MEASUREMENT OF RESULTS We use various measures to analyze the growth and profitability of our three business segments. In the insurance and reinsurance segments, we measure growth in terms of gross, ceded and net premiums written and we measure underwriting profitability by examining our loss, expense and combined ratios. We also measure our gross and net written premiums to surplus ratios to measure the adequacy of capital in relation to premiums written. In the insurance services segment, we measure growth in terms of premiums produced by TRM on behalf of other insurance companies as well as fee and commission revenue received and we analyze profitability by evaluating income before taxes and the size of such income relative to TICNY's net premiums earned. On a consolidated basis, we measure profitability in terms of net income and return on average equity.
Loss and loss adjustment expenses and loss ratio. Gross and net losses and loss adjustment expenses were $73.4 million and $14.7 million, respectively, in 2003, compared with $52.4 million and $14.8 million, respectively, in 2002. Our gross and net loss ratios were 60.9% and 65.7%, respectively, in 2003, compared with 62.0% and 58.3%, respectively, in 2002.
The commission portion of our underwriting expense ratio was 17.1% in 2003 as compared with 18.3% in 2002. Commissions in 2002 were affected by amounts paid for the Empire renewal rights business, which amounted to $932,000 in 2002. There was no such expense in 2003. Additionally, in 2003 we negotiated lower commission rates with our producers and increased the volume of premiums in lines with lower commissions such as workers' compensation.
The portion of the underwriting expense ratio represented by other underwriting expenses was 13.4% in 2003 and 13.1% in 2002. Improvement in this ratio in 2003 was due to operational efficiencies achieved through focused expense management, technological integration and realization of greater economies of scale. These benefits were partially offset in 2003 by increased expenses incurred in anticipation of the IPO, including additions to senior management, technology staff and consultants, and by the reclassification of New York State taxes to premium taxes, which are treated as other underwriting expenses.
The statutory surplus that we are required to maintain varies depending on the type and amount of revenue that is derived. The statutory surplus requirements are based upon various capital adequacy tests and ratios established by rating agencies and insurance regulators. Statutory surplus requirements are greater for net premiums earned than for premiums that we cede or transfer to reinsurers. Non-risk bearing revenues that are generated primarily from TRM do not require us to maintain any surplus, except capital necessary to meet TRM's operating expenses. For these reasons, throughout our history before the October 2004 IPO we attempted to reduce our statutory surplus requirement by limiting our net retention of premiums while emphasizing ceding commissions and non-risk bearing revenues from TRM.
o our failure to comply with the covenants or other provisions of the indentures or the trust preferred securities; or
On October 20, 2004, the Securities and Exchange Commission declared Tower Group, Inc.'s registration statement effective. The Company's IPO was for 13,000,000 shares and was priced at $8.50 per share. Also on October 20, 2004 Tower Group, Inc. offered a concurrent private placement of 500,000 shares of its common stock to an affiliate of Friedman, Billings, Ramsey & Co., Inc. the lead underwriter for the Company's IPO, at the price of $8.50 per share. On November 10, 2004 the underwriters exercised their 30-day over-allotment option. Pursuant to this exercise, the underwriters purchased 629,007 additional shares of common stock from the Company and 1,320,993 shares of common stock from the selling stockholders at the IPO price of $8.50 per share, less the underwriting discount. The Company did not receive any proceeds from the sale of common stock by any selling stockholder. The Company received net cash proceeds of $107,845,000 from the offering and concurrent private placement after the underwriting discounts, commissions and offering expenses. The total costs of the IPO and private placement were $12,252,000 of which $8,407,000 was for the underwriters discount, and $3,845,000 was for all other costs. Costs of the IPO have been reflected as a reduction in Paid-in-Capital.
At December 31, 2004 and 2003, U.S. Treasury Notes with fair values of approximately $651,000 and $546,000, respectively, were held by the Superintendent of Insurance of the State of New York in order to comply with New York Insurance Law.
The Company offers insurance coverage for limits up to $10,000,000 for property risks, $2,000,000 for liability coverages and $10,000,000 for workers' compensation. Through various quota share, excess of loss and catastrophe reinsurance agreements, as described further below, the Company limits its exposure to a maximum loss on any one risk of $400,000 during the period January 1, through September 30, 2004, $750,000 during the period October 1, through December 31, 2004, $450,000 during the period January 1, through September 30, 2003 (after commutation - see discussion below), $312,500 during the period October 1 through December 31, 2003 and $250,000 in 2002.
UNPAID PAID LOSSES LOSSES TOTAL -------- -------- -------- DECEMBER 31, 2004: PXRE Reinsurance Company $ 33,852 $ 3,804 $ 37,656 American Re-Insurance Company 13,298 1,175 14,473 Tokio Millennium Re Ltd. 31,278 3,317 34,595 Hannover Reinsurance (Ireland) Ltd. 7,750 850 8,600 E+S Reinsurance (Ireland) Ltd. 1,937 212 2,149 SCOR Reinsurance Company 1,323 9 1,332 Others 2,335 33 2,368 -------- -------- -------- TOTAL $ 91,773 $ 9,400 $101,173 ======== ======== ========
The Company earns ceding commissions under quota share reinsurance agreements for 2004, 2003 and 2002 based on a sliding scale of commission rates and ultimate treaty year loss ratios on the policies reinsured under each of these agreements. The sliding scale includes minimum and maximum commission rates in relation to specified ultimate loss ratios. The commission rate and ceding commissions earned increase when the estimated ultimate loss ratio decreases and, conversely, the commission rate and ceding commissions earned decrease when the estimated ultimate loss ratio increases.
PXRE PXRE participated in various reinsurance agreements with the Company from 2001 through September 30, 2003, including a quota share participation in the layer of coverage representing the first $500,000 of each loss. Ceded written premiums include $20,261,000 and $72,434,000 ceded to PXRE in 2003 and 2002, respectively. Effective September 30, 2003, the 2003 quota share agreement with PXRE was cancelled. The quota share agreements with PXRE are in run-off. As a result of the cancellation of the 2003 quota share agreement with PXRE as of September 30, 2003, the Company was owed $15,748,000 in return premium net of ceding commissions as of December 31, 2003. This amount was collected in January, 2004.
The weighted average amortization period of identified intangible assets of finite useful life is 17.5 years. The estimated aggregate amortization expense for each of the next five years is: