Net investment income was $158.1 million in the first nine months of 2005, compared to $104.4 million for the first nine months of 2004 reflecting both an increase in interest rates and also our increased allocation to other investments, which includes hedge funds and private equity investments, which earned $47.0 million in the first nine months of 2005 compared to $21.5 million in the first nine months of 2004.
Equity in earnings of other ventures represents our pro-rata share of the net income from our investments in Top Layer Re, Channel Re and Tower Hill. In the first nine months of 2004 equity in earnings of other ventures included Top Layer Re and Channel Re and an equity pickup from a joint venture focused on trading weather-sensitive commodities and securities. Beginning in the third quarter of 2004, the increase in value of this joint venture focused on trading weather-sensitive commodities and securities is captured in net investment income as a result of a change in the entity's structure. Equity in earnings of other ventures generated $23.0 million in income in the first nine months of 2005, compared to $20.5 million in the first nine months of 2004. Included in this is our equity in the earnings of our investment in Top Layer Re of $11.1 million for the first nine months of 2005, compared to $10.8 million for the same period in 2004. Our equity in the earnings of Channel Re was $11.1 million for the first nine months of 2005, compared to $5.8 million for the same period in 2004. Our investment in Channel Re was made in February 2004 and the results are reported on a quarter's lag so the results in 2004 include only a quarter and a half of activity, compared to three quarters in 2005. During the first quarter of 2005 we made a $10.0 million equity investment in Tower Hill, a Florida-based holding company. We recorded earnings of $0.8 million from the Tower Hill investment in the first nine months of 2005. As with Channel Re, we are recording our pro-rata share of the net income of Tower Hill on a one quarter lag.
The fee income and other items as reported in other income (loss) are detailed below:
Fee income was principally generated from an annual management fee we receive from Platinum. The $4.5 million loss from other items was primarily a result of $2.4 million in losses from short positions in credit derivatives and a $2.9 million decrease in the fair value of our Platinum warrant. Commencing in the fourth quarter of 2004, a lock-up relating to the Platinum warrant expired and, accordingly, the change in the fair value of our Platinum warrant investment is recorded in other income in accordance with FAS 133. The $7.8 million loss in other items in 2004 was driven by $6.9 million of losses from short positions in credit derivatives.
A description of the changes in other non-underwriting income and expense items is as follows:
dollar denominated fixed income investment portfolio, which is classified as available for sale. These gains are partially offset by unrealized foreign exchange losses on the investments, which are recorded in other comprehensive income. We do not currently apply hedge accounting to these derivative transactions.
Realized gains (losses) – During the first nine months of 2005, we incurred net realized losses of $3.4 million, compared to net realized gains of $20.6 million during the first nine months of 2004.
Corporate expenses – Our corporate expenses of $41.8 million incurred during the first nine months of 2005 were $27.8 million higher than the first nine months of 2004. The increase in such expenses is due principally to $29.5 million in professional fees and an accrual for other costs incurred during the first nine months of 2005 related to the investigations by the Securities and Exchange Commission and other governmental authorities. See "Part II – Other Information – Item 1."
Minority Interest – DaVinciRe – Minority interest increased by $13.1 million to $44.3 million in the first nine months of 2005, compared to $57.4 million in the first nine months of 2004, due to lower incurred losses by DaVinci which decreased DaVinciRe's net loss and, correspondingly, the minority interest benefit.
FINANCIAL CONDITION
RenaissanceRe is a holding company, and we therefore rely on dividends from our subsidiaries and investment income to make principal, interest and dividend payments on our debt and capital securities, and to make dividend payments to our preference shareholders and common shareholders.
