ARCH CAPITAL GROUP LTD. REPORTS 2004 THIRD QUARTER RESULTS
HAMILTON, BERMUDA, October 28, 2004 — Arch Capital Group Ltd. (NASDAQ: ACGL) reports that net income for the 2004 third quarter was $18.0 million, or $0.25 per share, compared to $82.6 million, or $1.22 per share, for the 2003 third quarter, and $209.8 million, or $2.91 per share, for the nine months ended September 30, 2004, compared to $196.9 million, or $2.91 per share, for the nine months ended September 30, 2003. The Company’s diluted book value per share increased by 15.7% to $29.53 at September 30, 2004 from $25.52 at December 31, 2003 (see “Calculation of Book Value Per Share” in the Supplemental Financial Information section of this release). Gross premiums written were $927.7 million for the 2004 third quarter, compared to $928.2 million for the 2003 third quarter, and $2.75 billion for the nine months ended September 30, 2004, compared to $2.46 billion for the nine months ended September 30, 2003. The Company’s combined ratio was 103.4% for the 2004 third quarter, compared to 89.8% for the 2003 third quarter, and 93.6% for the nine months ended September 30, 2004, compared to 90.2% for the nine months ended September 30, 2003. All per share amounts discussed in this release are on a diluted basis.
The Company also reported after-tax operating income of $9.1 million, or $0.12 per share, for the 2004 third quarter, compared to $70.2 million, or $1.04 per share, for the 2003 third quarter, and $202.8 million, or $2.81 per share, for the nine months ended September 30, 2004, compared to $178.6 million, or $2.64 per share, for the nine months ended September 30, 2003. The Company’s after-tax operating income represented a 14.1% annualized return on average equity for the nine months ended September 30, 2004, compared to 15.6% for the nine months ended September 30, 2003. Operating income, a non-GAAP measure, is defined as net income or loss before extraordinary items, excluding net realized gains or losses, net foreign exchange gains or losses, other income or loss, reversal of deferred tax asset valuation allowances and non-cash compensation, net of income taxes. See page 6 for a further discussion of operating income and Regulation G.
In the 2004 third quarter, the Company recorded net losses related to Hurricanes Charley, Frances, Ivan and Jeanne and Typhoon Songda, after reinsurance and after-tax, of approximately $144.6 million, or $1.97 per share. The recorded loss amounts relating to these events were based on available information derived from modeling techniques, industry assessments of exposure and claims information obtained from the Company’s clients and brokers. To date, the Company has received relatively few claims advices from clients and brokers. The Company’s actual losses from these events may vary materially from the recorded net losses due to the inherent uncertainties in making such determinations resulting from several factors, including the potential inaccuracies and inadequacies in the data provided by clients and brokers, the modeling techniques and the application of such techniques, as well as the high frequency of recent catastrophic events and the effects of any resultant demand surge on claims activity.
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The following table summarizes the Company’s underwriting results:
| | (Unaudited) | | (Unaudited) | |
| | Three Months Ended
September 30, | | Nine Months Ended
September 30, | |
(U.S. dollars in thousands) | | 2004 | | 2003 | | 2004 | | 2003 | |
| | | | | | | | | |
Gross premiums written | | $ | 927,658 | | $ | 928,243 | | $ | 2,753,769 | | $ | 2,464,348 | |
Net premiums written | | 743,229 | | 774,167 | | 2,304,463 | | 2,111,032 | |
Net premiums earned | | 735,408 | | 608,956 | | 2,166,633 | | 1,522,263 | |
Underwriting (loss) income | | (23,766 | ) | 63,567 | | 141,964 | | 152,871 | |
| | | | | | | | | |
Combined ratio | | 103.4 | % | 89.8 | % | 93.6 | % | 90.2 | % |
| | | | | | | | | | | | | |
The following table summarizes, on an after-tax basis, the Company’s consolidated financial data, including a reconciliation of operating income to net income and related diluted per share results.
| | (Unaudited) | | (Unaudited) | |
(U.S. dollars in thousands, | | Three Months Ended
September 30, | | Nine Months Ended
September 30, | |
except per share data) | | 2004 | | 2003 | | 2004 | | 2003 | |
| | | | | | | | | |
Operating income | | $ | 9,117 | | $ | 70,193 | | $ | 202,802 | | $ | 178,613 | |
Net realized gains | | 12,805 | | 10,454 | | 18,170 | | 19,315 | |
Net foreign exchange (losses) gains | | (1,787 | ) | 3,708 | | (2,004 | ) | 6,519 | |
Other income (loss) | | 62 | | 355 | | (2,111 | ) | 1,707 | |
Reversal of deferred tax asset valuation allowance | | — | | 773 | | — | | 773 | |
Non-cash compensation | | (2,168 | ) | (3,712 | ) | (7,091 | ) | (10,886 | ) |
Extraordinary gain – excess of fair value of acquired net assets over cost | | — | | 816 | | — | | 816 | |
Net income | | $ | 18,029 | | $ | 82,587 | | $ | 209,766 | | $ | 196,857 | |
| | | | | | | | | |
Diluted per share results: | | | | | | | | | |
Operating income | | $ | 0.12 | | $ | 1.04 | | $ | 2.81 | | $ | 2.64 | |
Net realized gains | | 0.18 | | 0.15 | | 0.25 | | 0.29 | |
Net foreign exchange (losses) gains | | (0.02 | ) | 0.05 | | (0.02 | ) | 0.10 | |
Other income (loss) | | 0.00 | | 0.01 | | (0.03 | ) | 0.02 | |
Reversal of deferred tax asset valuation allowance | | — | | 0.01 | | — | | 0.01 | |
Non-cash compensation | | (0.03 | ) | (0.05 | ) | (0.10 | ) | (0.16 | ) |
Extraordinary gain – excess of fair value of acquired net assets over cost | | — | | 0.01 | | — | | 0.01 | |
Net income | | $ | 0.25 | | $ | 1.22 | | $ | 2.91 | | $ | 2.91 | |
| | | | | | | | | |
Diluted average shares outstanding | | 73,547,450 | | 67,774,722 | | 72,090,798 | | 67,539,330 | |
The combined ratio represents a measure of underwriting profitability, excluding investment income, and is the sum of the loss ratio and expense ratio. A combined ratio under 100% represents an underwriting profit and a combined ratio over 100% represents an underwriting loss. The combined ratio of the Company’s insurance and reinsurance subsidiaries consisted of a loss ratio of 76.4% and an underwriting expense ratio of 27.0% for the 2004 third quarter, compared to a loss ratio of 64.4% and an underwriting expense ratio of 25.4% for the 2003 third quarter. The combined ratio of the Company’s insurance and reinsurance subsidiaries for the nine months ended September 30, 2004 consisted of a loss ratio of 65.9% and an underwriting expense ratio of 27.7%, compared to a loss ratio of 64.8% and an underwriting expense ratio of 25.4% for the nine months ended September 30, 2003. The loss ratio of 65.9% for the nine months ended September 30, 2004 was comprised of
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17.0 points of paid losses, 9.1 points related to reserves for reported losses and 39.8 points related to incurred but not reported reserves.
In establishing the reserves for losses and loss adjustment expenses, the Company has made various assumptions relating to the pricing of its reinsurance contracts and insurance policies and also has considered available historical industry experience and current industry conditions. The Company primarily uses the expected loss method of reserving, which is commonly applied when limited loss experience exists. Any estimates and assumptions made as part of the reserving process could prove to be inaccurate due to several factors, including the fact that limited historical information has been reported to the Company through September 30, 2004.
For a discussion of underwriting activities and a review of the Company’s results by operating division, see “Segment Information” in the Supplemental Financial Information section of this release.
Consolidated cash flow provided by operating activities for the 2004 third quarter was $509.1 million, compared to $478.2 million for the 2003 third quarter, and $1.35 billion for the nine months ended September 30, 2004, compared to $1.15 billion for the nine months ended September 30, 2003. Net investment income for the 2004 third quarter was $40.8 million, compared to $20.5 million for the 2003 third quarter, and $98.1 million for the nine months ended September 30, 2004, compared to $58.8 million for the nine months ended September 30, 2003. The growth in net investment income in the 2004 periods was primarily due to a significant increase in the Company’s invested assets, primarily resulting from cash flow provided by operating activities and the Company’s capital raising activities during the first half of 2004. In addition, our pre-tax and after-tax investment income yields (net of investment expenses), respectively, for the 2004 third quarter increased to 3.2% and 3.1%, from 2.8% and 2.5% for the 2003 third quarter. The Company’s investment portfolio mainly consists of high quality fixed income securities, which had an average Standard & Poor’s quality rating of “AA+” and an average duration of 3.7 years at September 30, 2004, compared to 3.6 years at June 30, 2004.
