loss triggers based on the number and size of industry losses calculated by independent third parties. Based on a combination of public information, our own assessment of each industry loss and historical industry development factors, we believe that these
38
industry loss trigger points have been exceeded; however, these industry loss figures are only estimates and as such are subject to change. Consequently, actual reinsurance recoveries could be materially reduced.
During the nine months ended September 30, 2005, we experienced favorable prior period development of $63.9 million, or 6.5 percentage points, compared to $61.9 million, or 9.7 percentage points, for the nine months ended September 30, 2004. In estimating the ultimate cost of losses, we primarily use the Bornhuetter-Ferguson method. This method takes as a starting point an initial expected loss and loss expense ratio and blends in the loss and loss expense ratio implied by our experience to date.
Acquisition Costs. Acquisition costs were $163.4 million, or 16.6% of net premiums earned, for the nine months ended September 30, 2005 compared to $104.7 million, or 16.5% of net premiums earned, for the nine ended September 30, 2004. Although the ratio remained consistent, there was a reduction of $7.9 million in the amounts expensed under incentive commission arrangements with brokers for 2004. Excluding incentive commissions, the acquisition cost ratio was 17.3% for the nine months ended September 30, 2005 compared to 16.2% for the nine months ended September 30, 2004. The increase was primarily due to a change in business mix with more business coming from non-catastrophe excess of loss product lines, which typically have higher acquisition costs.
General and Administrative Expenses. The 0.9 percentage point decrease in the general and administrative expense ratio was due primarily to an increase in the level of net premiums earned.
Financial Condition, Liquidity and Capital Resources
We are a holding company and have no substantial operations of our own. Our assets consist primarily of our investments in subsidiaries. At September 30, 2005, we had operating subsidiaries in Bermuda, Ireland and the United States, a branch in the United Kingdom, a branch in Switzerland and a representative office in Singapore. Accordingly, our future cash flows depend upon the availability of dividends or other statutorily permissible payments from our subsidiaries. The ability to pay dividends or distributions is limited by the applicable laws and regulations of Bermuda, Ireland and the United States, which subject our insurance subsidiaries to significant regulatory restrictions. These laws and regulations require, among other things, some of our insurance subsidiaries to maintain minimum solvency requirements and limit the amount of dividends that these subsidiaries can pay to us, which in turn may limit our ability to pay dividends and make other payments.
We are subject to Bermuda regulatory constraints that affect our ability to pay dividends on our common shares and make other payments. Under the Bermuda Companies Act 1981, as amended, AXIS Capital may declare or pay a dividend or make a distribution out of contributed surplus only if it has no reasonable grounds for believing that it is, or would after the payment be, unable to pay its liabilities as they become due or that the realizable value of its assets would thereby be less than the aggregate of our liabilities and issued share capital and share premium accounts.
At September 30, 2005, the maximum amount of distributions that our subsidiaries could pay to AXIS Capital under applicable laws and regulations without prior regulatory approval was approximately $1.1 billion.
Financial Condition
At September 30, 2005, our total investments at fair market value, accrued interest receivable and cash net of unsettled investment trades were $6.9 billion, compared to $6.0 billion at December 31, 2004. Our investment portfolio consisted primarily of fixed income securities at September 30, 2005 and was managed by several external investment management firms. At September 30, 2005, all of these fixed income securities were investment grade, with 85.5% rated Aa3 or AA- or better by an internationally
39
recognized rating agency. The weighted-average rating of our fixed income portfolio was AAA based on ratings assigned by Standard & Poor’s.
During 2005, we continued to increase the size of the allocation to other investments within our investment portfolio. At September 30, 2005, other investments were $514.2 million compared to $271.3 million at December 31, 2004, and consisted of investments in funds of funds, a fund that invests in U.S. dollar high yield credit, a portfolio of investments in collaterized loan obligations, and medium term notes that have an interest in various pools of European fixed income securities.