The payment of dividends by our Bermuda subsidiaries is, under certain circumstances, limited under Bermuda insurance law, which requires our Bermuda insurance subsidiaries to maintain certain measures of solvency and liquidity. At September 30, 2005, the statutory capital and surplus of our Bermuda insurance subsidiaries was $2,156.5 million, and the amount of capital and surplus required to be maintained was $498.5 million. Our principal U.S. insurance subsidiary, Stonington, is also required to maintain certain measures of solvency and liquidity. At September 30, 2005, the statutory capital and surplus of Stonington was $53.0 million. Because of an accumulated deficit in earned surplus, Stonington currently cannot pay an ordinary dividend without the approval of the Commissioner of the Texas Department of Insurance. In addition, because of deficits in the retained earnings of Glencoe Group and Glencoe, Glencoe Group and Glencoe cannot currently pay ordinary dividends. In addition, Glencoe Group and Glencoe cannot currently return capital to their shareholders without Bermuda Monetary Authority approval.
In the aggregate, our operating subsidiaries have historically produced sufficient cash flows to meet their expected claims payments and operational expenses and to provide dividend payments to us. However, following our recent operating losses, RenaissanceRe has contributed capital to its principal operating subsidiaries, Renaissance Reinsurance and Glencoe Group, which has reduced liquidity available at RenaissanceRe. Our subsidiaries maintain a concentration of investments in high quality liquid securities, which management believes will provide additional liquidity for extraordinary claims payments should the need arise. Additionally, we maintain a $500 million revolving credit facility and a $900 million letter of credit facility to meet additional liquidity and capital requirements, if necessary. See "Capital Resources."
CASH FLOWS
Cash flows from operations for the first nine months of 2005 were $542.5 million, which principally consisted of increases in net reserves for claims and claims expenses of $515.2 million, increases in reserves for unearned premiums of $341.0 million and an increase in reinsurance balances payable of $152.4 million, partially offset by our net loss of $45.0 million, a $271.9 million increase in premiums receivable and a $50.7 million increase in deferred acquisition costs, among other items.
Because a large portion of the coverages we provide typically can produce losses of high severity and low frequency, it is not possible to accurately predict our future cash flows from operating activities. As a consequence, cash flows from operating activities may fluctuate, perhaps significantly, between individual quarters and years.
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RESERVES FOR CLAIMS AND CLAIM EXPENSES
Our gross case reserves, additional case reserves and IBNR by line of business at September 30, 2005 and December 31, 2004 were as follows:
| | | | | | | | | | | | | | | | | | |
| At September 30, 2005 | | Case Reserves (1) | | Additional Case
Reserves (2) | | IBNR | | Total |
| (in thousands of U.S. dollars) | | | | | | | | |
| Property catastrophe reinsurance | | $ | 170,647 | | | $ | 679,305 | | | $ | 264,181 | | | $ | 1,114,133 | |
| Specialty reinsurance | | | 116,385 | | | | 98,759 | | | | 412,972 | | | | 628,116 | |
| Total Reinsurance | | | 287,032 | | | | 778,064 | | | | 677,153 | | | | 1,742,249 | |
| Individual Risk | | | 128,675 | | | | — | | | | 429,307 | | | | 557,982 | |
| Total | | $ | 415,707 | | | $ | 778,064 | | | $ | 1,106,460 | | | $ | 2,300,231 | |
| At December 31, 2004 | | | | | | | | | | | | | | | | |
| Property catastrophe reinsurance | | $ | 137,902 | | | $ | 125,639 | | | $ | 330,744 | | | $ | 594,285 | |
| Specialty reinsurance | | | 50,661 | | | | 56,429 | | | | 419,917 | | | | 527,007 | |
| Total Reinsurance | | | 188,563 | | | | 182,068 | | | | 750,661 | | | | 1,121,292 | |
| Individual Risk | | | 138,285 | | | | — | | | | 199,821 | | | | 338,106 | |
| Total | | $ | 326,848 | | | $ | 182,068 | | | $ | 950,482 | | | $ | 1,459,398 | |
|
| |
| (1) | Case reserves include our estimate of case reserves for insurance policies and case reserves reported by our counterparties for reinsurance contracts. |
| |
| (2) | Additional case reserves represent our estimate of additional case reserves on reinsurance contracts established by management. |
At September 30, 2005 our estimated IBNR reserves were $1,106.5 million. A 5% change in such IBNR reserves would equate to a $55.3 million adjustment to claims and claim expenses incurred, which would represent 2.2% of shareholders' equity at September 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.
