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 SEPTEMBER 30, 2005
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
7 TIMES SQUARE TOWER, 17TH FLOOR, NY, NY 10036
- -------------------------------------------------------------------------------
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 BY CHECK MARK WHETHER THE REGISTRANT IS A SHELL COMPANY (AS DEFINED IN
RULE 12b-2 OF THE EXCHANGE ACT).
YES [ ] NO [X]
- -------------------------------------------------------------------------------
INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF
COMMON STOCK, AS OF THE LAST PRACTICABLE DATE.
7,897,189 SHARES AS OF OCTOBER 31, 2005
- -------------------------------------------------------------------------------
ITEM 1. FINANCIAL STATEMENTS
ALLEGHANY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE THREE MONTHS ENDED
SEPTEMBER 30, 2005 AND 2004
(dollars in thousands, except share and per share amounts)
(unaudited)
2005 2004
----------- -----------
REVENUES
Net premiums earned $ 194,489 $ 198,606
Interest, dividend and other income 25,300 18,512
Net gain on investment transactions 49,906 6,688
----------- -----------
Total revenues 269,695 223,806
----------- -----------
COSTS AND EXPENSES
Loss and loss adjustment expenses 360,038 242,166
Commissions and brokerage 55,738 48,700
Salaries, administrative and other operating expenses 9,960 7,770
Corporate administration 11,362 10,299
Interest expense 877 585
----------- -----------
Total costs and expenses 437,975 309,520
----------- -----------
Loss from continuing operations, before income taxes (168,280) (85,714)
Income tax benefit (63,320) (34,995)
----------- ---------
Loss from continuing operations (104,960) (50,719)
Discontinued operations
Earnings from discontinued operations (including gain
on disposal of $13,714 in 2005) 13,659 6,220
Income taxes 1,188 2,505
----------- -----------
Earnings from discontinued operations, net 12,471 3,715
----------- -----------
Net loss ($ 92,489) ($ 47,004)
=========== ===========
Basic (loss) earnings per share of common stock **
Continuing operations ($ 13.30) ($ 6.48)
Discontinued operations 1.58 0.48
----------- -----------
($ 11.72) ($ 6.00)
=========== ===========
Diluted (loss) earnings per share of common stock **
Continuing operations ($ 13.30) ($ 6.48)
Discontinued operations 1.58 0.48
----------- -----------
($ 11.72) ($ 6.00)
=========== ===========
Dividends per share of common stock * *
=========== ===========
Average number of outstanding shares of common stock ** 7,892,663 7,828,819
=========== ===========
* In March 2005 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 2005.
See Notes to Unaudited Consolidated Financial Statements.
ALLEGHANY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 2005 AND 2004
(dollars in thousands, except share and per share amounts)
(unaudited)
2005 2004
----------- ----------
REVENUES
Net premiums earned $ 626,695 $ 591,489
Interest, dividend and other income 64,598 46,604
Net gain on investment transactions 97,750 44,223
----------- ----------
Total revenues 789,043 682,316
----------- ----------
COSTS AND EXPENSES
Loss and loss adjustment expenses 589,620 427,280
Commissions and brokerage 164,160 133,088
Salaries, administrative and other operating expenses 25,163 22,352
Corporate administration 31,074 29,193
Interest expense 2,542 1,708
----------- ----------
Total costs and expenses 812,559 613,621
----------- ----------
(Loss) earnings from continuing operations, before income taxes (23,516) 68,695
Income tax (benefit) provision (16,706) 17,457
----------- ----------
(Loss) earnings from continuing operations (6,810) 51,238
Discontinued operations
Earnings from discontinued operations (including gain
on disposal of $12,548 in 2005) 13,006 22,043
Income taxes 6,412 9,498
----------- ----------
Earnings from discontinued operations, net 6,594 12,545
----------- ----------
Net earnings ($ 216) $ 63,783
=========== ==========
Basic (loss) earnings per share of common stock **
Continuing operations ($ 0.86) $ 6.55
Discontinued operations 0.83 1.61
----------- ----------
($ 0.03) $ 8.16
=========== ==========
Diluted (loss) earnings per share of common stock **
Continuing operations ($ 0.86) $ 6.54
Discontinued operations 0.83 1.60
----------- ----------
($ 0.03) $ 8.14
=========== ==========
Dividends per share of common stock * *
=========== ==========
Average number of outstanding shares of common stock ** 7,881,121 7,818,601
=========== =========
* In March 2005 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 2005.
See Notes to Unaudited Consolidated Financial Statements.
ALLEGHANY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share amounts)
SEPTEMBER 30,
2005 DECEMBER 31,
(UNAUDITED) 2004*
------------- ------------
ASSETS
Available for sale securities at fair value:
Equity securities (cost: 2005 $373,159; 2004 $290,597) $ 773,518 $ 645,184
Debt securities (cost: 2005 $1,669,865; 2004 $1,178,982) 1,654,036 1,179,210
Short-term investments 531,178 374,391
------------- ------------
2,958,732 2,198,785
Cash 74,788 267,760
Notes receivable 91,535 91,665
Accounts receivable, net 17,802 16,776
Premium balances receivable 179,958 203,141
Reinsurance recoverables 1,621,503 623,325
Ceded unearned premium reserves 294,275 286,451
Deferred acquisition costs 60,313 56,165
Property and equipment at cost, net of
accumulated depreciation and amortization 18,246 15,691
Goodwill and other intangibles, net of amortization 169,627 172,707
Deferred tax assets 112,702 98,753
Assets of discontinued operations 0 336,584
Current taxes receivable 54,992 0
Other assets 59,803 59,922
------------- ------------
$ 5,714,276 $ 4,427,725
============= ============
LIABILITIES AND COMMON STOCKHOLDERS' EQUITY
Losses and loss adjustment expenses $ 2,557,249 $ 1,232,337
Unearned premiums 769,878 751,131
Reinsurance payable 135,541 112,479
Deferred tax liabilities 211,403 206,250
Subsidiaries' debt 80,000 80,000
Current taxes payable 0 15,713
Liabilities of discontinued operations 0 136,397
Other liabilities 152,920 120,002
------------- ------------
Total liabilities 3,906,991 2,654,309
Common stockholders' equity 1,807,285 1,773,416
------------- ------------
$ 5,714,276 $ 4,427,725
============= ============
COMMON SHARES OUTSTANDING ** 7,895,189 7,829,721
============= ============
* Certain amounts have been reclassified to conform to the 2005 presentation.
** Adjusted to reflect the common stock dividend declared in March 2005.
See Notes to Unaudited Consolidated Financial Statements.
