SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR QUARTERLY PERIOD ENDED JUNE 30, 2004
COMMISSION FILE NUMBER 1-9371
ALLEGHANY CORPORATION
----------------------------------------------------
EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER
DELAWARE
------------------------------------------------------------
STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION
51-0283071
-------------------------------------------------------
INTERNAL REVENUE SERVICE EMPLOYER IDENTIFICATION NUMBER
375 PARK AVENUE, NEW YORK NY 10152
---------------------------------------------------------
ADDRESS OF PRINCIPAL EXECUTIVE OFFICE, INCLUDING ZIP CODE
212-752-1356
--------------------------------------------------
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE
NOT APPLICABLE
--------------------------------------------------------------------------
FORMER NAME, FORMER ADDRESS, AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST
REPORT
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS.
YES [X] NO [ ]
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED IN RULE 12B-2 OF THE EXCHANGE ACT).
YES [X] NO [ ]
INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF
COMMON STOCK, AS OF THE LAST PRACTICABLE DATE.
7,675,313 SHARES AS OF JULY 31, 2004
ITEM 1. FINANCIAL STATEMENTS
ALLEGHANY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE THREE MONTHS ENDED
JUNE 30, 2004 AND 2003
(dollars in thousands, except share and per share amounts)
(unaudited)
2004 2003
---------- ----------
REVENUES
Net fastener sales $ 43,577 $ 27,292
Interest, dividend and other income 11,667 13,111
Net insurance premiums earned 203,215 33,525
Net mineral and filtration sales 71,246 68,860
Net gain on investment transactions 4,352 1,578
---------- ----------
Total revenues 334,057 144,366
---------- ----------
COSTS AND EXPENSES
Underwriting expenses 42,750 14,921
Salaries, administrative and other operating expenses 25,930 19,978
Loss and loss adjustment expenses 92,016 19,815
Cost of goods sold - fasteners 32,435 20,809
Cost of mineral and filtration sales 55,065 52,201
Interest expense 1,315 1,468
Corporate administration 10,092 6,483
---------- ----------
Total costs and expenses 259,603 135,675
---------- ----------
Earnings before income taxes 74,454 8,691
Income taxes 25,731 2,695
---------- ----------
Net earnings $ 48,723 $ 5,996
========== ==========
Basic earnings per share of common stock ** $ 6.35 $ 0.79
========== ==========
Diluted earnings per share of common stock ** $ 6.33 $ 0.79
========== ==========
Dividends per share of common stock * *
========== ==========
Average number of outstanding shares of common stock ** 7,670,297 7,582,105
========== ==========
* In March 2003 and 2004, Alleghany declared a stock dividend consisting of
one share of Alleghany common stock for every fifty shares outstanding.
** Adjusted to reflect the common stock dividend declared in March 2004.
See Notes to Consolidated Financial Statements.
ALLEGHANY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE SIX MONTHS ENDED
JUNE 30, 2004 AND 2003
(dollars in thousands, except share and per share amounts)
(unaudited)
2004 2003
---------- ----------
REVENUES
Net fastener sales $ 81,380 $ 55,245
Interest, dividend and other income 28,019 25,091
Net insurance premiums earned 392,883 66,940
Net mineral and filtration sales 138,327 130,908
Net gain on investment transactions 37,535 4,842
---------- ----------
Total revenues 678,144 283,026
---------- ----------
COSTS AND EXPENSES
Underwriting expenses 84,388 28,283
Salaries, administrative and other operating expenses 50,173 37,584
Loss and loss adjustment expenses 185,114 39,668
Cost of goods sold - fasteners 60,341 41,568
Cost of mineral and filtration sales 106,443 100,121
Interest expense 2,559 2,746
Corporate administration 18,894 12,783
---------- ----------
Total costs and expenses 507,912 262,753
---------- ----------
Earnings before income taxes 170,232 20,273
Income taxes 59,445 6,553
---------- ----------
Net earnings $ 110,787 $ 13,720
========== ==========
Basic earnings per share of common stock ** $ 14.46 $ 1.81
========== ==========
Diluted earnings per share of common stock ** $ 14.40 $ 1.80
========== ==========
Dividends per share of common stock * *
========== ==========
Average number of outstanding shares of common stock ** 7,661,002 7,571,762
========== ==========
* In March 2003 and 2004, Alleghany declared a stock dividend consisting of
one share of Alleghany common stock for every fifty shares outstanding.
** Adjusted to reflect the common stock dividend declared in March 2004.
See Notes to Consolidated Financial Statements.