As a result of the level of gross premium written during the nine months ended September 30, 2005, our insurance and reinsurance premium balances receivable, deferred acquisition costs and unearned premium increased by $230.9 million, $31.4 million and $358.4 million, respectively, over those balances at December 31, 2004. Following Hurricanes Katrina and Rita, we recorded significant reinsurance recoveries that have generated an increase of $696.7 million in reinsurance recoverable balances and reinsurance recoverable balances on paid losses. Of the reinsurance recoverable balances, 98.1% was due from reinsurers rated the equivalent of A- or better by internationally recognized rating agencies. The occurrence of the several large loss events during the quarter ended September 30, 2005 could reduce the reinsurance coverage available to us in the future and could weaken the financial condition of our reinsurers.
At September 30, 2005, we had other assets of $344.8 million compared to $68.6 million at December 31, 2004. The increase was primarily due to our Series A preferred share offering, which closed on October 5, 2005 and from which we received net proceeds of $242.3 million.
At September 30, 2005, we had $4.5 billion of reserves for loss and loss expenses compared to $2.4 billion at December 31, 2004, an increase of $2.1 billion. Of this balance, $3.3 billion, or 73.6%, was incurred but not reported reserves.
At September 30, 2005, our shareholders’ equity was $2.9 billion compared to $3.2 billion at December 31, 2004. The reduction of $0.3 billion was primarily due to a net loss of $143.4 million for the nine months ended September 30, 2005 and a share repurchase of $350.0 million of common shares pursuant to our repurchase program. This was primarily offset by our Series A preferred share offering of $250.0 million.
Liquidity
Our cash flows from operations generally represent the difference between: (1) premiums collected, reinsurance recoveries and investment earnings realized; and (2) losses and loss expenses paid, reinsurance purchased and underwriting and other expenses paid. Cash flows from operations may differ substantially, however, from net income. The potential for a large claim under one of our insurance or reinsurance contracts means that substantial and unpredictable payments may need to be made within relatively short periods of time.
During the nine months ended September 30, 2005, we generated a net operating cash inflow of $1,148.8 million, primarily related to premiums received and investment income. During the same period, we paid gross losses of $471.1 million and received reinsurance recoveries of $169.0 million. At September 30, 2005, we had a cash balance of $862.2 million. During the nine months ended September 30, 2005, net cash of $173.3 million was used for financing activities. On February 16, 2005, we repurchased 12,783,094 common shares owned by initial investors at the formation of the Company pursuant to our repurchase program. The average purchase price was $27.38 per common share and the aggregate purchase price was $350.0 million. During the nine months ended September 30, 2005, we paid dividends of $69.9 million and interest on our Senior Notes of $15.7 million.
40
During the nine months ended September 30, 2004, we generated a net operating cash inflow of $1,262.8 million, primarily relating to premiums received and investment income. During the same period, we paid gross losses of $142.0 million. At September 30, 2004, we had a cash balance of $935.3 million. During the nine months ended September 30, 2004, we invested a net cash amount of $875.3 million.
On September 9, 2005, we declared a quarterly dividend of $0.15 per common share to shareholders of record at September 30, 2005. The dividend was paid on October 14, 2005.
On an ongoing basis, our sources of funds primarily consist of premiums written, reinsurance recoveries, investment income and proceeds from sales and redemptions of investments. Cash is used primarily to pay losses and loss expenses, reinsurance premiums, acquisition costs, general and administrative expenses, to purchase new investments and fund dividends, share repurchases and interest payments.
Capital Resources
On August 25, 2005, we entered into a $1.5 billion credit agreement with a syndicate of lenders replacing our existing $750 million credit facility. The credit agreement is an unsecured five-year facility that allows us and our operating subsidiaries to issue letters of credit up to the full amount of the facility and to borrow up to $500 million for general corporate purposes, with total usage not to exceed $1.5 billion. The credit agreement contains various loan covenants, including limitations on the incurrence of future indebtedness, future liens, fundamental changes, investments and certain transactions with affiliates. The facility also requires that we maintain 1) a minimum consolidated net worth of $2.0 billion plus (a) 25% of consolidated net income (if positive) of AXIS Capital for each semi-annual fiscal period ending on or after December 31, 2005 plus (b) an amount equal to 25% of the net cash proceeds received by AXIS Capital from the issuance of its capital stock during each such semi-annual fiscal period; and 2) a maximum debt to total capitalization ratio of 0.35:1.0. We were in compliance with all covenants contained in the credit agreement at September 30, 2005. As at September 30, 2005, we had letters of credit of $436.1 million (2004: $421.7 million) outstanding. There was no debt outstanding under the credit agreements as at September 30, 2005 or December 31, 2004.
