losses and loss adjustment expenses. Of the total gross reserves for unpaid losses of $2,989.3 million at the balance sheet date of September 30, 2006 a total of $1,374.2 million or 46.0% represented IBNR claims.
For the nine months ended September 30, 2006, there was a reduction of our estimate of the ultimate net claims to be paid in respect of prior accident years of $58.1 million. An analysis of this reduction by line of business is as follows:
The key elements which gave rise to the net favourable development during the nine months ended September 30, 2006 were as follows:
Table of ContentsOur quarterly reserving process currently includes an independent review by a firm of consulting actuaries. Having factored in the uncertainties impacting the reserves for our book of business, our consulting actuaries concluded that our reserves as at September 30, 2006 lie within a range of reasonable best estimates.
Other than the matters described above, we did not make any significant changes in assumptions used in our reserving process. However, because the period of time we have been in operation is short, our loss experience is limited and reliable evidence of changes in trends of numbers of claims incurred, average settlement amounts, numbers of claims outstanding and average losses per claim will necessarily take years to develop.
For a more detailed description see ‘‘Management’s Discussion and Analysis — Critical Accounting Policies — Reserves for Losses and Loss Expenses,’’ included in our 2005 Annual Report on Form 10-K for the year ended December 31, 2005 filed with the United States Securities and Exchange Commission.
Liquidity and Capital Resources
Aspen is a holding company that does not have any significant operations or assets other than its ownership of the shares of its direct and indirect subsidiaries, including Aspen Re, Aspen Bermuda and Aspen Specialty. Aspen relies primarily on dividends and other permitted distributions from these insurance subsidiaries to pay its operating expenses, interest on debt finance and dividends, if any, on its ordinary shares and preference shares. There are restrictions on the payment of dividends by Aspen Re, Aspen Bermuda and Aspen Specialty to Aspen, which are described in more detail in the ‘‘Business — Regulatory Matters’’ section of the 2005 Annual Report on Form 10-K filed with the Securities and Exchange Commission.
Our aggregate cash and invested assets as of September 30, 2006 were $4.8 billion, compared to aggregate invested assets and cash of $4.4 billion as of December 31, 2005. The increase in invested assets since December 31, 2005 resulted from collections of premiums on insurance policies and reinsurance contracts and investment income, offset by claims, policy acquisition expenses, reinsurance premiums and operating and administrative expenses paid.
Total net cash flow from operations from December 31, 2005 through September 30, 2006 was $371.8 million, a reduction from $605.9 million in the prior year period. The reduction was a result of significant claims having been paid in the period, particularly in respect of 2004 and 2005 hurricanes. For the nine months ended September 30, 2006, our cash flow from operations provided us with sufficient liquidity to meet our operating requirements. On August 23, 2006, we paid a dividend of $0.15 per ordinary share to shareholders of record on June 9, 2006. A dividend totaling $3.2 million on our Perpetual Preferred Income Equity Replacement Securities (‘‘Perpetual PIERS’’) was also declared. This amount has been paid to our dividend disbursing agent, and was paid on October 1, 2006 to all Perpetual PIERS holders of record on September 15, 2006.
Our contractual obligations other than our obligations to employees consist mainly of amounts outstanding under our senior notes, reserves relating to our insurance and reinsurance contracts and operating leases. Note 6 to the unaudited condensed consolidated financial statements summarises amounts outstanding under our contractual obligations as of September 30, 2006.
