At June 30, 2005 our estimated IBNR reserves were $827.6 million. A 5% change in such IBNR reserves would equate to a $41.4 million adjustment to claims and claim expenses incurred, which would represent 1.5% of shareholders' equity at June 30, 2005.
As discussed in "Summary of Critical Accounting Policies and Estimates" above, the most significant accounting judgment made by management is the estimation of the claims and claim expense reserves. Because of the significant variability and uncertainty associated with loss estimation, it is possible that our 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 the event causing the loss, the location of the loss, and whether our losses are from policies with insurers or reinsurers.
During 2003 and 2004 we increased our specialty reinsurance and Individual Risk gross written premiums. The growth 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, additional case reserves, and our estimates for IBNR reserves are based on 1) claims reports from insureds, brokers and program managers; 2) our underwriters' experience in setting claims reserves; 3) the use of computer models where applicable; and 4) historical industry claims experience. For some classes of business we also use statistical and actuarial methods to estimate ultimate expected claims and claim expenses. We review our claims reserves on a regular basis. See "Summary of Critical Accounting Policies and Estimates."
Our total capital resources as of June 30, 2005 and December 31, 2004 were as follows:
During the first six months of 2005, our capital resources increased primarily as a result of our net income attributable to common shareholders of $216.3 million, offset by dividend payments to our common shareholders of $28.5 million and a reduction in accumulated other comprehensive income of $17.6 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 intention 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 June 30, 2005.
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 six months of 2005 and the year ended December 31, 2004, RenaissanceRe did not purchase any of the Capital Securities. RenaissanceRe has 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 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 June 30, 2005. The Capital Securities mature on March 1, 2027.
During May 2005, DaVinciRe amended and restated its credit agreement to extend the termination date of the revolving credit facility established thereunder from May 25, 2007 to May 25, 2010. All other material terms of and conditions in the credit agreement remained the same. The credit agreement provides for a $100 million committed revolving credit facility, the full amount of which was drawn in 2002 and remains outstanding. 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 3.8% during the first six months of 2005 (2004 – 2.3%). 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 June 30, 2005, DaVinciRe was in compliance with the covenants of this agreement. The term of the credit facility may be further extended and the size of the facility may be increased to $125 million if certain conditions are met.
Under the terms of certain reinsurance contracts, our insurance and reinsurance subsidiaries and joint ventures 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 syndicated secured facility which accepts as collateral shares issued by our subsidiary Renaissance Investment Holdings Ltd. ("RIHL"). 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
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shares that have a net asset value at least equal to 15% of its facility usage, and RIHL shares having an aggregate net asset value equal to at least 15% of the net asset value of all outstanding RIHL shares must remain unencumbered. 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. As of April 29, 2005, the facility was amended to provide for an aggregate commitment of the lenders of $900 million and to extend the term until April 28, 2006. Subject to certain conditions, the size of the facility may be increased to $1.3 billion. At June 30, 2005, we had outstanding letters of credit under the facility aggregating $667.4 million and under all letters of credit facilities of $752.6 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 June 30, 2005. 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.
Credit Ratings
In July, following our announcement that our Chairman and CEO received a Wells Notice from the staff of the Securities and Exchange Commission (the "SEC"), as discussed herein under "Part II – Other Information – Item 1", (i) Standard & Poor's Ratings Services placed on CreditWatch with negative implications the counterparty credit, senior debt, and preferred stock ratings on the Company, the counterparty credit and financial strength ratings on Renaissance Reinsurance, and the counterparty credit and financial strength ratings on DaVinci; (ii) Moody's Investors Service Inc. placed under review for possible downgrade the senior debt, subordinated debt, and preferred stock ratings of the Company, the insurance financial strength rating of Renaissance Reinsurance, the capital securities rating of RenaissanceRe Capital Trust, and the capital securities rating of RenaissanceRe Capital Trust II; (iii) Fitch Ratings Ltd. placed on Rating Watch Negative the senior notes and preferred stock ratings of the Company, the insurer financial strength rating of Renaissance Reinsurance, and the capital securities rating of RenaissanceRe Capital Trust; and (iv) A.M. Best Company, Inc. announced that the various financial strength, issuer credit and debt ratings of the Company and its affiliates remain unchanged with a stable outlook.
