Our gross case reserves and IBNR by line of business at September 30, 2004 and December 31, 2003 were as follows:
Of the total case reserve amounts above, the amount reported by ceding insurers and insureds was $242.5 million at September 30, 2004 and $244.0 million at December 31, 2003. The remaining balance represents additional case reserve estimates established by management.
The $742.9 million increase in IBNR at September 30, 2004 compared to December 31, 2003 is primarily due to the third quarter 2004 hurricanes losses.
At September 30, 2004 our estimated IBNR reserve was $1,339.4 million. A 5% change in such IBNR reserves would equate to a $67.0 million adjustment to claims and claim expenses incurred, which would represent 2.7% of shareholders' equity at September 30, 2004.
As discussed in "Summary of Critical Accounting Policies and Estimates", for insurance and reinsurance companies, the most significant accounting judgment made by management is the estimation of the claims and claim expense reserves. Because of the variability and uncertainty associated with loss estimation, it is possible that our individual case reserves are incorrect, possibly materially.
A large portion of our coverages provide protection from natural and man-made catastrophes which are generally infrequent, but can be significant, such as losses from hurricanes and earthquakes. Our claims and claim expense reserves will generally fluctuate, sometimes materially, based upon the occurrence of a significant natural or man-made catastrophic loss for which we provide reinsurance. Our claims reserves will also fluctuate based on the payments we make for these large loss events. The timing of our payments on loss events can be affected by various factors, including the event causing the loss, the location of the loss, and whether our losses are from policies with insurers or reinsurers.
During 2003 and continuing in the first nine months of 2004, we increased our specialty reinsurance and Individual Risk gross written premiums (see – "Summary of Results of Operations"). The addition of these lines of business adds complexity to our claims reserving process and therefore adds uncertainty to our claims reserve estimates, as the reporting of information, the setting of initial reserves and the loss settlement process for these lines of business vary from our traditional property catastrophe line of business.
For our Reinsurance and Individual Risk operations, our estimates of claims reserves include case reserves reported to us as well as our estimate of appropriate additional case reserves and IBNR. Our
case reserves and our estimates for IBNR reserves are based on 1) claims reports from insureds and program managers, 2) aggregate industry loss reports and estimates, 3) our underwriters' experience in setting claims reserves, 4) the use of computer models where applicable and 5) historical industry claims experience. For some classes of business we use statistical and actuarial methods to estimate ultimate expected claims and claim expenses. We review our claims reserves on a regular basis. (Also see "Summary of Critical Accounting Policies and Estimates")
CAPITAL RESOURCES
Our total capital resources as at September 30, 2004 and December 31, 2003 were as follows:
| | | | | | | | | | |
| (in thousands of U.S. dollars) | | At September 30,
2004 | | At December 31,
2003 |
| Common shareholders' equity | | $ | 1,957,115 | | | $ | 2,084,643 | |
| Preference shares | | | 500,000 | | | | 250,000 | |
| Total shareholders' equity | | | 2,457,115 | | | | 2,334,643 | |
| 7.0% Senior Notes | | | 150,000 | | | | 150,000 | |
| 5.875% Senior Notes | | | 100,000 | | | | 100,000 | |
| DaVinci revolving credit facility — borrowed | | | 100,000 | | | | 100,000 | |
| 8.54% subordinated obligation to capital trust | | | 103,093 | | | | 103,093 | |
| Revolving credit facility — unborrowed | | | 500,000 | | | | 400,000 | |
| Total capital resources | | $ | 3,410,208 | | | $ | 3,187,736 | |
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During the first nine months of 2004, our capital resources increased primarily as a result of the issuance of $250 million of Series C preference shares and an increase in our revolving credit facility, offset by our net loss attributable to common shareholders of $70.8 million and dividends payable to our common shareholders of $40.3 million.
In March 2004, we raised $250 million through the issuance of 10 million Series C preference shares, in February 2003, we raised $100 million through the issuance of 4 million Series B preference shares, and in November 2001, we raised $150 million through the issuance of 6 million Series A preference shares. The Series C, Series B and Series A preference shares may be redeemed at $25 per share at our option on or after March 23, 2009, February 4, 2008 and November 19, 2006, respectively; however, we have no current intentions to redeem the shares. Dividends on the Series C, Series B and Series A preference shares are cumulative from the date of original issuance and are payable quarterly in arrears at 6.08%, 7.3% and 8.1%, respectively, when, if, and as declared by the Board of Directors. If RenaissanceRe submits a proposal to our shareholders concerning an amalgamation or submit any proposal that, as a result of any changes to Bermuda law, requires approval of the holders of RenaissanceRe preference shares to vote as a single class, RenaissanceRe may redeem the Series C, Series B and Series A preference shares prior to March 23, 2009, February 4, 2008 and November 19, 2006, respectively, at $26 per share. The preference shares have no stated maturity and are not convertible into any other of our securities.