Starting in 2002 and 2003, we significantly increased gross premiums written in our specialty reinsurance business unit and Individual Risk segment, respectively. 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
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ultimate expected claims and claim expenses. We review our claims reserves on a regular basis. See "Summary of Critical Accounting Policies and Estimates" for additional information including a summary of our reserve reviews.
CAPITAL RESOURCES
Our total capital resources as of September 30, 2005 and December 31, 2004 were as follows:
| | | | | | | | | | |
| (in thousands of U.S. dollars) | | At September 30,
2005 | | At December 31,
2004 |
| Common shareholders' equity | | $ | 1,990,693 | | | $ | 2,144,042 | |
| Preference shares | | | 500,000 | | | | 500,000 | |
| Total shareholders' equity | | | 2,490,693 | | | | 2,644,042 | |
| 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 | | | | 500,000 | |
| Total capital resources | | $ | 3,443,786 | | | $ | 3,597,135 | |
|
During the first nine months of 2005, our capital resources decreased primarily as a result of our net loss attributable to common shareholders of $71.0 million, dividend payments to our common shareholders of $42.7 million and a reduction in accumulated other comprehensive income of $50.6 million. In addition, we have estimated a net negative impact of $250 million to $300 million arising from Hurricane Wilma, which occurred in the fourth quarter of 2005. Following the Hurricane Wilma loss, we expect that DaVinciRe will seek additional capital. We believe that DaVinciRe will be able to obtain such capital from existing and new investors in the fourth quarter of 2005. In addition, we may seek to raise additional equity capital for RenaissanceRe. Our ability to complete any such transaction, or our ability to do so successfully or on attractive terms, would be subject to factors including timing, pricing and execution risks inherent in the capital markets and other markets for financial resources and market, legal, regulatory or other factors which could constrain our ability to raise capital, many of which are beyond our control.
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 submits 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
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subsidiaries and limitations on liens on the stock of designated subsidiaries. RenaissanceRe was in compliance with the related covenants at September 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 nine 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 September 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 4.0% during the first nine months of 2005 (2004 – 2.1%). 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, 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 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 September 30, 2005, we had outstanding letters of credit under the facility aggregating $682.3 million and under all letters of credit facilities of $730.9 million. Due to the losses incurred in the third quarter of 2005 from hurricanes Dennis, Katrina and Rita, and the losses that we expect to incur from hurricane Wilma in the fourth quarter of 2005, we are currently in discussions to increase the size of our letter of credit facility to $1.75 billion.
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.