SHAREHOLDERS' EQUITY
During the first three months of 2005, our consolidated shareholders' equity, including preference shares, increased by $179.0 million to $2,823.0 million as of June 30, 2005, from $2,644.0 million as of December 31, 2004. The change in shareholders' equity was due to our net income available to common shareholders of $216.3 million, offset by dividend payments to our common shareholders of $28.5 million and a reduction in accumulated other comprehensive income of $17.6 million.
INVESTMENTS
At June 30, 2005, we held investments totaling $5.1 billion, compared to $4.8 billion at December 31, 2004.
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The table below shows the aggregate amounts of our invested assets:
| | | | | | | | | | |
| (in thousands of U.S. dollars) | | At June 30,
2005 | | At December 31,
2004 |
| Fixed maturity investments available for sale, at fair value | | $ | 3,218,715 | | | $ | 3,223,292 | |
| Short term investments, at cost | | | 687,356 | | | | 608,292 | |
| Other investments, at fair value | | | 838,199 | | | | 684,590 | |
| Total managed investments portfolio | | | 4,744,270 | | | | 4,516,174 | |
| Equity investment in reinsurance company, at fair value | | | 153,508 | | | | 150,519 | |
| Investments in other ventures, under equity method | | | 165,371 | | | | 159,556 | |
| Total investments | | $ | 5,063,149 | | | $ | 4,826,249 | |
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Our total investments for the six months ended June 30, 2005 increased by $236.9 million from December 31, 2004 primarily from investing a portion of our net cash provided by operating activities in our investment portfolio, offset by a reduction in unrealized gains on our fixed maturity investments available for sale.
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 June 30, 2005, our invested asset portfolio of fixed maturities and short term investments had a dollar weighted average rating of AA (December 31, 2004 – AA), an average duration of 2.2 years (December 31, 2004 – 2.2 years) and an average yield to maturity of 4.0% (December 31, 2004 – 3.3%).
Other Investments
The table below shows our portfolio of other investments as at June 30, 2005 and December 31, 2004:
| | | | | | | | | | |
| (in thousands of U.S. dollars) | | At June 30,
2005 | | At December 31,
2004 |
| Type of investment | |
| Hedge funds | | $ | 316,585 | | | $ | 293,462 | |
| Senior secured bank loan fund | | | 139,209 | | | | 116,560 | |
| Private equity partnerships | | | 113,237 | | | | 82,381 | |
| Fixed income global opportunities fund | | | 101,044 | | | | — | |
| European high yield credit fund | | | 87,720 | | | | 87,689 | |
| Medium term note representing an interest in a pool of European fixed income securities | | | 50,000 | | | | 50,000 | |
| Non-US convertible fund | | | 25,885 | | | | 28,214 | |
| Miscellaneous other investments | | | 4,519 | | | | 26,284 | |
| Total investments | | $ | 838,199 | | | $ | 684,590 | |
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Interest income, income distributions and realized and unrealized gains and losses on other investments are included in net investment income and totaled $25.7 million and $13.6 million for the first six months of 2005 and 2004, respectively, of which $9.4 million for the first six months of 2005 and $3.9 million for the first six months of 2004 was related to net unrealized gains.
We have $211.7 million of unfunded committed capital to private equity partnerships at June 30, 2005.
Equity Investment in Reinsurance Company
The equity investment 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 ten-year
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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 June 30, 2005, we owned (exclusive of the warrant) 9.2% of Platinum's outstanding common shares. We have recorded our investment in Platinum at fair value, and at June 30, 2005 the aggregate fair value was $153.5 million, compared to $150.5 million at December 31, 2004. The fair value of the common shares is based on the market price of Platinum's shares as of the balance sheet date. The fair value of the warrant is estimated by the Company using the Black-Scholes option pricing model. The aggregate unrealized gain on the Platinum common shares of $41.8 million (December 31, 2004 – $38.9 million) is included in accumulated other comprehensive income. During the fourth quarter of 2004, a lockup provision on the warrant expired and as a result the warrant met the definition of a derivative under FAS 133 and therefore changes in the fair value of the warrant were recorded prospectively in other income from November, 2004. For the six months ended June 30, 2005, a $0.1 million gain was recorded in other income representing an increase in the fair value of the warrant.