ALLEGHANY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 2005 AND 2004
(dollars in thousands)
(unaudited)
2005 2004
------------ -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Earnings (loss) from continuing operations ($ 6,810) $ 51,238
Adjustments to reconcile net earnings to net cash provided by operations:
Depreciation and amortization 17,682 22,605
Net gain on investment transactions (97,750) (44,223)
Tax benefit on stock options exercised 755 1,251
Decrease in accounts and notes receivable 7,100 10,935
(Increase) decrease in other assets (354) 19,536
Increase in reinsurance recoverables (975,116) (519,799)
Decrease in premium balances receivable 23,183 109,104
Increase in ceded unearned premium reserves (7,824) (53,423)
Increase in deferred acquisition costs (4,148) (9,603)
Increase in other liabilities and current taxes (11,967) (49,996)
Increase in unearned premiums 18,747 91,140
Increase in losses and loss adjustment expenses 1,324,912 715,852
------------ -----------
Net adjustments 295,220 293,379
------------ -----------
Net cash provided by operations 288,410 344,617
------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investments (1,055,598) (1,161,234)
Sales of investments 585,471 844,109
Purchases of property and equipment (7,812) (6,007)
Net change in short-term investments (150,043) 64,096
Acquisition of insurance companies, net of cash acquired (25,574) (17,742)
Net proceeds from sale of subsidiary 201,893 -
Other, net (30,619) (26,989)
------------ -----------
Net cash used in investing activities (482,282) (303,767)
------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Other, net 900 1,304
------------ -----------
Net cash provided by financing activities 900 1,304
------------ -----------
Net (decrease) increase in cash (192,972) 42,154
Cash at beginning of period 267,760 213,842
------------ -----------
Cash at end of period $ 74,788 $ 255,996
============ ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 1,946 $ 2,208
Income taxes $ 64,214 $ 106,548
See Notes to Unaudited Consolidated Financial Statements.
Notes to Unaudited Consolidated Financial Statements
This report should be read in conjunction with the Annual Report on Form
10-K for the year ended December 31, 2004 (the "2004 Form 10-K") and the
Quarterly Reports on Form 10-Q for the quarters ended March 31, 2005 (the "2005
First Quarter Form 10-Q") and June 30, 2005 (the "2005 Second 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
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 and/or director 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 ranging
from 17 to 19 percent; risk-free interest rates ranging from 3.21 percent to
4.40 percent; and expected lives of seven and eight 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 the third quarters of 2005 and 2004, no stock options to acquire
shares of common stock were granted under the Company's fixed option plans. The
expense relating to options granted in prior periods was $70,000 in the third
quarter of 2005 and $47,000 in the third quarter of 2004. With respect to its
performance-based stock plan, the Company recognized after-tax compensation
expense of $3.7 million in the 2005 third quarter and $2.5 million in the 2004
third 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 2005 and 2004 third quarters, the
Company would have recognized after-tax expense of $70,000 in the 2005 third
quarter and $64,000 in the 2004 third quarter. Had the Company applied SFAS 123
to all
-5-
outstanding stock-based awards during the same periods, the Company would have
recognized after-tax expense of $2.7 million in the 2005 third quarter and $2.0
million in the 2004 third quarter.
In December 2004, SFAS 123 (revised) "Share-Based Payment" ("Revised SFAS
123") was issued. Revised SFAS 123 requires that the cost resulting from all
stock-based payment transactions be recognized in the financial statements,
establishes fair value as the measurement objective in accounting for
stock-based payment arrangements and requires the application of a fair
value-based measurement method in accounting for stock-based payment
transactions with employees. Revised SFAS 123 is effective as of the beginning
of the first interim or annual reporting period that begins after December 15,
2005. Accordingly, the Company will adopt Revised SFAS 123 in the first quarter
of 2006.
The following table illustrates the effect on net earnings and earnings
per share if the fair value-based method of SFAS 123 or Revised SFAS 123 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 nine months ended
(dollars in thousands, except per Sept. 30, Sept. 30, Sept. 30, Sept. 30,
share amounts) 2005 2004 2005 2004
--------- --------- --------- ---------
Net (loss) earnings, as reported $ (92,489) $ (47,004) $ (216) $ 63,783
Add: stock-based employee
compensation expense included in
reported net earnings, net of
related tax 3,680 2,534 9,479 6,994
Less: stock-based employee
compensation expense determined
under fair value method for all
stock-based awards, net of
related tax 2,671 1,983 7,401 6,556
--------- --------- --------- ---------
Pro forma net (loss) earnings $ (91,480) $ (46,453) $ 1,862 $ 64,221
========= ========= ========= =========
(Loss) earnings per share
Basic - as reported $ (11.72) $ (6.00) $ (0.03) $ 8.16
Basic - pro forma $ (11.59) $ (5.93) $ 0.24 $ 8.21
Diluted - as reported $ (11.72) $ (6.00) $ (0.03) $ 8.14
Diluted - pro forma $ (11.55) $ (5.91) $ 0.24 $ 8.18
-6-
Employee Benefit Plans
The Company has two unfunded noncontributory defined benefit pension plans
for executives and a funded noncontributory defined benefit pension plan for
employees. Under the executive plans, defined benefits are based on years of
service and the employee's highest 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. With respect to the funded employee plan, the Company's 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 12 to the Consolidated
Financial Statements in the Company's 2004 Form 10-K. The Company plans to
contribute $0.3 million to the funded employee plan in 2005, compared with
contributions of $0.5 million in 2004.
The components of net periodic benefit cost for the three and nine months
ended September 30, 2005 and 2004 consisted of the following:
For the three months ended For the nine months ended
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
(dollars in millions) 2005 2004 2005 2004
--------- --------- --------- ---------
Net periodic pension cost included the
following expense (income) components:
Service cost-benefits earned $ 0.3 $ 0.4 $ 1.0 $ 1.1
Interest cost on projected benefit obligation 0.2 0.2 0.4 0.5
Expected return on plan assets (0.1) (0.1) (0.2) (0.2)
Net amortization 0.3 0.3 0.9 0.9
Settlement loss -- 1.1 -- 1.1
--------- --------- --------- ---------
Net periodic pension cost $ 0.7 $ 1.9 $ 2.1 $ 3.4
========= ========= ========= =========
Comprehensive Income (Loss)
The Company's total comprehensive (loss) income for the three months ended
September 30, 2005 and 2004 was $(35.9) million and $(21.1) million, and $25.8
million and $86.3 million for the nine months ended September 30, 2005 and 2004.