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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, 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 November, following our announcement that our then Chairman and CEO resigned from the Company in light of the ongoing investigations resulting from the Company's restatement of its financial results, and our announcement that our Chief Operating Officer and Chief Financial Officer John M. Lummis intends to retire at the end of his contract term on June 30, 2006, as discussed herein under "Part II – Other Information – Item 1", (i) Standard & Poor's Ratings Services removed from Credit Watch and lowered its counterparty credit and senior debt ratings on the Company to "A–" from "A", the preferred stock ratings on the Company to "BBB" from "BBB+", and the counterparty credit and financial strength ratings on Renaissance Reinsurance to "A+" from "AA–"; and also removed from Credit Watch and affirmed its "A" counterparty credit and financial strength ratings on DaVinci; (ii) Moody's Investors Service Inc. lowered its senior debt rating on the Company to "Baa1" from "A3", the insurance financial strength rating of Renaissance Reinsurance to "A2" from "A1", the rating of the capital securities issued by RenaissanceRe Capital Trust to "Baa2" from "Baa1", and the capital securities rating of RenaissanceRe Capital Trust II to "(P)Baa2" from "(P)Baa1"; and also lowered the ratings for the Company's junior subordinated debt to "Baa2" from "Baa1", the preference stock to "Baa3" from "Baa2", the provisional senior unsecured debt to "(P)Baa1" from "(P)A3", the provisional subordinated debt to "(P)Baa2" from "(P)Baa1", and the provisional preference stock to "(P)Baa3" from "(P)Baa2"; (iii) Fitch Ratings Ltd. downgraded the long-term rating of the Company to "BBB+" from "A–", the rating on the Company's senior unsecured notes to "BBB+" from "A–", the rating on the Company's preferred stock to "BBB" from "BBB+", and the insurer financial strength rating on Renaissance Reinsurance to "A" from "A+"; and also removed these ratings from Rating Watch Negative and announced the Rating Outlook is Negative; and (iv) A.M. Best Company, Inc. downgraded the financial strength rating of Renaissance Reinsurance to "A" from "A+", the financial strength ratings of the operating subsidiaries of Glencoe Group to "A–" from "A", the financial strength ratings of the operating subsidiaries of Overseas Partners Cat Limited to "A–" from "A", the issuer credit rating of DaVinci to "a" from "a+", and the issuer credit rating of the Company to "bbb" from "a–" (and also downgraded the Company's debt ratings); and announced its ratings remain under review with negative implications.
While the ratings of Renaissance Reinsurance remain among the highest in our business, these ratings actions could have an adverse effect on our ability to fully realize the market opportunities we currently expect to participate in over coming periods. In addition, it is increasingly common for our reinsurance contracts to contain provisions permitting our clients to cancel coverage pro-rata if our relevant operating subsidiary is downgraded below a certain rating level. Whether a client would exercise this right would depend, among other factors, on the reason for such a downgrade, the extent of the downgrade, the prevailing market conditions and the pricing and availability of replacement reinsurance coverage. Therefore, it is not possible to predict in advance the extent to which this cancellation right would be exercised, if at all, or what effect such cancellations would have on the financial condition or future operations, but such effect potentially could be material. To date we are not aware that we have experienced such an event.
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SHAREHOLDERS' EQUITY
During the first nine months of 2005, our consolidated shareholders' equity, including preference shares, decreased by $153.3 million to $2,490.7 million as of September 30, 2005, from $2,644.0 million as of December 31, 2004. The decrease in shareholders' equity was due to our net loss attributable to common shareholders of $71.0 million, dividend payments to our common shareholders of $42.7 million and a reduction in accumulated other comprehensive income of $50.6 million.
INVESTMENTS
At September 30, 2005, we held investments totaling $5.3 billion, compared to $4.8 billion at December 31, 2004.
The table below shows the aggregate amounts of our invested assets:
| | | | | | | | | | |
| (in thousands of U.S. dollars) | | At September 30,
2005 | | At December 31,
2004 |
| Fixed maturity investments available for sale, at fair value | | $ | 3,085,509 | | | $ | 3,223,292 | |
| Short term investments, at cost | | | 1,133,542 | | | | 608,292 | |
| Other investments, at fair value | | | 774,234 | | | | 684,590 | |
| Total managed investments portfolio | | | 4,993,285 | | | | 4,516,174 | |
| Equity investment in reinsurance company, at fair value | | | 142,788 | | | | 150,519 | |
| Investments in other ventures, under equity method | | | 175,482 | | | | 159,556 | |
| Total investments | | $ | 5,311,555 | | | $ | 4,826,249 | |
|
Our total investments for the nine months ended September 30, 2005 increased by $485.3 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 September 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 2.0 years (December 31, 2004 – 2.2 years) and an average yield to maturity of 4.4% (December 31, 2004 – 3.3%).