Investments in Other Ventures
The investments in other ventures, under equity method primarily include our investments in Channel Re, Top Layer Re and other ventures. The increase in this balance is primarily due to a $10.0 million investment we made during the first quarter of 2005 in Tower Hill, as well as the undistributed earnings in these ventures earned during the first six months of 2005. As with Channel Re, our equity pick-up from Tower Hill is recorded one quarter in arrears and accordingly our initial pick-up from this investment was recorded in the second quarter of 2005.
RIHL
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.
Other
At June 30, 2005, $296.2 million of cash and cash equivalents and investments were invested in currencies other than the U.S. dollar, which represented 5.6% of our total cash and cash equivalents and investments.
EFFECTS OF INFLATION
The potential exists, after a catastrophe loss, for the development of inflationary pressures in a local 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.
OFF-BALANCE SHEET AND SPECIAL PURPOSE ENTITY ARRANGEMENTS
As of June 30, 2005, 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 June 30, 2005 | |
| (in thousands of U.S. dollars) | | Total | | Less than 1 year | | 1-3 years | | 3-5 years | | More than 5 years |
| | |
| Long-term debt obligations (1) | |
| 7.0% Senior Notes | | $ | 181,960 | | | $ | 10,500 | | | $ | 21,000 | | | $ | 150,460 | | | $ | — | |
| 5.875% Senior Notes | | | 138,952 | | | | 5,875 | | | | 11,750 | | | | 5,875 | | | | 115,452 | |
| Capital Securities | | | 285,026 | | | | 8,540 | | | | 17,080 | | | | 17,080 | | | | 242,326 | |
| DaVinciRe revolving credit facility (2) | | | 107,677 | | | | 4,038 | | | | 103,639 | | | | — | | | | — | |
| Private equity commitments | | | 211,646 | | | | 211,646 | | | | — | | | | — | | | | — | |
| Operating lease obligations | | | 52,701 | | | | 3,940 | | | | 7,902 | | | | 7,562 | | | | 33,297 | |
| Obligations under derivative contracts | | | 4,168 | | | | 1,285 | | | | 2,545 | | | | 338 | | | | — | |
| Reserve for claims and claim expenses (3) | | | 1,474,235 | | | | 481,273 | | | | 469,542 | | | | 177,399 | | | | 346,021 | |
| Total contractual obligations | | $ | 2,456,365 | | | $ | 727,097 | | | $ | 633,458 | | | $ | 358,714 | | | $ | 737,096 | |
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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 2005 and 2006 based upon the current interest rate on the facility. |
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| (3) | We caution the reader that the information provided above related to estimated future payment dates of our reserves for claims and claim expenses is not prepared or utilized for internal purposes and that we currently do not estimate the future payment dates of claims and claim expenses. Because of the nature of the coverages that we provide, the amount and timing of the cash flows associated with our policy liabilities will fluctuate, perhaps significantly, and therefore are highly uncertain. In order to estimate the payment dates of our contractual obligations for our reserve for claims and claim expense, we have used the work of an actuarial firm. |
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| This firm has based its estimate of future claim payments upon benchmark payment patterns constructed internally, drawing upon available relevant sources of loss and allocated loss adjustment expense development data. These benchmarks are revised periodically as new trends emerge. We believe that it is likely that this benchmark data will not be predictive of our future claim payments and that material fluctuations can occur due to the nature of the losses which we insure and the coverages which we provide. |
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 bear an increased interest rate or be subject to penalties as a result of such a default.
CURRENT OUTLOOK
We currently anticipate the following developments in our business:
Reinsurance segment
Since 2001, there has been an increase in the number of traditional reinsurance companies dedicating capital to the property catastrophe reinsurance market. This increase, combined with the entrance of non-traditional market participants, has resulted in an excess of supply over demand in certain sectors of the market and, correspondingly, has caused deterioration in pricing and in terms and conditions. Therefore, during the first half of 2005 a growing number of transactions did not meet our hurdle rates and accordingly our property catastrophe reinsurance premiums declined in the first six months of 2005 as compared to the first six months of 2004. We also note that during 2004, we recorded $30.1 million of reinstatement premiums and $27.4 million of premiums on back-up covers related to the third quarter Florida hurricanes. If there is an absence of similar catastrophic events during 2005, we anticipate that such premiums will not recur and, therefore, the decline in property catastrophe reinsurance premiums in 2005 will be more pronounced.
