UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 

FORM 10-Q

 

(Mark One)

ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the quarterly period ended June 30, 2004

 

 

Or

 

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the transition period                          to                         

 

 

Commission file number:  0-26456

 

ARCH CAPITAL GROUP LTD.

(Exact name of registrant as specified in its charter)

 

Bermuda

 

Not Applicable

(State or other jurisdiction of incorporation or
organization)

 

(I.R.S. Employer Identification No.)

 

 

 

Wessex House, 45 Reid Street
Hamilton HM 12, Bermuda

 

 

(Address of principal executive offices)

 

(Zip Code)

 

 

 

Registrant’s telephone number, including area code:  (441) 278-9250

 

 

 

 

 

 

(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 ý  No o

 

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes ý  No o

 

Indicate the number of shares outstanding of each of the issuer’s classes of common shares.

 

Class

 

Outstanding at July 31, 2004

Common Shares, $0.01 par value

 

34,564,833

 

 



 

ARCH CAPITAL GROUP LTD.

 

INDEX

 

PART I.  Financial Information

 

 

 

Item 1 — Consolidated Financial Statements

 

 

 

Report of Independent Registered Public Accounting Firm

2

 

 

Consolidated Balance Sheets
June 30, 2004 and December 31, 2003

3

 

 

Consolidated Statements of Income
For the three and six month periods ended June 30, 2004 and 2003

4

 

 

Consolidated Statements of Changes in Shareholders’ Equity
For the six month periods ended June 30, 2004 and 2003

5

 

 

Consolidated Statements of Comprehensive Income
For the six month periods ended June 30, 2004 and 2003

6

 

 

Consolidated Statements of Cash Flows
For the six month periods ended June 30, 2004 and 2003

7

 

 

Notes to Consolidated Financial Statements

8

 

 

Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations

26

 

 

Item 3 — Quantitative and Qualitative Disclosures About Market Risk

64

 

 

Item 4 — Controls and Procedures

64

 

 

PART II.  Other Information

65

 

 

Item 1 — Legal Proceedings

65

 

 

Item 2 – Changes in Securities, Use of Proceeds and Issuer Purchase of Equity Securities

66

 

 

Item 4 – Submission of Matters to a Vote of Security Holders

66

 

 

Item 5 — Other Information

67

 

 

Item 6 — Exhibits and Reports on Form 8-K

67

 

1



 

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Shareholders of
Arch Capital Group Ltd.:

 

We have reviewed the accompanying consolidated balance sheet of Arch Capital Group Ltd. and its subsidiaries as of June 30, 2004, and the related consolidated statements of income for each of the three and six month periods ended June 30, 2004 and 2003, and the consolidated statements of comprehensive income, changes in shareholders equity and cash flows for each of the six month periods ended June 30, 2004 and 2003. These interim consolidated financial statements are the responsibility of the Company’s management.

 

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States).  A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than an audit conducted in accordance with standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the consolidated financial statements taken as a whole.  Accordingly, we do not express such an opinion.

 

Based on our review, we are not aware of any material modifications that should be made to the accompanying consolidated interim financial information for it to be in conformity with accounting principles generally accepted in the United States of America.

 

We previously audited in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2003, and the related consolidated statements of income, comprehensive income, changes in shareholders equity, and cash flows for the year then ended (not presented herein), and in our report dated February 14, 2004, we expressed an unqualified opinion on those consolidated financial statements.  In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2003, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived.

 

 

/s/ PricewaterhouseCoopers LLP

 

New York, New York

August 3, 2004

 

2



 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(U.S. dollars in thousands, except share data)

 

 

 

(Unaudited)

 

 

 

 

 

June 30,
2004

 

December 31,
2003

 

Assets

 

 

 

 

 

Investments:

 

 

 

 

 

Fixed maturities available for sale, at fair value (amortized cost:  2004, $4,486,543; 2003, $3,363,193)

 

$

4,461,137

 

$

3,398,424

 

Short-term investments available for sale, at fair value (amortized cost:  2004, $84,031; 2003, $228,616)

 

84,031

 

229,348

 

Privately held securities (cost:  2004, $18,848; 2003, $27,632)

 

24,229

 

32,476

 

Total investments

 

4,569,397

 

3,660,248

 

Cash

 

188,121

 

56,899

 

Accrued investment income

 

42,219

 

30,316

 

Premiums receivable

 

602,862

 

477,032

 

Funds held by reinsureds

 

206,796

 

211,944

 

Unpaid losses and loss adjustment expenses recoverable

 

506,715

 

409,451

 

Paid losses and loss adjustment expenses recoverable

 

23,183

 

18,549

 

Prepaid reinsurance premiums

 

232,329

 

236,061

 

Goodwill and intangible assets

 

31,423

 

35,882

 

Deferred income tax assets, net

 

53,875

 

33,979

 

Deferred acquisition costs, net

 

302,069

 

275,696

 

Other assets

 

157,144

 

139,264

 

Total Assets

 

$

6,916,133

 

$

5,585,321

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Reserve for losses and loss adjustment expenses

 

$

2,702,358

 

$

1,951,967

 

Unearned premiums

 

1,529,275

 

1,402,998

 

Reinsurance balances payable

 

104,382

 

117,916

 

Senior notes

 

300,000

 

 

Revolving credit agreement borrowings

 

 

200,000

 

Deposit accounting liabilities

 

41,495

 

25,762

 

Other liabilities

 

201,119

 

175,949

 

Total Liabilities

 

4,878,629

 

3,874,592

 

 

 

 

 

 

 

Commitments and Contingencies

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ Equity

 

 

 

 

 

Preference shares ($0.01 par value, 50,000,000 shares authorized, issued: 2004, 38,364,972; 2003, 38,844,665)