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Other Investments
The table below shows our portfolio of other investments as at September 30, 2005 and December 31, 2004:
| | | | | | | | | | |
| (in thousands of U.S. dollars) | | At September 30,
2005 | | At December 31,
2004 |
| Type of investment | | | | | | | | |
| Hedge funds | | $ | 271,944 | | | $ | 293,462 | |
| Senior secured bank loan fund | | | 96,237 | | | | 116,560 | |
| Private equity partnerships | | | 143,324 | | | | 82,381 | |
| Fixed income global opportunities fund | | | 101,488 | | | | — | |
| European high yield credit fund | | | 89,319 | | | | 87,689 | |
| Medium term note representing an interest in a pool of European fixed income securities | | | 40,000 | | | | 50,000 | |
| Non-US convertible fund | | | 27,404 | | | | 28,214 | |
| Miscellaneous other investments | | | 4,518 | | | | 26,284 | |
| Total investments | | $ | 774,234 | | | $ | 684,590 | |
|
Interest income, income distributions and realized and unrealized gains and losses on other investments are included in net investment income and totaled $47.0 million and $21.5 million for the first nine months of 2005 and 2004, respectively, of which $22.6 million for the first nine months of 2005 and $4.9 million for the first nine months of 2004 was related to net unrealized gains. Currently, we plan to reduce our absolute and relative allocation to alternative investments, primarily hedge funds, and accordingly, in the fourth quarter we commenced actions to redeem certain of our positions in these investments.
We have $198.8 million of unfunded committed capital to private equity partnerships at September 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 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, 2005, we owned (exclusive of the warrant) approximately 8.0% of Platinum's outstanding common shares. We have recorded our investment in Platinum at fair value, and at September 30, 2005 the aggregate fair value was $142.8 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 $34.2 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 nine months ended September 30, 2005, a $2.9 million loss was recorded in other income (loss) representing a decrease 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 nine months of 2005. As with Channel Re, our
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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 September 30, 2005, $299.3 million of cash and cash equivalents and investments were invested in currencies other than the U.S. dollar, which represented 5.5% 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 September 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 September 30, 2005 | | Total | | Less than 1 year | | 1-3 years | | 3-5 years | | More than
5 years |
| (in thousands of U.S. dollars) | | | | | | | | | | |
| Long-term debt obligations (1) | | | | | | | | | | | | | | | | | | | | |
| 7.0% Senior Notes | | $ | 179,285 | | | $ | 10,500 | | | $ | 168,785 | | | $ | — | | | $ | — | |
| 5.875% Senior Notes | | | 137,471 | | | | 5,875 | | | | 11,750 | | | | 5,875 | | | | 113,971 | |
| Capital Securities | | | 282,873 | | | | 8,540 | | | | 17,080 | | | | 17,080 | | | | 240,173 | |
| DaVinciRe revolving credit facility (2) | | | 106,660 | | | | 4,038 | | | | 102,622 | | | | — | | | | — | |
| Private equity commitments | | | 198,756 | | | | 198,756 | | | | — | | | | — | | | | — | |
| Operating lease obligations | | | 55,307 | | | | 4,520 | | | | 9,065 | | | | 8,742 | | | | 32,980 | |
| Obligations under derivative contracts | | | 3,997 | | | | 1,335 | | | | 2,517 | | | | 145 | | | | — | |
| Reserve for claims and claim expenses (3) | | | 2,300,231 | | | | 867,806 | | | | 780,817 | | | | 265,411 | | | | 386,197 | |
| Total contractual obligations | | $ | 3,264,580 | | | $ | 1,101,370 | | | $ | 1,092,636 | | | $ | 297,253 | | | $ | 773,321 | |
|
| |
| (1) | Includes contractual interest and dividend payments. |
| |
| (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:
Potential improvements in market conditions
In the third and fourth quarters of 2005, the insurance industry experienced substantial catastrophe losses. Hurricane Katrina is estimated to have resulted in a record level of insured property losses, and there has also been an aggregation of other catastrophic losses, including Hurricanes Dennis, Rita and Wilma, as well as the hurricanes of 2004. These losses may increase perceptions of risk which could result in increased demand for, and reduced supply of, catastrophe exposed insurance and reinsurance. The affected lines include catastrophe reinsurance and catastrophe exposed homeowner business, and also includes other lines of business, such as offshore energy and large account commercial property. We have also increased certain of our assumptions of catastrophe frequency, and we expect to seek higher nominal prices for catastrophe exposed business, although it remains unclear
45
whether our margins will expand meaningfully. We may also experience higher prices in our purchases of reinsurance. For lines of business that are not catastrophe exposed, it is unclear whether pricing will be favorably affected by recent catastrophe experience. We expect that our Individual Risk business will continue to grow into lines that are not catastrophe exposed, given programs that we have recently entered into.