On November 15, 2004, we completed a public offering of $500 million of Senior Notes. The Senior Notes bear interest at 5.75%, payable semi-annually and, unless previously redeemed, will mature on December 1, 2014.
On March 14, 2005, we announced that our Board of Directors had authorized an additional repurchase program for up to $150 million of our common shares.
On September 28, 2005, we announced that we had agreed to offer to the public $250.0 million of 7.25% Series A preferred shares, $0.0125 par value per share, with a liquidation preference of $25.00 per share. We completed the offering on October 5, 2005 and received net proceeds of $242.3 million. We may redeem the shares on or after October 15, 2010 at a redemption price of $25.00 per share.
Contractual Commitments
We did not make any significant capital expenditures during the quarter ended September 30, 2005. We currently expect capital expenditures for 2005 to be less than $50 million.
During the quarter ended September 30, 2005, we increased our reserve for losses and loss expenses primarily due to gross loss and loss expenses incurred of $1.3 billion from Hurricane Katrina.
41
Estimates as to the size of the industry loss from Hurricane Katrina vary significantly due primarily to the extent of damage, the interpretation of coverage under insurance contracts and the delay in adjusting losses in the effected areas. Most policies do not cover flood damage, or substantially limit flood damage, however they may cover water damage caused by wind, such as storm surge. Difficulties will arise in estimating a loss when a combination of flood and storm surge damage has caused the insured damage. Given the uncertainty surrounding our estimate of net incurred loss and loss expenses for Hurricane Katrina, there is also significant uncertainty surrounding our expected payments for losses from Hurricane Katrina.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to potential loss on our investment portfolio from various market risks, including changes in interest rates and foreign currency exchange rates, and from credit risk. Our investment portfolio primarily consists of fixed income securities denominated in both U.S. and foreign currencies. External investment professionals manage our portfolio under the direction of our management in accordance with investment guidelines provided by us. Our guidelines do not currently permit the use of derivatives other than foreign currency forward contracts. In the future, we may change our guidelines to permit the use of derivatives.
Interest Rate Risk. Fluctuations in interest rates have a direct impact on the market valuation of fixed income securities included in our investment portfolio. As interest rates rise, the market value of our fixed income portfolio falls, and the converse is also true. We manage interest rate risk by selecting investments with characteristics such as duration, yield, currency and liquidity tailored to the anticipated cash outflow characteristics of our insurance and reinsurance liabilities.
Our current duration target for our investments is two to four years. The duration of an investment is based on the maturity of the security and also reflects the payment of interest and the possibility of early principal payment of such security. We seek to utilize investment benchmarks that reflect this duration target. We periodically revise our investment benchmarks based on business and economic conditions, including the average duration of our potential liabilities. At September 30, 2005, our invested assets (assets under management by external investment managers) had an approximate duration of 3.1 years.
At September 30, 2005, we held $2,240.7 million at fair market value, or 38.9% of our total invested assets, in mortgage-backed securities compared to $1,714.8 million, or 32.0%, at December 31, 2004. When interest rates decline, these assets are exposed to prepayment risk, which occurs when holders of underlying mortgages increase the frequency with which they prepay the outstanding principal before the maturity date and refinance at a lower interest rate cost. When interest rates increase, these assets are exposed to extension risk, which occurs when holders of underlying mortgages reduce the frequency with which they prepay the outstanding principal before the maturity date and delay any refinancing of the outstanding principal.