Comprehensive income includes the Company's net earnings adjusted for changes in
unrealized appreciation (depreciation) of investments, which were $42.8 million
and $24.4 million for the three months ended September 30, 2005 and 2004, and
$18.5 million and $24.1 million for the nine months ended September 30, 2005 and
2004, and cumulative translation adjustments, which were $9.4 million and $1.5
million for the
-7-
three months ended September 30, 2005 and 2004, and $3.2 million and $(1.6)
million for the nine months ended September 30, 2005 and 2004. In addition,
during the 2005 third quarter, the Company also reported comprehensive income
arising from the sale of World Minerals Inc. ("World Minerals") and the
termination of its minimum pension liability of $4.4 million. There was no
corresponding amount in the 2004 third quarter or year to date figures.
Discontinued Operations
Sale of Heads & Threads
On December 31, 2004, the Company completed the merger of its wholly owned
subsidiary Heads & Threads International LLC ("Heads & Threads") with and into
HTI Acquisition LLC, an acquisition vehicle formed by a private investor group
led by Heads & Threads management and by Capital Partners, Inc. The transaction
generated a pre-tax loss of $1.95 million and an after-tax loss of $1.2 million,
and such amounts were included in the Company's year-end financial statements.
Upon final settlement with the private investor group, the Company wrote off a
receivable in the amount of $1.2 million pre-tax and $0.8 million after tax
during the 2005 second quarter. Such amounts are included in discontinued
operations.
Sale of World Minerals
On July 14, 2005, the Company completed the sale of its world-wide
industrial minerals business, World Minerals, to Imerys USA, Inc. (the
"Purchaser"), a wholly owned subsidiary of Imerys, S.A., pursuant to a Stock
Purchase Agreement, dated as of May 19, 2005 by and among Imerys USA, Inc.,
Imerys, S.A. and the Company (the "Stock Purchase Agreement"). Under the terms
of the Stock Purchase Agreement, the purchase price was $230.0 million, which
was reduced by $13.2 million reflecting contractual obligations to be paid by
the Purchaser after the closing, resulting in an adjusted purchase price of
$216.8 million (the "Adjusted Purchase Price"). $206.8 million of the Adjusted
Purchase Price was paid in cash by the Purchaser to the Company on the closing
date, with the remaining $10.0 million being held by the Purchaser as security
for certain indemnification obligations undertaken by the Company pursuant to
the Stock Purchase Agreement. The $10.0 million holdback will bear interest at
the U.S. Treasury 10-year note rate and is scheduled to be released to the
Company (to the extent not applied toward such indemnification obligations)
during the period covering the fifth through the tenth anniversaries of the
closing date. The Company is carrying a receivable in the amount of $9.1 million
on its balance sheet in respect of the holdback, equal to the $10.0 million face
amount less an interest rate discount of $0.9 million. As described in more
detail in the Notes to Consolidated Financial Statements under "Obligations
under Guarantees" included in the 2005 Second Quarter Form 10-Q, the Company
established a $0.6 million reserve in connection with its indemnification
obligations under the Stock Purchase Agreement during the 2005 second quarter.
-8-
The Company paid legal, accounting and investment banking fees of $4.9
million in connection with the transaction. The sale of World Minerals produced
an after-tax gain of $14.6 million in the 2005 third quarter. The Company has
classified the operations of World Minerals as a "discontinued operation" in its
financial statements for all periods presented. Historical balance sheet
information* relating to World Minerals is set forth in the following table:
Dec. 31,
(dollars in thousands) 2004
--------
ASSETS
Short-term investments $ 4,061
Cash 20,676
Accounts receivable, net 53,771
Inventory 41,521
Property and equipment at cost, net 152,625
Goodwill 50,999
Deferred tax assets 5,810
Other assets 7,121
--------
$336,584
========
LIABILITIES AND STOCKHOLDERS' EQUITY
Bank debt $ 58,258
Other liabilities 59,542
Deferred tax liabilities 18,597
--------
136,397
--------
Common stockholder's equity 200,187
--------
$336,584
========
* The balance sheet accounts shown above are before inter-company eliminations
made in the preparation of the Company's Consolidated Balance Sheets.
At July 14, 2005, the Company's investment in World Minerals was $182.9
million. Historical information relating to the results of operations of World
Minerals is as follows:
For the three For the nine months ended
July 1 to July months ended Sept. 30, Sept. 30,
(dollars in millions) 14, 2005 Sept. 30, 2004 2005 2004
-------------- -------------- --------- ---------
Revenues $ 15.8 $ 72.9 $ 156.2 $ 211.2
Costs and expenses
Salaries, administration and other expenses 1.9 10.3 23.4 30.2
Cost of mineral and filtration sales 13.3 56.0 130.1 162.4
Interest expense 0.6 0.6 2.2 1.7
-------- ------ --------- ---------
Total cost and expenses 15.8 66.9 155.7 194.3
-------- ------ --------- ---------
Earnings before taxes -- 6.0 0.5 16.8
Income taxes 5.9 2.7 11.6 7.7
-------- ------ --------- ---------
Net (loss) earnings from discontinued operations $ (5.9) $ 3.3 $ (11.1) $ 9.1
======== ====== ========= =========
-9-
Prior to the sale, World Minerals produced an after-tax loss on operations
of $5.9 million for the period from July 1 to July 14, 2005, and an after-tax
loss on operations of $11.1 million for the nine months ended September 30,
2005. World Minerals was unprofitable in 2005 primarily due to competitive
pricing pressures, rising energy and other operating costs, a $5.7 million
after-tax write-off related to foreign tax credits that will not be used, $3.9
million for foreign tax expense and a $2.8 million after-tax write-off related
to the termination of a major systems project in connection with the sale of
World Minerals.
Income Taxes
The full year effective tax rate changed during the quarter due to the
impact of catastrophe losses on estimated results. As a result, the effective
rate is now projected to be a benefit of 71.7%. There was no significant change
in permanent items such as tax-exempt interest income, dividend received
deduction and state income taxes.
Segment Information
Information related to the Company's reportable business operating
segments is shown in the tables below. The Company's reportable segments are
reported in a manner consistent with the way management evaluates the
businesses. As such, insurance underwriting activities are evaluated separately
from investment activities. Realized investment gains are not considered
relevant in evaluating investment performance on an annual basis.