Interest expense was $6.3 million for the 2004 third quarter and $12.4 million for the nine months ended September 30, 2004. Such amounts primarily relate to the Company’s senior notes issued in May 2004.
The Company’s effective tax rates may fluctuate from period to period based on the relative mix of income reported by jurisdiction primarily due to the varying tax rates in each jurisdiction. The Company’s quarterly tax provision is adjusted to reflect changes in its expected annual effective tax rates, if any. The effective tax rates on income before extraordinary items and income taxes and pre-tax operating income were approximately 6.0% for the nine months ended September 30, 2004. For the nine months ended September 30, 2003, the effective tax rate on income before extraordinary items and income taxes, excluding the reversal of a $773,000 deferred tax asset valuation allowance, was 11.4% and the effective tax rate on pre-tax operating income was 11.5%. The reduction in the effective tax rates in the 2004 period resulted from a change in the relative mix of income reported by jurisdiction. The Company currently expects that its annual effective tax rate on pre-tax operating income for the year ended December 31, 2004 will be in the range of 5% to 8%.
Non-cash compensation expense for the 2004 third quarter was $2.3 million, compared to $3.9 million for the 2003 third quarter, and $7.7 million for the nine months ended September 30, 2004, compared to $11.7 million for the nine months ended September 30, 2003. Such non-cash compensation expense is currently expected to be approximately $1.5 million in the 2004 fourth quarter. These amounts primarily relate to the Company’s capital raising activities during 2001 and the new underwriting initiative started in 2001. In addition, other non-cash compensation expenses that primarily relate to incentive compensation have been included in other operating expenses and, accordingly, operating income.
Net foreign exchange losses for the 2004 third quarter of $1,787,000 consisted of net unrealized losses of $1,435,000 and net realized losses of $352,000, and net foreign exchange gains for the 2003 third quarter of
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$3,708,000 consisted of net unrealized gains of $3,212,000 and net realized gains of $496,000. Net foreign exchange losses for the nine months ended September 30, 2004 of $1,603,000 consisted of net unrealized losses of $985,000 and net realized losses of $618,000, and net foreign exchange gains for the nine months ended September 30, 2003 of $6,519,000 consisted of net unrealized gains of $4,859,000 and net realized gains of $1,660,000.
Diluted weighted average shares outstanding, which is used in the calculation of operating income and net income per share, was 5.8 million shares, or 8.5%, higher in the 2004 third quarter than in the 2003 third quarter and 4.6 million shares, or 6.7%, higher for the nine months ended September 30, 2004 than in the 2003 period. Most of the increase in diluted weighted average shares outstanding was due to the issuance of 4.7 million shares in the Company’s March 2004 stock offering. Also contributing were increases in the dilutive effects of stock options and nonvested restricted stock calculated using the treasury stock method. Under such method, the dilutive impact of options and nonvested stock on diluted weighted average shares outstanding fluctuates as the market price of the Company’s common shares changes. In addition, part of the increase resulted from the exercise of stock options during 2003 and 2004 and the vesting of restricted shares.
On September 16, 2004, the Company entered into an agreement (“Credit Agreement”) for a three-year $300 million unsecured revolving loan and letter of credit facility and a three-year $400 million secured letter of credit facility. Borrowings of revolving loans may be made by the Company at a variable rate based on LIBOR or an alternative base rate at the option of the Company. The $300 million unsecured revolving loan is also available for the issuance of unsecured letters of credit up to $100 million for the Company’s U.S.-based reinsurance operations. The Credit Agreement replaced the Company’s former credit agreement which provided for unsecured borrowings of up to $300 million. There were no loans outstanding under the Credit Agreement at September 30, 2004.
At September 30, 2004, the Company’s capital of $2.43 billion consisted of senior notes of $300.0 million, representing 12.4% of the total, and shareholders’ equity of $2.13 billion, representing 87.6% of the total. The increase in the Company’s capital during 2004 of $517.7 million was primarily attributable to the effects of net income for the nine months ended September 30, 2004, net proceeds from the stock offering in March 2004 and the net increase in debt outstanding as a result of the offering of senior notes in May 2004.
The New York Attorney General and others are investigating allegations relating to contingent commission payments, bid-rigging and other practices in the insurance industry. The Company has not been served with any subpoena or complaint in these matters. Since 2002, certain subsidiaries of the Company have entered into some placement service and market service agreements with insurance brokers under which, to date, the Company has paid a total of approximately $19.5 million. While the Company is not presently aware of any of its employees having engaged in any bid-rigging, such as alleged by the New York Attorney General in his complaint against certain brokers with respect to other insurers, the Company has engaged the law firm Cahill Gordon & Reindel LLP to conduct an internal review with respect to these issues as a proactive measure.
The Company will hold a conference call for investors and analysts at 10:00 a.m. Eastern Time on October 29, 2004. A live webcast of this call will be available via the Media-Earnings Webcasts section of the Company’s website at http://www.archcapgroup.bm and will be archived on the website from 12:00 p.m. Eastern Time on October 29 through midnight Eastern Time on November 29, 2004. A telephone replay of the conference call also will be available beginning on October 29 at 12:00 p.m. Eastern Time until November 5 at midnight Eastern Time. To access the replay, domestic callers should dial 888-286-8010 (passcode 74029112), and international callers should dial 617-801-6888 (passcode 74029112).
Arch Capital Group Ltd., a Bermuda-based company with over $2.4 billion in capital, provides insurance and reinsurance on a worldwide basis through its wholly owned subsidiaries.
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Cautionary Note Regarding Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. This release or any other written or oral statements made by or on behalf of the Company may include forward-looking statements, which reflect the Company’s current views with respect to future events and financial performance. All statements other than statements of historical fact included in this release are forward-looking statements. Forward-looking statements can generally be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “believe” or “continue” or their negative or variations or similar terminology.
Forward-looking statements involve the Company’s current assessment of risks and uncertainties. Actual events and results may differ materially from those expressed or implied in these statements. Important factors that could cause actual events or results to differ materially from those indicated in such statements are discussed below and elsewhere in this release and in the Company’s periodic reports filed with the Securities and Exchange Commission (the “SEC”), and include:
• | the Company’s ability to successfully implement its business strategy during “soft” as well as “hard” markets; |
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• | acceptance of the Company’s business strategy, security and financial condition by rating agencies and regulators, as well as by brokers and the Company’s insureds and reinsureds; |
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• | the Company’s ability to maintain or improve its ratings, which may be affected by the Company’s ability to raise additional equity or debt financings, as well as other factors described herein; |
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• | general economic and market conditions (including inflation, interest rates and foreign currency exchange rates) and conditions specific to the reinsurance and insurance markets in which the Company operates; |
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• | competition, including increased competition, on the basis of pricing, capacity, coverage terms or other factors; |
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• | the Company’s ability to successfully integrate new management and operating personnel and to establish and maintain operating procedures (including the implementation of improved computerized systems and programs to replace and support manual systems) to effectively support its underwriting initiatives and to develop accurate actuarial data, especially in the light of the rapid growth of the Company’s business; |
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• | the loss of key personnel; |
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• | the integration of businesses the Company has acquired or may acquire into its existing operations; |
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• | accuracy of those estimates and judgments utilized in the preparation of the Company’s financial statements, including those related to revenue recognition, insurance and other reserves, reinsurance recoverables, investment valuations, intangible assets, bad debts, income taxes, contingencies and litigation, for a relatively new insurance and reinsurance company, like the Company, are even more difficult to make than those made in a mature company since very limited historical information has been reported to the Company through September 30, 2004; |
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• | greater than expected loss ratios on business written by the Company and adverse development on claim and/or claim expense liabilities related to business written by the Company’s insurance and reinsurance subsidiaries; |
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• | severity and/or frequency of losses; |
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• | claims for natural or man-made catastrophic events in the Company’s insurance or reinsurance business could cause large losses and substantial volatility in the Company’s results of operations; |
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• | acts of terrorism, political unrest and other hostilities or other unforecasted and unpredictable events; |
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• | losses relating to aviation business and business produced by a certain managing underwriting agency for which the Company may be liable to the purchaser of the Company’s prior reinsurance business or to others in connection with the May 5, 2000 asset sale described in the Company’s periodic reports filed with the SEC; |
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• | availability to the Company of reinsurance to manage its gross and net exposures and the cost of such reinsurance; |
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• | the failure of reinsurers, managing general agents or others to meet their obligations to the Company; |
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• | the timing of loss payments being faster or the receipt of reinsurance recoverables being slower than anticipated by the Company; |
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• | changes in accounting principles or the application of such principles by accounting firms or regulators; |
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• | statutory or regulatory developments, including as to tax policy and matters and insurance and other regulatory matters (such as the adoption of proposed legislation that would affect Bermuda-headquartered companies and/or Bermuda-based insurers or reinsurers); and |
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• | rating agency policies and practices. |
In addition, other general factors could affect the Company’s results, including: (a) developments in the world’s financial and capital markets and the Company’s access to such markets; (b) changes in regulation or tax laws applicable to the Company, its subsidiaries, brokers or customers, including, without limitation, any such changes resulting from the recent investigations and inquiries by the New York Attorney General and others relating to the insurance brokerage industry and any attendant litigation; and (c) the effects of business disruption or economic contraction due to terrorism or other hostilities.