In January 2003, RenaissanceRe issued $100 million of 5.875% Senior Notes due February 15, 2013, with interest on the notes payable on February 15 and August 15 of each year. In July 2001, RenaissanceRe issued $150 million of 7.0% Senior Notes due July 15, 2008 with interest on the notes payable on January 15 and July 15 of each year. The notes can be redeemed by RenaissanceRe prior to maturity subject to payment of a "make-whole" premium; however, we have no current intentions of calling the notes. The notes, which are senior obligations, contain various covenants, including limitations on mergers and consolidations, restriction as to the disposition of stock of designated subsidiaries and limitations on liens on the stock of designated subsidiaries. RenaissanceRe was in compliance with the related covenants at September 30, 2004.
Our Capital Trust has issued Capital Securities which pay cumulative cash distributions at an annual rate of 8.54%, payable semi-annually. During the first nine months of 2004 and the year ended December 31, 2003, RenaissanceRe did not purchase any of the Capital Securities. RenaissanceRe has
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purchased an aggregate $15.4 million of the Capital Securities since their issuance in 1997. The sole asset of the Capital Trust consists of our junior subordinated debentures. The Indenture relating to these junior subordinated debentures contains certain covenants, including a covenant prohibiting us from the payment of dividends if we are in default under the Indenture. We were in compliance with all of the covenants of the Indenture at September 30, 2004. The Capital Securities mature on March 1, 2027.
During May 2004, DaVinciRe amended and restated its credit agreement providing for a $100 million committed revolving credit facility and maintained as outstanding the full $100 million available under this facility. Neither RenaissanceRe nor Renaissance Reinsurance is a guarantor of this facility and the lenders have no recourse against us or our subsidiaries other than DaVinciRe and its subsidiary under the DaVinciRe facility. Pursuant to the terms of the $500 million facility maintained by RenaissanceRe, a default by DaVinciRe on its obligations will not result in a default under the RenaissanceRe facility. Interest rates on the facility are based on a spread above LIBOR, and averaged approximately 2.1% during the first nine months of 2004 (2003 – 2.2%). As amended, the credit agreement contains certain covenants requiring DaVinciRe to maintain a debt to capital ratio of 30% or below and a minimum net worth of $250 million. At September 30, 2004, DaVinciRe was in compliance with the covenants of this agreement. The amended and restated agreement extended the term of the facility to May 25, 2007.
Under the terms of certain reinsurance contracts, we may be required to provide letters of credit to reinsureds in respect of reported claims and/or unearned premiums. Our principal letter of credit facility is a $600 million syndicated secured facility which accepts as collateral shares issued by our subsidiary Renaissance Investment Holdings Ltd. ("RIHL"), whose assets consist of high grade fixed income securities. Our participating operating subsidiaries and our managed joint ventures have pledged (and must maintain) RIHL shares issued to them with a sufficient collateral value to support their respective obligations under the facility, including reimbursement obligations for outstanding letters of credit. The participating subsidiaries and joint ventures also have the option to post alternative forms of collateral. In addition, for liquidity purposes, in order to be permitted to pledge RIHL shares as collateral, each participating subsidiary and joint venture must maintain additional unpledged RIHL shares that have a net asset value at least equal to 15% of its facility usage, and in the aggregate the net asset value of all unpledged RIHL shares must be maintained at least equal to 15% of all of the outstanding RIHL shares. In the case of a default under the facility, or in other circumstances in which the rights of our lenders to collect on their collateral may be impaired, the lenders may exercise certain remedies under the facility agreement, in accordance with and subject to its terms, including redemption of pledged shares and conversion of the collateral into cash or eligible marketable securities. The redemption of shares by the collateral agent takes priority over any pending redemption of unpledged shares by us or other holders. In March 2004, the facility was increased to $600 million from $485 million and the term was extended to March 30, 2005. At September 30, 2004, we had outstanding letters of credit aggregating $384.2 million.
Also, in connection with our Top Layer Re joint venture we have committed $37.5 million of collateral to support a letter of credit and are obligated to make a mandatory capital contribution of up to $50.0 million in the event that a loss reduces Top Layer Re's capital below a specified level.
During August 2004, we amended and restated our committed revolving credit agreement to increase the facility from $400 million to $500 million, to extend the term to August 6, 2009 and to make certain other changes. The interest rates on this facility are based on a spread above LIBOR. No balance was outstanding at September 30, 2004. As amended, the agreement contains certain financial covenants. These covenants generally provide that consolidated debt to capital shall not exceed the ratio (the "Debt to Capital Ratio") of 0.35:1 and that the consolidated net worth (the "Net Worth Requirements") of RenaissanceRe and Renaissance Reinsurance shall equal or exceed $1 billion and $500 million, respectively, subject to certain adjustments under certain circumstances in the case of the Debt to Capital Ratio and certain grace periods in the case of the Net Worth Requirements, all as more fully set forth in the agreement. We have the right, subject to certain conditions, to increase the size of this facility to $600 million.