For the three months ended For the nine months ended
Sept. 30, Sept. 30, Sept. 30, Sept.30,
(dollars in millions) 2005 2004 2005 2004
--------- --------- --------- --------
REVENUES FROM CONTINUING OPERATIONS
AIHL insurance group
Net premiums earned
RSUI $133.1 $147.5 $446.8 $449.8
CATA 39.4 37.7 119.2 111.7
Darwin 22.0 13.4 60.7 30.0
------ ------ ------ ------
194.5 198.6 626.7 591.5
Interest, dividend and other income 19.7 11.1 48.6 30.7
Net gain on investment transactions 4.6 6.7 30.4 42.5
------ ------ ------ ------
Total insurance group 218.8 216.4 705.7 664.7
Corporate activities
Interest, dividend and other income 5.6 7.4 16.0 15.9
Net gain on investment transactions 45.3 --- 67.3 1.7
------ ------ ------ ------
Total $269.7 $223.8 $789.0 $682.3
====== ====== ====== ======
(LOSS) EARNINGS FROM CONTINUING OPERATIONS
AIHL insurance group
-10-
For the three months ended For the nine months ended
Sept. 30, Sept. 30, Sept. 30, Sept. 30,
(dollars in millions) 2005 2004 2005 2004
--------- --------- --------- ---------
Underwriting (loss) profit
RSUI $ (226.4) $(88.0) $(139.4) $ 34.0
CATA 4.8 (4.5) 11.2 (2.6)
Darwin 0.4 0.2 1.1 (0.3)
-------- ------ ------ ------
(221.2) (92.3) (127.1) 31.1
Interest, dividend and other income 19.7 11.1 48.6 30.8
Net gain on investment transactions 4.6 6.7 30.4 42.5
Other expenses (9.6) (7.0) (23.2) (20.0)
-------- ------ ------ ------
Total insurance group (206.5) (81.5) (71.3) 84.4
Corporate activities
Interest, dividend and other income 5.6 7.4 16.0 15.9
Net gain on investment transactions 45.3 --- 67.3 1.7
Other expenses (11.8) (11.0) (33.0) (31.6)
Interest expense (0.9) (0.6) (2.5) (1.7)
-------- ------ ------ ------
Corporate activities 38.2 (4.2) 47.8 (15.7)
-------- ------ ------ ------
Total (168.3) (85.7) (23.5) 68.7
Income taxes 63.3 (35.0) (16.7) 17.5
-------- ------ ------ ------
(Loss) earnings from continuing operations $ (105.0) $(50.7) $ (6.8) $ 51.2
======== ====== ====== ======
Sept. 30, Dec. 31,
2005 2004
--------- --------
IDENTIFIABLE ASSETS
AIHL Insurance group $4,732.7 $3,388.7
Corporate activities 981.6 1,039.0
-------- --------
Total $5,714.3 $4,427.7
======== ========
Segment accounting policies are the same as the Consolidated Accounting
Policies described in Note 17 to the Consolidated Financial Statements in the
2004 Form 10-K. Property and casualty insurance operations are the Company's
primary business, conducted by Alleghany Insurance Holdings LLC ("AIHL") and its
subsidiaries RSUI Group, Inc. ("RSUI"), Capitol Transamerica Corporation
("CATA") and Darwin Professional Underwriters, Inc. ("Darwin"). The primary
components of "corporate activities" are Alleghany Properties LLC and
corporate activities at the parent level.
Reinsurance
At September 30, 2005, AIHL's operating units had reinsurance recoverables
of $1.62 billion on gross loss and loss adjustment expense ("LAE") reserves of
$2.56 billion, compared with reinsurance recoverables of $623.3 million on gross
loss and LAE reserves of $1.23 billion at December 31, 2004. Although
reinsurance makes a reinsurer liable to the applicable AIHL operating unit, to
the extent risk is transferred or ceded to the reinsurer, it does not relieve
the AIHL operating unit of its liability to its policyholders. Accordingly,
AIHL's operating units bear risk with respect to their reinsurers to the extent
they do not pay claims made by such operating
-11-
units on a timely basis or do not pay some or all of these claims. Therefore,
the financial strength of their reinsurers is important. Approximately 96.9%
percent, or $1.57 billion, of AIHL's reinsurance recoverables balance at
September 30, 2005 was due from reinsurance companies having financial strength
ratings of A or higher (at September 30, 2005) by A.M. Best Company, Inc., an
independent organization that analyzes the insurance industry. AIHL's operating
units had no allowance for uncollectible reinsurance as of September 30, 2005.
During the 2005 third quarter, Darwin modified on a prospective basis its
excess of loss reinsurance program for directors and officers liability and
errors and omissions liability, which provides excess of loss coverage on a
swing rated basis (whereby premium will vary, within a range, depending on
profitability of the underlying premium subject to the policy) for losses up to
$3.0 million in excess of $2.0 million, to include technology errors and
omissions liability policies. A second excess cession layer on such reinsurance
program provides coverage for losses up to $5.0 million in excess of $5.0
million, with Darwin having a 15% co-participation on such losses. In addition,
Darwin purchased excess of loss coverage for managed care errors and omissions
liability exposures for losses up to $10.0 million in excess of $10.0 million,
with Darwin having a 10% co-participation on such losses. Finally, Darwin
entered into a quota share reinsurance agreement to cede 75.0% of its premium
and corresponding loss exposure on a pro rata basis on certain of its business
produced through its i-bind distribution platform.
Loss and Loss Adjustment Expenses
At September 30, 2005, the Company had gross loss and LAE reserves of
$2.56 billion and net loss and LAE reserves of $1.0 billion, compared with gross
loss and LAE reserves of $1.23 billion and net loss and LAE reserves of $640.9
million at December 31, 2004. Gross and net loss and LAE reserves increased at
September 30, 2005 from December 31, 2004, primarily reflecting increases in
property and casualty loss and LAE reserves. With respect to property lines of
business, the increase in gross and net loss and LAE reserves reflects the
impact of the 2005 third quarter hurricanes, partially offset by amounts paid
during the first nine months of 2005 with respect to 2004 third quarter
catastrophe losses. The 2005 third quarter hurricanes added $1.3 billion to
gross property loss and LAE reserves and $256.8 million to net property loss and
LAE reserves at September 30, 2005. The increase in gross and net loss and LAE
reserves for casualty lines of business (which include, among others, excess and
umbrella liability, directors and officers' liability, professional liability,
general liability and workers' compensation) primarily reflects increased net
earned premiums for general liability, umbrella and professional liability
exposures and limited paid loss activity for the current and prior casualty
accident years.
-12-
Contingencies
The Company's subsidiaries are parties to pending claims and litigation in
the ordinary course of their businesses. Each such subsidiary 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 September 30, 2005.
Subsequent Events
On November 4, 2005, the Company made an investment of approximately $150
million, comprised of cash and marketable securities, in RSUI Group, Inc.
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 nine months ended September 30, 2005 and
2004. 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 2004 Form 10-K, 2005 First Quarter Form 10-Q and 2005 Second Quarter
Form 10-Q.