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During the first half of 2005, we also noted increased competition in the specialty reinsurance market, and accordingly we experienced a decrease in our premiums from specialty reinsurance for the first six months of 2005. Our premiums from this line of business are attributable to a relatively small number of large deals and the amount of the premiums can fluctuate significantly between quarters and between years depending upon the number of, and nature of, the transactions that we complete. We now expect that premiums from our specialty unit will likely be flat to modestly down for 2005 when compared to 2004.
Individual Risk segment
Various classes of Individual Risk business, in particular commercial property, have begun to experience deterioration in pricing and in terms and conditions due to increased competition. However, we have added several new program managers during the first half of 2005 and, accordingly, we expect our premiums from our Individual Risk segment to grow significantly in 2005 when compared to 2004.
New Business
We believe that the current market environment may create more opportunities for the creation of joint ventures and strategic investments. We have established Ventures to facilitate strategic investments. 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.
Reserve Review
With the growth in our reserves for claims and claim expenses, we announced on May 3, 2005 that we would review the processes and assumptions for establishing and evaluating our reserves. We completed a review of our catastrophe reinsurance reserves in the second quarter of 2005 and we expect to review our specialty and Individual Risk reserves during the remainder of 2005. As a result of the review of our catastrophe reinsurance reserves, which is now complete, we reduced prior year net catastrophe reserves within our Reinsurance segment by $118.2 million. After adjusting for the impact of minority interest, our second quarter 2005 net income benefited by $108.2 million as a result of this review. The reserve changes reflect a reassessment of our reserves for claims and claim expenses in light of historical paid loss trends and reported loss activity in our catastrophe portfolio for the 1994 to 2004 accident years.
As noted in "Summary of Critical Accounting Policies and Estimates – Claims and Claim Expenses", because of the numerous factors which can affect reserves for claims and claim expenses, but which can not be determined with certainty in advance, we have a reserving philosophy which attempts to incorporate prudent assumptions and estimates. In recent years, we have experienced favorable reserve development on prior years' reserves. In comparison to our property catastrophe portfolio of reinsurance coverage which we have been writing for over ten years, we do not have the benefit of a significant amount of our own historical experience in our specialty and Individual Risk lines. Accordingly, the review of our specialty and Individual Risk reserves may result in a change to those reserves; however, because of the uncertainties related to the outcome of this review, it is not possible for us to reasonably estimate the amount of any potential change to these reserves, including whether or not the review will result in an increase or a decrease to these reserves.
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Other
We estimate that Hurricane Dennis will have a net negative impact of approximately $40 million on our third quarter results. We are currently evaluating the impact of Hurricane Emily, although we currently do not believe it will have a material impact on our third quarter results.
Government Investigations
The SEC, the New York Attorney General, certain state insurance regulatory authorities and others are investigating various practices within the insurance industry, including contingent commission payments to brokers, alleged "bid-rigging," and "steering", as well as the use of non-traditional, or loss mitigation, (re)insurance products. Government authorities are also currently investigating our restatement of the Company's financial statements. See "Part II — Other Information — Item 1." We cannot predict the effect that these investigations, and any changes in industry practice, including future legislation or regulations that may become applicable to us, will have on the insurance industry, the regulatory framework or our business.
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," "potential," or words of similar import generally involve forward-looking statements. For example, we have included certain forward-looking statements in "Management's Discussion and Analysis of Financial Condition and Results of Operations" with regard to trends in results, prices, volumes, operations, investment results, margins, combined ratios, reserves, overall market trends, risk management and exchange rates. This Form 10-Q also contains forward-looking statements with respect to our business and industry, such as those relating to our strategy and management objectives, trends in market conditions, prices, market standing and product volumes, investment results and pricing conditions in the reinsurance and insurance industries.