ALLEGHANY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 2004 AND DECEMBER 31, 2003
(dollars in thousands, except share amounts)
JUNE 30,
2004 DECEMBER 31,
(UNAUDITED) 2003 *
---------- ----------
ASSETS
Available for sale securities at fair value: 6/30/2004 12/31/2003
--------- ----------
Equity securities (cost: $322,971 $370,982) $ 594,206 $ 620,754
Debt securities (cost: $1,235,530 $910,307) 1,219,710 917,270
Short term investments 168,102 135,079
---------- ----------
1,982,018 1,673,103
Cash 166,098 231,583
Notes receivable 91,804 92,082
Accounts receivable, net 74,369 75,154
Premium balances receivable 192,486 279,682
Reinsurance receivables 323,856 228,423
Ceded unearned premium reserves 336,188 264,038
Deferred acquisition costs 56,271 47,282
Property and equipment-at cost, net of accumulated depreciation 171,615 177,708
Inventory 88,239 84,612
Goodwill and other intangibles, net of amortization 232,423 233,739
Deferred tax assets 104,822 85,736
Other assets 77,780 94,898
---------- ----------
$3,897,969 $3,568,040
========== ==========
LIABILITIES AND COMMON STOCKHOLDERS' EQUITY
Current taxes payable $ 29,077 $ 49,605
Losses and loss adjustment expenses 684,429 454,664
Other liabilities 242,316 211,000
Reinsurance payable 127,286 255,117
Unearned premiums 773,340 676,940
Subsidiaries' debt 162,585 167,050
Deferred tax liabilities 203,237 190,842
---------- ----------
Total liabilities 2,222,270 2,005,218
Common stockholders' equity 1,675,699 1,562,822
---------- ----------
$3,897,969 $3,568,040
========== ==========
COMMON SHARES OUTSTANDING ** 7,675,313 7,644,232
========== ==========
* Certain amounts have been reclassified to conform to the 2004
presentation.
** Adjusted to reflect the common stock dividend declared in March 2004.
See Notes to Consolidated Financial Statements.
ALLEGHANY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
FOR THE SIX MONTHS ENDED
JUNE 30, 2004 AND 2003
(dollars in thousands)
(unaudited)
2004 2003
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings $ 110,787 $ 13,720
Adjustments to reconcile net earnings to cash provided by operations:
Depreciation and amortization 22,828 10,013
Net gain on investment transactions (37,535) (4,842)
Tax benefit on stock options exercised 1,251 3,085
Decrease (increase) in accounts and notes receivable 1,063 (23,985)
Increase in inventory (3,627) (8,490)
Decrease in other assets 13,249 26,366
Increase in reinsurance payable, net of reinsurance receivables (223,264) (7,678)
Decrease in premium balances receivable 87,196 8,345
Increase in ceded unearned premium reserves (72,150) (13,598)
Increase in deferred acquisition costs (8,989) (2,293)
Increase (decrease) in other liabilities and current taxes 29,738 (4,849)
Increase in unearned premiums 96,400 20,316
Increase in losses and loss adjustment expenses 229,765 12,386
--------- ---------
Net adjustments 135,925 14,776
--------- ---------
Net cash provided by operating activities 246,712 28,496
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investments (574,865) (243,659)
Sales of investments 341,499 268,296
Purchases of property and equipment (5,952) (5,505)
Net change in short-term investments (33,023) 36,211
Other, net (20,581) 4,173
Acquisition of insurance companies, net of cash acquired (16,672) (19,675)
--------- ---------
Net cash (used in) provided by investing activities (309,594) 39,841
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on long-term debt (11,465) (48,926)
Proceeds of long-term debt 7,000 67,465
Other, net 1,862 342
--------- ---------
Net cash (used in) provided by financing activities (2,603) 18,881
--------- ---------
Net (decrease) increase in cash (65,485) 87,218
Cash at beginning of period 231,583 27,423
--------- ---------
Cash at end of period $ 166,098 $ 114,641
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 2,633 $ 2,163
Income taxes $ 86,373 $ 6,330
Notes to the Consolidated Financial Statements
This report should be read in conjunction with the Annual Report on Form
10-K for the year ended December 31, 2003 (the "2003 Form 10-K") and the
Quarterly Report on Form 10-Q for the quarter ended March 31, 2004 (the "2004
First Quarter Form 10-Q") of Alleghany Corporation (the "Company").
The information included in this report is unaudited but reflects all
adjustments which, in the opinion of management, are necessary to a fair
statement of the results of the interim periods covered thereby. All adjustments
are of a normal and recurring nature except as described herein.
Stock-Based Compensation Accounting
In December 2002, the Financial Accounting Standards Board issued SFAS No.
148, "Accounting for Stock-Based Compensation Transition and Disclosure" ("SFAS
148"). SFAS 148 amended FASB Statement No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123") to provide alternative methods of transition for
enterprises that elect to change to the SFAS 123 fair value method of accounting
for stock-based employee compensation and to amend the disclosure requirements
of SFAS 123.