All subsequent written and oral forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by these cautionary statements. The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with other cautionary statements that are included herein or elsewhere. The Company undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.
Comment on Regulation G
Throughout this release, the Company presents its operations in the way it believes will be the most meaningful and useful to investors, analysts, rating agencies and others who use the Company’s financial information in evaluating the performance of the Company. This presentation includes the use of operating income, which is defined as net income or loss before extraordinary items, excluding net realized gains or losses, net foreign exchange gains or losses, other income or loss, reversal of deferred tax asset valuation allowances and non-cash compensation, net of income taxes. The Company believes that net realized gains or losses, net foreign exchange gains or losses, other income or loss, reversal of deferred tax asset valuation allowances and non-cash compensation for any particular period are not indicative of the performance of, or trends in, the Company’s business performance. This presentation is a “non-GAAP financial measure” as defined in Regulation G. The reconciliation of such measure to net income (the most directly comparable GAAP financial measure) in accordance with Regulation G is included on page 2 of this release.
Extraordinary items have been excluded from the non-GAAP financial measure due to their non-recurring nature. In addition, although net realized gains or losses and net foreign exchange gains or losses are an integral part of the Company’s operations, the decision to realize investment gains or losses and the recognition of foreign exchange gains or losses are independent of the insurance underwriting process and result, in large part,
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from general economic and financial market conditions. Furthermore, certain users of the Company’s financial information believe that, for many companies, the timing of the realization of investment gains or losses is largely opportunistic, and, under applicable GAAP accounting, losses on the Company’s investments can be realized as the result of other-than-temporary declines in value without actual realization. Due to these reasons, the Company excludes net realized gains or losses and net foreign exchange gains or losses from the calculation of operating income. Other income or loss is generated by certain of the Company’s privately held securities which are accounted for under the equity method of accounting and, for the nine months ended September 30, 2004, the one-time write down of the carrying value of the Company’s merchant banking subsidiary, Hales & Company Inc., which was sold in October 2004. Under equity method accounting, the Company records a proportionate share of the investee company’s net income or loss based on its ownership percentage in such investment. As this is a non-cash item which fluctuates based on the underlying results of the investee companies, the Company excludes other income from the calculation of operating income. With respect to non-cash compensation, since these charges, in large part, relate to the Company’s capital raising activities during 2001 and the new underwriting initiative, the Company has excluded such charges from operating income. Non-cash compensation also does not have any impact on the Company’s shareholders’ equity.
The Company believes that showing net income exclusive of the items referred to above reflects the underlying fundamentals of the Company’s business since the Company evaluates the performance of and manages its business to produce an underwriting profit. In addition to presenting net income, the Company believes that this presentation enables investors and other users of the Company’s financial information to analyze the Company’s performance in a manner similar to how the Company’s management analyzes performance. The Company also believes that this measure follows industry practice and, therefore, allows the users of the Company’s financial information to compare the Company’s performance with its industry peer group. The Company believes that the equity analysts and certain rating agencies who follow the Company and the insurance industry as a whole exclude these items from their analyses for the same reasons.
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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(U.S. dollars in thousands, except share data)
| | (Unaudited) | | (Unaudited) | |
| | Three Months Ended
September 30, | | Nine Months Ended
September 30, | |
| | 2004 | | 2003 | | 2004 | | 2003 | |
Revenues | | | | | | | | | |
Net premiums written | | $ | 743,229 | | $ | 774,167 | | $ | 2,304,463 | | $ | 2,111,032 | |
Increase in unearned premiums | | (7,821 | ) | (165,211 | ) | (137,830 | ) | (588,769 | ) |
Net premiums earned | | 735,408 | | 608,956 | | 2,166,633 | | 1,522,263 | |
Net investment income | | 40,752 | | 20,542 | | 98,136 | | 58,752 | |
Net realized gains | | 13,503 | | 11,366 | | 20,083 | | 21,454 | |
Fee income | | 5,853 | | 5,489 | | 14,151 | | 16,099 | |
Other income (loss) | | 95 | | 546 | | (3,248 | ) | 2,271 | |
Total revenues | | 795,611 | | 646,899 | | 2,295,755 | | 1,620,839 | |
| | | | | | | | | |
Expenses | | | | | | | | | |
Losses and loss adjustment expenses | | 561,602 | | 391,974 | | 1,428,111 | | 986,435 | |
Acquisition expenses | | 137,480 | | 115,851 | | 427,225 | | 289,623 | |
Other operating expenses | | 70,331 | | 47,202 | | 195,579 | | 119,276 | |
Interest expense | | 6,334 | | — | | 12,350 | | — | |
Net foreign exchange losses (gains) | | 1,787 | | (3,708 | ) | 1,603 | | (6,519 | ) |
Non-cash compensation | | 2,330 | | 3,899 | | 7,724 | | 11,661 | |
Total expenses | | 779,864 | | 555,218 | | 2,072,592 | | 1,400,476 | |
| | | | | | | | | |
Income Before Income Taxes and Extraordinary Item | | 15,747 | | 91,681 | | 223,163 | | 220,363 | |
| | | | | | | | | |
Income tax (benefit) expense | | (2,282 | ) | 9,910 | | 13,397 | | 24,322 | |
| | | | | | | | | |
Income Before Extraordinary Item | | 18,029 | | 81,771 | | 209,766 | | 196,041 | |
| | | | | | | | | |
Extraordinary gain – excess of fair value of net assets acquired over cost (net of $0 income tax) | | — | | 816 | | — | | 816 | |
| | | | | | | | | |
Net Income | | $ | 18,029 | | $ | 82,587 | | $ | 209,766 | | $ | 196,857 | |
| | | | | | | | | |
Net Income Per Share Data | | | | | | | | | |
Basic: | | | | | | | | | |
Income before extraordinary item | | $ | 0.55 | | $ | 3.12 | | $ | 6.82 | | $ | 7.50 | |
Extraordinary gain | | — | | $ | 0.03 | | — | | $ | 0.03 | |
Net income | | $ | 0.55 | | $ | 3.15 | | $ | 6.82 | | $ | 7.53 | |
| | | | | | | | | |
Diluted: | | | | | | | | | |
Income before extraordinary item | | $ | 0.25 | | $ | 1.21 | | $ | 2.91 | | $ | 2.90 | |
Extraordinary gain | | — | | $ | 0.01 | | — | | $ | 0.01 | |
Net income | | $ | 0.25 | | $ | 1.22 | | $ | 2.91 | | $ | 2.91 | |
| | | | | | | | | |
Weighted Average Shares Outstanding | | | | | | | | | |
Basic | | 32,985,085 | | 26,255,775 | | 30,770,428 | | 26,153,718 | |
Diluted | | 73,547,450 | | 67,774,722 | | 72,090,798 | | 67,539,330 | |
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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(U.S. dollars in thousands, except share data)
| | (Unaudited) | | | |
| | September 30,
2004 | | December 31,
2003 | |
Assets | | | | | |
Investments: | | | | | |
Fixed maturities available for sale, at fair value (amortized cost: 2004, $5,049,129; 2003, $3,363,193) | | $ | 5,095,952 | | $ | 3,398,424 | |
Short-term investments available for sale, at fair value (amortized cost: 2004, $138,263; 2003, $228,816) | | 138,260 | | 229,348 | |
Privately held securities (cost: 2004, $17,937; 2003, $27,632) | | 23,292 | | 32,476 | |
Total investments | | 5,257,504 | | 3,660,248 | |
Cash | | 92,763 | | 56,899 | |
Accrued investment income | | 49,706 | | 30,316 | |
Premiums receivable | | 601,220 | | 477,032 | |
Funds held by reinsureds | | 203,818 | | 211,944 | |
Unpaid losses and loss adjustment expenses recoverable | | 623,317 | | 409,451 | |
Paid losses and loss adjustment expenses recoverable | | 20,231 | | 18,549 | |
Prepaid reinsurance premiums | | 260,332 | | 236,061 | |
Goodwill and intangible assets | | 31,423 | | 35,882 | |
Deferred income tax assets, net | | 43,443 | | 33,979 | |
Deferred acquisition costs, net | | 304,454 | | 275,696 | |
Other assets | | 170,317 | | 139,264 | |
Total Assets | | $ | 7,658,528 | | $ | 5,585,321 | |
| | | | | |
Liabilities | | | | | |
Reserve for losses and loss adjustment expenses | | $ | 3,229,783 | | $ | 1,951,967 | |
Unearned premiums | | 1,565,097 | | 1,402,998 | |
Reinsurance balances payable | | 126,387 | | 117,916 | |
Senior notes | | 300,000 | | — | |
Revolving credit agreement borrowings | | — | | 200,000 | |
Deposit accounting liabilities | | 55,277 | | 25,762 | |
Other liabilities | | 253,530 | | 175,949 | |
Total Liabilities | | 5,530,074 | | 3,874,592 | |
| | | | | |
Commitments and Contingencies | | | | | |
| | | | | |
Shareholders’ Equity | | | | | |
Preference shares ($0.01 par value, 50,000,000 shares authorized, issued: 2004, 37,348,150; 2003, 38,844,665) | | 373 | | 388 | |
Common shares ($0.01 par value, 200,000,000 shares authorized, issued: 2004, 34,737,693; 2003, 28,200,372) | | 347 | | 282 | |
Additional paid-in capital | | 1,555,284 | | 1,361,267 | |
Deferred compensation under share award plan | | (12,262 | ) | (15,004 | ) |
Retained earnings | | 537,729 | | 327,963 | |
Accumulated other comprehensive income, net of deferred income tax | | 46,983 | | 35,833 | |
Total Shareholders’ Equity | | 2,128,454 | | 1,710,729 | |
Total Liabilities and Shareholders’ Equity | | $ | 7,658,528 | | $ | 5,585,321 | |
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ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(U.S. dollars in thousands)
| | (Unaudited) | |
| | Nine Months Ended
September 30, | |
| | 2004 | | 2003 | |
Preference Shares | | | | | |
Balance at beginning of year | | $ | 388 | | $ | 388 | |
Converted to common shares | | (15 | ) | — | |
Balance at end of period | | 373 | | 388 | |
| | | | | |
Common Shares | | | | | |
Balance at beginning of year | | 282 | | 277 | |
Common shares issued | | 50 | | 4 | |
Converted from preference shares | | 15 | | — | |
Balance at end of period | | 347 | | 281 | |
| | | | | |
Additional Paid-in Capital | | | | | |
Balance at beginning of year | | 1,361,267 | | 1,347,165 | |
Common shares issued | | 189,542 | | 5,666 | |
Exercise of stock options | | 5,430 | | 6,068 | |
Common shares retired | | (3,019 | ) | (794 | ) |
Other | | 2,064 | | 1,227 | |
Balance at end of period | | 1,555,284 | | 1,359,332 | |
| | | | | |
Deferred Compensation Under Share Award Plan | | | | | |
Balance at beginning of year | | (15,004 | ) | (25,290 | ) |
Restricted common shares issued | | (7,395 | ) | (4,762 | ) |
Deferred compensation expense recognized | | 10,137 | | 11,973 | |
Balance at end of period | | (12,262 | ) | (18,079 | ) |
| | | | | |
Retained Earnings | | | | | |
Balance at beginning of year | | 327,963 | | 47,372 | |
Net income | | 209,766 | | 196,857 | |
Balance at end of period | | 537,729 | | 244,229 | |
| | | | | |
Accumulated Other Comprehensive Income | | | | | |
Balance at beginning of year | | 35,833 | | 41,332 | |
Change in unrealized appreciation in value of investments, net of deferred income tax | | 12,735 | | 8,756 | |
Foreign currency translation adjustments | | (1,585 | ) | — | |
Balance at end of period | | 46,983 | | 50,088 | |
| | | | | |
Total Shareholders’ Equity | | $ | 2,128,454 | | $ | 1,636,239 | |
10
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(U.S. dollars in thousands)
| | (Unaudited) | |
| | Nine Months Ended
September 30, | |
| | 2004 | | 2003 | |
| | | | | |
Comprehensive Income | | | | | |
Net income | | $ | 209,766 | | $ | 196,857 | |
Other comprehensive income, net of deferred income tax Unrealized appreciation in value of investments: | | | | | |
Unrealized holding gains arising during period | | 28,948 | | 28,071 | |
Reclassification of net realized investment gains, net of income taxes, included in net income | | (16,213 | ) | (19,315 | ) |
Foreign currency translation adjustments | | (1,585 | ) | — | |
Other comprehensive income | | 11,150 | | 8,756 | |
Comprehensive Income | | $ | 220,916 | | $ | 205,613 | |
11
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(U.S. dollars in thousands)
| | (Unaudited) | |
| | Nine Months Ended
September 30, | |
| | 2004 | | 2003 | |
Operating Activities | | | | | |
Net income | | $ | 209,766 | | $ | 196,857 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | |
Net realized gains | | (19,570 | ) | (21,454 | ) |
Other loss (income) | | 3,248 | | (2,271 | ) |
Non-cash compensation | | 11,719 | | 12,873 | |
Excess of fair value of net assets acquired over cost | | — | | (816 | ) |
Changes in: | | | | | |
Reserve for losses and loss adjustment expenses, net of unpaid losses and loss adjustment expenses recoverable | | 1,063,950 | | 820,862 | |
Unearned premiums, net of prepaid reinsurance premiums | | 137,828 | | 588,769 | |
Premiums receivable | | (124,188 | ) | (252,421 | ) |
Deferred acquisition costs, net | | (28,758 | ) | (132,810 | ) |
Funds held by reinsureds | | 8,126 | | (126,551 | ) |
Reinsurance balances payable | | 8,471 | | 21,740 | |
Accrued investment income | | (19,390 | ) | (5,986 | ) |
Paid losses and loss adjustment expenses recoverable | | (1,682 | ) | (8,441 | ) |
Deferred income tax asset | | (8,285 | ) | (1,934 | ) |
Deposit accounting liabilities | | 29,515 | | 17,903 | |
Other liabilities | | 68,202 | | 47,129 | |
Other items, net | | 13,537 | | (7,360 | ) |
Net Cash Provided By Operating Activities | | 1,352,489 | | 1,146,089 | |
| | | | | |
Investing Activities | | | | | |
Purchases of fixed maturity investments | | (5,260,351 | ) | (3,595,697 | ) |
Sales of fixed maturity investments | | 3,566,717 | | 2,099,515 | |
Sales of equity securities | | 13,332 | | 7,801 | |
Net sales of short-term investments | | 99,062 | | 134,119 | |
Acquisitions, net of cash | | — | | (11,774 | ) |
Purchases of furniture, equipment and other | | (13,809 | ) | (19,930 | ) |
Net Cash Used For Investing Activities | | (1,595,049 | ) | (1,385,966 | ) |
| | | | | |
Financing Activities | | | | | |
Proceeds from common shares issued | | 183,775 | | 4,843 | |
Proceeds from issuance of senior notes | | 296,442 | | — | |
(Repayment of) proceeds from revolving credit agreement borrowings | | (200,000 | ) | 200,000 | |
Repurchase of common shares | | (1,525 | ) | (795 | ) |
Net Cash Provided By Financing Activities | | 278,692 | | 204,048 | |
Effects of exchange rate changes on foreign currency cash | | (268 | ) | — | |
Increase (decrease) in cash | | 35,864 | | (35,829 | ) |
Cash beginning of year | | 56,899 | | 91,717 | |
Cash end of period | | $ | 92,763 | | $ | 55,888 | |
Income taxes paid, net | | $ | 25,304 | | $ | 28,399 | |
Interest paid | | $ | 1,967 | | — | |
| | | | | | | | |
12
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
SUPPLEMENTAL FINANCIAL INFORMATION
The following table provides information on the Company’s investing activities, including investment income yield (net of investment expenses), average duration and average credit quality.