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Table of ContentsAs at September 30, 2006 we have provided collateral or other security to policyholders totaling $1,789.0 million and made up of:
| | | | | | | | | | | | |
| | | | As at
September 30, 2006 | | | As at
December 31, 2005 |
| | | | ($ in millions) |
| Assets held in multi-beneficiary trusts | | | | $ | 1,269.6 | | | | | $ | 1,143.3 | |
| Assets held in single beneficiary trusts | | | | | 50.0 | | | | | | 48.3 | |
| Letters of credit issued under our revolving credit facilities (1) | | | | | 256.4 | | | | | | 309.4 | |
| Secured letters of credit (2) | | | | | 213.0 | | | | | | 211.6 | |
| Total | | | | $ | 1,789.0 | | | | | $ | 1,712.6 | |
| Total as % of cash and invested assets | | | | | 37.0 | | | | | | 38.6 | |
|
| |
| (1) | These letters of credit are not secured by cash or securities, though they are secured by a pledge of the shares of certain of the Company’s subsidiaries under a pledge agreement. |
| |
| (2) | Almost all of the collateral and other security shown above is provided for the benefit of U.S. cedants in pursuance of our contractual obligations. This enables the beneficiaries to take credit for the amounts they expect to recover from us in their statutory returns. Such arrangements are usual in respect of non-U.S. reinsurers. |
For a more detailed description of our liquidity and capital resources, refer to our Annual Report on Form 10-K for the year ended December 31, 2005.
Effects of Inflation
The effects of inflation could cause the severity of claims from catastrophes or other events to rise in the future. Our calculation of reserves for losses and loss adjustment expenses includes assumptions about future payments for settlement of claims and claims-handling expenses, such as medical treatments and litigation costs. We write casualty/liability business in the United States, the United Kingdom and Australia, where claims inflation has grown particularly strong in recent years. To the extent inflation causes these costs to increase above reserves established for these claims, we will be required to increase our loss reserves with a corresponding reduction in current period earnings.
Cautionary Statement Regarding Forward-Looking Statements
This Form 10-Q contains, and the Company may from time to time make other verbal or written, forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the ‘‘Securities Act’’), and Section 21E of the Securities Exchange Act of 1934, as amended, that involve risks and uncertainties, including statements regarding our capital needs, business strategy, expectations and intentions. Statements that use the terms ‘‘believe’’, ‘‘do not believe’’, ‘‘anticipate’’, ‘‘expect’’, ‘‘plan’’, ‘‘estimate’’, ‘‘intend’’ and similar expressions are intended to identify forward-looking statements. These statements reflect our current views with respect to future events and because our business is subject to numerous risks, uncertainties and other factors, our actual results could differ materially from those anticipated in the forward-looking statements. The risks, uncertainties and other factors set forth in the Company's 2005 Annual Report on Form 10-K filed with the Securities and Exchange Commission and other cautionary statements made in this report, as well as the following factors, should be read and understood as being applicable to all related forward-looking statements wherever they appear in this report.
All forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in these statements. We believe that these factors include, but are not limited to, the following:
| | |
| • | the impact that our future operating results, capital position and rating agency and other considerations have on the execution of any capital management initiatives; |
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Table of Contents | | |
| • | the impact of any capital management initiatives on our financial condition; |
| | |
| • | the impact of acts of terrorism and related legislation and acts of war; |
| | |
| • | the possibility of greater frequency or severity of claims and loss activity, including as a result of natural or man-made catastrophic events such as Hurricanes Katrina, Rita and Wilma, than our underwriting, reserving, reinsurance purchasing or investment practices have anticipated; |
| | |
| • | evolving interpretive issues with respect to coverage as a result of Hurricanes Katrina, Rita and Wilma; |
| | |
| • | the level of inflation in repair costs due to limited availability of labor and materials after catastrophes; |
| | |
| • | the effectiveness of our loss limitation methods; |
| | |
| • | changes in the availability, cost or quality of reinsurance or retrocessional coverage; |
| | |
| • | the reliability of, and changes in assumptions to, catastrophe pricing, accumulation and estimated loss models; |
| | |
| • | a decline in our operating subsidiaries’ ratings with Standard & Poor’s, A.M. Best Company (‘‘A.M. Best’’) or Moody’s Investors Service; |
| | |
| • | changes in general economic conditions, including inflation, foreign currency exchange rates, interest rates and other factors that could affect our investment portfolio; |
| | |
| • | increased competition on the basis of pricing, capacity, coverage terms or other factors; |
| | |
| • | decreased demand for our insurance or reinsurance products and cyclical downturn of the industry; |
| | |
| • | changes in governmental regulations or tax laws in jurisdictions where we conduct business; |
| | |
| • | Aspen Holdings or Aspen Bermuda becoming subject to income taxes in the United States or the United Kingdom; |
| | |
| • | the effect on insurance markets, business practices and relationships of ongoing litigation, investigations and regulatory activity by the New York State Attorney General’s office and other authorities concerning contingent commission arrangements with brokers and bid solicitation activities; |
| | |
| • | the total industry losses resulting from Hurricanes Katrina, Rita and Wilma, and the actual number of our insureds incurring losses from these storms; and |
| | |
| • | with respect to Hurricanes Katrina, Rita and Wilma, the Company’s reliance on loss reports received from cedants and loss adjustors, our reliance on industry loss estimates and those generated by modeling techniques, the impact of these storms on our reinsurers, changes in assumptions on flood damage exclusions as a result of prevailing lawsuits and case law, any changes in our reinsurers’ credit quality, the amount and timing of reinsurance recoverables and reimbursements actually received by us from our reinsurers and the overall level of competition, and the related demand and supply dynamics as contracts come up for renewal. |
The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this report. We undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise or disclose any difference between our actual results and those reflected in such statements.