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 us or any other person that our objectives or plans will be achieved. Numerous factors could cause our 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 net claims relating to the 2004 Florida hurricane losses, the 2005 European windstorm and the 2005 Hurricanes Dennis and Emily described herein may change due to the developing 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. | risks relating to the government investigation related to our restatement of the Company's financial statements, as well as the industry-wide investigations into non-traditional, or loss mitigation, (re)insurance, and other industry practices, all of the possible consequences of which we are unable to foresee; |
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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. | 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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| 12. | a decrease in the level of demand for our reinsurance or insurance business, or increased competition in the industry; |
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| 13. | 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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| 14. | changes in economic conditions, including interest rate, currency, equity and credit conditions which could affect our investment portfolio; |
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| 15. | 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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| 16. | a contention by the U.S. Internal Revenue Service that our Bermuda subsidiaries, including Renaissance Reinsurance, Glencoe and RIHL, are subject to U.S. taxation; |
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| 17. | the lowering or loss of any of the 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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| 18. | loss of services of any one of our key executive officers; |
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| 19. | 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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| 20. | 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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| 21. | 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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| 22. | 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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| 23. | 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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| 24. | 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 SEC. 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.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are principally exposed to four types of market risk: interest rate risk; foreign currency risk; equity price risk; and credit risk. The Company's investment guidelines permit, subject to approval, investments in derivative instruments such as futures, options, foreign currency forward contracts and swap agreements, which may be used to assume risks or for hedging purposes.
Interest Rate Risk
Our investment portfolio includes fixed maturity investments available for sale and short-term investments, whose fair values will fluctuate with changes in interest rates. We attempt to maintain adequate liquidity in our fixed maturity investments portfolio to fund operations, pay reinsurance and insurance liabilities and claims and provide funding for unexpected events. We seek to manage our 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 fair value of 2.2%, which equated to a decrease in fair value of approximately $85.9 million on a portfolio valued at $3,906.1 million at June 30, 2005. At December 31, 2004, the decrease in fair value would have been 2.2%, which equated to a decrease in fair value of approximately $84.3 million on a portfolio valued at $3,831.6 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.
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 foreign exchange gains and losses and incur underwriting losses in currencies other than U.S. dollars, which will in turn affect our consolidated financial statements. All changes in exchange rates, with the exception of non-U.S. dollar denominated investments classified as available for sale, are recognized currently in our statements of income.
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, we 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 June 30, 2005, we had notional exposure of $25.0 million (December 31, 2004 – $30.0 million) related to foreign currency forward and option contracts purchased in connection with our underwriting operations. Our foreign currency and option contracts are recorded at fair value, which is determined principally by obtaining quotes from independent dealers and counterparties. During the first six months of 2005 and 2004, we incurred gains of $0.4 million and $1.2 million, respectively, on our foreign currency forward and option contracts related to 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 and other funds. As of June 30, 2005, our combined investment in these bonds and funds was $279.7 million (December 31, 2004 – $236.6 million). To hedge our exposure to currency fluctuations from these funds, we have entered into foreign currency forward and option contracts with notional exposure of $276.4 million (December 31,
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2004 – $191.9 million). In the future, we may choose to increase our exposure to non-dollar investments. Foreign exchange gains or losses arising from non-U.S. dollar investments classified as available for sale are recorded in other comprehensive income or net realized gains (losses) on investments; the foreign exchange gains (losses) associated with our hedging of these non-U.S. dollar assets are recorded through net foreign exchange gains (losses) in our statements of income. During the first six months of 2005 and 2004, we recorded a gain of $14.4 million and a loss of $1.4 million, respectively, on our foreign currency forward and option contracts related to our hedging of non-U.S. dollar investments.
Equity Price Risk
We are exposed to equity price risk principally due to our investment in the common shares and warrant to purchase additional common shares of Platinum (see "Summary of 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 adverse changes in the price of Platinum's common stock. The aggregate fair value of this investment in Platinum was $153.5 million at June 30, 2005 compared to $150.5 million at December 31, 2004. A hypothetical 10 percent decline in the price of Platinum stock, holding all other factors constant, would have resulted in a $12.6 million decline in the fair value of the stock and a $6.3 million decline in the fair value of the warrant (assuming no other changes to the inputs to the Black-Scholes option valuation model that we use). The decline in the fair value of the stock would be recorded in net unrealized gains (losses) on securities and included in other comprehensive income in shareholders' equity. The decline in the fair value of the warrant would be recorded in other income. We are also indirectly exposed to equity market risk through our investments in: 1) some hedge funds that have net long equity positions; and 2) private equity partnerships whose exit strategies often depend on the equity markets. Such investments totaled $530.9 million at June 30, 2005 (December 31, 2004 – $375.8 million).