| | (Unaudited) | | (Unaudited) | |
| | Three Months Ended
September 30, | | Nine Months Ended
September 30, | |
Investment income yield (at amortized cost) | | 2004 | | 2003 | | 2004 | | 2003 | |
| | | | | | | | | |
Pre-tax | | 3.2 | % | 2.8 | % | 2.9 | % | 3.0 | % |
After-tax | | 3.1 | % | 2.5 | % | 2.7 | % | 2.7 | % |
| | (Unaudited) | | | |
Fixed maturities and short-term investments | | September 30,
2004 | | December 31,
2003 | |
| | | | | |
Average duration (in years) | | 3.7 | | 2.0 | |
Average credit quality (Standard & Poors) | | AA | + | AA | + |
Average yield to maturity (book yield) | | 3.4 | % | 2.5 | % |
| | (Unaudited) | | (Unaudited) | |
�� | | Three Months Ended
September 30, | | Nine Months Ended
September 30, | |
| | 2004 | | 2003 | | 2004 | | 2003 | |
| | | | | | | | | |
Annualized operating return on average equity (1) | | NM | | 17.5 | % | 14.1 | % | 15.6 | % |
(1) Annualized operating return on average equity, a non-GAAP measure, equals annualized operating income divided by average shareholders’ equity (calculated using the beginning and ending values during the period). See “Comment on Regulation G” above. Annualized operating return on average equity based on the 2004 third quarter results is not meaningful due to the significant level of catastrophic activity in the period.
Segment Information
The Company classifies its businesses into two underwriting segments — reinsurance and insurance — and a corporate and other segment (non-underwriting). The Company’s reinsurance and insurance operating segments each have segment managers who are responsible for the overall profitability of their respective segments and who are directly accountable to the Company’s chief operating decision makers, the President and Chief Executive Officer of ACGL and the Chief Financial Officer of ACGL. The chief operating decision makers do not assess performance, measure return on equity or make resource allocation decisions on a line of business basis. The Company determined its reportable operating segments using the management approach described in SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information.”
Management measures segment performance based on underwriting income or loss. The Company does not manage its assets by segment and, accordingly, investment income is not allocated to each underwriting segment. In addition, other revenue and expense items are not evaluated by segment. The accounting policies of the segments are the same as those used for the preparation of the Company’s consolidated financial statements. Inter-segment insurance business is allocated to the segment accountable for the underwriting results.
The reinsurance segment, or division, consists of the Company’s reinsurance underwriting subsidiaries. The reinsurance segment generally seeks to write significant lines on specialty property and casualty reinsurance treaties. Classes of business include: casualty; casualty clash; marine and aviation; non-traditional; other specialty; property catastrophe; and property excluding property catastrophe (losses on a single risk, both excess of loss and pro rata).
The insurance segment, or division, consists of the Company’s insurance underwriting subsidiaries which primarily write on a direct basis. The insurance segment consists of eight product lines, including: casualty; construction and surety; executive
13
assurance; healthcare; professional liability; programs; property, marine and aviation; and other (primarily non-standard auto, collateralized protection business and certain programs).
The corporate and other segment (non-underwriting) includes net investment income, other fee income, other income or losses, other expenses incurred by the Company, net realized gains or losses, net foreign exchange gains or losses and non-cash compensation. The corporate and other segment also includes the results of the Company’s merchant banking operations.
The following tables set forth underwriting income or loss by segment, together with a reconciliation of underwriting income to net income:
| | (Unaudited) | |
| | Three Months Ended
September 30, 2004 | |
(U.S. dollars in thousands) | | Reinsurance | | Insurance | | Total | |
| | | | | | | |
Gross premiums written (1) | | $ | 412,355 | | $ | 552,608 | | $ | 927,658 | |
Net premiums written | | 394,495 | | 348,734 | | 743,229 | |
| | | | | | | |
Net premiums earned | | $ | 403,113 | | $ | 332,295 | | $ | 735,408 | |
Policy-related fee income | | — | | 4,915 | | 4,915 | |
Other underwriting-related fee income | | 184 | | 635 | | 819 | |
Losses and loss adjustment expenses | | (329,451 | ) | (232,151 | ) | (561,602 | ) |
Acquisition expenses, net | | (101,622 | ) | (35,858 | ) | (137,480 | ) |
Other operating expenses | | (11,562 | ) | (54,264 | ) | (65,826 | ) |
Underwriting (loss) income | | $ | (39,338 | ) | $ | 15,572 | | (23,766 | ) |
| | | | | | | |
Net investment income | | | | | | 40,752 | |
Net realized gains | | | | | | 13,503 | |
Other fee income, net of related expenses | | | | | | 119 | |
Other income | | | | | | 95 | |
Other expenses | | | | | | (4,505 | ) |
Interest expense | | | | | | (6,334 | ) |
Net foreign exchange losses | | | | | | (1,787 | ) |
Non-cash compensation | | | | | | (2,330 | ) |
Income before income taxes | | | | | | 15,747 | |
Income tax benefit | | | | | | 2,282 | |
| | | | | | | |
Net income | | | | | | $ | 18,029 | |
| | | | | | | |
Underwriting Ratios | | | | | | | |
Loss ratio | | 81.7 | % | 69.9 | % | 76.4 | % |
Acquisition expense ratio (2) | | 25.2 | % | 9.3 | % | 18.0 | % |
Other operating expense ratio | | 2.9 | % | 16.3 | % | 9.0 | % |
Combined ratio | | 109.8 | % | 95.5 | % | 103.4 | % |
(1) Certain amounts included in the gross premiums written of each segment are related to intersegment transactions and are included in the gross premiums written of each segment. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.
(2) The acquisition expense ratio is adjusted to include policy-related fee income.
14
| | (Unaudited) | |
| | Three Months Ended
September 30, 2003 | |
(U.S. dollars in thousands) | | Reinsurance | | Insurance | | Total | |
| | | | | | | |
Gross premiums written (1) | | $ | 411,443 | | $ | 558,863 | | $ | 928,243 | |
Net premiums written | | 397,418 | | 376,749 | | 774,167 | |
| | | | | | | |
Net premiums earned | | $ | 348,883 | | $ | 260,073 | | $ | 608,956 | |
Policy-related fee income | | — | | 3,583 | | 3,583 | |
Other underwriting-related fee income | | 1,369 | | — | | 1,369 | |
Losses and loss adjustment expenses | | (223,419 | ) | (168,555 | ) | (391,974 | ) |
Acquisition expenses, net | | (79,011 | ) | (36,840 | ) | (115,851 | ) |
Other operating expenses | | (8,862 | ) | (33,654 | ) | (42,516 | ) |
Underwriting income | | $ | 38,960 | | $ | 24,607 | | 63,567 | |
| | | | | | | |
Net investment income | | | | | | 20,542 | |
Net realized gains | | | | | | 11,366 | |
Other fee income, net of related expenses | | | | | | 537 | |
Other income | | | | | | 546 | |
Other expenses | | | | | | (4,686 | ) |
Net foreign exchange gains | | | | | | 3,708 | |
Non-cash compensation | | | | | | (3,899 | ) |
Income before income taxes and extraordinary item | | | | | | 91,681 | |
Income tax expense | | | | | | (9,910 | ) |
| | | | | | | |
Income before extraordinary item | | | | | | 81,771 | |
Extraordinary gain, net of $0 income tax | | | | | | 816 | |
| | | | | | | |
Net income | | | | | | $ | 82,587 | |
| | | | | | | |
Underwriting Ratios | | | | | | | |
Loss ratio | | 64.0 | % | 64.8 | % | 64.4 | % |
Acquisition expense ratio (2) | | 22.6 | % | 12.8 | % | 18.4 | % |
Other operating expense ratio | | 2.5 | % | 12.9 | % | 7.0 | % |
Combined ratio | | 89.1 | % | 90.5 | % | 89.8 | % |
(1) Certain amounts included in the gross premiums written of each segment are related to intersegment transactions and are included in the gross premiums written of each segment. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.