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SHAREHOLDERS' EQUITY
During the first nine months of 2004, our consolidated shareholders' equity, including preference shares, increased by $122.5 million to $2.5 billion as of September 30, 2004, from $2.3 billion as of December 31, 2003. The change in shareholders' equity was due to the issuance of $250 million of Series C preference shares, partially offset by our net loss attributable to common shareholders of $70.8 million and dividend payments to our common shareholders of $40.3 million.
INVESTMENTS
At September 30, 2004, we held investments totaling $5.0 billion, compared to $4.2 billion at December 31, 2003.
The table below shows the aggregate amounts of our invested assets:
| | | | | | | | | | | | | | |
| (in thousands of U.S. dollars) | | At September 30,
2004 | | At December 31,
2003 | |
| Fixed maturity investments available for sale, at fair value | | $ | 3,389,065 | | | $ | 2,947,841 | | |
| Short term investments, at cost | | | 697,380 | | | | 660,564 | | |
| Other investments, at fair value | | | 590,461 | | | | 369,242 | | |
| Total managed investment portfolio | | | 4,676,906 | | | | 3,977,647 | | |
| Equity investments in reinsurance company, at fair value | | | 139,712 | | | | 145,535 | | |
| Investments in other ventures, under equity method | | | 150,551 | | | | 41,130 | | |
| Total investments | | $ | 4,967,169 | | | $ | 4,164,312 | | |
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The $802.9 million growth in our total investments for the nine months ended September 30, 2004 resulted primarily from net cash provided by operating activities of $751.8 million and the proceeds from our sale of $250 million of Series C preference shares, partially offset by a $75.9 million increase in cash and cash equivalents and by dividends to common and preference shareholders of $40.3 million and $22.5 million, respectively.
Because our coverages include substantial protection for damages resulting from natural and man-made catastrophes, we may become liable for substantial claim payments on short-term notice. Accordingly, our investment portfolio is structured to preserve capital and provide a high level of liquidity which means that the large majority of our investment portfolio consists of highly rated fixed income securities, including U.S. Treasuries, highly-rated sovereign and supranational securities, high-grade corporate securities and mortgage-backed and asset-backed securities. At September 30, 2004, our invested asset portfolio of fixed maturities and short term investments had a dollar weighted average rating of AA, an average duration of 2.3 years and an average yield to maturity of 3.5%. As noted in our discussion of our cash flows above, our future cash flows from operations will be negatively impacted by losses we will be required to pay related to the recent third quarter hurricanes. Accordingly we will be appropriately adjusting the liquidity and duration of our investments to meet those claim payments (see – "Cash Flows" above).
The other investments consist mainly of investments in hedge funds, private equity funds, a fund that invests in senior secured bank loans, a high yield credit fund, a non-U.S. dollar convertible fund, an investment in a medium term note which represents an interest in a pool of European fixed income securities, catastrophe bonds and an investment in a joint venture focused on trading weather-sensitive commodities and securities. During the first nine months of 2004, the increase in such investments was primarily the result of additional investments spread amongst the investment classes listed above. At September 30, 2004, we have committed capital to private equity partnerships of $182.1 million, of which $54.7 million has been contributed at September 30, 2004.
The equity investments in reinsurance company relates to our November 1, 2002 purchase of 3,960,000 common shares of Platinum in a private placement transaction. In addition, we received a 10-year
35
warrant to purchase up to 2.5 million additional common shares of Platinum for $27.00 per share. We purchased the common shares and warrant for an aggregate price of $84.2 million. At September 30, 2004, we own 9.2% of Platinum's outstanding common shares. We have recorded our investments in Platinum at fair value, and at September 30, 2004 the aggregate fair value was $139.7 million, compared to $145.5 million at December 31, 2003. The aggregate unrealized gain of $55.5 million on the Platinum investments is included in accumulated other comprehensive income, of which $23.8 million represents our estimate of the value of the warrant. In the fourth quarter of 2004, a lockup on the underlying shares of the warrant will expire, at which time the warrant will meet the GAAP definition of a derivative and the Company will record the fair value of the warrant in current earnings in accordance with the provisions of SFAS 133, "Accounting for Derivative Instruments and Hedging Activities". This will result in an initial increase in earnings in an amount equal to the unrealized gain on the warrant at that time.
The investments in other ventures, under equity method primarily represents our investments in Channel Re, Top Layer Re and other unconsolidated ventures. The increase in this balance is primarily due to our $119.7 million funding of Channel Re in February 2004.