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 June 30, 2005 and December 31, 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 and to assist in managing the credit risk associated with ceded reinsurance. At June 30, 2005, the maximum payments we were obligated to make under credit default swaps was $4.2 million (December 31, 2004 – $21.5 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 June 30, 2005 was a liability of $2.8 million (December 31, 2004 – $12.6 million). During the first six months of 2005 and 2004, we recorded losses of $2.2 million and $0.5 million, respectively, from these credit derivatives in our consolidated statement of income. 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.
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 and procedures 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
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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 and procedures or internal control over financial reporting will prevent all errors and all fraud. Controls, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the controls are met. Further, we believe that the design of prudent controls 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 controls, 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 Rules 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 June 30, 2005, the Company's disclosure controls and procedures were effective in ensuring that all material information required to be filed in this Report has been made known to them in a timely fashion. During the second quarter of 2005 we completed a review of our processes and assumptions for establishing and evaluating our catastrophe reinsurance reserves. During this review we developed and completed certain procedures, relating to our catastrophe reserving, which should enhance our existing internal controls over loss reserving in future periods. We expect to complete a review of our specialty and Individual Risk reserves during the remainder of 2005. Except for the preceding items, there has been no change in the Company's internal control over financial reporting during the three months ended June 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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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.
We received a subpoena from the SEC in February 2005, a subpoena from the Office of the Attorney General for the State of New York (the "NYAG") in March 2005, and a subpoena from the United States Attorney's Office for the Southern District of New York in June 2005, each of which relates to the industry-wide investigations into non-traditional, or loss mitigation, (re)insurance products. The subpoenas from the SEC and the United States Attorney's Office also relate to our business practice review and/or to our determination to restate the Company's financial statements for the fiscal years ended December 31, 2003, 2002 and 2001. In July 2005, James N. Stanard, the Company's Chairman and CEO, received a Wells Notice from the staff of the SEC in connection with the SEC's investigation. The Wells Notice indicates that the staff intends to recommend that the SEC bring a civil enforcement action against Mr. Stanard alleging violations of federal securities laws. The Company understands that Michael W. Cash, a former officer of the Company, also received a Wells Notice in connection with the SEC's investigation. In April 2005, we also received subpoenas from the SEC and the NYAG relating to our investment in Channel Re. We are cooperating with the SEC, the NYAG, and the United States Attorney's Office in these ongoing investigations. We are unable to predict the ultimate impact, if any, these investigations may have on our business, including as to our senior management team. It is possible that the investigations may result in penalties or require remediation, or may otherwise impact out senior management team in a manner which may be adverse to us, perhaps materially so.
In late July 2005 and the first week of August 2005, at least three putative class action lawsuits were filed in the United States District Court for the Southern District of New York by purchasers of the Company's common stock naming the Company and certain of its present and former executive officers and directors as defendants. The complaints allege that the Company and the other defendants violated the federal securities laws by making material misstatements and failing to state material facts about the Company's business and financial condition, among other things, in securities act filings and public statements. Plaintiffs seek damages in an unspecified amount to compensate an alleged class of persons who purchased the Company's stock between January 24, 2002 and July 25, 2005. One of the actions also includes claims on behalf of purchasers of the Company's 6.08% Series C perpetual preference shares. No class has been certified in these actions, and the Company has not been served with the complaints. The Company intends to vigorously defend these lawsuits but is unable at this time to ascertain the impact this litigation may have on its financial position or results of operations.