(2) The acquisition expense ratio is adjusted to include policy-related fee income.
15
| | (Unaudited)
Nine Months Ended
September 30, 2004 | |
(U.S. dollars in thousands) | | Reinsurance | | Insurance | | Total | |
| | | | | | | |
Gross premiums written (1) | | $ | 1,361,081 | | $ | 1,499,693 | | $ | 2,753,769 | |
Net premiums written | | 1,309,654 | | 994,809 | | 2,304,463 | |
| | | | | | | |
Net premiums earned | | $ | 1,165,037 | | $ | 1,001,596 | �� | $ | 2,166,633 | |
Policy-related fee income | | — | | 12,308 | | 12,308 | |
Other underwriting-related fee income | | 560 | | 1,059 | | 1,619 | |
Losses and loss adjustment expenses | | (767,747 | ) | (660,364 | ) | (1,428,111 | ) |
Acquisition expenses, net | | (307,015 | ) | (120,210 | ) | (427,225 | ) |
Other operating expenses | | (31,213 | ) | (152,047 | ) | (183,260 | ) |
Underwriting income | | $ | 59,622 | | $ | 82,342 | | 141,964 | |
| | | | | | | |
Net investment income | | | | | | 98,136 | |
Net realized gains | | | | | | 20,083 | |
Other fee income, net of related expenses | | | | | | 224 | |
Other income (loss) | | | | | | (3,248 | ) |
Other expenses | | | | | | (12,319 | ) |
Interest expense | | | | | | (12,350 | ) |
Net foreign exchange losses | | | | | | (1,603 | ) |
Non-cash compensation | | | | | | (7,724 | ) |
Income before income taxes | | | | | | 223,163 | |
Income tax expense | | | | | | (13,397 | ) |
| | | | | | | |
Net income | | | | | | $ | 209,766 | |
| | | | | | | |
Underwriting Ratios | | | | | | | |
Loss ratio | | 65.9 | % | 65.9 | % | 65.9 | % |
Acquisition expense ratio (2) | | 26.4 | % | 10.8 | % | 19.2 | % |
Other operating expense ratio | | 2.7 | % | 15.2 | % | 8.5 | % |
Combined ratio | | 95.0 | % | 91.9 | % | 93.6 | % |
(1) Certain amounts included in the gross premiums written of each segment are related to intersegment transactions and are included in the gross premiums written of each segment. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.
(2) The acquisition expense ratio is adjusted to include policy-related fee income.
16
| | (Unaudited)
Nine Months Ended
September 30, 2003 | |
(U.S. dollars in thousands) | | Reinsurance | | Insurance | | Total | |
| | | | | | | |
Gross premiums written (1) | | $ | 1,311,142 | | $ | 1,283,776 | | $ | 2,464,348 | |
Net premiums written | | 1,268,374 | | 842,658 | | 2,111,032 | |
| | | | | | | |
Net premiums earned | | $ | 932,334 | | $ | 589,929 | | $ | 1,522,263 | |
Policy-related fee income | | — | | 10,358 | | 10,358 | |
Other underwriting-related fee income | | 5,097 | | — | | 5,097 | |
Losses and loss adjustment expenses | | (591,131 | ) | (395,304 | ) | (986,435 | ) |
Acquisition expenses, net | | (217,379 | ) | (72,244 | ) | (289,623 | ) |
Other operating expenses | | (22,644 | ) | (86,145 | ) | (108,789 | ) |
Underwriting income | | $ | 106,277 | | $ | 46,594 | | 152,871 | |
| | | | | | | |
Net investment income | | | | | | 58,752 | |
Net realized gains | | | | | | 21,454 | |
Other fee income, net of related expenses | | | | | | 644 | |
Other income | | | | | | 2,271 | |
Other expenses | | | | | | (10,487 | ) |
Net foreign exchange gains | | | | | | 6,519 | |
Non-cash compensation | | | | | | (11,661 | ) |
Income before income taxes and extraordinary item | | | | | | 220,363 | |
Income tax expense | | | | | | (24,322 | ) |
| | | | | | | |
Income before extraordinary item | | | | | | 196,041 | |
Extraordinary gain, net of $0 income tax | | | | | | 816 | |
| | | | | | | |
Net income | | | | | | $ | 196,857 | |
| | | | | | | |
Underwriting Ratios | | | | | | | |
Loss ratio | | 63.4 | % | 67.0 | % | 64.8 | % |
Acquisition expense ratio (2) | | 23.3 | % | 10.5 | % | 18.3 | % |
Other operating expense ratio | | 2.4 | % | 14.6 | % | 7.1 | % |
Combined ratio | | 89.1 | % | 92.1 | % | 90.2 | % |
(1) Certain amounts included in the gross premiums written of each segment are related to intersegment transactions and are included in the gross premiums written of each segment. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total.
(2) The acquisition expense ratio is adjusted to include policy-related fee income.
17
The following tables set forth the reinsurance segment’s net premiums written and earned by major line of business and type of business, together with net premiums written by client location:
| | (Unaudited)
Three Months Ended
September 30, | |
| | 2004 | | 2003 | |
REINSURANCE SEGMENT
(U.S. dollars in thousands) | | Amount | | % of
Total | | Amount | | % of
Total | |
| | | | | | | | | |
Net premiums written | | | | | | | | | |
Casualty | | $ | 222,448 | | 56.4 | % | $ | 174,945 | | 44.0 | % |
Property excluding property catastrophe | | 57,943 | | 14.7 | % | 76,996 | | 19.4 | % |
Other specialty | | 51,792 | | 13.1 | % | 107,638 | | 27.1 | % |
Marine and aviation | | 23,263 | | 5.9 | % | 14,548 | | 3.7 | % |
Property catastrophe | | 23,052 | | 5.8 | % | 21,872 | | 5.5 | % |
Non-traditional | | 13,692 | | 3.5 | % | (231 | ) | (0.1 | )% |
Casualty clash | | 2,305 | | 0.6 | % | 1,650 | | 0.4 | % |
Total | | $ | 394,495 | | 100.0 | % | $ | 397,418 | | 100.0 | % |
| | | | | | | | | |
Net premiums earned | | | | | | | | | |
Casualty | | $ | 212,371 | | 52.7 | % | $ | 123,840 | | 35.5 | % |
Property excluding property catastrophe | | 68,654 | | 17.0 | % | 81,645 | | 23.4 | % |
Other specialty | | 64,047 | | 15.9 | % | 83,984 | | 24.1 | % |
Marine and aviation | | 26,195 | | 6.5 | % | 18,333 | | 5.2 | % |
Property catastrophe | | 23,357 | | 5.8 | % | 24,408 | | 7.0 | % |
Non-traditional | | 5,320 | | 1.3 | % | 14,010 | | 4.0 | % |
Casualty clash | | 3,169 | | 0.8 | % | 2,663 | | 0.8 | % |
Total | | $ | 403,113 | | 100.0 | % | $ | 348,883 | | 100.0 | % |
| | | | | | | | | |
Net premiums written | | | | | | | | | |
Pro rata | | $ | 288,349 | | 73.1 | % | $ | 324,839 | | 81.7 | % |
Excess of loss | | 106,146 | | 26.9 | % | 72,579 | | 18.3 | % |
Total | | $ | 394,495 | | 100.0 | % | $ | 397,418 | | 100.0 | % |
| | | | | | | | | |
Net premiums earned | | | | | | | | | |
Pro rata | | $ | 298,309 | | 74.0 | % | $ | 256,766 | | 73.6 | % |
Excess of loss | | 104,804 | | 26.0 | % | 92,117 | | 26.4 | % |
Total | | $ | 403,113 | | 100.0 | % | $ | 348,883 | | 100.0 | % |
| | | | | | | | | |
Net premiums written by client location | | | | | | | | | |
North America | | $ | 219,842 | | 55.7 | % | $ | 233,577 | | 58.8 | % |
Europe | | 86,769 | | 22.0 | % | 124,435 | | 31.3 | % |
Bermuda | | 66,515 | | 16.9 | % | 26,711 | | 6.7 | % |
Asia and Pacific | | 5,099 | | 1.3 | % | 1,273 | | 0.3 | % |
Other | | 16,270 | | 4.1 | % | 11,422 | | 2.9 | % |
Total | | $ | 394,495 | | 100.0 | % | $ | 397,418 | | 100.0 | % |
18
| | (Unaudited)
Nine Months Ended
September 30, | |
| | 2004 | | 2003 | |
REINSURANCE SEGMENT