 

384

 

388

 

Common shares ($0.01 par value, 200,000,000 shares authorized, issued: 2004, 33,548,012; 2003, 28,200,372)

 

335

 

282

 

Additional paid-in capital

 

1,548,442

 

1,361,267

 

Deferred compensation under share award plan

 

(11,792

)

(15,004

)

Retained earnings

 

519,700

 

327,963

 

Accumulated other comprehensive (loss) income, net of deferred income tax

 

(19,565

)

35,833

 

Total Shareholders’ Equity

 

2,037,504

 

1,710,729

 

Total Liabilities and Shareholders’ Equity

 

$

6,916,133

 

$

5,585,321

 

 

See Notes to Consolidated Financial Statements

 

3



 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(U.S. dollars in thousands, except share data)

 

 

 

(Unaudited)

 

(Unaudited)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Revenues

 

 

 

 

 

 

 

 

 

Net premiums written

 

$

677,646

 

$

560,002

 

$

1,561,234

 

$

1,336,865

 

Decrease (increase) in unearned premiums

 

45,753

 

(51,146

)

(130,009

)

(423,558

)

Net premiums earned

 

723,399

 

508,856

 

1,431,225

 

913,307

 

Net investment income

 

32,811

 

19,772

 

57,384

 

38,210

 

Net realized (losses) gains

 

(2,321

)

3,889

 

6,580

 

10,088

 

Fee income

 

4,304

 

4,934

 

8,298

 

10,610

 

Other (loss) income

 

(4,385

)

587

 

(3,343

)

1,726

 

Total revenues

 

753,808

 

538,038

 

1,500,144

 

973,941

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

Losses and loss adjustment expenses

 

436,895

 

331,333

 

866,509

 

594,461

 

Acquisition expenses

 

136,889

 

95,620

 

289,745

 

173,772

 

Other operating expenses

 

69,155

 

40,995

 

125,248

 

72,075

 

Interest expense

 

4,642

 

 

6,016

 

 

Net foreign exchange gains

 

(5,503

)

(1,761

)

(184

)

(2,811

)

Non-cash compensation

 

2,756

 

3,498

 

5,394

 

7,762

 

Total expenses

 

644,834

 

469,685

 

1,292,728

 

845,259

 

 

 

 

 

 

 

 

 

 

 

Income Before Income Taxes

 

108,974

 

68,353

 

207,416

 

128,682

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

4,692

 

6,569

 

15,679

 

14,412

 

 

 

 

 

 

 

 

 

 

 

Net Income

 

$

104,282

 

$

61,784

 

$

191,737

 

$

114,270

 

 

 

 

 

 

 

 

 

 

 

Net Income Per Share Data

 

 

 

 

 

 

 

 

 

Basic

 

$

3.26

 

$

2.36

 

$

6.47

 

$

4.38

 

Diluted

 

$

1.42

 

$

0.91

 

$

2.69

 

$

1.70

 

 

 

 

 

 

 

 

 

 

 

Weighted Average Shares Outstanding

 

 

 

 

 

 

 

 

 

Basic

 

32,023,865

 

26,185,445

 

29,650,932

 

26,101,843

 

Diluted

 

73,500,041

 

67,728,798

 

71,336,798

 

67,381,859

 

 

See Notes to Consolidated Financial Statements

 

4



 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(U.S. dollars in thousands)

 

 

 

(Unaudited)

 

 

 

Six Months Ended
June 30,

 

 

 

2004

 

2003

 

Preference Shares

 

 

 

 

 

Balance at beginning of year

 

$

388

 

$

388

 

Converted to common shares

 

(4

)

 

Balance at end of period

 

384

 

388

 

 

 

 

 

 

 

Common Shares

 

 

 

 

 

Balance at beginning of year

 

282

 

277

 

Common shares issued

 

49

 

3

 

Converted from preference shares

 

4

 

 

Balance at end of period

 

335

 

280

 

 

 

 

 

 

 

Additional Paid-in Capital

 

 

 

 

 

Balance at beginning of year

 

1,361,267

 

1,347,165

 

Common shares issued

 

184,437

 

3,585

 

Exercise of stock options

 

3,592

 

4,887

 

Common shares retired

 

(2,708

)

(645

)

Other

 

1,854

 

1,022

 

Balance at end of period

 

1,548,442

 

1,356,014

 

 

 

 

 

 

 

Deferred Compensation Under Share Award Plan

 

 

 

 

 

Balance at beginning of year

 

(15,004

)

(25,290

)

Restricted common shares issued

 

(2,142

)

(2,686

)

Deferred compensation expense recognized

 

5,354

 

7,655

 

Balance at end of period

 

(11,792

)

(20,321

)

 

 

 

 

 

 

Retained Earnings

 

 

 

 

 

Balance at beginning of year

 

327,963

 

47,372

 

Net income

 

191,737

 

114,270

 

Balance at end of period

 

519,700

 

161,642

 

 

 

 

 

 

 

Accumulated Other Comprehensive Income (Loss)

 

 

 

 

 

Balance at beginning of year

 

35,833

 

41,332

 

Change in unrealized (decline) appreciation in value of investments, net of deferred income tax

 

(53,958

)

27,007

 

Foreign currency translation adjustments

 

(1,440

)

 

Balance at end of period

 

(19,565

)

68,339

 

 

 

 

 

 

 

Total Shareholders’ Equity

 

$

2,037,504

 

$

1,566,342

 

 

See Notes to Consolidated Financial Statements

 

5



 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(U.S. dollars in thousands)

 

 

 

(Unaudited)

 

 

 

Six Months Ended
June 30,

 

 

 