The Company maintains fixed option plans and a performance-based stock
plan. Effective January 1, 2003, the Company adopted the fair value recognition
provisions of SFAS 123 prospectively for all employee awards granted, modified
or settled under any of its stock-based compensation plans after January 1,
2003. Fair value is estimated on the date of grant using the Black-Scholes
option pricing model with the following weighted-average assumptions: no cash
dividend yield for all years; expected volatility of 19 percent for all years;
risk-free interest rates ranging from 3.56 to 4.4 percent; and expected lives of
seven years. Prior to 2003, the Company accounted for its fixed option plans and
performance-based stock plan under the recognition and measurement provisions of
APB Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25").
During each of the second quarters of 2004 and 2003, 7,000 stock options
were granted to Company directors under the Company's fixed option plans. The
expense relating to options issued in prior periods was $45,000 in the 2004
second quarter and $12,360 in the 2003 second quarter. With respect to its
performance-based stock plan, the Company recognized after-tax compensation
expense of approximately $2.7 million in the 2004 second quarter and
approximately $0.7 million in the 2003 second quarter (in each case calculated
pursuant to the prospective method under SFAS 123).
Had the Company applied SFAS 123 to all option awards outstanding under
its fixed option plans during the 2004 and 2003 second quarters, the Company
would have
6
recognized after-tax expense of $93,000 in the 2004 second quarter and $58,000
in the 2003 second quarter. Had the Company applied SFAS 123 to all awards
outstanding under its performance-based stock plan during the same periods, the
Company would have recognized additional after-tax expense of approximately $2.6
million in the 2004 second quarter and approximately $1.3 million in the 2003
second quarter.
The following table illustrates the effect on net earnings and earnings
per share if the fair value based method had been applied to all outstanding and
unvested awards under all of the Company plans in each period.
For the three months ended For the six months ended
(dollars in thousands, June 30, June 30, June 30, June 30,
except per share amounts) 2004 2003 2004 2003
----------- ----------- ----------- -----------
Net earnings, as reported $ 48,723 $ 5,996 $ 110,787 $ 13,720
Add: stock-based employee
compensation expense
included in reported net
earnings, net of related
tax 2,721 754 4,460 1,337
Less: stock-based
compensation expense
determined under fair
value method for all
stock options, net of
related tax 2,712 1,330 4,574 2,255
----------- ----------- ----------- -----------
Pro forma net earnings $ 48,732 $ 5,420 $ 110,673 $ 12,802
=========== =========== =========== ===========
Earnings per share
Basic - as reported $ 6.35 $ 0.79 $ 14.46 $ 1.81
Basic - pro forma $ 6.35 $ 0.71 $ 14.45 $ 1.69
Diluted - as reported $ 6.33 $ 0.79 $ 14.40 $ 1.80
Diluted - pro forma $ 6.33 $ 0.71 $ 14.39 $ 1.68
7
Employee Benefit Plans
The Company has several noncontributory defined benefit pension plans. The
defined benefits are based on years of service and the employee's average annual
base salary over a consecutive three-year period during the last ten years or,
if applicable, shorter period of employment plus one-half of the highest average
annual bonus over a consecutive five-year period during the last ten years, or,
if applicable, shorter period of employment. The Company's funding policy is to
contribute annually the amount necessary to satisfy the Internal Revenue
Service's funding requirements. Contributions are intended to provide not only
for benefits attributed to service to date but also for those expected to be
earned in the future. Additional details regarding the Company's noncontributory
defined benefit pension plans can be found in Note 11 to the Consolidated
Financial Statements in the Company's 2003 Form 10-K.
The components of net periodic pension cost for the three and six months
ended June 30, 2004 and 2003 consisted of the following:
For the three months ended For the six months ended
June 30, June 30, June 30, June 30,
(dollars in thousands) 2004 2003 2004 2003
---- ---- ---- ----
Net periodic pension cost included
the following expense (income) components:
Service cost-benefits earned during the quarter $0.8 $0.8 $1.7 $1.6
Interest cost on projected benefit obligation 1.1 1.1 2.2 2.1
Expected return on plan assets (0.9) (0.8) (1.8) (1.6)
Net amortization 0.7 0.6 1.3 1.3
---- ---- ---- ----
Net periodic pension cost $1.7 $1.7 $3.4 $3.4
==== ==== ==== ====
The Company plans to contribute approximately $7.4 million to the plans in
2004, compared with contributions of approximately $6.9 million in 2003.
Acquisition of U.S. Aegis Energy Insurance Company
On May 3, 2004, Alleghany Insurance Holdings LLC purchased U.S. AEGIS
Energy Insurance Company (subsequently renamed Darwin National Assurance
Company), an admitted insurance company domiciled in Delaware, from Associated
Electric & Gas Insurance Services Limited to support future business
underwritten by Darwin Professional Underwriters, Inc. for cash consideration
of approximately $20.4 million, $17.1 million of which represented
consideration for AEGIS's investment portfolio and approximately $3.3 million
of which represented consideration for licenses.
Comprehensive Income
The Company's total comprehensive income for the three months ended June
30, 2004 and 2003 was $62.1 million and $59.0 million, and $107.4 million and
$57.1 million for the six months ended June 30, 2004 and 2003. Comprehensive
income includes the Company's net earnings adjusted for changes in unrealized
appreciation (depreciation) of investments, which were $14.2 million and $47.1
million for the three months ended June 30, 2004 and 2003, and $(0.4) million
and $37.3 million for the six months ended June 30, 2004 and 2003, and
cumulative translation adjustments, which
8
were $(0.9) million and $5.9 million for the three months ended June 30, 2004
and 2003, and $(3.0) million and $6.1 million, for the six months ended June 30,
2004 and 2003.
Segment Information
Information concerning the Company's operations by industry segment is
summarized below:
For the three months ended For the six months ended
June 30, June 30, June 30, June 30,
(dollars in millions) 2004 2003 2004 2003
-------- -------- -------- --------
REVENUES
Property and casualty
insurance $ 217.0 $ 38.3 $ 448.3 $ 77.0
Mining and filtration 71.3 69.0 138.3 131.1
Corporate activities 45.8 37.1 91.5 74.9
-------- -------- -------- --------
Total $ 334.1 $ 144.4 $ 678.1 $ 283.0
======== ======== ======== ========
EARNINGS (LOSSES) BEFORE
INCOME TAXES
Property and casualty
insurance $ 75.2 $ 2.7 $ 165.9 $ 7.6
Mining and filtration 5.6 6.5 10.8 11.4
Corporate activities (6.4) (0.5) (6.5) 1.3
-------- -------- -------- --------
Total 74.4 8.7 170.2 20.3
======== ======== ======== ========
Income taxes 25.7 2.7 59.4 6.6
-------- -------- -------- --------
Net earnings $ 48.7 $ 6.0 $ 110.8 $ 13.7
======== ======== ======== ========
June 30, December 31,
(dollars in millions) 2004 2003
-------- -----------
IDENTIFIABLE ASSETS
Property and casualty
insurance $2,936.1 $2,606.9
Mining and filtration 340.0 331.3
Corporate activities 621.9 629.8
-------- --------
Total $3,898.0 $3,568.0
======== ========
9
Contingencies
The Company's subsidiaries are parties to pending claims and litigation in
the ordinary course of their businesses. Each such operating unit makes
provisions on its books in accordance with generally accepted accounting
principles for estimated losses to be incurred as a result of such claims and
litigation, including related legal costs. In the opinion of management, such
provisions are adequate as of June 30, 2004.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis presents a review of the Company and
its subsidiaries for the three and six months ended June 30, 2004 and 2003. This
review should be read in conjunction with the consolidated financial statements
and other data presented herein as well as Management's Discussion and Analysis
of Financial Condition and Results of Operation contained in the Company's 2003
Form 10-K and 2004 First Quarter Form 10-Q.
The Company reported net earnings in the second quarter of 2004 of $48.7
million, compared with net earnings of approximately $6.0 million in the second
quarter of 2003. The Company's common stockholders' equity per share at June 30,
2004 was $218.32, an increase from common stockholders' equity per share of
$210.33 as of March 31, 2004 (both as adjusted for the stock dividend declared
in March 2004). In the first six months of 2004, the Company's net earnings were
$110.8 million, compared with net earnings of $13.7 million in the first six
months of 2003. The 2004 six-month net earnings results include net gains on
investment transactions after taxes (taxed at the federal income tax rate) of
$24.4 million, compared with $3.1 million in the corresponding 2003 period.
Alleghany Insurance Holdings LLC ("AIHL") recorded pre-tax earnings of
$75.2 million on revenues of $217.0 million in the 2004 second quarter, compared
with pre-tax earnings of $2.7 million on revenues of $38.3 million in the second
quarter of 2003, and pre-tax earnings of $165.9 million on revenues of $448.3
million in the first six months of 2004, compared with pre-tax earnings of $7.6
million on revenues of $77.0 million in the first six months of 2003. AIHL's
2004 second quarter net earnings include after-tax investment income of $6.5
million and a realized after-tax net gain on investment transactions of $2.8
million, compared with after-tax investment income of $3.3 million and no
realized after-tax net gain on investment transactions in the corresponding 2003
period. AIHL's 2004 second quarter after-tax investment income reflects a larger
invested asset base, principally due to capital contributions by the Company and
the acquisition of the operations of RSUI Group, Inc. ("RSUI") in July 2003.