(U.S. dollars in thousands) | | Amount | | % of
Total | | Amount | | % of
Total | |
| | | | | | | | | |
Net premiums written | | | | | | | | | |
Casualty | | $ | 674,624 | | 51.5 | % | $ | 480,769 | | 37.9 | % |
Property excluding property catastrophe | | 232,519 | | 17.8 | % | 258,844 | | 20.4 | % |
Other specialty | | 200,323 | | 15.3 | % | 311,579 | | 24.6 | % |
Property catastrophe | | 94,276 | | 7.2 | % | 93,982 | | 7.4 | % |
Marine and aviation | | 65,973 | | 5.0 | % | 60,318 | | 4.8 | % |
Non-traditional | | 31,171 | | 2.4 | % | 51,352 | | 4.0 | % |
Casualty clash | | 10,768 | | 0.8 | % | 11,530 | | 0.9 | % |
Total | | $ | 1,309,654 | | 100.0 | % | $ | 1,268,374 | | 100.0 | % |
| | | | | | | | | |
Net premiums earned | | | | | | | | | |
Casualty | | $ | 554,724 | | 47.6 | % | $ | 314,448 | | 33.7 | % |
Other specialty | | 223,962 | | 19.2 | % | 204,572 | | 21.9 | % |
Property excluding property catastrophe | | 210,329 | | 18.1 | % | 213,396 | | 22.9 | % |
Property catastrophe | | 73,968 | | 6.4 | % | 81,653 | | 8.8 | % |
Marine and aviation | | 68,658 | | 5.9 | % | 55,604 | | 6.0 | % |
Non-traditional | | 24,842 | | 2.1 | % | 52,461 | | 5.6 | % |
Casualty clash | | 8,554 | | 0.7 | % | 10,200 | | 1.1 | % |
Total | | $ | 1,165,037 | | 100.0 | % | $ | 932,334 | | 100.0 | % |
| | | | | | | | | |
Net premiums written | | | | | | | | | |
Pro rata | | $ | 899,767 | | 68.7 | % | $ | 882,379 | | 69.6 | % |
Excess of loss | | 409,887 | | 31.3 | % | 385,995 | | 30.4 | % |
Total | | $ | 1,309,654 | | 100.0 | % | $ | 1,268,374 | | 100.0 | % |
| | | | | | | | | |
Net premiums earned | | | | | | | | | |
Pro rata | | $ | 862,531 | | 74.0 | % | $ | 635,974 | | 68.2 | % |
Excess of loss | | 302,506 | | 26.0 | % | 296,360 | | 31.8 | % |
Total | | $ | 1,165,037 | | 100.0 | % | $ | 932,334 | | 100.0 | % |
| | | | | | | | | |
Net premiums written by client location | | | | | | | | | |
North America | | $ | 800,581 | | 61.1 | % | $ | 785,006 | | 61.9 | % |
Europe | | 323,450 | | 24.7 | % | 355,099 | | 28.0 | % |
Bermuda | | 129,922 | | 9.9 | % | 75,008 | | 5.9 | % |
Asia and Pacific | | 22,970 | | 1.8 | % | 23,796 | | 1.9 | % |
Other | | 32,731 | | 2.5 | % | 29,465 | | 2.3 | % |
Total | | $ | 1,309,654 | | 100.0 | % | $ | 1,268,374 | | 100.0 | % |
| | | | | | | | | | | | | | | | |
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The following tables set forth the insurance segment’s net premiums written and earned by major line of business and type of business, together with net premiums written by client location:
| | (Unaudited)
Three Months Ended
September 30, | |
| | 2004 | | 2003 | |
INSURANCE SEGMENT
(U.S. dollars in thousands) | | Amount | | % of
Total | | Amount | | % of
Total | |
| | | | | | | | | |
Net premiums written | | | | | | | | | |
Casualty | | $ | 67,250 | | 19.3 | % | $ | 68,788 | | 18.3 | % |
Programs | | 62,327 | | 17.9 | % | 116,172 | | 30.8 | % |
Property, marine and aviation | | 48,886 | | 14.0 | % | 42,770 | | 11.3 | % |
Construction and surety | | 45,799 | | 13.1 | % | 53,374 | | 14.2 | % |
Professional liability | | 45,763 | | 13.1 | % | 28,850 | | 7.7 | % |
Executive assurance | | 31,342 | | 9.0 | % | 34,817 | | 9.2 | % |
Healthcare | | 18,036 | | 5.2 | % | 9,855 | | 2.6 | % |
Other | | 29,331 | | 8.4 | % | 22,123 | | 5.9 | % |
Total | | $ | 348,734 | | 100.0 | % | $ | 376,749 | | 100.0 | % |
| | | | | | | | | |
Net premiums earned | | | | | | | | | |
Programs | | $ | 72,239 | | 21.7 | % | $ | 81,712 | | 31.4 | % |
Casualty | | 57,687 | | 17.4 | % | 46,660 | | 17.9 | % |
Professional liability | | 45,406 | | 13.7 | % | 21,428 | | 8.2 | % |
Construction and surety | | 45,264 | | 13.6 | % | 25,672 | | 9.9 | % |
Property, marine and aviation | | 39,446 | | 11.9 | % | 27,730 | | 10.7 | % |
Executive assurance | | 29,873 | | 9.0 | % | 24,380 | | 9.4 | % |
Healthcare | | 14,676 | | 4.4 | % | 10,900 | | 4.2 | % |
Other | | 27,704 | | 8.3 | % | 21,591 | | 8.3 | % |
Total | | $ | 332,295 | | 100.0 | % | $ | 260,073 | | 100.0 | % |
| | | | | | | | | |
Net premiums written by client location | | | | | | | | | |
North America | | $ | 338,029 | | 96.9 | % | $ | 368,308 | | 97.8 | % |
Other | | 10,705 | | 3.1 | % | 8,441 | | 2.2 | % |
Total | | $ | 348,734 | | 100.0 | % | $ | 376,749 | | 100.0 | % |
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| | (Unaudited)
Nine Months Ended
September 30, | |
| | 2004 | | 2003 | |
INSURANCE SEGMENT
(U.S. dollars in thousands) | | Amount | | % of
Total | | Amount | | % of
Total | |
| | | | | | | | | |
Net premiums written | | | | | | | | | |
Programs | | $ | 244,304 | | 24.6 | % | $ | 263,748 | | 31.3 | % |
Casualty | | 183,509 | | 18.5 | % | 169,115 | | 20.1 | % |
Professional liability | | 125,814 | | 12.6 | % | 77,538 | | 9.2 | % |
Property, marine and aviation | | 114,409 | | 11.5 | % | 77,511 | | 9.2 | % |
Construction and surety | | 111,787 | | 11.2 | % | 95,588 | | 11.3 | % |
Executive assurance | | 89,357 | | 9.0 | % | 80,583 | | 9.6 | % |
Healthcare | | 41,830 | | 4.2 | % | 24,656 | | 2.9 | % |
Other | | 83,799 | | 8.4 | % | 53,919 | | 6.4 | % |
Total | | $ | 994,809 | | 100.0 | % | $ | 842,658 | | 100.0 | % |
| | | | | | | | | |
Net premiums earned | | | | | | | | | |
Programs | | $ | 262,806 | | 26.2 | % | $ | 182,872 | | 31.0 | % |
Casualty | | 170,028 | | 17.0 | % | 108,671 | | 18.4 | % |
Construction and surety | | 136,436 | | 13.6 | % | 51,402 | | 8.7 | % |
Professional liability | | 117,822 | | 11.8 | % | 44,555 | | 7.6 | % |
Property, marine and aviation | | 107,800 | | 10.8 | % | 57,349 | | 9.7 | % |
Executive assurance | | 92,284 | | 9.2 | % | 59,509 | | 10.1 | % |
Healthcare | | 38,342 | | 3.8 | % | 26,797 | | 4.5 | % |
Other | | 76,078 | | 7.6 | % | 58,774 | | 10.0 | % |
Total | | $ | 1,001,596 | | 100.0 | % | $ | 589,929 | | 100.0 | % |
| | | | | | | | | |
Net premiums written by client location | | | | | | | | | |
North America | | $ | 965,939 | | 97.1 | % | $ | 825,939 | | 98.0 | % |
Other | | 28,870 | | 2.9 | % | 16,719 | | 2.0 | % |
Total | | $ | 994,809 | | 100.0 | % | $ | 842,658 | | 100.0 | % |
| | | | | | | | | | | | | |
Discussion of 2004 Third Quarter Performance
The reinsurance division incurred an underwriting loss of $39.3 million for the 2004 third quarter, compared to underwriting income of $39.0 million for the 2003 third quarter. The combined ratio for the reinsurance division was 109.8% for the 2004 third quarter, compared to 89.1% for the 2003 third quarter. The reinsurance division incurred estimated pre-tax net losses, after reinsurance, related to Hurricanes Charley, Frances, Ivan and Jeanne and Typhoon Songda of $111.7 million in the 2004 third quarter. Before reinsurance, such estimated losses were $143.4 million.