2004

 

2003

 

Comprehensive Income

 

 

 

 

 

Net income

 

$

191,737

 

$

114,270

 

Other comprehensive (loss) income, net of deferred income tax

 

 

 

 

 

Unrealized (decline) appreciation in value of investments:

 

 

 

 

 

Unrealized holding (losses) gains arising during period

 

(50,987

)

35,868

 

Reclassification of net realized gains, net of income taxes, included in net income

 

(2,971

)

(8,861

)

Foreign currency translation adjustments

 

(1,440

)

 

Comprehensive Income

 

$

136,339

 

$

141,277

 

 

See Notes to Consolidated Financial Statements

 

6



 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(U.S. dollars in thousands)

 

 

 

(Unaudited)

 

 

 

Six Months Ended
June 30,

 

 

 

2004

 

2003

 

Operating Activities

 

 

 

 

 

Net income

 

$

191,737

 

$

114,270

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Net realized gains

 

(5,630

)

(10,088

)

Other loss (income)

 

3,343

 

(1,726

)

Provision for non-cash compensation

 

5,394

 

7,762

 

Changes in:

 

 

 

 

 

Reserve for losses and loss adjustment expenses, net of unpaid losses and loss adjustment expenses recoverable

 

653,127

 

497,825

 

Unearned premiums, net of prepaid reinsurance premiums

 

130,009

 

423,558

 

Premiums receivable

 

(125,830

)

(217,145

)

Deferred acquisition costs, net

 

(26,373

)

(91,340

)

Funds held by reinsureds

 

5,148

 

(57,687

)

Reinsurance balances payable

 

(13,534

)

(7,600

)

Accrued investment income

 

(11,903

)

(8,411

)

Paid losses and loss adjustment expenses recoverable

 

(4,634

)

(4,039

)

Deferred income tax asset

 

(13,213

)

27

 

Deposit accounting liabilities

 

15,733

 

8,780

 

Other liabilities

 

24,360

 

12,010

 

Other items, net

 

15,671

 

1,657

 

Net Cash Provided By Operating Activities

 

843,405

 

667,853

 

 

 

 

 

 

 

Investing Activities

 

 

 

 

 

Purchases of fixed maturity investments

 

(3,413,832

)

(1,602,839

)

Sales of fixed maturity investments

 

2,277,089

 

683,660

 

Sales of equity securities

 

11,043

 

7,019

 

Net sales of short-term investments

 

148,182

 

235,943

 

Acquisitions, net of cash

 

 

(11,774

)

Purchases of furniture, equipment and other

 

(10,878

)

(12,802

)

Net Cash Used For Investing Activities

 

(988,396

)

(700,793

)

 

 

 

 

 

 

Financing Activities

 

 

 

 

 

Proceeds from common shares issued

 

182,090

 

3,882

 

Proceeds from issuance of senior notes

 

296,442

 

 

Repayment of revolving credit agreement borrowings

 

(200,000

)

 

Repurchase of common shares

 

(879

)

(646

)

Net Cash Provided By Financing Activities

 

277,653

 

3,236

 

 

 

 

 

 

 

Effects of exchange rate changes on foreign currency cash

 

(1,440

)

 

 

 

 

 

 

 

Increase (decrease) in cash

 

131,222

 

(29,704

)

Cash beginning of year

 

56,899

 

91,717

 

Cash end of period

 

$

188,121

 

$

62,013

 

 

 

 

 

 

 

Income taxes paid, net

 

$

22,663

 

$

22,213

 

Interest paid

 

$

1,861

 

 

 

See Notes to Consolidated Financial Statements

 

7



 

ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1.                   General

 

Arch Capital Group Ltd. (“ACGL”) is a Bermuda public limited liability company which provides insurance and reinsurance on a worldwide basis through its wholly owned subsidiaries.

 

The interim consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States (“GAAP”) and include the accounts of ACGL and its subsidiaries (together with ACGL, the “Company”). All significant intercompany transactions and balances have been eliminated in consolidation. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and assumptions. In the opinion of management, the accompanying unaudited interim consolidated financial statements reflect all adjustments necessary for a fair statement of results on an interim basis. The results of any interim period are not necessarily indicative of the results for a full year or any future periods.

 

Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations; however, management believes that the disclosures are adequate to make the information presented not misleading. This report should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, including the Company’s audited consolidated financial statements and related notes and the section entitled “Business—Risk Factors.”

 

To facilitate period-to-period comparisons, certain amounts in the 2003 consolidated financial statements have been reclassified to conform to the 2004 presentation. Such reclassifications had no effect on the Company’s consolidated net income, shareholders’ equity or cash flows.

 

2.                   Stock Options

 

The Company has adopted the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”), and related interpretations in accounting for its employee stock options. Accordingly, under APB No. 25, compensation expense for stock option grants is recognized by the Company to the extent that the fair value of the underlying stock exceeds the exercise price of the option at the measurement date. As provided under Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” the Company has elected to continue to account for stock-based compensation in accordance with APB No. 25 and has provided the required additional pro forma disclosures.