10
The comparative pre-tax contributions to AIHL's results made by its
operating units RSUI, Capitol Transamerica Corporation ("CATA") and Darwin
Professional Underwriters, Inc. ("Darwin") were as follows (in thousands, except
ratios):
Three Months Ended June 30,
RSUI(1) CATA(2) Darwin(3) Total
------- ------- --------- -------
2004
Gross premiums written $ 308.1 $ 46.7 $ 20.2 $ 375.0
Net premiums written 171.8 42.2 14.6 228.6
Net premiums earned $ 154.0 $ 39.5 $ 9.7 $ 203.2
Loss and loss adjustment expenses 63.4 22.6 6.1 92.1
Underwriting expenses 23.5 15.6 3.7 42.8
------- ------- ------- -------
Underwriting profit (loss) (4) $ 67.1 $ 1.3 $( 0.1) $ 68.3
======= ======= ======= =======
Loss ratio (5) 41.2% 57.2% 62.9% 45.3%
Expense ratio (6) 15.3% 39.5% 38.1% 21.1%
Combined ratio (7) 56.5% 96.7% 101.0% 66.4%
2003
Gross premiums written - $ 44.1 $ 2.1 $ 46.2
Net premiums written - 39.4 2.0 41.4
Net premiums earned - $ 33.4 $ 0.1 $ 33.5
Loss and loss adjustment expenses - 19.8 0.1 19.9
Underwriting expenses - 13.6 1.4 15.0
------- ------- -------
Underwriting profit (loss) (4) - $ 0.0 $ (1.4) $ (1.4)
======== ======== ========
Loss ratio (5) - 59.3% - 59.3%
Expense ratio (6) - 40.7% - 44.9%
Combined ratio (7) - 100.0% - 104.2%
11
Six Months Ended June 30,
RSUI(1) CATA(2) Darwin(3) Total
------- ------- --------- -------
2004
Gross premiums written $ 602.5 $ 88.4 $ 40.8 $ 731.7
Net premiums written 309.5 79.0 28.6 417.1
Net premiums earned $ 302.3 $ 74.0 $ 16.6 $ 392.9
Loss and loss adjustment expenses 133.4 41.4 10.4 185.2
Underwriting expenses 47.0 30.8 6.6 84.4
------- ------- ------- -------
Underwriting profit (loss) (4) $ 121.9 $ 1.8 $ (0.4) $ 123.3
======= ======= ======= =======
Loss ratio (5) 44.1% 56.0% 62.7% 47.1%
Expense ratio (6) 15.5% 41.6% 39.8% 21.5%
Combined ratio (7) 59.6% 97.6% 102.5% 68.6%
2003
Gross premiums written - $ 80.5 $ 2.1 $ 82.6
Net premiums written - 71.7 2.0 73.7
Net premiums earned - $ 66.8 $ 0.1 $ 66.9
Loss and loss adjustment expenses - 39.6 0.1 39.7
Underwriting expenses - 26.8 1.4 28.2
------- ------- -------
Underwriting profit (loss) (4) - $ 0.4 $ (1.4) $ (1.0)
======= ======= =======
Loss ratio (5) - 59.3% - 59.3%
Expense ratio (6) - 40.2% - 42.2%
Combined ratio (7) - 99.5% - 101.5%
(1) Since July 1, 2003.
(2) Includes the results of Platte River Insurance Company, which was acquired
contemporaneously with CATA in January 2002 and operates in conjunction
with CATA.
(3) Although Darwin is an underwriting manager for Platte River and certain
subsidiaries of CATA, the results of business generated by Darwin have
been separated from CATA's results for purposes of this table. Since
Darwin commenced operations in May 2003, it generated minimal business
during the second quarter and first six months of 2003. Therefore, ratios
for such periods are not separately presented.
(4) Represents net premiums earned less loss and loss adjustment expenses and
underwriting expenses, all as determined in accordance with generally
accepted accounting principles in the United States of America ("GAAP"),
and does not include income derived from investments. Underwriting profit
(loss) does not replace net income (loss) determined in accordance with
GAAP as a measure of
12
profitability; rather, it provides a basis for management to evaluate the
underwriting performance of its insurance operating units.
(5) Loss and loss adjustment expenses divided by net premiums earned, all as
determined in accordance with GAAP.
(6) Underwriting expenses divided by net premiums earned, all as determined in
accordance with GAAP.
(7) The sum of the Loss Ratio and Expense Ratio, all as determined in
accordance with GAAP, representing the percentage of each premium dollar
an insurance company has to spend on losses (including loss adjustment
expenses) and underwriting expenses.
RSUI's favorable underwriting results in the first half of 2004,
particularly with respect to its commercial property line, reflect the absence
of any significant catastrophe losses and lower than expected commercial
property non-catastrophe losses during the 2004 second quarter. RSUI's
commercial property business is exposed to catastrophe losses which have
historically occurred more frequently during the second and third quarters.
Rates at RSUI in the first half of 2004 as compared with the second half of 2003
continue to reflect overall industry trends, with flat or marginally increased
rates in RSUI's casualty lines of business (except for professional liability
which experienced more significant increases in rates) and decreased rates in
its property lines of business primarily due to increased competition. The
continuation of such trends may result in lower levels of gross premiums written
by RSUI during the remainder of 2004, since RSUI is expected to write more
business when it considers prices adequate to support acceptable profit margins
and less business when it considers prices inadequate to support acceptable
profit margins. In the 2004 second quarter, RSUI increased the amount of
retained premiums written in its general liability and professional liability
lines (for policies with limits of $1.0 million or less). Such increase in
retentions may partially offset the effect on net written premiums from
potentially lower volume of gross written premiums during the remainder of 2004.