The Company reported a net loss from continuing operations in the third
quarter of 2005 of $105.0 million, compared with a net loss from continuing
operations of $50.7 million in the 2004 third quarter. The Company's 2005 third
quarter results reflect $162.8 million of after-tax (after-tax amounts
throughout reflect tax at the federal income tax rate) catastrophe losses, net
of reinsurance, and $17.0 million of reinsurance reinstatement premiums at its
RSUI operating unit due to the impact of Hurricanes Katrina, Rita and Dennis
during the period. The Company's 2004 third quarter results reflect $97.9
million of after-tax catastrophe losses, net of reinsurance, and $6.9 million of
reinsurance reinstatement premiums at its RSUI and CATA operating units due to
the impact of the four Florida hurricanes during the period. Reported
catastrophe losses represent management's current best estimate of catastrophe
losses and include estimates of unreported claims, anticipated adverse
development on reported claims and a degree of demand surge. Actual losses from
2005 third quarter catastrophes, however, may exceed management's estimate as a
result of, among other things, the receipt of additional information from
insureds, the attribution of losses to coverages which, for purposes of
estimates, were assumed not to be exposed, and inflation in repair costs due to
the limited availability of labor and materials, in which case the Company's
operating results and financial condition could be further materially adversely
affected.
The Company's 2005 third quarter net losses were $92.5 million, compared
with net losses of $47.0 million in the corresponding 2004 period. Net losses
for the first nine months of 2005 were $0.2 million, compared with net earnings
of $63.8 million in the corresponding 2004 period. Discontinued operations
consist of the operations of Heads & Threads International LLC prior to its
disposition in December 2004 and the operations of World
-13-
Minerals prior to its disposition in July 2005. Additional information regarding
discontinued operations can be found in the Notes to Consolidated Financial
Statements included in this report on Form 10-Q.
The Company's 2005 third quarter net loss included net gains on investment
transactions after tax of $32.4 million, compared with $4.3 million in the 2004
third quarter. Alleghany common stockholders' equity per share at September 30,
2005 was $228.91, an increase of 1.1% from common stockholders' equity per share
of $226.50 at December 31, 2004 (as adjusted for the stock dividend declared in
March 2005). On a consolidated basis, cash and invested assets were
approximately $3.03 billion at September 30, 2005, an increase of 22.8% from
approximately $2.47 billion at December 31, 2004.
In the first nine months of 2005, the Company's net loss from continuing
operations was $6.8 million, compared with net earnings from continuing
operations of $51.2 million in the corresponding 2004 period. The 2005
nine-month net loss results include net gains on investment transactions after
tax of $63.5 million, compared with $28.7 million in the first nine months of
2004, and net catastrophe losses after tax of $188.8 million, compared with
$106.8 million in the corresponding 2004 period.
AIHL Insurance Group
Alleghany Insurance Holdings LLC ("AIHL") recorded a net loss of $132.4
million on revenues of $218.7 million in the 2005 third quarter, compared with a
net loss of $81.5 million on revenues of $216.4 million in the third quarter of
2004, and a net loss of $42.9 million on revenues of $705.7 million in the first
nine months of 2005, compared with net earnings of $84.4 million on revenues of
$664.7 million in the first nine months of 2004. AIHL's 2005 third quarter
results reflect $162.8 million of after-tax catastrophe losses, net of
reinsurance, and $17.0 million of reinsurance reinstatement premiums from 2005
third quarter hurricane activity. AIHL's 2004 third quarter results reflect
$97.9 million of after-tax catastrophe losses, net of reinsurance, and $6.9
million of reinsurance reinstatement premiums from the four Florida hurricanes
during the period.
The comparative pre-tax contributions to AIHL's results made by its
operating units RSUI, CATA and Darwin, and total AIHL results, were as follows
(in millions, except ratios):
Three Months Ended September 30,
RSUI CATA Darwin(1) AIHL
-------- ------ ---------- -------
2005
Gross premiums written (2) $ 305.9 $ 44.1 $ 43.0 $ 393.0
-14-
Net premiums written (2) 134.0 41.7 26.0 201.7
Net premiums earned $ 133.1 $ 39.4 $ 22.0 $ 194.5
Loss and loss adjustment expenses 326.8 18.3 14.9 360.0
Underwriting expenses 32.7 16.3 6.7 55.7
-------- ------ ------ -------
Underwriting (loss) profit (3) $ (226.4) $ 4.8 $ 0.4 (221.2)
======== ======= ======
Interest, dividend and other income 19.7
Net gain on investment transactions 4.6
Other expenses (9.6)
Loss before income taxes $(206.5)
=======
Loss ratio (4) 245.5% 46.3% 68.1% 185.1%
Expense ratio (5) 24.6% 41.5% 30.3% 28.7%
Combined ratio (6) 270.1% 87.8% 98.4% 213.8%
2004
Gross premiums written (2) $ 305.5 $ 43.7 $ 25.3 $ 374.5
Net premiums written (2) 155.7 39.1 17.2 212.0
Net premiums earned $ 147.5 $ 37.7 $ 13.4 $ 198.6
Loss and loss adjustment expenses 212.2 21.3 8.7 242.2
Underwriting expenses 23.3 20.9 4.5 48.7
-------- ------ ------ -------
Underwriting (loss) profit (3) $ (88.0) $ (4.5) $ 0.2 (92.3)
======== ======= ======
Interest, dividend and other income 11.1
Net gain on investment transactions 6.7
Other expenses (7.0)
-------
Loss before income taxes $ (81.5)
=======
Loss ratio (4) 143.9% 56.3% 65.0% 121.9%
Expense ratio (5) 15.8% 55.5% 33.8% 24.5%
Combined ratio (6) 159.7% 111.8% 98.8% 146.4%
Nine months Ended September 30,
RSUI CATA Darwin(1) AIHL
-------- ------ ---------- ---------
2005
Gross premiums written (2) $ 902.2 $133.0 $113.5 $1,148.7
Net premiums written (2) 443.8 126.5 67.3 637.6
Net premiums earned $ 446.8 $119.2 $ 60.7 $ 626.7
Loss and loss adjustment expenses 492.2 56.1 41.4 589.7
Underwriting expenses 94.1 51.9 18.2 164.1
-------- ------ ------ --------
Underwriting (loss) profit (3) $ (139.4) $ 11.2 $ 1.1 (127.1)
======== ====== ======
Interest, dividend and other income 48.6
Net gain on investment transactions 30.4
Other expenses (23.2)
--------
Loss before income taxes $ (71.3)
========
-15-
Loss ratio (4) 110.2% 47.1% 68.2% 94.1%
Expense ratio (5) 21.1% 43.5% 29.9% 26.2%
Combined ratio (6) 131.2% 90.6% 98.1% 120.3%
2004
Gross premiums written (2) $ 907.9 $132.1 $ 66.1 $1,106.1
Net premiums written (2) 465.3 118.1 45.8 629.2
Net premiums earned $ 449.8 $111.7 $ 30.0 $ 591.5
Loss and loss adjustment expenses 345.6 62.6 19.1 427.3
Underwriting expenses 70.2 51.7 11.2 133.1
-------- ------ ------ --------
Underwriting profit (loss) (3) $ 34.0 $ (2.6) $ (0.3) 31.1
======== ====== ======
Interest, dividend and other income 30.8
Net gain on investment transactions 42.5
Other expenses (20.0)
--------
Earnings before income taxes $ 84.4
========
Loss ratio (4) 76.8% 56.1% 63.6% 72.2%
Expense ratio (5) 15.6% 46.3% 37.2% 22.5%
Combined ratio (6) 92.4% 102.4% 100.8% 94.7%
(1) Although Darwin is an underwriting manager for Platte River and certain
subsidiaries of CATA, Darwin is managed on an operating unit basis and,
therefore, the results of business generated by Darwin have been separated from
CATA's results for purposes of this table.