We believe that we are well-positioned to participate in the improving market environment. However, various factors could constrain us, including (i) the possibility of a higher level of competition than currently anticipated, associated with the rapid movement of capital into the insurance and reinsurance sectors, which could result in a less attractive pricing environment; (ii) limitations on our growth or other adverse impacts arising from the recent downgrades of our various credit ratings (see – "Part I – Item 2 – Capital Resources – Credit ratings"); and (iii) limitations on human or capital resources available to us.
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 property catastrophe and specialty reinsurance reserves in the second and third quarters of 2005, respectively. We expect to review our Individual Risk reserves in the fourth quarter of 2005. As a result of the review of our property catastrophe and specialty reinsurance reserves, we reduced prior year net reserves within our Reinsurance segment by $248.1 million. After adjusting for the impact of minority interest, our year to date net loss was reduced by $225.8 million as a result of these reviews. The property catastrophe reinsurance 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. The reduction in specialty reinsurance reserves is principally due to a reassessment of our estimated loss reporting patterns. Since establishing the specialty reinsurance business unit in 2002, reported claim activity has been less than expected and therefore we have adjusted our estimated loss reporting patterns to reflect this experience.
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 Individual Risk segment. The review of our 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.
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
46
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 ultimate 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.
Management changes
We announced on November 1, 2005 the resignation of Mr. Stanard as Chairman and Chief Executive Officer in light of the ongoing investigations resulting from our restatement of our financial results. Mr. Stanard's rights and obligations following his resignation are governed by his employment agreement and by our standard practices for senior expatriate executives (principally relating to transitional period medical insurance, transitional travel from Bermuda, and the purchase or return of company-issued property). Upon his resignation on November 1, 2005, pursuant to the terms of his employment agreement with us, Mr. Stanard (i) vested in all options granted to him under the Company's 2004 Stock Option Incentive Plan, which options shall remain exercisable until the expiration of their stated term, subject to continued compliance with certain noncompetition obligations; and (ii) vested in all options and shares of restricted stock granted to him under the Company's 2001 Stock Incentive Plan and Company's Second Amended and Restated 1993 Stock Incentive Plan, with options remaining exercisable for thirty days following his termination of employment. We expect to incur an expense of approximately $13.3 million in the fourth quarter of 2005 due to the accelerated vesting of these options and shares. Mr. Stanard forfeits his options under the 2004 Plan in the event that he competes with us prior to exercising such options. We did not enter into a separation agreement with Mr. Stanard, and Mr. Stanard will not receive any other severance payments in connection with his departure. This management change could have an adverse impact on our business, including on our current or prospective relationships with clients or joint venture partners.
On November 1, 2005, we also announced that Chief Operating Officer and Chief Financial Officer John M. Lummis has indicated that he intends to retire at the end of his contract term on June 30, 2006. In addition, Martin J. Merritt, who served as Controller until April 2005, has left the Company.