We have calculated the effect that an immediate parallel shift in the U.S. interest rate yield curve would have on our assets under management by third party investment managers at September 30, 2005. The modeling of this effect was performed on each security individually using the security’s effective duration and changes in prepayment expectations for mortgage-backed and asset-backed securities. The results of this analysis are summarized in the table below.
42
Interest Rate Movement Analysis on Market Value of Assets under Management by External Investment Managers
|
| Interest Rate Shift in Basis Points |
| ||||||||
|
| -100 |
| -50 |
| 0 |
| +50 |
| +100 |
|
Total Market Value |
| 5,921,200 |
| 5,874,338 |
| 5,786,439 |
| 5,694,644 |
| 5,600,256 |
|
Market Value Change from Base |
| 2.33 | % | 1.52 | % | — | % | (1.59 | )% | (3.22 | )% |
Change in Unrealized Value |
| 134,761 |
| 87,899 |
| — |
| (91,795 | ) | (186,183 | ) |
Foreign Currency Risk. Fluctuations in foreign currency exchange rates have a direct impact on the market valuation of fixed income securities included in our investment portfolio that are denominated in those currencies. Therefore, we attempt to manage our foreign currency risk by seeking to match our liabilities under insurance and reinsurance policies that are payable in foreign currencies with cash and investments that are denominated in such currencies. In addition, we have implemented a currency hedging program whereby we entered into several foreign currency forward contracts in order to minimize the effects of fluctuations in foreign currency exchange rates on our foreign currency denominated assets and liabilities. A foreign currency forward contract involves an obligation to purchase or sell a specified currency at a future date at a price set at the time of the contract. Foreign currency forward contracts will not eliminate fluctuations in the value of our assets and liabilities denominated in foreign currencies but rather allow us to establish a rate of exchange for a future point in time. However, we do not expect to enter into such contracts with respect to a material amount of our assets. Foreign currency forward contracts purchased are not specifically identifiable against cash, any single security or any groups of securities and, therefore, do not qualify and are not designated as a hedge for financial reporting purposes. All realized gains and losses and unrealized gains and losses on foreign currency forward contracts are recognized in our statements of operations and comprehensive income.
At September 30, 2005, the net contractual amount of foreign currency forward contracts was $135.7 million with an unrealized gain of $2.5 million. At December 31, 2004, the net contractual amount of foreign currency forward contracts was $30.0 million with an unrealized loss of $0.1 million.
At September 30, 2005, we had insurance and reinsurance premium balances receivable of $1,145.5 million compared to $914.6 million at December 31, 2004. Of this balance, 80.2% was denominated in U.S. dollars, 10.3% was denominated in Euro and 6.7% in Sterling. A 10% increase or decrease in the value of the Euro and Sterling currencies against the U.S. dollar would produce a gain or loss of approximately $19.5 million at September 30, 2005 compared to $11.7 million at December 31, 2004.
Credit Risk. We have exposure to credit risk primarily as a holder of fixed income securities. Our risk management strategy and investment policy is to invest in debt instruments of high credit quality issuers and to limit the amount of credit exposure with respect to particular ratings categories and any one issuer. We attempt to limit our credit exposure by purchasing fixed income investments rated BBB-/Baa3 or higher. In addition, we have limited our exposure to any single corporate issuer to 5% or less of our portfolio for securities rated A-/A3 or above and 2% or less of our portfolio for securities rated between BBB-/Baa3 and BBB+/Baa1. At September 30, 2005, we did not have an aggregate exposure to any single issuer of more than 2% of our portfolio, other than with respect to U.S. government and agency securities. In addition, we have credit risk under some contracts where we receive premiums in return for assuming the risk of default on pre-determined portfolios of sovereign and corporate obligations.
Value-at-Risk. Our management uses Value-at-Risk (“VaR”) as one of its tools to measure potential losses in fair market values of our investment portfolio. The VaR calculation is calculated by a third party provider and reviewed by management. VaR uses a Monte Carlo simulation to project many different prices of fixed income securities, derivatives and currencies taking into account, among other things, the volatility and the correlation between security price changes over various forecast horizons.