The increase in CATA's gross premiums written in the second quarter and
first half of 2004 compared with the corresponding 2003 periods primarily
reflects premiums generated from an expansion of its business into the excess
and surplus markets. CATA's 2004 second quarter underwriting results reflect
better underwriting margins on the current accident year, offset by a resulting
increase in profit commissions and a $2.9 million pre-tax charge related to loss
reserve development on contract surety and commercial multi-peril liability
business written by CATA in the 2003 and prior accident years. Rates at CATA for
the 2004 second quarter as compared with the 2003 second quarter reflect overall
industry trends, with slightly lower levels of rate increases in its casualty
lines of business and rate decreases in its property lines of business,
primarily due to increased competition.
As previously reported, in the 2003 fourth quarter, CATA strengthened its
loss reserves related to assumed reinsurance treaties written between 1969 and
1976 in the amount of $21.9 million upon completion of an actuarial study
undertaken by management and an independent actuarial review. Losses on such
assumed reinsurance
13
treaties primarily relate to asbestos liabilities and environmental impairment
liabilities. After such increase, at year end 2003, CATA's aggregate reserves
for asbestos liabilities and environmental impairment liabilities were
approximately 17.5 times the annual average paid claims for the prior three-year
period. Although CATA believes that such reserve levels are appropriate, it has
engaged an outside reinsurance claims consultant to examine and develop more
detailed information relating to its assumed reinsurance treaties in order to
provide additional information for CATA and its outside actuary to consider in
connection with their review of such loss reserves during the second half of
2004. To the extent any such review should result in the need for an increase in
CATA's aggregate loss reserves, such increase would be reflected as a loss and
loss adjustment expense in the statement of earnings in the period in which the
increase is made.
Darwin's results in the second quarter and first half of 2004 continue to
reflect the incurrence of expenses for organizational build-up to support
expected future premium levels, as well as increased competition across all of
its lines of business. As Darwin commenced operations in May 2003, it does not
have any meaningful claims experience on which to base its reserves. In the
absence of such history, Darwin's management and outside actuaries have used
industry data related to the lines of business underwritten by Darwin to
establish reserves until sufficient claims experience exists.
World Minerals recorded pre-tax earnings of $5.6 million on revenues of
$71.3 million in the second quarter of 2004, compared with pre-tax earnings of
$6.5 million on revenues of $69.0 million in the corresponding period in 2003,
and pre-tax earnings of $10.8 million on revenues of $138.3 million in the first
six months of 2004, compared with pre-tax earnings of $11.4 million on revenues
of $131.1 million in the first six months of 2003. The 2004 first half results
reflect lower margins due to competitive pricing pressures and increased energy,
labor and benefit costs, partially offset by the continuing favorable impact of
the strong euro versus the U.S. dollar and an increase in net shipments.
Corporate activities recorded a pre-tax loss of $6.4 million on revenues
of $45.8 million in the second quarter of 2004, compared with a pre-tax loss of
$0.5 million on revenues of $37.1 million in the corresponding period in 2003,
and a pre-tax loss of $6.5 million on revenues of $91.5 million in the first six
months of 2004, compared with pre-tax earnings of $1.3 million on revenues of
$74.9 million in the corresponding 2003 period. Corporate activities includes
parent company results and the results of miscellaneous subsidiaries, including
Heads & Threads International LLC and Alleghany Properties, Inc. The 2004
results for corporate activities reflect increased expense for stock-based
incentive compensation due to a significant increase in the market price of the
Company's common stock from June 30, 2003 to June 30, 2004.
As of June 30, 2004, the Company beneficially owned 8.0 million shares, or
approximately 2.1 percent, of the outstanding common stock of Burlington
Northern
14
Santa Fe Corporation, which had an aggregate market value on that date of
approximately $280.6 million, or $35.07 per share, compared with a market value
on June 30, 2003 of $227.5 million, or $28.44 per share. The aggregate cost of
such shares is approximately $96.6 million, or $12.07 per share.
The Company has previously announced that it may purchase shares of its
common stock in open market transactions from time to time. In the second
quarter of 2004, the Company did not purchase any shares of its common stock. As
of June 30, 2004, the Company had 7,675,313 shares of common stock outstanding
(which includes the stock dividend declared in March 2004).
The Company's results in the 2004 second quarter are not indicative of
operating results in future periods. The Company and its subsidiaries have
adequate internally generated funds and unused credit facilities to provide for
the currently foreseeable needs of its and their businesses.