 

8



 

If compensation expense for stock-based employee compensation plans had been determined using the fair value recognition provisions of SFAS No. 123, the Company’s net income and earnings per share would have instead been reported as the pro forma amounts indicated below:

 

 

 

 

(Unaudited)

 

(Unaudited)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

(U.S. dollars in thousands, except share data)

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Net income, as reported

 

$

104,282

 

$

61,784

 

$

191,737

 

$

114,270

 

Total stock-based employee compensation expense under fair value method, net of income taxes

 

(427

)

(1,547

)

(937

)

(3,292

)

Pro forma net income

 

$

103,855

 

$

60,237

 

$

190,800

 

$

110,978

 

 

 

 

 

 

 

 

 

 

 

Earnings per share – basic:

 

 

 

 

 

 

 

 

 

As reported

 

$

3.26

 

$

2.36

 

$

6.47

 

$

4.38

 

Pro forma

 

$

3.24

 

$

2.30

 

$

6.43

 

$

4.25

 

Earnings per share – diluted:

 

 

 

 

 

 

 

 

 

As reported

 

$

1.42

 

$

0.91

 

$

2.69

 

$

1.70

 

Pro forma

 

$

1.41

 

$

0.89

 

$

2.67

 

$

1.65

 

 

3.                   Accounting Pronouncements

 

In December 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46R (“FIN 46R”), “Consolidation of Variable Interest Entities.” This interpretation of Accounting Research Bulletin No. 51 (“ARB 51”), “Consolidated Financial Statements”, which replaces FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities”, addresses consolidation by business enterprises of variable interest entities (“VIEs”). FIN 46R clarifies the application of ARB 51 to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. In addition, FIN 46R modified FIN 46 to address certain technical corrections and implementation issues relating to FIN 46. Pursuant to FIN 46, if an enterprise has a controlling financial interest in a VIE, the assets, liabilities and results of operations of the variable interest entity must be included in the consolidated financial statements with those of the business enterprise. An enterprise with an interest in an entity to which the provisions of FIN 46 have not been applied as of December 24, 2003, shall apply the provisions of FIN 46R no later than the end of the first reporting period that ends after March 15, 2004. The provisions of FIN 46 applied immediately to VIEs created after January 31, 2003; however, for VIEs created prior to January 31, 2003 the provisions of FIN 46R are effective for the first year or interim period beginning after March 15, 2004. The provisions of FIN 46R are required to be applied to financial statements of public entities that have interests in VIEs, commonly referred to as special-purpose entities, for periods ending after December 15, 2003.

 

The Company concluded that, under FIN 46R, it is required to consolidate the assets, liabilities and results of operations (if any) of a certain managing general agency in which one of the Company’s subsidiaries has an investment. Such agency ceased producing business in 1999 and is currently running-off its operations. Based on current information, there are no assets or liabilities of such agency required to be reflected on the face of the Company’s consolidated financial statements that are not, or have not been previously, otherwise reflected therein. Therefore, the adoption of FIN 46R did not have a material impact on the Company’s consolidated financial statements as of or for the six months ended June 30, 2004.

 

9



 

In March 2004, the FASB’s Emerging Issues Task Force (“EITF”) reached a consensus regarding EITF 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The consensus provides guidance for evaluating whether an investment is other-than-temporarily impaired. The EITF 03-1 guidance for determining other-than-temporary impairment will be effective beginning with the 2004 third quarter. The Company is currently evaluating the impact that EITF 03-1 may have on its consolidated financial statements.

 

4.                   Segment Information

 

The Company classifies its businesses into two underwriting segments – reinsurance and insurance – and a corporate and other segment (non-underwriting). The Company’s reinsurance and insurance operating segments each have segment managers who are responsible for the overall profitability of their respective segments and who are directly accountable to the Company’s chief operating decision makers, the President and Chief Executive Officer of ACGL and the Chief Financial Officer of ACGL. The chief operating decision makers do not assess performance, measure return on equity or make resource allocation decisions on a line of business basis. The Company determined its reportable operating segments using the management approach described in SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information.”

 

Management measures segment performance based on underwriting income or loss. The Company does not manage its assets by segment and, accordingly, investment income is not allocated to each underwriting segment. In addition, other revenue and expense items are not evaluated by segment. The accounting policies of the segments are the same as those used for the preparation of the Company’s consolidated financial statements. Inter-segment insurance business is allocated to the segment accountable for the underwriting results.

 

The reinsurance segment, or division, consists of the Company’s reinsurance underwriting subsidiaries. The reinsurance segment generally seeks to write significant lines on specialty property and casualty reinsurance treaties. Classes of business include casualty, casualty clash, marine and aviation, non-traditional, other specialty, property catastrophe, and property excluding property catastrophe (losses on a single risk, both excess of loss and pro rata).

 

The insurance segment, or division, consists of the Company’s insurance underwriting subsidiaries which primarily write on a direct basis. The insurance segment consists of eight product lines, including casualty, construction and surety, executive assurance, healthcare, professional liability, programs, property, marine and aviation, and other (primarily non-standard auto, collateralized protection business and certain programs).

 

The corporate and other segment (non-underwriting) includes net investment income, other fee income, net of related expenses, other income, other expenses incurred by the Company, net realized gains or losses, net foreign exchange gains or losses and non-cash compensation. The corporate and other segment also includes the results of Hales & Company Inc. (“Hales”), the Company’s merchant banking operations. Included in other (loss) income for the 2004 second quarter and six months ended June 30, 2004 is a charge of $4.5 million resulting from a write down of the carrying value of Hales (see Note 14, “Goodwill and Intangible Assets”).

 

10



 

The following table sets forth an analysis of the Company’s underwriting income by segment, together with a reconciliation of underwriting income to net income:

 

 

 

(Unaudited)

 

 

 

Three Months Ended
June 30, 2004

 

(U.S. dollars in thousands)

 

Reinsurance

 

Insurance

 

Total

 

 

 

 

 

 

 

 

 

Gross premiums written (1)

 

$

382,987

 

$

465,516

 

$

816,323

 

Net premiums written (1)

 

364,271

 

313,375

 

677,646

 

 

 

 

 

 

 

 

 

Net premiums earned

 

$

378,874

 

$

344,525

 

$

723,399

 

Policy-related fee income

 

 

3,608

 

3,608

 

Other underwriting-related fee income

 

56

 

296

 

352

 

Losses and loss adjustment expenses

 

(218,479

)

(218,416

)

(436,895

)

Acquisition expenses, net

 

(98,265

)

(38,624

)

(136,889

)

Other operating expenses

 

(10,380

)

(54,524

)

(64,904

)

Underwriting income

 

$

51,806

 

$

36,865

 

88,671

 

 

 

 

 

 

 

 

 

Net investment income

 

 

 

 

 

32,811

 

Net realized losses

 

 

 

 

 

(2,321

)

Other fee income, net of related expenses

 

 

 

 

 

344

 

Other (loss) income

 

 

 

 

 

(4,385

)

Other expenses

 

 

 

 

 

(4,251

)

Interest expense

 

 

 

 

 

(4,642

)

Net foreign exchange gains

 

 

 

 

 

5,503

 

Non-cash compensation

 

 

 

 

 

(2,756

)

Income before income taxes

 

 

 

 

 

108,974

 

Income tax expense

 

 

 

 

 

(4,692

)

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

$

104,282

 

 

 

 

 

 

 

 

 

Underwriting Ratios

 

 

 

 

 

 

 

Loss ratio

 

57.7

%

63.4

%

60.4

%

Acquisition expense ratio (2)

 

25.9

%

10.2

%

18.4

%

Other operating expense ratio

 

2.7

%

15.8

%

9.0

%

Combined ratio

 

86.3

%

89.4

%

87.8

%

 


(1)               Certain amounts included in the gross premiums written of each segment are related to intersegment transactions and are included in the gross premiums written of each segment. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total. The reinsurance segment and insurance segment results include $29.8 million and $2.4 million, respectively, of gross and net premiums written assumed through intersegment transactions.

(2)               The acquisition expense ratio is adjusted to include policy-related fee income.

 

11



 

The following table sets forth an analysis of the Company’s underwriting income by segment, together with a reconciliation of underwriting income to net income:

 

 

 

(Unaudited)

 

 

 

Three Months Ended
June 30, 2003

 

(U.S. dollars in thousands)

 

Reinsurance

 

Insurance

 

Total

 

 

 

 

 

 

 

 

 

Gross premiums written (1)

 

$

337,038

 

$

379,607

 

$

676,005

 

Net premiums written (1)

 

323,520

 

236,482

 

560,002

 

 

 

 

 

 

 

 

 

Net premiums earned

 

$

317,504

 

$

191,352

 

$

508,856

 

Policy-related fee income

 

 

3,562

 

3,562

 

Other underwriting-related fee income

 

1,801

 

 

1,801

 

Losses and loss adjustment expenses

 

(203,797

)

(127,536

)

(331,333

)

Acquisition expenses, net

 

(73,702

)

(21,918

)

(95,620

)

Other operating expenses

 

(7,663

)

(30,402

)

(38,065

)

Underwriting income

 

$

34,143

 

$

15,058

 

49,201

 

 

 

 

 

 

 

 

 

Net investment income

 

 

 

 

 

19,772

 

Net realized gains

 

 

 

 

 

3,889

 

Other fee income, net of related expenses

 

 

 

 

 

(429

)

Other income

 

 

 

 

 

587

 

Other expenses

 

 

 

 

 

(2,930

)

Net foreign exchange gains

 

 

 

 

 

1,761

 

Non-cash compensation

 

 

 

 

 

(3,498

)

Income before income taxes

 

 

 

 

 

68,353

 

Income tax expense

 

 

 

 

 

(6,569

)

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

$

61,784

 

 

 

 

 

 

 

 

 

Underwriting Ratios

 

 

 

 

 

 

 

Loss ratio

 

64.2

%

66.6

%

65.1

%

Acquisition expense ratio (2)

 

23.2

%

9.6

%

18.1

%

Other operating expense ratio

 

2.4

%

15.9

%

7.5

%

Combined ratio

 

89.8

%

92.1

%

90.7

%

 


(1)               Certain amounts included in the gross premiums written of each segment are related to intersegment transactions and are included in the gross premiums written of each segment. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total. The reinsurance segment results include $40.6 million of gross and net premiums written assumed through intersegment transactions.

(2)               The acquisition expense ratio is adjusted to include policy-related fee income.

 

12



 

The following table sets forth an analysis of the Company’s underwriting income by segment, together with a reconciliation of underwriting income to net income:

 

 

 

(Unaudited)

 

 

 

Six Months Ended
June 30, 2004

 

(U.S. dollars in thousands)

 

Reinsurance

 

Insurance

 

Total

 

 

 

 

 

 

 

 

 

Gross premiums written (1)

 

$

948,726

 

$

947,085

 

$

1,826,111

 

Net premiums written (1)

 

915,159

 

646,075

 

1,561,234

 

 

 

 

 

 

 

 

 

Net premiums earned

 

$

761,924

 

$

669,301

 

$

1,431,225

 

Policy-related fee income

 

 

7,393

 

7,393

 

Other underwriting-related fee income

 

376

 

424

 

800

 

Losses and loss adjustment expenses

 

(438,296

)

(428,213

)

(866,509

)

Acquisition expenses, net

 

(205,393

)

(84,352

)

(289,745

)

Other operating expenses

 

(19,651

)

(97,783

)

(117,434

)

Underwriting income

 

$

98,960

 

$

66,770

 

165,730

 

 

 

 

 

 

 

 

 

Net investment income

 

 

 

 

 

57,384

 

Net realized gains

 

 

 

 

 

6,580

 

Other fee income, net of related expenses

 

 

 

 

 

105

 

Other (loss) income

 

 

 

 

 

(3,343

)