(2) Amounts do not reflect the impact of an inter-company pooling agreement.
(3) Represents net premiums earned less loss and loss adjustment expenses and
underwriting expenses, all as determined in accordance with U.S. generally
accepted accounting principles ("GAAP"), and does not include interest, dividend
and other income or net gains on investment transactions. Underwriting profit
(loss) does not replace net earnings (loss) determined in accordance with GAAP
as a measure of profitability; rather, the Company believes that underwriting
profit (loss) enhances the understanding of AIHL's insurance operating units'
operating results by highlighting net earnings attributable to their
underwriting performance. With the addition of interest, dividend and other
income and net gains on investment transactions, reported pre-tax net earnings
(a GAAP measure) may show a profit despite an underlying underwriting loss.
Where such underwriting losses persist over extended periods, an insurance
company's ability to continue as an ongoing concern may be at risk. Therefore,
the Company views underwriting profit (loss) as an important measure in the
overall evaluation of the performance of its insurance operations.
(4) Loss and loss adjustment expenses divided by net premiums earned, all as
determined in accordance with GAAP.
(5) Underwriting expenses divided by net premiums earned, all as determined in
accordance with GAAP.
(6) 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 spends on losses (including loss adjustment expenses) and underwriting
expenses.
RSUI Group, Inc.
RSUI recorded an underwriting loss of $226.4 million in the 2005 third
quarter due to $249.9 million of pre-tax catastrophe losses, net of reinsurance
and $26.1 million of reinsurance reinstatement premiums, primarily reflecting
the impact of Hurricanes
-16-
Katrina, Rita and Dennis. RSUI's 2004 third quarter underwriting loss of $88.0
million reflects $147.9 million of pre-tax catastrophe losses, net of
reinsurance and $10.5 million of reinsurance reinstatement premiums, primarily
reflecting the impact of the four Florida hurricanes during the period. RSUI's
reported hurricane losses represent management's current best estimate and are
based on management's assessment of information from actual claim reports,
information derived from third party catastrophe modeling software, as well as
industry loss estimates. In addition, RSUI's reported hurricane losses include
estimates of unreported claims, anticipated adverse development on reported
claims and a degree of demand surge. RSUI's actual losses from the hurricanes,
however, may exceed its estimate as a result of, among other things, the receipt
of additional information from insureds, the attribution of losses to coverages
which, for purposes of estimates, were assumed not to be exposed, and inflation
in repair costs due to the limited availability of labor and materials, in which
case RSUI's operating results and financial condition could be further
materially adversely affected.
Of RSUI's $1.06 billion of estimated gross losses from Hurricane Katrina,
$855.8 million were ceded to RSUI's reinsurers under all of RSUI's reinsurance
programs. Of this amount, $513.8 million was first applied to RSUI's surplus
share, facultative and per risk reinsurance programs and $342.0 million was then
applied to RSUI's catastrophe reinsurance program. Under RSUI's $400.0 million
aggregate limit catastrophe reinsurance program, which applies to losses after
deducting all recoveries from other reinsurance programs, RSUI retains the first
$40.0 million of losses, 5% (or $18.0 million) of losses from $40.0 million to
$400.0 million and 100% of losses above $400.0 million. The reinsurance
recoveries for Hurricane Katrina anticipate the full utilization of RSUI's
catastrophe reinsurance program and significant utilization of the occurrence
limits of its surplus share and per risk reinsurance treaties. As a result,
should Hurricane Katrina's losses prove to be greater than currently estimated,
RSUI would not have reinsurance coverage under its catastrophe program or
significant reinsurance coverage under its other reinsurance programs available
for additional loss amounts. After payment of reinsurance reinstatement premiums
with respect to its catastrophe and per risk reinsurance treaties, RSUI
currently estimates it has in excess of 95% of the limits of its catastrophe
reinsurance program available in the event gross losses from Hurricane Rita
increase or future catastrophe events occur during the coverage period.
At September 30, 2005, RSUI had reinsurance recoverables of $1.52 billion
on gross unpaid loss and loss adjustment expenses of $2.22 billion. Although
reinsurance makes the reinsurer liable to RSUI to the extent risk is transferred
or ceded to the reinsurer, it does not relieve RSUI of its liability to its
policyholders. Accordingly, RSUI bears risk with respect to its reinsurers to
the extent they do not pay claims made by RSUI on a timely basis, or do not pay
some or all of these claims. Therefore, the financial strength of its
reinsurers is important. Approximately 97.7%, or $1.48 billion, of RSUI's
reinsurance recoverables balance at September 30, 2005 was due from reinsurance
companies having financial strength ratings of A or higher ( as of September
-17-
30, 2005) by A.M. Best Company, Inc., an independent organization that analyzes
the insurance industry. RSUI had no allowance for uncollectible reinsurance as
of September 30, 2005.
The availability and cost of reinsurance are subject to prevailing market
conditions, both in terms of price and available capacity, which can affect
RSUI's business volume and profitability. RSUI's reinsurance programs are
generally subject to renewal on an annual basis. RSUI's current catastrophe and
per risk reinsurance treaties expire on May 1, 2006, and its surplus share
reinsurance treaties expire on January 1, 2006. If RSUI is unable to renew its
expiring programs or to obtain new reinsurance coverage at terms and at a price
acceptable to it, either RSUI's net exposures would increase, which could
increase the volatility of its results, or, if RSUI was unwilling to bear an
increase in net exposures, the level of its underwriting commitments for
catastrophe and non-catastrophe exposed risks would have to be reduced, which
may reduce RSUI's revenues and net income.