We also announced on November 1, 2005, that Neill A. Currie has been named by the Board of Directors as the new Chief Executive Officer of the Company and has also been appointed to the Board of Directors, effective immediately, and that W. James MacGinnitie was appointed Non-Executive Chairman of the Board of Directors. Since July 5, 2005, Mr. Currie, age 52, has served as Executive Vice President of the Company, and has been responsible for the Company's Specialty Reinsurance business. Mr. Currie was a co-founder of the Company in 1993 and served as a Senior Vice President through 1997. Mr. MacGinnitie, 67, has served as a member of the Company's Board of Directors since February 2000 and is an independent actuary and consultant. Prior to that, he served as Senior Vice President and Chief Financial Officer of CNA Financial from September 1997 to September 1999. Mr. MacGinnitie is a Fellow and a past President of the Casualty Actuarial Society, as well as the Society of Actuaries, the American Academy of Actuaries and the International Actuarial Association.
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.
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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 2005 and 2004 hurricanes and windstorms 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 effecting our leadership transition; |
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| 3. | risks relating to the status and potential future outcome of the current regulatory and civil proceedings against the Company, which might impact the Company adversely, including as regards our senior executive team; |
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| 4. | 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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| 5. | 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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| 6. | the risk of 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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| 7. | 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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| 8. | 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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| 9. | acts of terrorism, war or political unrest; |
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| 10. | the inherent uncertainties in our reserving process, which we believe are increasing as we diversify into new product classes; |
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| 11. | emerging claim and coverage issues, which could expand our obligations beyond the amount we intend to underwrite; |
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| 12. | 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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| 13. | a decrease in the level of demand for our reinsurance or insurance business, or increased competition in the industry, including from new entrants; |
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| 14. | 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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| 15. | changes in economic conditions, including interest rate, currency, equity and credit conditions which could affect our investment portfolio; |
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| 16. | 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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| 17. | 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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| 18. | loss of services of any one of our key executive officers, or difficulties associated with the transition of new members of our senior management team; |
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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; |
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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.
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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; 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 in part 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 2.0%, which equated to a decrease in fair value of approximately $84.4 million on a portfolio valued at $4,219.1 million at September 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 September 30, 2005, we had notional exposure of $35.0 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 nine months of 2005 and 2004, we incurred a loss of $0.1 million and a gain of $0.4 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 September 30, 2005, our combined investment in these bonds and funds was $271.8 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 $253.9 million (December 31, 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 foreign exchange gains (losses) in our statements of income; 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 nine months of 2005 and 2004, we recorded a gain of $27.5 million and a loss of $3.9 million, respectively, on our foreign currency forward and option contracts
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related to our hedging of non-US dollar investments. This was offset by a loss of $27.9 million (September 30, 2004 – gain of $2.4 million) on the underlying hedged foreign-currency denominated investments, of which $12.9 million (September 30, 2004 – $1.6 million) relates to available for sale securities and was therefore included in other comprehensive income (loss) and $15.0 million (September 30, 2004 – $0.8 million) related to our other investments, which was included in net foreign exchange gains (losses) in our Consolidated Statements of Operations.
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 $142.8 million at September 30, 2005 compared to $150.5 million at December 31, 2004. A hypothetical 10 percent decline in the price of Platinum stock from the September 30, 2005 closing price, holding all other factors constant, would have resulted in an $11.8 million decline in the fair value of the stock and a $5.8 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 $415.3 million at September 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, including losses recoverable. At September 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 derivatives to hedge our exposures in the insurance industry and to assist in managing the credit risk associated with ceded reinsurance. At September 30, 2005, the maximum payments we were obligated to make under credit derivatives was $4.0 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 September 30, 2005 was a liability of $2.6 million (December 31, 2004 – $12.6 million). During the first nine months of 2005 and 2004, we recorded losses of $2.4 million and $6.9 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.