At September 30, 2004, $18.6 million of cash and cash equivalents were invested in currencies other than the U.S. dollar, which represented less than 1% of our total investments and cash.
A portion of our investment assets are directly held by our subsidiary RIHL, a Bermuda company organized for the primary purpose of holding investments in high quality marketable securities for RenaissanceRe, our operating subsidiaries and certain of our joint venture affiliates. We believe that RIHL permits us to consolidate and substantially facilitate our investment management operations. RenaissanceRe and each of our participating operating subsidiaries and affiliates have transferred marketable securities or other assets to RIHL, in return for subscriptions of RIHL equity interests. Each RIHL share is redeemable by the subscribing companies for cash or marketable securities. The subsidiaries and joint ventures which participate in RIHL both subscribe for additional shares and redeem outstanding shares, as our and their respective liquidity needs change. RIHL is currently rated AAAf/S2 by S&P.
NON-INDEMNITY INDEX TRANSACTIONS
We have assumed risk through derivative instruments under which losses could be triggered by an industry loss index or geological or physical variables. During the first nine months of 2004, we recorded income on non-indemnity index transactions of $nil, compared to a loss of $0.6 million for the same period in 2003. We report these gains or losses in other income.
EFFECTS OF INFLATION
The effects of inflation could cause the severity of claims to rise in the future. The Company's estimates for losses and loss expenses include assumptions about future payments for settlement of claims and claims handling expenses, such as litigation costs and the costs of medical treatments. To the extent inflation causes these costs to increase above reserves established for these claims, the Company will be required to increase the reserve for losses and loss expenses with a corresponding reduction in its earnings in the period in which the deficiency is identified. With respect to our catastrophe exposed businesses, the potential exists, after a catastrophe loss, for the development of inflationary pressures in a local or regional economy. The anticipated effects on us are considered in our catastrophe loss models. The effects of inflation are also considered in pricing and in estimating reserves for unpaid claims and claim expenses. The actual effects of this post-event inflation on our results cannot be accurately known until claims are ultimately settled. Inflation could also impair the value of our investment assets.
OFF-BALANCE SHEET AND SPECIAL PURPOSE ENTITY ARRANGEMENTS
As of September 30, 2004, we have not entered into any off-balance sheet arrangements, as defined by Item 303(a)(4) of Regulation S-K.
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CONTRACTUAL OBLIGATIONS
At September 30, 2004, the material changes to the Company's contractual obligations from December 31, 2003 were as follows.
| | | | | | | | | | | | | | | | | | | | | | |
| At September 30, 2004 | | Total | | Less than 1 year | | 1-3 years | | 3-5 years | | More than 5 years |
| (in thousands) | |
| Long-term debt obligations (1) | |
| DaVinciRe revolving credit facility (2) | | | 105,564 | | | | 2,100 | | | | 103,464 | | | | — | | | | — | |
| Private equity commitments | | | 127,400 | | | | 127,400 | | | | — | | | | — | | | | — | |
| Operating lease obligations | | | 54,193 | | | | 3,794 | | | | 7,947 | | | | 8,287 | | | | 34,165 | |
| Obligations under derivative contracts | | | 27,589 | | | | 9,263 | | | | 10,057 | | | | 8,269 | | | | — | |
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| (1) | Includes contractual interest and dividend payments. |
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| (2) | The interest on this facility is based on a spread above LIBOR. We have reflected the interest due in based upon the current interest rate on the facility. |
In certain circumstances many of our contractual obligations may be accelerated to dates other than those reflected in the table, due to defaults under the agreement governing those obligations (including pursuant to cross-default provisions in such agreement) or in connection with certain changes in control of the Company, if applicable. In addition, in connection with any such default under the agreement governing these obligations, in certain circumstances these obligations may be increased by interest or penalties as a result of such a default.
CURRENT OUTLOOK
We believe that the principal components of our operations continue to display strong fundamentals and we currently anticipate the following developments in our business:
Reinsurance segment
Prior to the occurrence of the recent hurricane activity we believed prices in the property markets would continue to decline. However, with the occurrence of the recent hurricane losses, we do see some signs of price improvement and although it is still early in the important January renewal process, we currently estimate that our 2005 cat premiums will remain relatively consistent with those of 2004.
In the specialty reinsurance market, prices in many but not all of the products we offer are showing signs of softening. However, conditions vary significantly by product type and certain products are attractive to us while others are not. We currently expect that our 2005 specialty premium will be roughly flat compared to 2004.