If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary materially from what we projected. Any forward-looking statements you read in this report reflect our current views with respect to future
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Table of Contentsevents and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. All subsequent written and oral forward-looking statements attributable to us or individuals acting on our behalf are expressly qualified in their entirety by the points made above. You should specifically consider the factors identified in this report which could cause actual results to differ before making an investment decision.
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Table of ContentsItem 3. Quantitative and Qualitative Disclosures about Market Risk
Interest rate risk. Our investment portfolio consists primarily of fixed income securities. Accordingly, our primary market risk exposure is to changes in interest rates. Fluctuations in interest rates have a direct impact on the market valuation of these securities. As interest rates rise, the market value of our fixed-income portfolio falls, and the converse is also true. We expect to manage interest rate risk by selecting fixed income investments with characteristics that take into account the average duration of the group’s liabilities.
Our strategy for managing interest rate risk also includes maintaining a high quality portfolio with a relatively short duration to reduce the effect of interest rate changes on book value. The portfolio is actively managed and trades are made to balance our exposure to interest rates.
As at September 30, 2006, our fixed income portfolio had an approximate duration of 2.98 years. The table below depicts interest rate change scenarios and the effect on our interest-rate sensitive invested assets:
| | | | | | | | | | | | | | | |
| Effect of changes in interest rates on portfolio given a parallel shift in the yield curve |
| Movement in rates in basis points | | | −100 | | | −50 | | | 0 | | | 50 | | | 100 |
| | | | ($ in thousands, except percentages) |
| Market value $ in thousands | | | $4,538,846 | | | $4,479,001 | | | $4,418,900 | | | $4,358,879 | | | $4,299,320 |
| Gain/(loss) $ in thousands | | | $119,946 | | | $60,101 | | | $0.00 | | | $(60,021) | | | $(119,580) |
| Percentage of portfolio | | | 2.71% | | | 1.36% | | | 0.00% | | | (1.36)% | | | (2.71)% |
|
Equity risk. We have invested in two funds of hedge funds totaling $150 million at September 30, 2006, which were 3.3% of our invested assets. These fund of hedge funds are structured to have low volatility and limited correlation with traditional fixed income markets. The nature of the underlying hedge funds consist of diverse strategies and securities.
To the extent the underlying hedge funds have equity positions and are market neutral, we are exposed to losses from changes in prices of those positions; to the extent the underlying hedge funds have net long or net short equity positions, we are exposed to losses that are more correlated to changes in equity markets in general. The funds in which we have invested, have historically exhibited approximately a quarter of the volatility of the S&P 500 Index.