Information regarding the Company's accounting policies is included in the
Company's 2003 Form 10-K, 2004 First Quarter Form 10-Q and the Notes to the
Consolidated Financial Statements included in this report on Form 10-Q.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Market risk is the risk of loss from adverse changes in market prices and
rates, such as interest rates, foreign currency exchange rates and commodity
prices. The primary market risk related to the Company's non-trading financial
instruments is the risk of loss associated with adverse changes in interest
rates. The investment portfolios of the Company and its insurance subsidiaries
may contain, from time-to-time, debt securities with fixed maturities that
expose them to risk related to adverse changes in interest rates.
The table below presents a sensitivity analysis of the debt securities of
the Company and its insurance subsidiaries that are sensitive to changes in
interest rates. Sensitivity analysis is defined as the measurement of potential
changes in future earnings, fair values or cash flows of market sensitive
instruments resulting from one or more selected hypothetical changes in interest
rates over a selected time. In this sensitivity analysis model, the Company uses
fair values to measure its potential change, and a +/- 200 basis point range of
change in interest rates to measure the hypothetical change in fair value of the
financial instruments included in the analysis. The change in fair value is
determined by calculating hypothetical June 30, 2004 ending prices based on
yields adjusted to reflect a +/ - 200 basis point range of change in interest
rates, comparing such hypothetical ending price to actual ending prices, and
multiplying the difference by the par outstanding.
15
SENSITIVITY ANALYSIS
At June 30, 2004
(dollars in millions)
Interest Rate Shifts -200 -100 0 100 200
- ------------------------------ -------- -------- -------- -------- --------
ASSETS
Debt securities, fair value $1,295.4 $1,256.9 $1,219.6 $1,182.6 $1,145.3
Estimated change in fair value $ 75.8 $ 37.3 -- $ (37.0) $ (74.3)
LIABILITIES
Subsidiaries' debt, fair value $ 160.9 $ 161.6 $ 162.8 $ 164.1 $ 165.4
Estimated change in fair value $ (1.9) $ (1.3) -- $ 1.3 $ 2.6
The Company's 2003 Form 10-K provides a more detailed discussion of the
market risks affecting its operations. Based on the Company's estimates as of
June 30, 2004, no material change has occurred in its liabilities, as compared
with amounts disclosed in the 2003 Form 10-K.
ITEM 4. CONTROLS AND PROCEDURES
The Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Chief Executive Officer
(the "CEO") and the Chief Financial Officer (the "CFO"), of the effectiveness of
the design and operation of the Company's disclosure controls and procedures as
of the end of the period covered by this report on Form 10-Q pursuant to Rule
13a-15 promulgated under the Securities Exchange Act of 1934. Based on that
evaluation, the Company's management, including the CEO and CFO, concluded that
the Company's disclosure controls and procedures are effective in timely
alerting them to material information required to be included in the Company's
periodic reports required to be filed with the U.S. Securities and Exchange
Commission. Additionally, as of the end of the period covered by this report on
Form 10-Q, the Company's CEO and CFO have concluded that there have been no
significant changes in internal control over financial reporting that have
occurred during the period covered by this report on Form 10-Q that have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
Forward-Looking Statements
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Quantitative and Qualitative Disclosures About Market Risk"
contain disclosures which are forward-looking statements. Forward-looking
statements include all statements
16
that do not relate solely to historical or current facts, and can be identified
by the use of words such as "may," "will," "expect," "project," "estimate,"
"anticipate," "plan" or "continue." These forward-looking statements are based
upon the Company's current plans or expectations and are subject to a number of
uncertainties and risks that could significantly affect current plans,
anticipated actions and the Company's future financial condition and results.
These statements are not guarantees of future performance, and the Company has
no specific intention to update these statements. The uncertainties and risks
include, but are not limited to, those relating to conducting operations in a
competitive environment and conducting operations in foreign countries, effects
of acquisition and disposition activities, adverse loss development for events
insured by the Company's insurance operations in either the current year or
prior years, general economic and political conditions, including the effects of
a prolonged U.S. or global economic downturn or recession, changes in costs,
including changes in labor costs, energy costs and raw material prices,
variations in political, economic or other factors such as currency exchange
rates, inflation rates or recessionary or expansive trends, changes in market
prices of the Company's significant equity investments, tax, legal and
regulatory changes, extended labor disruptions, significant weather-related or
other natural or human-made catastrophes and disasters, especially with respect
to their impact on losses at the Company's insurance subsidiaries, acts of
terrorism, civil unrest or other external factors over which the Company has no
control, and changes in the Company's plans, strategies, objectives,
expectations or intentions, which may happen at any time at the Company's
discretion. As a consequence, current plans, anticipated actions and future
financial condition and results may differ from those expressed in any
forward-looking statements made by or on behalf of the Company.
17
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES.
(c) Recent Sales of Unregistered Securities.