Individual Risk segment
We currently are expecting our Individual Risk premiums for 2004 to increase by 10% to 15% for the full year compared to the full year 2003. This is a reduction from our previous estimate that our 2004 Individual Risk premium would increase by approximately 30% for the 2004 year. The decrease is primarily due to the delay in bringing new programs and program managers on line in 2004. Our current expectation is that two of these programs will now incept in 2005 and accordingly we are expecting our 2005 Individual Risk premiums to increase by over 40% from our 2004 levels. We believe that our infrastructure, our strong credit ratings and our financial strength will enable us to continue to attract additional program managers who control attractive books of business and who, among other things, are currently concerned with the credit ratings of their current insurance carriers.
Because of our desire to be selective in which programs we choose to accept and our focus on programs with large premium volumes, it is probable that our quarterly written premiums in our Individual Risk segment will reflect the timing of entering into or exiting these agreements and therefore we expect to experience fluctuations in the comparison of our premiums written from quarter to quarter.
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New Business
We believe that our position in the reinsurance and insurance markets we target is increasingly strong as a result of our reputation for service, prompt claims payments, proprietary analytic tools and financial strength. Additionally, the general long term credit quality of many insurance and reinsurance companies, and the related credit ratings of those companies, are becoming an increasing concern of many insurance and reinsurance customers. We believe that these factors will continue to offer opportunities to companies such as ours with strong credit ratings, a seasoned management team, and a history of successful performance.
The current market environment is also providing us with selective opportunities for our joint venture and structured product initiatives. In evaluating these initiatives, we may consider opportunities in other areas of the insurance and reinsurance markets, or in other financial markets, either through organic growth, the formation of new joint ventures, or the acquisition of other companies or books of business of other companies. We are currently in the process of reviewing certain opportunities and periodically engage in discussions regarding possible transactions, although there can be no assurance that we will complete any such transactions or that any such transaction would contribute materially to our results of operations or financial condition. It is also possible that new ventures we pursue will have different return characteristics than our traditional businesses, including greater volatility.
Industry Developments
The New York Attorney General and other governmental and regulatory bodies are investigating allegations relating to a wide range of practices in the insurance and reinsurance industry, including contingent commissions payments and allegations of price fixing, market allocation, or bid rigging. As of the date hereof, we have not been contacted by any of these parties, although we have received a demand to produce information from the North Carolina Department of Insurance as part of an industry-wide review. The Company intends to cooperate with this request and others it may receive from governmental bodies.
We have undertaken to review our practices in light of the matters being reviewed by the New York Attorney General and other governmental authorities. To assist with our review, we have engaged the law firm Boies, Schiller & Flexner LLP. This review is ongoing. In the past, certain subsidiaries of the Company have entered into some placement service and market service agreements with insurance brokers. We are actively monitoring these ongoing, industry-wide investigations. It is possible that these investigations or related regulatory developments will mandate changes in industry practices in a fashion which increases our costs or requires us to alter aspects of the way we do business.
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Safe Harbor Disclosure
In connection with, and because it desires to take advantage of, the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company cautions readers regarding certain forward-looking statements contained in this report.
This Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Forward-looking statements are necessarily based on estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which, with respect to future business decisions, are subject to change. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, us.
In particular, statements using words such as "may", "should", "estimate", "expect", "anticipate", "intends", "believe", "predict" or words of similar import generally involve forward-looking statements. In light of the risks and uncertainties inherent in all future projections, the inclusion of forward-looking statements in this report should not be considered as a representation by the Company or any other person that its objectives or plans will be achieved. Numerous factors could cause the Company's actual results to differ materially from those addressed by the forward-looking statements, including the following:
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| 1. | the occurrence of natural or man-made catastrophic events with a frequency or severity exceeding our estimates, and the risk that the size of claims relating to the 2004 hurricane losses described herein may change due to the preliminary nature of some of the reports and estimates of loss and damage to date; |
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| 2. | risks associated with implementing our business strategies and initiatives for organic growth, including risks relating to managing that growth; |
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| 3. | risks associated with the growth of our specialty reinsurance and Individual Risk businesses, particularly the development of our infrastructure to support this growth; |
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| 4. | risks relating to our strategy of relying on program managers, third party administrators, and other vendors to support our Individual Risk operations; |
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| 5. | other risks of doing business with program managers, including the risk we might be bound to policyholder obligations beyond our underwriting intent, and the risk that our program managers or agents may elect not to continue or renew their programs with us; |
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| 6. | possible challenges in maintaining our fee-based operations, including risks associated with retaining our existing partners and attracting potential new partners; |