Foreign currency risk. Our reporting currency is the U.S. Dollar. The functional currencies of our segments are U.S. Dollars and British Pounds. As of September 30, 2006, approximately 79% of our cash and investments are held in U.S. Dollars, approximately 15% are in British Pounds and approximately 6% are in currencies other than the U.S. Dollar and the British Pound. For the nine months ended September 30, 2006, 11% of our gross premiums were written in currencies other than the U.S. Dollar and the British Pound and we expect that a similar proportion will be written in currencies other than the U.S. Dollar and the British Pound in the remainder of 2006. Other foreign currency amounts are remeasured to the appropriate functional currency and the resulting foreign exchange gains or losses are reflected in the statement of operations. Functional currency amounts of assets and liabilities are then translated into U.S. Dollars. The unrealized gain or loss from this translation, net of tax, is recorded as part of shareholders' equity. The change in unrealized foreign currency translation gain or loss during the year, net of tax, is a component of comprehensive income. Both the remeasurement and translation are calculated using current exchange rates for the balance sheets and average exchange rates for the statement of operations. We may experience exchange losses to the extent our foreign currency exposure is not properly managed or otherwise hedged, which in turn would adversely affect our results of operations and financial condition. Management estimates that a 10% change in the exchange rate between British Pounds and U.S. Dollars as at September 30, 2006, would have impacted reported net comprehensive income by approximately $1.3 million for the nine months ended September 30, 2006.
We attempt to manage our foreign currency risk by seeking to match our liabilities under insurance and reinsurance policies that are payable in foreign currencies with investments that are denominated in these currencies. Although in the past we have entered into forward foreign currency exchange contracts, we had no outstanding forward contracts as at September 30, 2006.
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Table of ContentsCredit risk. We have exposure to credit risk primarily as a holder of fixed income securities. Our risk management strategy and investment policy is to invest in debt instruments of high credit quality issuers and to limit the amount of credit exposure with respect to particular ratings categories and any one issuer. Under our policy, no more than 5% of the fixed-income securities in our investment portfolio may be rated below ‘‘A−’’. As at September 30, 2006, the average rate of fixed income securities in our investment portfolio was ‘‘AAA’’. In addition, we are exposed to the credit risk of our insurance and reinsurance brokers to whom we make claims payments for insureds and our reinsureds and from whom we receive premiums, as well as to the credit risk of our reinsurers and retrocessionaires who assume business from us. Other than fully collateralized reinsurance, the substantial majority of our reinsurers have a rating of ‘‘A’’ (Excellent), the third highest of fifteen rating levels, or better by A.M. Best and the minimum rating of any of our material reinsurers is ‘‘A−’’ (Excellent), the fourth highest of fifteen rating levels, by A.M. Best.
We are also exposed to the credit risk of our reinsurers. The following table shows our reinsurance recoverables by amount and percentage of total, as rated by S&P and A.M. Best, as at September 30, 2006:
| | | | | | | | | |
| | | | As at September 30, 2006 |
| | | | ($ in millions except for percentages) |
| S&P | | | | | | |
| AAA | | | $81.4 | | | 10.3% |
| AA+ | | | 1.8 | | | 0.2% |
| AA | | | 16.5 | | | 2.1% |
| AA− | | | 83.0 | | | 10.5% |
| A+ | | | 38.5 | | | 4.9% |
| A | | | 305.0 | | | 38.7% |
| AAA− | | | 148.9 | | | 18.9% |
| BBB+ | | | 0.0 | | | 0.0% |
| Fully collaterised | | | 76.6 | | | 9.7% |
| Not rated | | | 36.6 | | | 4.7% |
| | | | $788.3 | | | 100.0% |
| A.M. Best | | | | | | |
| A++ | | | $81.4 | | | 10.3% |
| A+ | | | 62.2 | | | 7.9% |
| A | | | 390.0 | | | 49.5% |
| AAA− | | | 148.9 | | | 18.9% |
| B+ | | | 0.0 | | | 0.0% |
| Fully collaterised | | | 76.6 | | | 9.7% |
| Not rated | | | 29.2 | | | 3.7% |
| | | | $788.3 | | | 100.0% |
|
With respect to our reinsurance recoverables, our reinsurers are due $45.3 million from us in reinstatement premiums, and we have received $59.8 million in outstanding claims advances. As a result, our net exposure on our reinsurance recoverables is $683.2 million, as at September 30, 2006. This includes $76.6 million which is fully collateralised.