As part of its approach to managing catastrophe risk, RSUI has
historically used a number of tools, including third party catastrophe modeling
software, to help model estimated losses. RSUI has used such estimated loss
scenarios to set its level of risk retention and help structure its reinsurance
programs. Such modeled estimates, however, have not accurately predicted RSUI's
ultimate losses with respect to recent hurricane activity. In the case of
Hurricane Katrina, the modeled estimates significantly underestimated RSUI's
current estimate of ultimate losses due to a number of factors, including
damageability ratios and the effect of storm surge. Accordingly, RSUI is
reviewing and analyzing its catastrophe exposure management approach, including
its modeling tools and its underwriting guidelines and procedures, in an attempt
to manage its accumulations of risk such that its loss exposure conforms to its
established risk tolerances and fits within its reinsurance programs. Actions
RSUI may take as a result of such review could end up reducing, possibly
significantly, its writings in certain classes of catastrophe exposed business.
Prior to completion of these actions, RSUI remains exposed to greater
catastrophe risks than previously expected.
Subsequent to the end of the 2005 third quarter, Hurricane Wilma made
landfall in Mexico and Florida. RSUI has exposure to Hurricane Wilma in Florida
but currently does not have sufficient information to estimate its losses. To
the extent that RSUI utilizes coverage under its catastrophe reinsurance program
with respect to losses from Wilma, such utilization will reduce the amounts
available for future catastrophe events that occur until the catastrophe
reinsurance program expires on May 1, 2006.
Capitol Transamerica Corporation
The increase in CATA's underwriting profit in the third quarter and first
nine months of 2005 compared with the corresponding 2004 periods primarily
reflects a $2.9
-18-
million pre-tax reduction in prior year loss reserves in the first nine months
of 2005 (compared with a $1.4 million increase in prior year loss reserves in
the first nine months of 2004) due to lower actual loss emergence than assumed
for purposes of setting reserves and a decrease in reinsurance costs. Gross
premiums written during the third quarter and first nine months of 2005
increased slightly from the corresponding 2004 periods, reflecting the continued
expansion of CATA's business into the excess and surplus markets, partially
offset by the loss of premiums attributable to the contract surety lines of
business that CATA exited in the 2005 first quarter. The increase in net
premiums earned at CATA in the third quarter and first nine months of 2005 from
the corresponding 2004 periods primarily reflects growth in both excess and
surplus markets and commercial surety lines and lower reinsurance costs
partially offset by the loss of premiums attributable to the exit from contract
surety. The decrease in loss and loss adjustment expenses in the third quarter
and first nine months of 2005 from the corresponding 2004 periods reflects the
$2.9 million pre-tax reduction in prior year loss reserves in the first nine
months of 2005 (compared with the $1.4 million increase in prior year loss
reserves during the first nine months of 2004), partially offset by additional
current accident year reserve provisions relating to the increase in net
premiums earned in the third quarter and first nine months of 2005.
CATA experienced lower levels of rate increases in its property and
casualty lines of business, primarily due to increased competition, and
generally unchanged commercial surety rates for the 2005 third quarter and first
nine months of 2005 as compared with the third quarter and first nine months of
2004.
Darwin Professional Underwriters
Darwin reported an increase in underwriting profit in the third quarter
and first nine months of 2005 from the corresponding 2004 periods, primarily
reflecting a significant increase in net premiums earned due to increased levels
of gross premiums written across all lines of business, partially offset by
increased loss and loss adjustment expenses and underwriting expenses primarily
attributable to such premium growth. As Darwin commenced operations in May 2003,
it does not have sufficient claims history 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.
Loss Reserves
The following table presents the reserves established in connection with
the losses and LAE liabilities of AIHL's insurance operating units on a gross
and net basis by line of business. Such reserve amounts represent the
accumulation of estimates of ultimate losses (including losses incurred but not
reported) and LAE.
-19-
PROPERTY CASUALTY CMP SURETY ALL OTHER TOTAL
-------- -------- ------ ------ --------- -----
(dollars in millions)
AT SEPTEMBER 30, 2005
Gross loss and LAE reserves $1,418.4 $923.8 $ 86.6 $17.4 $111.1 $2,557.3
Reinsurance recoverables on unpaid
losses (1,096.5) (369.1) (1.0) (1.9) (85.7) (1,554.2)
-------- ------ ------ ----- ------ --------
Net loss and LAE reserves $ 321.9 $554.7 $ 85.6 $15.5 $ 25.4 $1,003.1
======== ====== ====== ===== ====== ========
AT DECEMBER 31, 2004
Gross loss and LAE reserves $ 449.7 $563.2 $ 82.6 $15.8 $121.0 $1,232.3
Reinsurance recoverables on unpaid
losses (276.5) (217.3) (1.0) (1.0) (95.6) (591.4)
-------- ------ ------ ----- ------ --------
Net loss and LAE reserves $ 173.2 $345.9 $ 81.6 $14.8 $ 25.4 $ 640.9
======== ====== ====== ===== ====== ========
Gross and net loss and LAE reserves increased at September 30, 2005 from
December 31, 2004, primarily reflecting increases in property and casualty loss
and LAE reserves. With respect to property lines of business, the increase in
gross and net loss and LAE reserves reflects the impact of the 2005 third
quarter hurricanes, partially offset by amounts paid during the first nine
months of 2005 with respect to 2004 third quarter catastrophe losses. The 2005
third quarter hurricanes added $1.3 billion to gross property loss and LAE
reserves and $256.8 million to net property loss and LAE reserves at September
30, 2005.
The increase in gross and net loss and LAE reserves for casualty lines of
business (which include, among others, excess and umbrella liability, directors
and officers' liability, professional liability, general liability and workers'
compensation) primarily reflects increased net earned premiums for general
liability, umbrella and professional liability exposures and limited paid loss
activity for the current and prior casualty accident years. With respect to
commercial multiple peril ("CMP") lines of business, which include both property
and casualty exposures, the increase in gross and net loss and LAE reserves
primarily reflects an increase in CMP premiums earned in 2005. Surety gross and
net loss and LAE reserves have increased from December 31, 2004 to correspond to
the increase in the earned premiums associated with CATA's contract surety
business, which was put in run-off in the first quarter of this year.
The decrease in gross loss and LAE reserves in "All Other" lines of
business (which primarily consist of loss and LAE reserves for discontinued
lines of business and loss and LAE reserves acquired in connection with the
acquisition of companies for which the seller provided loss reserve guarantees)
primarily reflects a decrease in loss and LAE reserves acquired in connection
with the acquisition of Platte River Insurance Company in January 2002 for which
the seller provided loss reserve guarantees, partially offset by an increase in
loss and LAE reserves resulting from the acquisition in May 2005
-20-
of Ulico Indemnity Company ("Ulico") by Darwin National Assurance Company. Ulico
loss and LAE reserves at September 30, 2005, for which the seller provided loss
reserve guarantees, were approximately $6.2 million. On a net basis, the unpaid
loss and LAE reserves in "All Other" lines of business at September 30, 2005
were unchanged from year-end 2004. The net loss and LAE reserves are primarily
related to assumed reinsurance written by CATA in the early 1970's for which
there has been only small paid loss activity in 2005.