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| 7. | the risk that ongoing investigative regulatory developments will disrupt our business, or that of our business partners, or mandate changes in industry practices in a fashion which increases our costs or requires us to alter aspects of the way we do business; |
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| 8. | acts of terrorism, war or political unrest; |
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| 9. | the inherent uncertainties in our reserving process, which we believe are increasing as we diversify into new product classes; |
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| 10. | emerging claim and coverage issues, which could expand our obligations beyond the amount we intend to underwrite; |
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| 11. | a decrease in the level of demand for our reinsurance or insurance business, or increased competition in the industry; |
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| 12. | greater frequency or severity of claims and loss activity, including as a result of natural or man-made catastrophic events, than our underwriting, reserving or investment practices anticipate based on historical experience or industry data; |
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| 13. | changes in economic conditions, including interest rate, currency, equity and credit conditions which could affect our investment portfolio; |
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| 14. | extraordinary events affecting our clients or brokers, such as bankruptcies and liquidations, and the risk that we may not retain or replace our large clients; |
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| 15. | a contention by the U.S. Internal Revenue Service that our Bermuda subsidiaries, including Renaissance Reinsurance and Glencoe, are subject to U.S. taxation; |
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| 16. | the lowering or loss of any of the financial or claims-paying ratings of RenaissanceRe or of one or more of our subsidiaries or changes in the policies or practices of the rating agencies; |
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| 17. | loss of services of any one of our key executive officers; |
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| 18. | risks relating to the collectibility of our reinsurance, including both our Reinsurance and Individual Risk operations, as well as risks relating to the availability of coverage from creditworthy providers; |
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| 19. | failures of our reinsurers, brokers or program managers to honor their obligations, including their obligations to make third party payments for which we might be liable, a risk which may have increased as regards brokers in light of recent developments; |
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| 20. | changes in the distribution or placement of risks due to increased consolidation of insurance and reinsurance brokers, or program managers, or from potential changes in their business practices which may be required by future regulatory changes; |
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| 21. | changes in insurance regulations in the U.S. or other jurisdictions in which we operate, including potential challenges to Renaissance Reinsurance's claim of exemption from insurance regulation under current laws, and the risk of increased global regulation of the insurance and reinsurance industry; |
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| 22. | the passage of federal or state legislation subjecting Renaissance Reinsurance to supervision or regulation, including additional tax regulation, in the U.S. or other jurisdictions in which we operate; and |
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| 23. | actions of competitors, including industry consolidation, the launch of new entrants and the development of competing financial products. |
The factors listed above should not be construed as exhaustive. Certain of these factors are described in more detail from time to time in our filings with the Securities and Exchange Commission. We undertake no obligation to release publicly the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are principally exposed to four types of market risk: interest rate risk, equity price risk, foreign currency risk and credit risk. The Company's investment guidelines permit, subject to specific approval, investments in derivative instruments such as futures, options and foreign currency forward contracts for purposes other than trading.
Interest Rate Risk
Our investment portfolio includes fixed maturity investments available for sale and short-term investments, whose market values will fluctuate with changes in interest rates. We attempt to maintain adequate liquidity in our fixed maturities investment portfolio to fund operations, pay reinsurance and insurance liabilities and claims and provide funding for unexpected events. We seek to manage our credit risk through means including industry and issuer diversification, and interest rate risk by monitoring the duration and structure of our investment portfolio.
The aggregate hypothetical loss generated from an immediate adverse parallel shift in the treasury yield curve of 100 basis points would cause a decrease in total return of 2.3%, which equated to a decrease in market value of approximately $99.9 million on a portfolio valued at $4,342.5 million at September 30, 2004. At December 31, 2003, the decrease in total return would have been 2.0%, which equated to a decrease in market value of approximately $79.6 million on a portfolio valued at $3,977.6 million. The foregoing reflects the use of an immediate time horizon, since this presents the worst-case scenario. Credit spreads are assumed to remain constant in these hypothetical examples.
Equity Price Risk
We are exposed to equity price risk due to our investment in the common shares and warrant to purchase additional common shares of Platinum (see "Management's Discussion and Analysis of Financial Condition and Results of Operations – Investments"), which we carry on our balance sheet at fair value. The risk is the potential for loss in fair value resulting from the adverse changes in Platinum's common stock. The aggregate fair value of this investment in Platinum was $139.7 million as at September 30, 2004 compared to $145.5 million as at December 31, 2003. A hypothetical 10% decline in the price of Platinum stock, holding all other factors constant, would have resulted in a $17.2 million decline in fair value, which would be recorded in net unrealized gains (losses) on securities and included in other comprehensive income in shareholders' equity. We also have indirect exposure to the equity markets through certain investments in private equity funds and hedge funds, which investments totaled $273.8 million at September 30, 2004.
Foreign Currency Risk
Our functional currency is the U.S. dollar. We write a substantial portion of our business in currencies other than U.S. dollars and may, from time to time, experience exchange gains and losses and incur underwriting losses in currencies other than U.S. dollars, which will in turn affect our consolidated financial statements.