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Table of ContentsItem 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
During the fourth quarter of 2005, we successfully transitioned to a new financial reporting ledger system. We are in the process of finalizing the implementation of a new underwriting system that is expected to be complete during 2006. Later in 2006, the new underwriting system will automatically interface with the new financial reporting ledger. The introduction of the new systems is the final stage of the process to improve functionality and transition away from the IT facilities and services previously provided by Wellington.
The Company, under the supervision and with the participation of the Company's management, including the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the design and operation of the Company's disclosure controls and procedures as of the end of the period of this report. Our management does not expect that our disclosure controls or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. As a result of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons or by collusion of two or more people. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. As a result of the inherent limitations in a cost-effective control system, misstatement due to error or fraud may occur and not be detected. Accordingly, our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the disclosure controls and procedures are met. Based on the evaluation of the disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures were effective in ensuring that information required to be disclosed by the Company in this report is recorded, processed, summarized and reported in a timely fashion.
Changes in Internal Control over Financial Reporting
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, 2006. Based upon that evaluation, the Company's management is not aware of any change in its internal control over financial reporting that occurred during the quarter ended September 30, 2006 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
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Table of ContentsPART II
OTHER INFORMATION
Item 1. Legal Proceedings
Similar to the rest of the insurance and reinsurance industry, we are subject to litigation and arbitration in the ordinary course of business. We are not currently involved in any material pending litigation or arbitration proceedings.
Item 1A. Risk Factors
There have been no significant changes in the Company’s risk factors as discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
In connection with the options held by the Names’ Trustee as described further in Note 4 to our financial statements, the Names’ Trustee may exercise the options on a monthly basis. The options were exercised on a cashless basis at the exercise price as described in Note 4 to our financial statements. As a result, we issued the following unregistered shares to the Names’ Trustee and its beneficiaries as described below.
| | | | | | |
| Date Issued | | | Number of Shares Issued |
| August 15, 2006 | | | | | 589 | |
| September 15, 2006 | | | | | 219 | |
|
None of the transactions involved any underwriters, underwriting discounts or commissions, or any public offering and we believe that each transaction, if deemed to be a sale of a security, was exempt from the registration requirements of the Securities Act by virtue of Section 4(2) thereof or Regulation S for offerings of securities outside the United States. Such securities were restricted as to transfers and appropriate legends were affixed to the share certificates and instruments in such transactions.
On September 28, 2006, we agreed to repurchase 16,425 ordinary shares from the Names’ Trustee at a price per share of $25.71, for a consideration of approximately $422,000. We completed the repurchase on October 5, 2006.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submissions of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
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Table of ContentsItem 6. Exhibits
(a) The following sets forth those exhibits filed pursuant to Item 601 of Regulation S-K:
| | | |
Exhibit
Number | | | Description |
| 31.1 | | | Officer Certification of Christopher O'Kane, Chief Executive Officer of Aspen Insurance Holdings Limited, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed with this report. |
| 31.2 | | | Officer Certification of Julian Cusack, Chief Financial Officer of Aspen Insurance Holdings Limited, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed with this report. |
| 32.1 | | | Officer Certification of Christopher O'Kane, Chief Executive Officer of Aspen Insurance Holdings Limited, and Julian Cusack, Chief Financial Officer of Aspen Insurance Holdings Limited, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, submitted with this report. |
|
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Table of ContentsSIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
| | | | | | |
| | | | | | | ASPEN INSURANCE HOLDINGS LIMITED
(Registrant) |
| Date: November 3, 2006 | | | By: | | | /s/ Christopher O’Kane |
| | | | | | | Christopher O’Kane
Chief Executive Officer |
| Date: November 3, 2006 | | | By: | | | /s/ Julian Cusack |
| | | | | | | Julian Cusack
Chief Financial Officer |
|
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Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act![[ ]](https://capedge.com/proxy/10-Q/0001342180-06-000025/ebox.gif){kind=small}
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934