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The VaR of our investment portfolio at September 30, 2005 was approximately $191.5 million compared to $180.4 million at December 31, 2004, which represents the potential loss in fair market value of our investment portfolio over a one year time horizon within a 95% confidence level. This increase was primarily due to a slight extension of the portfolio duration and an increase in the size of the investment portfolio. The VaR computation is a risk analysis tool and does not purport to represent actual losses in fair market value. We cannot predict actual future movements in market rates and do not present these results to be indicative of future movements in such market rates or to be representative of any actual impact that future changes in market rates may have on our future results of operations or financial position.
Effects of Inflation
We do not believe that inflation has had a material effect on our results of operations, except insofar as inflation may affect interest rates. In addition, after a catastrophe loss, inflationary pressures often occur in the affected area. The anticipated effects of this inflation are considered in our catastrophe loss models and therefore, are reflected in pricing and in estimating reserves for unpaid claims and claim expenses. The actual effects of inflation on our results of operations cannot be accurately known until claims are ultimately settled.
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Cautionary Note Regarding Forward-Looking Statements
This quarterly report contains certain 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,” “should,” “could,” “anticipate,” “estimate,” “expect,” “plan,” “believe,” “predict,” “potential” and “intend.” Forward-looking statements contained in this quarterly report include information regarding our estimates of losses related to Hurricanes Katrina and Rita and the impact of such losses on our reinsurers, our expectations regarding pricing and other market conditions, the amount of our net losses and loss reserves, the projected amount of our capital expenditures, valuations of potential interest rate shifts, foreign currency rate changes and measurements of potential losses in fair market values of our investment portfolio. 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 actual events or results to be materially different from our expectations include (1) our limited operating history, (2) the occurrence of natural and man-made disasters, (3) actual claims exceeding our loss reserves, (4) the failure of any of the loss limitation methods we employ, (5) the effects of emerging claims and coverage issues, (6) the failure of our cedents to adequately evaluate risks, (7) the loss of one or more key executives, (8) a decline in our ratings with rating agencies, (9) the loss of business provided to us by our major brokers, (10) changes in governmental regulations, (11) increased competition, (12) general economic conditions and (13) the other matters set forth under Item 8, “Management’s Discussions and Analysis of Financial Condition and Results of Operations - Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2004 filed with the SEC on March 1, 2005. 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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Item 4. Controls and Procedures
The Company’s management has performed an evaluation, with the participation of the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) as of September 30, 2005. Based upon that evaluation, the Company’s Chief Executive Officer and the Company’s Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.
The Company’s management has performed an evaluation, with the participation of the Company’s Chief Executive Officer and the Company’s Chief Financial Officer, of changes in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2005. Based upon that evaluation, the Company’s management has not identified any change in its internal control over financial reporting that occurred during quarter ended September 30, 2005 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
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Except as set forth below, we are not currently a party to any material legal proceedings. From time to time, we are subject to routine legal proceedings, including arbitrations, arising in the ordinary course of business. These legal proceedings generally relate to claims asserted by or against us in the ordinary course of our insurance or reinsurance operations.
Our U.S. holding company has received subpoenas from the Office of the Attorney General of the State of New York seeking information regarding incentive commission agreements, fictitious and inflated quotes and related matters and conditioning direct insurance on the placement of reinsurance. In addition, our U.S. insurance companies have received subpoenas and requests for information from various state insurance regulators regarding these same matters. These inquiries are part of industry-wide investigations in these jurisdictions and we understand that officials from other jurisdictions in which we do business have also initiated investigations into similar matters. Accordingly, we may in the future receive additional subpoenas and requests for information. We are cooperating fully with the Attorney General of the State of New York and the other state regulators in their investigations and intend to cooperate fully with any future investigations.
In connection with these inquiries, we have conducted an internal investigation, led by outside counsel, to determine whether we have engaged in any of the improper business practices that are the focus of the inquiries. This investigation is complete and has uncovered no evidence indicating that we engaged in bid rigging, fictitious or inflated quotes or related matters or conditioning direct insurance on the placement of reinsurance. Consistent with long-standing and wide-spread industry practice, we have in the past entered into incentive commission arrangements with brokers; however, we have not entered into any of these arrangements with respect to business underwritten in 2005.