Our foreign currency policy with regard to our underwriting operations is generally to hold foreign currency assets, including cash, investments and receivables that approximate the foreign currency liabilities, including claims and claim expense reserves and reinsurance balances payable. When necessary, the Company will use foreign currency forward and option contracts to minimize the effect of fluctuating foreign currencies on the value of non-U.S. dollar denominated assets and liabilities associated with our underwriting operations. As of September 30, 2004, the Company had notional exposure of $55.0 million related to foreign currency forward and option contracts purchased to minimize the effect of fluctuating foreign currencies on assets and liabilities associated with our underwriting operations.
For our investment operations, we are exposed to currency fluctuations through our investments in non-U.S. Dollar bonds and Euro denominated fixed income funds. As of September 30, 2004, our combined investment in these bonds and funds was $174.6 million. To hedge our exposure to currency
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fluctuations from these funds, we have entered into foreign currency forward and option contracts with notional exposure of $166.0 million. In the future, we may choose to increase our exposure to non-dollar investments.
Our foreign currency and option contracts are recorded at fair value, which is determined principally by obtaining quotes from independent dealers and counter parties. The fair value of these contracts as of September 30, 2004 was a loss of $4.2 million. All changes in exchange rates are recognized currently in our statements of income.
Credit Risk
Our exposure to credit risk is primarily due to our fixed maturity investments available for sale and short term investments, and to a lesser extent, reinsurance premiums receivable and ceded reinsurance balances. At September 30, 2004, our invested asset portfolio had a dollar weighted average rating of AA. From time to time we purchase credit default swaps to hedge our exposures in the insurance industry, to assist in managing the credit risk associated with our ceded reinsurance program and to hedge other credit sensitive positions. At September 30, 2004, the maximum payments we were obligated to make under these credit default swaps was $23.4 million. We account for these credit derivatives at fair value and record them on our consolidated balance sheet as other assets or other liabilities depending on the rights or obligations. The fair value of these credit derivatives, as recognized in other liabilities in our balance sheet, at September 30, 2004 and 2003 was a liability of $8.7 million and $1.4 million, respectively. During the first nine months of 2004 and 2003, we recorded losses of $6.9 million and $1.9 million, respectively, in our consolidated statement of income, which include cash payments and fair value adjustments. The net fair value of these instruments is $8.7 million and $1.4 million and is reflected as a liability on the balance sheets at September 30, 2004 and 2003, respectively. The fair value of the credit derivatives are determined using industry valuation models. The fair value of these credit derivatives can change based on a variety of factors including changes in credit spreads, default rates and recovery rates, the correlation of credit risk between the referenced credit and the counterparty, and market rate inputs such as interest rates. Our $121.3 investment in the Channel Re financial guaranty business is also subject to potential variability due to changes in credit market conditions.
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Item 4. CONTROLS AND PROCEDURES
Disclosure Controls and Internal Controls: We have designed various disclosure controls and procedures (as defined in Rules 13a-15(e) and Rule 15d-15(e) under the Exchange Act), to help ensure that information required to be disclosed in our periodic Exchange Act reports, such as this quarterly report, is recorded, processed, summarized and reported on a timely and accurate basis. Our disclosure controls are also designed with the objective of ensuring that such information is accumulated and communicated to our senior management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the issuer; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the issuer are being made only in accordance with authorizations of management and directors of the issuer; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the issuer's assets that could have a material effect on financial statements.
Limitations on the effectiveness of controls: Our Board of Directors and management, including our Chief Executive Officer and Chief Financial Officer, do not expect that our disclosure controls or internal controls will prevent all error 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, we believe that the design of any prudent control system must reflect appropriate resource constraints, such that the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, there can be no absolute assurance that all control issues and instances of fraud, if any, applicable to us have been or will be detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple errors or mistakes. Additionally, controls can be circumvented by the individual acts of some individuals, by collusion of more than one person, or by management override of the control. 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, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Evaluation: An evaluation was performed under the supervision and with the participation of the Company's management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures as required by Rule 13a-15(b) and 15d-15(b) of the Exchange Act. Based upon that evaluation, the Company's management, including our Chief Executive Officer and Chief Financial Officer, concluded, subject to the limitations noted above, that at September 30, 2004, the Company's disclosure controls and procedures are effective in ensuring that all material information required to be filed in this Report has been made known to them in a timely fashion. There has been no change in the Company's internal controls over financial reporting during the nine months ended September 30, 2004 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
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Part II — OTHER INFORMATION
Item 1 — Legal Proceedings
We are, from time to time, a party to litigation and arbitration that arises in the normal course of our business operations. We are also subject to other potential litigation, disputes, and regulatory or governmental inquiry. While any proceeding contains an element of uncertainty, we believe that we are not presently a party to any such litigation or arbitration that is likely to have a material adverse effect on our business or operations.
Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds
Below is a summary of stock repurchases for the quarter ended September 30, 2004. RenaissanceRe's Board has authorized a share repurchase program of $150 million. No shares were repurchased under this program in the quarter ended September 30, 2004. See Note 5 of our Notes to Condensed Consolidated Financial Statements for information regarding RenaissanceRe's stock repurchase plan.
| | | | | | | | | | | | | | | | | | |
| | | Total
number of
shares
purchased | | Average
price paid
per share | | Total number of
shares purchased as
part of publicly
announced plans or
programs | | Maximum dollar
value of shares
that may yet be purchased
under the publicly announced
plans or programs (1) |
| | | (in thousands) | | | | (in thousands) | | (in millions) |
| Beginning shares available to be repurchased | | | - | | | | - | | | | - | | | $ | 150.0 | |
| July 1 - 31, 2004 (2) | | | 19 | | | $ | 53.50 | | | | 0 | | | | 150.0 | |
| August 1 - 31, 2004 | | | 0 | | | | - | | | | 0 | | | | 150.0 | |
| September 1 - 30, 2004 | | | 0 | | | | - | | | | 0 | | | | 150.0 | |
| Total | | | 19 | | | $ | 53.50 | | | | 0 | | | $ | 150.0 | |
|
| |
| (1) | The Company publicly announced its share repurchase program of $150 million on August 7, 2003. No expiration date has been established for this program. |
| |
| (2) | These repurchases exclusively represent withholdings from employees surrendered in respect of withholding tax obligations on the vesting of restricted stock, or in lieu of cash payments for the exercise price of employee stock options. |
Item 3 — Defaults Upon Senior Securities
None
Item 4 — Submission of Matters to a Vote of Security Holders
| |
| (a) | A Special General Meeting of our shareholders was held on August 31, 2004. |
| |
| (b) | Proxies were solicited by our management pursuant to Regulation 14A under the Exchange Act; there was no solicitation of opposition to our proposal. |
| |
| (c) | At the Special General Meeting, our shareholders approved the RenaissanceRe Holdings Ltd. 2004 Stock Option Incentive Plan, by the following vote: |
| | | | | | | | | | | | | | |
| | | Votes For | | Votes Against | | Abstained |
| TOTAL | | 46,627,639 | | 2,628,339 | | 74,191 |
| Percentage | | 94.5% | | 5.3% | | 0.2% |
|
Item 5 — Other Information
None
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Item 6 — Exhibits
a. Exhibits:
| | | | | | |
| 10.1 | | RenaissanceRe Holdings Ltd. 2004 Stock Option Incentive Plan (the "Plan") (incorporated by reference to RenaissanceRe Holdings Ltd.'s Current Report on Form 8-K, filed with the Commission on September 2, 2004). |
| 10.2 | | Option Agreement pursuant to which option grants are made under the Plan to James N. Stanard (incorporated by reference to RenaissanceRe Holdings Ltd.'s Current Report on Form 8-K, filed with the Commission on September 2, 2004). |
| 10.3 | | Form of Option Agreement pursuant to which option grants are made under the Plan to executive officers (excluding grants to Mr. Stanard). (incorporated by reference to RenaissanceRe Holdings Ltd.'s Current Report on Form 8-K, filed with the Commission on September 2, 2004). |
| 10.4 | | Second Amended and Restated Credit Agreement, dated as of August 6, 2004, among RenaissanceRe Holdings Ltd., the Lenders named therein, Deutsche Bank AG New York Branch, as LC Issuer and Co-Documentation Agent, HSBC Bank US, National Association, as Co-Documentation Agent, Citibank, N.A. and Wachovia Bank, National Association, as Co-Syndication Agents, Bank of America, N.A., as Administrative Agent and Banc of America Securities LLC, as Sole Lead Arranger and Sole Book Manager. |
| 10.5 | | Form of Option Grant Notice and Agreement pursuant to which option grants are made under the RenaissanceRe Holdings Ltd. 2001 Stock Incentive Plan. |
| 10.6 | | Form of Restricted Stock Grant Notice and Agreement pursuant to which Restricted Stock grants are made under the RenaissanceRe Holdings Ltd. 2001 Stock Incentive Plan. |
| 31.1 | | Certification of James N. Stanard, Chief Executive Officer of RenaissanceRe Holdings Ltd., pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended. |
| 31.2 | | Certification of John M. Lummis, Chief Financial Officer of RenaissanceRe Holdings Ltd., pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended. |
| 32.1 | | Certification of James N. Stanard, Chief Executive Officer of RenaissanceRe Holdings Ltd., pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002. |
| 32.2 | | Certification of John M. Lummis, Chief Financial Officer of RenaissanceRe Holdings Ltd., pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002. |
|
45
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed by the undersigned thereunto duly authorized.
| RenaissanceRe Holdings Ltd. |
| | |
| By: | /s/ John M. Lummis
John M. Lummis
Executive Vice President and
Chief Financial Officer |
Date: November 9, 2004
46