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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 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 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 September 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 and third quarters of 2005 we completed a review of our processes and assumptions for establishing and evaluating our catastrophe reinsurance reserves and specialty reinsurance reserves, respectively. During these reviews we developed and completed certain procedures, relating to our property catastrophe and specialty reinsurance reserving, which should enhance our existing internal controls over loss reserving in future periods. We expect to complete a review of our Individual Risk reserves during the fourth quarter of 2005. In addition, during the third quarter of 2005 we reviewed and enhanced certain of our internal controls around ceded reinsurance balances, including losses recoverable. Except for the preceding items, there has been no change in the Company's internal control over financial reporting during the three months ended September 30, 2005 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
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Part II – OTHER INFORMATION
Item 1 – Legal Proceedings
We received a subpoena from the Securities and Exchange Commission (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 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 then 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 addition, in September 2005, the Company received a Wells Notice 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 the Company alleging violations of federal securities laws and that the staff may seek permanent injunctive relief, civil penalties, and disgorgement. 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. The SEC and the United States Attorneys' Office have continued to request information from the Company in connection with their investigations. They have interviewed and deposed a number of current and former officers and employees of the Company, and have indicated that they plan to conduct additional interviews or depositions of such individuals. It is possible that additional current or former officers or employees could be interviewed or deposed in the future. It is possible that additional investigations or proceedings may be commenced against the Company and/or its current or former senior executives in connection with these matters, which could be criminal or civil. We are unable to predict the ultimate outcome of these investigations or the impact these investigations may have on our business, including as to our senior management team. These investigations could result in penalties, require remediation, or otherwise impact the Company and/or our senior management team in a manner which may be adverse to us, perhaps materially so. We intend to continue to cooperate with these investigations.
Since late July 2005, at least seven putative class action lawsuits have been 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 U.S. 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 U.S. Exchange 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 suit purports to be filed on behalf of purchasers between October 21, 2003 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.
In addition to the above, we are, from time to time, a party to litigation and arbitration that arises in the normal course of our business operations. While any such litigation or arbitration contains an element of uncertainty, we believe that any such litigation or arbitration to which we are presently a party is not likely to have a material adverse effect on our business or 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 September 30, 2005. RenaissanceRe's Board has authorized a share repurchase program of $150 million. We repurchased $0.7 million in shares under this program in the nine months ended September 30, 2005.
| | | | | | | | | | | | | | |
| | | Shares
purchased | | Average price
per share | | Maximum shares
still available for
repurchase (2) |
| | | | | | | (in millions) |
| Beginning shares available to be repurchased | | | | | | | | | | $ | 150.0 | |
| July 1 – 31, 2005 | | | | | | | | | | | | |
| From employees (1) | | | 24,670 | | | $ | 46.72 | | | | N/A | |
| Under share repurchase program (2) | | | 17,200 | | | $ | 41.94 | | | | (0.7 | ) |
| August 1 – 31, 2005 | | | — | | | $ | — | | | | N/A | |
| September 1 – 30, 2005 | | | | | | | | | | | | |
| From employees (1) | | | 434 | | | $ | 44.27 | | | | N/A | |
| Total | | | 42,304 | | | | | | | $ | 149.3 | |
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| (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. |
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| (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
None
Item 5 – Other Information
None
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Item 6 – Exhibits
| | | | | | |
| a. | | Exhibits: |
| 10.1 | | Amended and Restated Employment Agreement, dated as of June 30, 2003, between Renaissance Reinsurance Ltd. and Kevin J. O'Donnell. |
| 10.2 | | Employment Agreement, dated as of June 21, 2005, between RenaissanceRe Holdings Ltd. and Neill A. Currie. |
| 10.3 | | Investment Manager Agreement, entered into as of July 1, 2005, by and between Renaissance Underwriting Managers Ltd. and BlackRock Financial Management, Inc. (1) |
| 31.1 | | Certification of Neill A. Currie, 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 Neill A. Currie, 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. |
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| (1) | Incorporated by reference to RenaissanceRe Holdings Ltd.'s Current Report on Form 8-K, filed with the Commission on July 8, 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. |
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| By: | /s/ John M. Lummis
John M. Lummis
Executive Vice President, Chief Operating
Officer and Chief Financial Officer |
Date: November 9, 2005
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