A purported shareholders class action lawsuit has been filed against us and some of our executive officers relating to the practices being investigated by the Attorney General of the State of New York and other state regulators. James Dolan v. AXIS Capital Holdings Limited, Michael A. Butt and John R. Charman was filed on October 28, 2004 in the United States District Court, Southern District of New York. Robert Schimpf v. AXIS Capital Holdings Limited, Michael A. Butt, Andrew Cook and John R. Charman was filed on November 5, 2004 in the United States District Court, Southern District of New York. On April 13, 2005, these lawsuits were consolidated and are now known as In re AXIS Capital Holdings Ltd. Securities Litigation. On May 13, 2005, the plaintiffs filed an amended, consolidated complaint and added as defendants the managing underwriters and one of the selling shareholders in our secondary offering completed in March 2004. The lawsuit alleges securities violations in connection with the failure to disclose payments made pursuant to incentive commission arrangements and seeks damages in an unspecified amount. We believe that the lawsuit is completely without merit and intend to vigorously defend against it.
A putative class action lawsuit also has been filed against our U.S. insurance companies. In re Insurance Brokerage Antitrust Litigation was filed on August 1, 2005 in the United States District Court for the District of New Jersey and includes as defendants numerous insurance brokers and insurance companies. The lawsuit alleges antitrust and RICO violations in connection with the payment of contingent commissions and manipulation of insurance bids and seeks damages in an unspecified amount. We believe that the lawsuit is completely without merit and intend to vigorously defend against it.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On March 14, 2005, we announced that our Board of Directors had approved the repurchase of up to $150 million of our common shares to be effected from time to time in open market or privately negotiated transactions. The repurchase program is authorized to continue until December 2006. The following table sets forth information regarding the number of shares we repurchased during each month in the quarter ended September 30, 2005.
ISSUER PURCHASES OF EQUITY SECURITIES
Period |
| Total Number of Shares Purchased(a) |
| Average Price Paid Per Share |
| Total Number Of Shares Purchased as Part Of Publicly Announced Plans or Programs |
| Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Announced Plans or Programs |
| ||
July 1-31, 2005 |
| 820 |
| $ | 28.36 |
| 0 |
| $ | 150,000,000 |
|
August 1-31, 2005 |
| 12,580 |
| $ | 29.00 |
| 0 |
| $ | 150,000,000 |
|
September 1-30, 2005 |
| 15,200 |
| $ | 28.89 |
| 0 |
| $ | 150,000,000 |
|
Total |
| 28,600 |
| $ | 28.92 |
| 0 |
| $ | 150,000,000 |
|
(a) Comprises shares withheld to satisfy tax liabilities upon the vesting of restricted stock awarded under our 2003 Long Term Equity Compensation Plan. These shares are not included in our repurchase program.
(a) |
| Exhibits |
|
|
|
3.1 |
| Certificate of Incorporation and Memorandum of Association (incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1 /A (Registration No. 333-103620) filed on April 16, 2003). |
|
|
|
3.2 |
| Certificate of Designations setting forth the specific rights, preferences, limitations and other terms of the Series A Preferred Shares (incorporated by reference to exhibit 3.1 to the Company’s Current Report on Form 8-K filed on October 4, 2005). |
|
|
|
3.3 |
| Bye-Laws (incorporated by reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004). |
|
|
|
31.1 |
| Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|
|
|
31.2 |
| Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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|
|
|
32.1 |
| Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|
|
|
32.2 |
| Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: November 7, 2005
AXIS CAPITAL HOLDINGS LIMITED | |
|
|
By: | /s/ John R. Charman |
| John R. Charman |
| President and Chief Executive Officer |
| (Authorized Officer) |
|
|
| /s/ Andrew Cook |
| Andrew Cook |
| Chief Financial Officer |
| (Principal Financial Officer) |
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