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Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds
Below is a summary of stock purchases for the quarter ended June 30, 2005. RenaissanceRe's Board has authorized a share repurchase program of $150 million. No shares were purchased under this program in the six months ended June 30, 2005. See Note 5 of our Notes to Unaudited Consolidated Financial Statements for information regarding RenaissanceRe's stock repurchase plan.
| | | | | | | | | | | | | | |
| | | Shares
purchased (1) | | Average price
per share | | Maximum shares
still available for
repurchase (2) |
| | | | | | | (in millions) |
| Beginning shares available to be repurchased | | | | | | | | | | $ | 150.0 | |
| April 1 - 30, 2005 | | | 145 | | | $ | 45.50 | | | | N/A | |
| May 1 - 31, 2005 | | | 19,456 | | | $ | 45.20 | | | | N/A | |
| June 1 - 30, 2005 | | | 4,845 | | | $ | 47.23 | | | | N/A | |
| Total | | | 24,446 | | | | | | | $ | 150.0 | |
|
| |
| (1) | These purchases 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. |
| |
| (2) | The Company publicly announced its share repurchase program of $150 million on August 7, 2003. No expiration date has been established for this program. |
Item 3 — Defaults Upon Senior Securities
None
Item 4 — Submission of Matters to a Vote of Security Holders
| |
| (a) | Our 2005 Annual General Meeting of Shareholders was held on June 9, 2005. |
| |
| (b) | Proxies were solicited by our management pursuant to Regulation 14A under the Exchange Act; there was no solicitation of opposition to our nominees listed in the proxy statement; the reelected directors were re-elected for three year terms as described in item (c)(1) below. |
The other directors, whose term of office as a director continued after the meeting are:
James N. Stanard
William I. Riker
Thomas A. Cooper
William F. Hecht
W. James MacGinnitie
Nicholas L. Trivisonno
| |
| (c) | The following matters were voted upon at the Annual General Meeting with the voting results indicated: |
| | |
| (1) | The Board Nominees Proposal |
Our Bye-laws provide for a classified Board, divided into three classes of approximately equal size. At the 2005 Annual Meeting, the shareholders elected three of Class I Directors, who shall serve until our 2008 Annual Meeting.
| | | | | | | | | | |
| Nominee | | Votes For | | Votes Against |
| Edmund B. Greene | | 62,844,334 | | 230,686 |
| Brian R. Hall | | 63,022,671 | | 52,349 |
| Jean D. Hamilton | | 63,015,552 | | 55,151 |
| Scott E. Pardee | | 63,019,869 | | 59,468 |
|
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| | |
| (2) | The Auditors Proposal |
Our shareholders voted to approve the appointment of Ernst & Young as our independent auditors for the 2005 fiscal year.
| | | | | | | | | | |
| Votes For | | Votes Against | | Votes Abstained |
| 63,028,097 | | 27,322 | | 19,601 |
|
Item 5 — Other Information
None
Item 6 — Exhibits
| | | | | | |
| a. | | Exhibits: |
| 10.1 | | Second Amended and Restated Credit Agreement, dated as of May 25, 2005, by and among DaVinciRe Holdings Ltd., the banks, financial institutions and other institutional lenders listed thereto (the "Lenders"), Citigroup Global Markets Inc., as lead arranger, bank manager and syndication agent, and Citibank, N.A., as administrative agent for the Lenders. (1) |
| 10.2 | | Investment Manager Agreement, entered into as of July 1, 2005, by and between Renaissance Underwriting Managers, Ltd. and BlackRock Financial Management, Inc. (2) |
| 10.3 | | Amended and Restated Employment Agreement, dated as of June 30, 2003, between Renaissance Reinsurance Ltd. and Kevin J. O'Donnell. |
| 10.4 | | Third Amendment to First Amended and Restated Reimbursement Agreement, dated as of April 29, 2005, by and among Renaissance Reinsurance Ltd., Renaissance Reinsurance of Europe, Glencoe Insurance Ltd., DaVinci Reinsurance Ltd., RenaissanceRe Holdings Ltd., the banks and financial institutions parties thereto, Wachovia Bank, National Association, as issuing bank, administrative agent, and collateral agent for the lenders, and certain co-documentation agents. (3) |
| 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. |
|
| |
| (1) | Incorporated by reference to RenaissanceRe Holdings Ltd.'s Current Report on Form 8-K, filed with the Commission on June 1, 2005. |
| |
| (2) | Incorporated by reference to RenaissanceRe Holdings Ltd.'s Current Report on Form 8-K, filed with the Commission on July 8, 2005. |
| |
| (3) | Incorporated by reference to RenaissanceRe Holdings Ltd's Current Report on Form 8-K, filed with the Commission on May 2, 2005. |
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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, Chief Operating Officer and Chief Financial Officer |
|
Date: August 8, 2005
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