Other expenses

 

 

 

 

 

(7,814

)

Interest expense

 

 

 

 

 

(6,016

)

Net foreign exchange gains

 

 

 

 

 

184

 

Non-cash compensation

 

 

 

 

 

(5,394

)

Income before income taxes

 

 

 

 

 

207,416

 

Income tax expense

 

 

 

 

 

(15,679

)

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

$

191,737

 

 

 

 

 

 

 

 

 

Underwriting Ratios

 

 

 

 

 

 

 

Loss ratio

 

57.5

%

64.0

%

60.5

%

Acquisition expense ratio (2)

 

27.0

%

11.5

%

19.7

%

Other operating expense ratio

 

2.6

%

14.6

%

8.2

%

Combined ratio

 

87.1

%

90.1

%

88.4

%

 


(1)               Certain amounts included in the gross premiums written of each segment are related to intersegment transactions and are included in the gross premiums written of each segment. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total. The reinsurance segment and insurance segment results include $64.5 million and $5.2 million, respectively, of gross and net premiums written assumed through intersegment transactions.

(2)               The acquisition expense ratio is adjusted to include policy-related fee income.

 

13



 

The following table sets forth an analysis of the Company’s underwriting income by segment, together with a reconciliation of underwriting income to net income:

 

 

 

(Unaudited)

 

 

 

Six Months Ended
June 30, 2003

 

(U.S. dollars in thousands)

 

Reinsurance

 

Insurance

 

Total

 

 

 

 

 

 

 

 

 

Gross premiums written (1)

 

$

899,699

 

$

724,913

 

$

1,536,105

 

Net premiums written (1)

 

870,956

 

465,909

 

1,336,865

 

 

 

 

 

 

 

 

 

Net premiums earned

 

$

583,451

 

$

329,856

 

$

913,307

 

Policy-related fee income

 

 

6,775

 

6,775

 

Other underwriting-related fee income

 

3,728

 

 

3,728

 

Losses and loss adjustment expenses

 

(367,712

)

(226,749

)

(594,461

)

Acquisition expenses, net

 

(138,368

)

(35,404

)

(173,772

)

Other operating expenses

 

(13,782

)

(52,491

)

(66,273

)

Underwriting income

 

$

67,317

 

$

21,987

 

89,304

 

 

 

 

 

 

 

 

 

Net investment income

 

 

 

 

 

38,210

 

Net realized gains

 

 

 

 

 

10,088

 

Other fee income, net of related expenses

 

 

 

 

 

107

 

Other income

 

 

 

 

 

1,726

 

Other expenses

 

 

 

 

 

(5,802

)

Net foreign exchange gains

 

 

 

 

 

2,811

 

Non-cash compensation

 

 

 

 

 

(7,762

)

Income before income taxes

 

 

 

 

 

128,682

 

Income tax expense

 

 

 

 

 

(14,412

)

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

$

114,270

 

 

 

 

 

 

 

 

 

Underwriting Ratios

 

 

 

 

 

 

 

Loss ratio

 

63.0

%

68.7

%

65.1

%

Acquisition expense ratio (2)

 

23.7

%

8.7

%

18.3

%

Other operating expense ratio

 

2.4

%

15.9

%

7.3

%

Combined ratio

 

89.1

%

93.3

%

90.7

%

 


(1)               Certain amounts included in the gross premiums written of each segment are related to intersegment transactions and are included in the gross premiums written of each segment. Accordingly, the sum of gross premiums written for each segment does not agree to the total gross premiums written as shown in the table above due to the elimination of intersegment transactions in the total. The reinsurance segment results include $88.5 million of gross and net premiums written assumed through intersegment transactions.

(2)               The acquisition expense ratio is adjusted to include policy-related fee income.

 

14



 

Set forth below is summary information regarding net premiums written and earned by major line of business and by client location for the reinsurance segment:

 

 

 

(Unaudited)

 

 

 

Three Months Ended
June 30,

 

 

 

2004

 

2003

 

REINSURANCE SEGMENT
(U.S. dollars in thousands)

 

Amount

 

% of
Total

 

Amount

 

% of
Total

 

 

 

 

 

 

 

 

 

 

 

Net premiums written (1)

 

 

 

 

 

 

 

 

 

Casualty

 

$

223,626

 

61.4

%

$

141,864

 

43.9

%

Property excluding property catastrophe

 

65,987

 

18.1

%

69,248

 

21.4

%

Other specialty

 

42,234

 

11.6

%

67,926

 

21.0

%

Property catastrophe

 

13,019

 

3.6

%

23,337

 

7.2

%

Marine and aviation

 

12,067

 

3.3

%

14,349

 

4.4

%

Non-traditional

 

5,751

 

1.6

%

3,948

 

1.2

%

Casualty clash

 

1,587

 

0.4

%

2,848

 

0.9

%

Total

 

$

364,271

 

100.0

%

$

323,520

 

100.0

%

 

 

 

 

 

 

 

 

 

 

Net premiums earned (1)

 

 

 

 

 

 

 

 

 

Casualty

 

$

189,777

 

50.1

%

$

112,101

 

35.3

%

Other specialty

 

73,800

 

19.5

%

62,916

 

19.8

%

Property excluding property catastrophe

 

56,878

 

15.0

%

70,684

 

22.3

%

Property catastrophe

 

23,397

 

6.2

%

29,634

 

9.3

%

Marine and aviation

 

21,682

 

5.7

%

21,689

 

6.8

%

Non-traditional

 

10,743

 

2.8

%

16,423

 

5.2

%

Casualty clash

 

2,597

 

0.7

%

4,057

 

1.3

%

Total

 

$

378,874

 

100.0

%

$

317,504

 