On April 8, 2004, the Company issued 1,960 shares of common stock to Allan
P. Kirby, Jr. upon the exercise of an option to purchase 1,000 shares of the
Company's common stock, subject to adjustment for stock dividends and the
spin-off by the Company of Chicago Title Corporation in 1998, at an exercise
price of $72.30 per share, or $141,750 in the aggregate, granted to Mr. Kirby on
April 25, 1994 pursuant to the Alleghany Corporation Amended and Restated
Directors' Stock Option Plan. The sale of the common stock was exempt from
registration under the Securities Act of 1933, as amended (the "Securities
Act"), pursuant to Section 4(2) thereof, as a transaction not involving a public
offering.
On May 13, 2004, the Company issued an aggregate of 399 shares of the
Company's common stock to seven non-employee directors of the Company pursuant
to the Alleghany Corporation Directors' Equity Compensation Plan. Such shares
represent one-half of the value of each director's retainer for the following
twelve months' service as a director, exclusive of any per meeting fees,
committee fees or expense reimbursements. The sale of common stock was exempt
from registration under the Securities Act pursuant to Section 4(2) thereof, as
a transaction not involving a public offering.
The above does not include unregistered issuances of the Company's common
stock that did not involve a sale, consisting of issuances of common stock and
other securities pursuant to employee incentive plans.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company's 2004 Annual Meeting of Stockholders was held on April 23,
2004. At the Annual Meeting, three directors were elected to serve for
three-year terms on the Company's Board of Directors, by the following votes:
FOR WITHHELD
--------- --------
Allan P. Kirby, Jr. 6,461,138 69,525
Thomas S. Johnson 6,401,065 129,598
James F. Will 6,461,462 69,201
18
The selection of KPMG LLP, independent registered accounting firm, as
auditors for the Company for the year 2004 was ratified by a vote of 6,416,912
shares in favor and 98,014 shares opposed. A total of 15,737 shares abstained
from voting.
ITEM 5. OTHER INFORMATION
In July 2004, the Company entered into a three-year unsecured credit
agreement with a bank syndicate (the "Credit Agreement"). The Credit Agreement
provides commitments for revolving credit loans in an aggregate principal amount
of up to $200.0 million. The Credit Agreement replaced a prior 364-day credit
agreement which expired on June 14, 2004 and a three-year credit agreement which
was scheduled to expire on June 14, 2005, each of which provided for revolving
credit loans in an aggregate principal amount of up to $100.0 million. Wachovia
Bank, National Association, serves as administrative agent for the banks under
the Credit Agreement. At the Company's option, borrowings under the Credit
Agreement will bear interest at either (x) the higher of (i) the administrative
agent's prime commercial lending rate or (ii) the federal funds rate plus 0.5%
or (y) the London Interbank Overnight Rate plus a margin (currently 80 basis
points) based on the Company's Standard & Poors and/or Moody's rating.
Borrowings under the Credit Agreement will be available for working capital and
general corporate purposes. The Company's practice is to repay borrowings under
its credit agreements promptly in order to keep the facilities available for
future acquisitions. No borrowings under the Company's former credit facilities
were outstanding as at June 30, 2004.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
Exhibit Number Description
10.1 Trust Agreement, dated as of June 10, 2004, by and
among Royal Indemnity Company, Royal Surplus Lines
Insurance Company, RSUI Indemnity Company and The
Bank of New York, as Trustee.
10.2 Assignment of Net Premium Receivables, dated as of
June 10, 2004, by and among The Bank of New York,
Royal Indemnity Company and Royal Surplus Lines
Insurance Company.
10.3 Assignment of Reinsurance Recoverables, dated as of
June 10, 2004, by and among RSUI Indemnity Company,
The Bank of New York, Royal Indemnity Company and
Royal Surplus Lines Insurance Company.
19
10.4 Credit Agreement, dated as of July 28, 2004, among
the Company, the banks which are signatories
thereto, Wachovia Bank, National Association as
administrative agent for the banks, U.S. Bank
National Association as syndication agent for the
banks, and LaSalle Bank National Association and
HSBC Bank USA, National Association, as
documentation agents for the banks (the "Credit
Agreement").
10.5 List of Contents of Exhibits and Schedules to the
Credit Agreement. The Company agrees to furnish
supplementally a copy of any omitted exhibit or
schedule to the Securities and Exchange Commission
upon request.
31.1 Certification of the Chief Executive Officer of the
Company pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer of the
Company pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer
pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002. This exhibit shall not be deemed "filed"
as a part of this Report on Form 10-Q.
32.2 Certification of the Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002. This exhibit shall not be deemed "filed"
as a part of this Report on Form 10-Q.
(b) Reports on Form 8-K.
On August 3, 2004, the Company filed a report on Form 8-K under Item 12
thereof regarding a press release reporting on the Company's financial results
as of and for the quarter ended June 30, 2004.
20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ALLEGHANY CORPORATION
Registrant
Date: August 3, 2004 /s/ David B. Cuming
-----------------------------
David B. Cuming
Senior Vice President
(and chief financial officer)
21