Gross premiums written for the reinsurance division were $412.4 million for the 2004 third quarter, compared to $411.4 million for the 2003 third quarter, as increases in international casualty, U.S. regional property and non-traditional business were partially offset by decreases in other specialty and non-U.S. property business . Net premiums earned for the reinsurance division increased to $403.1 million for the 2004 third quarter, compared to $348.9 million for the 2003 third quarter, reflecting an increased contribution from casualty business. Net premiums earned reflect period to period changes in net premiums written, including the mix and type of business.
The reinsurance division’s loss ratio was 81.7% for the 2004 third quarter, compared to 64.0% for the 2003 third quarter. The loss ratio for the 2004 third quarter reflects $109.9 million related to the catastrophic activity noted above, compared to approximately $19.9 million in losses related to catastrophic activity in the 2003 third quarter. The net increase in catastrophic activity in the 2004 third quarter accounts for 22.3 points of the increase in the 2004 third quarter loss ratio. The loss ratio for the 2004 third quarter also reflects estimated net favorable development in prior year reserves of $13.1 million, or a 3.3 point reduction in the loss ratio.
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In addition, in its reserving process in 2002 and 2003, the reinsurance division recognized that there is a possibility that the assumptions made could prove to be inaccurate due to several factors primarily related to the start up nature of its operations. Due to the availability of additional data, and based on reserve analyses, the reinsurance division determined that it was no longer necessary to continue to include such factors in the reserving process. This resulted in a decline of 1.3 points in the loss ratio from the 2003 third quarter to the 2004 third quarter.
The reinsurance division’s acquisition expense ratio for the 2004 third quarter was 25.2%, compared to 22.6% for the 2003 third quarter. The increase was primarily due to movements in the reinsurance division’s non-traditional business. The other operating expense ratio increased to 2.9% for the 2004 third quarter, compared to 2.5% for the 2003 third quarter, reflecting additional expenses incurred in 2004 as a result of the continued development of the reinsurance division’s operating platform.
The insurance division’s underwriting income was $15.6 million for the 2004 third quarter, compared to $24.6 million for the 2003 third quarter. The insurance division’s combined ratio was 95.5% for the 2004 third quarter, compared to 90.5% for the 2003 third quarter. The insurance division incurred estimated pre-tax net losses, after reinsurance, related to Hurricanes Charley, Frances, Ivan and Jeanne of $40.2 million in the 2004 third quarter. Before reinsurance, such losses were estimated at $89.4 million.
Gross premiums written for the insurance division were $552.6 million for the 2004 third quarter, compared to $558.9 million for the 2003 third quarter. Net premiums written for the insurance division were $348.7 million for the 2004 third quarter, compared to $376.7 million for the 2003 third quarter. The decrease in net premiums written in the 2004 third quarter was primarily due to a reduction in program business in 2004 as a result of the non-renewal of certain programs. In addition, decreases in the insurance division’s executive assurance and the excess casualty component of its casualty business were in response to market conditions while construction and surety volume was down due to the elimination of a distribution arrangement in 2004. Such decreases were offset by continued growth in the primary casualty and property, marine and aviation lines. The insurance division entered into a reinsurance agreement to cede 30% of certain program business with effective dates subsequent to March 31, 2004, which reduced 2004 third quarter net premiums written by $6.2 million. Net premiums earned for the insurance division increased to $332.3 million for the 2004 third quarter, compared to $260.1 million for the 2003 third quarter. Net premiums earned reflect period to period changes in net premiums written, including the mix of business.
The insurance division’s loss ratio for the 2004 third quarter was 69.9%, compared to 64.8% for the 2003 third quarter. The loss ratio for the 2004 third quarter reflects $40.2 million, or a 12.1 point increase in the loss ratio, related to the hurricane activity noted above, partially offset by estimated net favorable development in prior year reserves of $7.8 million, or a 2.3 point reduction in the loss ratio. The remainder of the change in the loss ratio compared to the 2003 third quarter primarily resulted from better experience in the portion of our property business not impacted by catastrophic activity.
The acquisition expense ratio for the insurance division is calculated net of certain policy-related fee income and is influenced by, among other things, (1) the amount of ceding commissions received from unaffiliated reinsurers and (2) the amount of business written on a surplus lines (non-admitted) basis. The acquisition expense ratio was 9.3% for the 2004 third quarter (net of 1.5 points of policy-related fee income), compared to 12.8% for the 2003 third quarter (net of 1.4 points of policy-related fee income). The acquisition expense ratio in the 2004 third quarter decreased from the 2003 third quarter as the percentage of ceded business was higher in the 2004 period and the contribution of program business (which operates at a higher acquisition expense ratio) was lower in the 2004 period. The insurance division’s other operating expense ratio for the 2004 third quarter was 16.3%, compared to 12.9% for the 2003 third quarter, reflecting additional expenses incurred in 2004 as a result of the continued development of the insurance division’s operating platform.
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Calculation of Book Value Per Share
The following book value per share calculations are based on shareholders’ equity of $2.13 billion and $1.71 billion at September 30, 2004 and December 31, 2003, respectively. The shares and per share numbers set forth below exclude the effects of stock options and Class B warrants.
| | (Unaudited) | | | | | |
| | September 30, 2004 | | December 31, 2003 | |
| | Outstanding
Shares | | Cumulative
Book Value
Per Share | | Outstanding
Shares | | Cumulative
Book Value
Per Share | |
Common shares (1) | | 34,737,693 | | $ | 38.69 | | 28,200,372 | | $ | 31.74 | |
Series A convertible preference shares | | 37,348,150 | | | | 38,844,665 | | | |
Total | | 72,085,843 | | $ | 29.53 | | 67,045,037 | | $ | 25.52 | |
(1) Book value per common share at September 30, 2004 and December 31, 2003 was determined by dividing (i) the difference between total shareholders’ equity and the aggregate liquidation preference of the Series A convertible preference shares of $784.3 million and $815.7 million, respectively, by (ii) the number of common shares outstanding. Restricted common shares are included in the number of common shares outstanding as if such shares were issued on the date of grant.
Pursuant to the subscription agreement entered into in connection with the November 2001 capital infusion (the “Subscription Agreement”), in November 2005, there will be a calculation of a final adjustment basket based on (1) liabilities owed to Folksamerica (if any) under the Asset Purchase Agreement, dated as of January 10, 2000, between the Company and Folksamerica, and (2) specified tax and ERISA matters under the Subscription Agreement.
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