100.0

%

 

 

 

 

 

 

 

 

 

 

Net premiums written by client location (1)

 

 

 

 

 

 

 

 

 

North America

 

$

239,841

 

65.9

%

$

206,364

 

63.8

%

Europe

 

78,079

 

21.4

%

79,308

 

24.5

%

Bermuda

 

26,282

 

7.2

%

13,973

 

4.3

%

Asia and Pacific

 

12,419

 

3.4

%

17,802

 

5.5

%

Other

 

7,650

 

2.1

%

6,073

 

1.9

%

Total

 

$

364,271

 

100.0

%

$

323,520

 

100.0

%

 


(1)               Reinsurance segment results include premiums written and earned assumed through intersegment transactions of $29.8 million and $34.7 million, respectively, for the 2004 second quarter and $40.6 million and $39.7 million, respectively, for the 2003 second quarter. Reinsurance segment results exclude premiums written and earned ceded through intersegment transactions of $2.4 million and $1.9 million, respectively, for the 2004 second quarter.

 

15



 

Set forth below is summary information regarding net premiums written and earned by major line of business and by client location for the reinsurance segment:

 

 

 

(Unaudited)

 

 

 

Six Months Ended
June 30,

 

 

 

2004

 

2003

 

REINSURANCE SEGMENT
(U.S. dollars in thousands)

 

Amount

 

% of
Total

 

Amount

 

% of
Total

 

 

 

 

 

 

 

 

 

 

 

Net premiums written (1)

 

 

 

 

 

 

 

 

 

Casualty

 

$

452,177

 

49.4

%

$

305,824

 

35.1

%

Property excluding property catastrophe

 

174,576

 

19.1

%

181,848

 

20.9

%

Other specialty

 

148,531

 

16.2

%

203,941

 

23.4

%

Property catastrophe

 

71,223

 

7.8

%

72,110

 

8.3

%

Marine and aviation

 

42,710

 

4.7

%

45,770

 

5.3

%

Non-traditional

 

17,479

 

1.9

%

51,583

 

5.9

%

Casualty clash

 

8,463

 

0.9

%

9,880

 

1.1

%

Total

 

$

915,159

 

100.0

%

$

870,956

 

100.0

%

 

 

 

 

 

 

 

 

 

 

Net premiums earned (1)

 

 

 

 

 

 

 

 

 

Casualty

 

$

342,353

 

44.9

%

$

190,608

 

32.7

%

Other specialty

 

159,915

 

21.0

%

120,588

 

20.6

%

Property excluding property catastrophe

 

141,675

 

18.6

%

131,751

 

22.6

%

Property catastrophe

 

50,610

 

6.6

%

57,245

 

9.8

%

Marine and aviation

 

42,464

 

5.6

%

37,271

 

6.4

%

Non-traditional

 

19,522

 

2.6

%

38,451

 

6.6

%

Casualty clash

 

5,385

 

0.7

%

7,537

 

1.3

%

Total

 

$

761,924

 

100.0

%

$

583,451

 

100.0

%

 

 

 

 

 

 

 

 

 

 

Net premiums written by client location (1)

 

 

 

 

 

 

 

 

 

North America

 

$

580,739

 

63.5

%

$

551,428

 

63.3

%

Europe

 

236,681

 

25.9

%

230,664

 

26.5

%

Bermuda

 

63,407

 

6.9

%

48,297

 

5.5

%

Asia and Pacific

 

17,871

 

1.9

%

22,523

 

2.6

%

Other

 

16,461

 

1.8

%

18,044

 

2.1

%

Total

 

$

915,159

 

100.0

%

$

870,956

 

100.0

%

 


(1)               Reinsurance segment results include premiums written and earned assumed through intersegment transactions of $64.5 million and $68.7 million, respectively, for the six months ended June 30, 2004 and $88.5 million and $61.5 million, respectively, for the six months ended June 30, 2003. Reinsurance segment results exclude premiums written and earned ceded through intersegment transactions of $5.2 million and $3.5 million, respectively, for the six months ended June 30, 2004.

 

16



 

Set forth below is summary information regarding net premiums written and earned by major line of business and by client location for the insurance segment:

 

 

 

(Unaudited)

 

 

 

Three Months Ended
June 30,

 

 

 

2004

 

2003

 

INSURANCE SEGMENT
(U.S. dollars in thousands)

 

Amount

 

% of
Total

 

Amount

 

% of
Total

 

 

 

 

 

 

 

 

 

 

 

Net premiums written (1)

 

 

 

 

 

 

 

 

 

Programs

 

$

92,197

 

29.4

%

$

76,949

 

32.5

%

Casualty

 

52,712

 

16.8

%

50,992

 

21.5

%

Property, marine and aviation

 

35,792

 

11.4

%

20,503

 

8.7

%

Professional liability

 

34,329

 

11.0

%

28,845

 

12.2

%

Executive assurance

 

30,533

 

9.7

%

20,502

 

8.7

%

Construction and surety

 

27,745

 

8.9

%

22,504

 

9.5

%

Healthcare

 

10,367

 

3.3

%

(1,463

)

(0.6

)%

Other

 

29,700

 

9.5

%

17,650

 

7.5

%

Total

 

$

313,375

 

100.0

%

$

236,482

 

100.0

%

 

 

 

 

 

 

 

 

 

 

Net premiums earned (1)

 

 

 

 

 

 

 

 

 

Programs

 

$

102,496

 

29.8

%

$

61,328

 

32.1

%

Casualty

 

57,560

 

16.7

%

36,756

 

19.2

%

Construction and surety

 

41,260

 

12.0

%

15,901

 

8.3

%

Professional liability

 

37,630

 