AIHL Investment Results
AIHL's 2005 third quarter net earnings include investment income of $19.7
million, compared with $11.1 million in the corresponding 2004 period. AIHL's
net earnings for the first nine months in 2005 include investment income of
$48.6 million, compared with $30.7 million in the corresponding 2004 period. The
increase in the more recent periods reflects higher invested assets and higher
investment yields compared with the corresponding 2004 periods.
AIHL's 2005 third quarter net earnings include net gains on investment
transactions of $4.6 million, compared with $6.7 million in the corresponding
2004 period. AIHL's net earnings for the first nine months in 2005 include net
gains on investment transactions of $30.4 million, compared with $42.5 million
in the corresponding 2004 period.
Corporate Activities
Corporate activities' 2005 third quarter results include $45.3 million of
net gains on investment transactions before tax as a result of the disposition
of 1.0 million shares of common stock of Burlington Northern Santa Fe
Corporation, compared with no such gains in the corresponding 2004 period, and
corporate activities' results in the first nine months of 2005 include $67.3
million of net gains on investment transactions before tax, compared with $1.7
million in the first nine months of 2004.
As of September 30, 2005, the Company beneficially owned 7.0 million
shares, or approximately 1.9 percent, of the outstanding common stock of
Burlington Northern Santa Fe Corporation, which had an aggregate market value on
that date of approximately $418.6 million, or $59.80 per share. The aggregate
cost of such shares is approximately $84.5 million, or $12.07 per share.
As of September 30, 2005, the Company had 7,895,189 shares of common stock
outstanding (which includes the stock dividend declared in March 2005).
The Company's results in the third quarter and first nine months of 2005
are not indicative of operating results in future periods. The Company and its
subsidiaries have
-21-
adequate internally generated funds and unused credit facilities to provide for
the currently foreseeable needs of its and their businesses.
The Company and its subsidiaries have certain obligations to make future
payments under contracts and credit-related financial instruments and
commitments. At September 30, 2005, certain long-term contractual obligations
and credit-related financial commitments were as follows (in thousands):
MORE THAN 1 MORE THAN MORE
WITHIN 1 YEAR BUT 3 YEARS BUT THAN 5
CONTRACTUAL OBLIGATIONS TOTAL YEAR WITHIN 3 WITHIN 5 YEARS
----------------------- ---------- -------- ----------- ----------- --------
Long-term debt obligations $ 80,000 $ -- $ 80,000 $ -- $ --
Operating lease obligations 43,879 6,490 13,948 12,160 11,281
Other long-term liabilities reflected on
consolidated balance sheet under GAAP*
7,493 981 1,962 1,337 3,213
Losses and LAE 2,557,249 939,608 849,774 366,563 401,334
---------- -------- -------- -------- --------
TOTAL $2,688,621 $947,079 $945,654 $380,060 $415,828
========== ======== ======== ======== ========
* Other long-term liabilities primarily reflect pension and long-term incentive
obligations.
The Company's insurance operations have obligations to make certain
payments for losses and LAE pursuant to insurance policies they issue. These
future payments are reflected as reserves on the Company's financial statements.
With respect to loss and LAE, there is typically no minimum contractual
commitment associated with insurance contracts and the timing and ultimate
amount of actual claims related to these reserves is uncertain.
Information regarding the Company's accounting policies is included in the
Company's 2004 Form 10-K, 2005 First Quarter Form 10-Q, 2005 Second Quarter Form
10-Q and the Notes to 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, as well as
equity securities which are subject to fluctuations in market value. The Company
holds its equity securities and debt securities as available for sale. Any
-22-
changes in the fair value in these securities, net of tax, would be reflected in
the Company's accumulated other comprehensive income as a component of
stockholders' equity.
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 +/- 300 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 September 30, 2005 ending prices based on
yields adjusted to reflect a +/ - 300 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.
-23-
SENSITIVITY ANALYSIS
At September 30, 2005
(dollars in millions)
INTEREST RATE SHIFTS -300 -200 -100 0 100 200 300
- -------------------- -------- -------- -------- -------- -------- -------- --------
ASSETS
Debt securities, fair value $1,810.1 $1,757.6 $1,706.0 $1,654.0 $1,599.3 $1,544.1 $1,489.0
Estimated change in fair value $ 156.1 $ 103.6 $ 52.0 $ --- $ (54.7) $ (109.9) $ (165.0)
LIABILITIES
Subsidiaries' debt, fair value $ 81.2 $ 81.2 $ 82.2 $ 83.2 $ 84.2 $ 85.2 $ 85.2
Estimated change in fair value $ (2.0) $ (2.0) $ (1.0) $ --- $ 1.0 $ 2.0 $ 2.0
The Company's 2004 Form 10-K provides a more detailed discussion of the
market risks affecting its operations.
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 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 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 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 as defined in the
Private Securities Litigation Reform Act of 1995. Forward-looking statements
include all statements 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," "believe," "potential," "should,"
"continue" or the negative versions of those words or other comparable words.
These forward-looking statements are based upon the Company's current plans or
expectations and are subject to a number of uncertainties
-24-
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 risks relating to the Company's insurance subsidiaries such as
- - significant weather-related or other natural or human-made catastrophes
and disasters;
- - the cyclical nature of the property casualty industry;
- - the long-tail and potentially volatile nature of certain casualty lines of
business written by such subsidiaries;
- - the availability of reinsurance;
- - exposure to terrorist acts;
- - the willingness and ability of such subsidiaries' reinsurers to pay
reinsurance recoverables owed to such subsidiaries;
- - changes in the ratings assigned to such subsidiaries;
- - claims development and the process of estimating reserves;
- - legal and regulatory changes;
- - the uncertain nature of damage theories and loss amounts;
- - increases in the levels of risk retention by such subsidiaries;
- - adverse loss development for events insured by such subsidiaries in either
the current year or prior year.
Additional risks and uncertainties include 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; risks relating to conducting operations in a competitive environment;
effects of acquisition and disposition activities, inflation rates or
recessionary or expansive trends, changes in market prices of the Company's
significant equity investments; extended labor disruptions, 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 its 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.
-25-
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS.
Exhibit Number Description
31.1 Certification of the Chief Executive Officer of the Company
pursuant to Rule 13a-14(a) or Rule 15(d)-14(a) of the
Securities Exchange Act of 1934, as amended.
31.2 Certification of the Chief Financial Officer of the Company
pursuant to Rule 13a-14(a) or Rule 15(d)-14(a) of the
Securities Exchange Act of 1934, as amended.
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.
-26-
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: November 9, 2005 /s/ Roger B. Gorham
-------------------
Roger B. Gorham
Senior Vice President
(and chief financial officer)