10.9

%

14,752

 

7.7

%

Property, marine and aviation

 

33,643

 

9.8

%

17,124

 

8.9

%

Executive assurance

 

31,373

 

9.1

%

18,855

 

9.9

%

Healthcare

 

12,149

 

3.5

%

7,084

 

3.7

%

Other

 

28,414

 

8.2

%

19,552

 

10.2

%

Total

 

$

344,525

 

100.0

%

$

191,352

 

100.0

%

 

 

 

 

 

 

 

 

 

 

Net premiums written by client location (1)

 

 

 

 

 

 

 

 

 

North America

 

$

303,075

 

96.7

%

$

232,743

 

98.4

%

Other

 

10,300

 

3.3

%

3,739

 

1.6

%

Total

 

$

313,375

 

100.0

%

$

236,482

 

100.0

%

 


(1)               Insurance segment results include premiums written and earned assumed through intersegment transactions of $2.4 million and $1.9 million, respectively, for the 2004 second quarter. Insurance segment results exclude premiums written and earned ceded through intersegment transactions of $29.8 million and $34.7 million, respectively, for the 2004 second quarter and $40.6 million and $39.7 million, respectively, for the 2003 second quarter.

 

17



 

Set forth below is summary information regarding net premiums written and earned by major line of business and by client location for the insurance segment:

 

 

 

(Unaudited)

 

 

 

Six Months Ended
June 30,

 

 

 

2004

 

2003

 

INSURANCE SEGMENT
(U.S. dollars in thousands)

 

Amount

 

% of
Total

 

Amount

 

% of
Total

 

 

 

 

 

 

 

 

 

 

 

Net premiums written (1)

 

 

 

 

 

 

 

 

 

Programs

 

$

181,977

 

28.2

%

$

147,576

 

31.7

%

Casualty

 

116,259

 

18.0

%

100,327

 

21.5

%

Professional liability

 

80,051

 

12.4

%

48,688

 

10.4

%

Construction and surety

 

65,988

 

10.2

%

42,214

 

9.1

%

Property, marine and aviation

 

65,523

 

10.1

%

34,741

 

7.5

%

Executive assurance

 

58,016

 

9.0

%

45,766

 

9.8

%

Healthcare

 

23,793

 

3.7

%

14,801

 

3.2

%

Other

 

54,468

 

8.4

%

31,796

 

6.8

%

Total

 

$

646,075

 

100.0

%

$

465,909

 

100.0

%

 

 

 

 

 

 

 

 

 

 

Net premiums earned (1)

 

 

 

 

 

 

 

 

 

Programs

 

$

190,567

 

28.6

%

$

101,160

 

30.7

%

Casualty

 

112,340

 

16.8

%

62,011

 

18.8

%

Construction and surety

 

91,172

 

13.6

%

25,730

 

7.8

%

Professional liability

 

72,416

 

10.8

%

23,127

 

7.0

%

Property, marine and aviation

 

68,355

 

10.2

%

29,619

 

9.0

%

Executive assurance

 

62,411

 

9.3

%

35,129

 

10.6

%

Healthcare

 

23,666

 

3.5

%

15,897

 

4.8

%

Other

 

48,374

 

7.2

%

37,183

 

11.3

%

Total

 

$

669,301

 

100.0

%

$

329,856

 

100.0

%

 

 

 

 

 

 

 

 

 

 

Net premiums written by client location (1)

 

 

 

 

 

 

 

 

 

North America

 

$

627,910

 

97.2

%

$

461,071

 

99.0

%

Other

 

18,165

 

2.8

%

4,838

 

1.0

%

Total

 

$

646,075

 

100.0

%

$

465,909

 

100.0

%

 


(1)               Insurance segment results include premiums written and earned assumed through intersegment transactions of $5.2 million and $3.5 million, respectively, for the six months ended June 30, 2004. Insurance segment results exclude premiums written and earned ceded through intersegment transactions of $64.5 million and $68.7 million, respectively, for the six months ended June 30, 2004 and $88.5 million and $61.5 million, respectively, for the six months ended June 30, 2003.

 

18



 

5.                   Reinsurance

 

In the normal course of business, the Company’s insurance subsidiaries cede a substantial portion of their premium through pro rata, excess of loss and facultative reinsurance agreements. The Company’s reinsurance subsidiaries are currently retaining substantially all of their assumed reinsurance premiums written. However, the Company’s reinsurance subsidiaries participate in “common account” retrocessional arrangements for certain pro rata treaties. Such arrangements reduce the effect of individual or aggregate losses to all companies participating on such treaties, including the reinsurers, such as the Company’s reinsurance subsidiaries, and the ceding company. Reinsurance recoverables are recorded as assets, predicated on the reinsurers’ ability to meet their obligations under the reinsurance agreements. To the extent that the reinsurers are unable or otherwise unwilling to satisfy their obligations under the agreements, the Company’s insurance and reinsurance subsidiaries would be liable for such amounts.

 

The following table sets forth the effects of reinsurance with unaffiliated reinsurers on the Company’s reinsurance and insurance subsidiaries:

 

 

 

(Unaudited)

 

(Unaudited)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

(U.S. dollars in thousands)

 

2004

 

2003

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

Premiums Written:

 

 

 

 

 

 

 

 

 

Direct

 

$

446,137

 

$

348,381

 

$

907,168

 

$

671,680

 

Assumed

 

370,186

 

327,624

 

918,943

 

864,425

 

Ceded

 

(138,677

)

(116,003

)

(264,877

)

(199,240

)

Net

 

$

677,646

 

$

560,002

 

$

1,561,234

 

$

1,336,865

 

 

 

 

 

 

 

 

 

 

 

Premiums Earned: