(1) The financial information for this period reflects our results from November 8, 2001, the date of incorporation of AXIS Specialty Bermuda, to December 31, 2001.
(6) Book value per common share is based on total common shareholders’ equity divided by common shares outstanding of 148,868,759 as of December 31, 2005, 152,764,917 as of December 31, 2004, 152,474,011 as of December 31, 2003, 138,168,520 as of December 31, 2002 and 135,122,688 as of December 31, 2001.
We believe that we are currently operating in a marketplace that, with appropriate risk selection, can offer favorable pricing and/or terms and conditions in our business segments. Following the wake of record catastrophe losses incurred by the industry in 2005, caused by Hurricanes Katrina, Rita and Wilma, we have experienced significantly improved pricing terms and conditions in our short tail lines of business. The most dramatic hardening, including major revisions of terms, conditions and structure, has occurred for business exposed to U.S. wind perils. This reflects the recalibration of catastrophe models and more disciplined underwriting, addressing assumptions regarding the potential for the frequency and severity of losses and increased capital requirements against loss scenarios. Despite the catastrophic events of the third and fourth quarters of 2005, the aviation line of business continues to experience severe pricing competition. This competition has resulted in our declining a substantial amount of aviation renewal business. This business is largely incepted in the fourth quarter of each year and subsequently earned over the course of the following year. For other short-tail insurance and reinsurance business outside of the U.S., and for casualty insurance and reinsurance lines of business globally, pricing, terms and conditions are broadly stable and at or above the level required to produce target returns. We expect that the aforementioned hardening in short-tail lines will continue throughout 2006 and impact the insurance and reinsurance markets more broadly due to the incorporation of catastrophe modeling changes in the industry, the impact of greater reinsurance costs on the competitive behavior of insurance companies, wider recognition of increased capital requirements and continued contraction of capacity for catastrophe-exposed business, despite new capital entering the industry.
Renewal dates for our business segments depend upon the underlying line of business. For the majority of business in our insurance segment, gross premiums are written throughout the year. An exception to this is the business written in our aviation and aviation war accounts, which is predominantly written in the last quarter of the calendar year, and our property accounts for which two significant renewal dates are April 1 and July 1. For our reinsurance segment, a significant portion of our gross premiums is written in the first quarter of the calendar year, with the remainder primarily split between the second and third quarters.
Our premium income is supplemented by the income we generate from our investment portfolio. Our investment portfolio consists primarily of fixed income investments that are held as available for sale. Under U.S. GAAP, these investments are carried at fair market value and unrealized gains and losses on the investments are not included in our statement of operations. Rather, these unrealized gains and losses are included on our balance sheet in accumulated other comprehensive gain (loss) as a separate component of shareholders’ equity. Our investment strategy seeks to preserve principal and maintain liquidity while trying to maximize investment return through a high-quality, diversified portfolio. The volatility of claims and the interest rate environment can affect the returns we generate on our investment portfolio.
Interest expense consists of interest due on outstanding debt, the amortization of debt offering expenses and offering discounts and fees paid in respect of our credit facility. Prior to December 31, 2004, fees paid in respect of our credit facility were included in general and administrative expenses. Consequently, disclosures relating to prior periods have been restated to reflect this change.
throughout the organization. Four financial measures that are meaningful in analyzing our performance are return on common equity, book value per common share, combined ratio and underwriting income. Our return on common equity calculation is based on the level of net income available to common shareholders generated from the average of the opening and closing common shareholders’ equity during the period. The combined ratio is a formula used by insurance and reinsurance companies to relate net premiums earned during a period to net losses and loss expenses, acquisition costs and general and administrative expenses during a period. Book value per common share is calculated by dividing common shareholders’ equity by the number of outstanding common shares at any period end. We consider return on common equity and book value per common share appropriate indicators of our returns to common shareholders. A combined ratio above 100% indicates that a company is incurring more in net losses and loss expenses, acquisition costs and general and administrative expenses than it is earning in net premiums. We consider the combined ratio an appropriate indicator of our underwriting performance, particularly given the relatively short tail orientation of our overall portfolio of risks. Underwriting income on a segment basis is a measure of underwriting profitability that takes into account net premiums earned and other insurance related income as revenue and net losses and loss expenses, acquisition costs and underwriting related general and administrative expenses as expenses. Underwriting income is the difference between these revenue and expense items.
On February 28, 2003, we completed the acquisition of Sheffield Insurance Corporation for $34.7 million and subsequently renamed it AXIS Surplus Insurance Company. At the time of
Reserve for losses and loss expenses. For most insurance and reinsurance companies, the most significant judgment made by management is the estimation of the reserve for losses and loss expenses, which we also refer to as loss reserves. Our loss reserves are established based upon our estimate of the total cost of claims that were reported to us but not yet paid, or case reserves, the costs of additional case reserves on claims reported to us but not considered to be adequately reserved, or ACR, and the anticipated cost of claims incurred but not reported, or IBNR.
In order to reflect this increased level of uncertainty in establishing our loss reserves, some of our underwriting, claims and reserving practices have been modified for our reinsurance business. In deciding whether to provide treaty reinsurance, we carefully review and analyze the cedant’s underwriting and risk management practices to ensure appropriate underwriting, data capture and reporting procedures. We also utilize an outsourced claims audit program that allows us to review a cedant’s claims administration to ensure that its claim reserves are consistent with reinsured exposures, are adequately established and are properly reported in a timely manner, and to verify that claims are being handled appropriately. For those losses where we receive contract-specific loss notifications, our claims department evaluates each notification and may record ACRs if claims are not considered to be adequately reserved. Where claims information is received in an aggregated form, our reinsurance contracts typically require that pre-defined large losses must be separately notified so that these losses can be adequately evaluated. As our independent actuaries reserve on a line of business basis, their actuarial methodology allows for reporting time lags when establishing ultimate loss and loss expenses for reinsurance business. In addition, because we have limited loss experience and insufficient claims development data to calculate credible trends, our independent actuaries use industry data when establishing ultimate loss and loss expenses for our reinsurance business.
Loss reserving for catastrophe events in our insurance and reinsurance businesses is an inherently uncertain process. When a catastrophe occurs, we review our exposures to determine which exposures will be impacted by the event. We contact brokers and clients to determine their estimate of involvement and the extent to which their programs are affected. We may also use computer modeling to estimate loss exposures under the actual event scenario. We currently use Risklink version 5.1 licensed by RMS, Classic/2 and CATRADER version 7.5 licensed by AIR and WORLDCAT Enterprise licensed by Eqecat. As part of the underwriting process, we obtain exposure data from our clients, so that when an event occurs we can run our models to produce an estimate of the losses incurred by clients on programs that we insure or reinsure. Typically, we derive our estimate for the losses from a catastrophic event by blending all of the sources of loss information available to us. This estimate is derived by the claims team and, where there are no reported case reserves, is known as “case IBNR”. For catastrophic events, there generally is considerable uncertainty underlying the assumptions and associated estimated reserves for losses and loss expenses. Reserves are reviewed quarterly and as experience develops and additional information is known, the reserves are adjusted as necessary. Adjustments are reflected in the period in which they become known.
Our estimate of our ultimate loss and loss expenses is determined in consultation with Ernst & Young, who acts as our independent reserving actuary, and is based on generally accepted actuarial principles. The independent actuaries utilize various actuarial methodologies to arrive at a single
For our insurance segment, the assumed ultimate loss and loss expense ratios developed by the independent actuaries are based on benchmarks derived from the independent actuaries’ wider market experience together with our limited historical data. These benchmarks are then adjusted for rating increases and changes in terms and conditions that have been observed by the market and by us. For our reinsurance segment, the assumed ultimate loss and loss expense ratios are based on contract-­by-­contract initial expected loss ratios derived during pricing, together with benchmarks derived from the independent actuaries’ wider market experience. Under U.S. GAAP, we are not permitted to establish loss reserves until an event that gives rise to a loss occurs. Consequently, on some contracts that respond to highly visible, major loss events, we do not establish general IBNR, although in certain cases we are holding case IBNR where potential exposure has been identified.
Our independent actuaries apply loss and loss expense ratios to our earned premium to generate estimated baseline ultimate costs of the losses. From the estimated baseline ultimate costs of losses, we deduct paid losses and reported case reserves to generate our baseline IBNR. The estimated baseline ultimate costs of losses will almost certainly differ from our actual losses and loss expenses. The uncertainty surrounding our actual losses and loss expenses is greater for a company like ours that has a limited operating history and claims loss development patterns. In addition, our limited operating history and claims loss development patterns have necessitated the use of benchmarks in deriving our IBNR. These benchmarks could differ materially from our actual experience despite management’s and the independent actuaries’ care in selecting them.
At December 31, 2005, our loss and loss expense reserves of $4,743.3 million included loss and loss expense reserves relating to Hurricanes Katrina, Rita and Wilma, which struck in September and October of 2005. These hurricanes produced record industry catastrophe losses and due to the extent of damage, the delay in adjusting losses in affected areas and the interpretation of coverage under insurance contracts, there is considerable uncertainty surrounding our net loss estimates. If our net loss and loss expense estimate of $1,019.1 million for these events was inaccurate by a factor of 5%, this would equate to a $51.0 million change in net loss reserves, which change would represent 56.6% of net income available to common shareholders and 1.5% of shareholders’ equity.
In estimating our non-hurricane related ultimate loss and loss expenses, our independent actuaries utilize actuarial methodologies that rely on the use of various assumptions. As of December 31, 2005, the key assumptions used by our actuaries were the establishment of initial expected loss ratios and the establishment of development factors. Both of these assumptions are largely based upon loss information, which may not be indicative of our actual loss experience. A 5% change in either of these loss assumptions would equate to 3.2% of our total loss reserves, which change would represent 171.1% of net income and 4.4% of shareholders’ equity. As of December 31, 2004, a 5% change in these assumptions would equate to 4.1% in our total loss reserves, which change would represent 20.1% of net income and 3.1% of shareholders’ equity.
The methodology of estimating loss reserves is reviewed each quarter to evaluate whether the assumptions made continue to be appropriate. Any adjustments that result from this review are recorded in the quarter in which they are identified.
Our reserving practices and the establishment of any particular reserve reflect management’s judgment concerning sound financial practice and do not represent any admission of liability with respect to any claims made against us. No assurance can be given that actual claims made and related payments will not be in excess of the amounts reserved. During the loss settlement period, it often becomes necessary to refine and adjust the estimates of liability on a claim either upward or
downward. Even after such adjustments, ultimate liability may exceed or be less than the revised estimates.
Our ceded unpaid losses and loss expenses consist of two elements, those for reported losses and those for IBNR. Ceded amounts for IBNR are developed as part of our loss reserving process. Consequently, the estimation of ceded unpaid losses and loss expenses is subject to similar risks and uncertainties as the estimation of gross IBNR (see “Reserve for losses and loss expenses”). As of December 31, 2005 and 2004, ceded IBNR recoverable balances were $555.0 million and $355.5 million, respectively.
judgments and expectations. This is most likely where the underwriter believes that the estimate is not prudent. Under these circumstances, we will generally recognize as revenue a lower than advised premium written estimate. We actively monitor the development of actual reported premium to the estimates made; where actual reported premium deviates from the estimate, we carry out an analysis to determine the cause and may, if necessary, adjust the estimated premium in the period in which the determination was made. During the years ended December 31, 2005, 2004 and 2003, line slip premiums accounted for 8%, 5% and 7%, respectively, of total gross premiums written.
securities. For example, the generic 3 year treasury started the year with a yield of 3.22% and finished the year with a yield of 4.36%. This negative price return was, however, offset by a higher income return due to the rising interest rates.
Other Insurance Related Income/(Loss). The decrease of $16.3 million in other insurance related income/loss was primarily due to the movement in the fair value of insurance contracts that meet the definition of derivatives. During the year ended December 31, 2005, all contracts accounted for as derivatives expired.
Net Losses and Loss Expenses. The increase of $804.9 million in net losses and loss expenses was primarily generated by an increase in the level of hurricane related net losses and loss expenses. We incurred net loss and loss expenses of $1,019.1 million in the year ended December 31, 2005 relating to Hurricanes Katrina, Rita and Wilma compared to net losses and loss expenses of $266.3 million in the year ended December 31, 2004 relating to Hurricanes Charley, Frances, Ivan and Jeanne. Our loss ratio increased by 18.9 percentage points in the year ended December 31, 2005 compared to the year ended December 31, 2004.
Our total net loss and loss expenses for each hurricane within each of our operating segments was as follows:
With respect to Hurricanes Katrina and Rita, the majority of our estimate of loss and loss expenses is represented by actual amounts reported by our clients, brokers and loss adjustors. For Hurricane Wilma, our estimate of loss and loss expenses is currently in the early stages of estimation and is based on a blend of industry model outputs, management’s experience and actual reported losses.
Foreign Exchange. Our functional currency is the U.S. dollar; however, some of our business is written in other currencies. For the year ended December 31, 2005, we experienced a foreign exchange loss of $54.1 million, compared to an exchange gain of $14.5 million for the year ended December 31, 2004. The loss was principally attributable to the decline of the Euro against the U.S. dollar and an increase in our asset balances denominated in Euros following an increase in the level of gross premiums written in this currency in our reinsurance segment.
Interest Expense. The increase of $27.2 million was primarily due to the issuance of our senior unsecured debt in November 2004, which bears interest at 5.75% per annum. Interest expense consists of interest due on outstanding debt, the amortization of debt offering expenses and offering discounts, and fees relating to our credit facility.
Income Tax. The increase of $0.6 million in the income tax expense was primarily attributable to the generation of additional taxable income in our U.S. subsidiaries.
Preferred Dividends. The increase of $4.4 million was due to the dividends on our 7.25% Series A preferred shares that we issued in October 2005.
Premiums. Our gross premiums written increased by $0.7 billion; of this increase, 57.6% was generated by our reinsurance segment and 42.4% by our insurance segment. The increase in gross premiums written in our reinsurance segment was primarily driven by our expansion into continental Europe in November 2003, greater market penetration and our ability to participate fully in the first quarter’s renewal season. The increase in gross premiums written in our insurance segment was primarily driven by greater market penetration and new lines of business. We expect the mix of business within and between our segments to change over time based on market conditions and our view of the long term profit potential of individual lines of business.
Premiums ceded increased by $223.4 million. The increase was generated by our insurance segment where we purchase reinsurance to reduce our exposure to risk of loss on some lines of business.
Net Investment Income. Net investment income for the year ended December 31, 2004 increased by $78.1 million due to a combination of higher investment balances and higher investment yields. Net investment income consisted primarily of interest on fixed income securities that was partially offset by net investment expenses of $7.0 million for the year ended December 31, 2004 compared with $5.8 million for the year ended December 31, 2003. The higher expenses were a result of an increase in our assets managed by external portfolio managers offset by securities lending income.
Net Realized Gains. Net realized gains decreased by $9.0 million. We invest our portfolios to produce a total return. In assessing returns under this approach, we include investment income, realized gains and losses and unrealized gains and losses generated by the investment portfolios. As a result, there can be significant changes in the levels of our net realized gains (losses) from quarter to quarter. Some of our mortgage-backed securities are required to be classified as derivatives; included within net realized gains was $0.3 million in realized gains associated with these securities.
The total return for our investment portfolio (calculated using beginning and ending market portfolio values, adjusted for external cash flows) for the year ended December 31, 2004 was 3.4% compared with 3.5% for the year ended December 31, 2003. The total return for an investment portfolio consists of price and income return. These components will primarily be affected by the timing of cash flows, changes in interest rates and changes in asset allocation. Our total return for the year ended December 31, 2004 was similar to the previous year, however, the component returns were different. In 2004, we obtained a higher income return than in 2003 due to an increase in U.S. interest rates at the short end of the yield curve, which resulted in higher portfolio yields. This increase resulted in a negligible price return in 2004 compared to a positive price return in 2003.
Other Insurance Related Income. The decrease of $13.7 million related to the movement in the fair value of our insurance and reinsurance contracts that met the definition of a derivative.
Net Losses and Loss Expenses. Net losses and loss expenses increased by $512.2 million. The net loss and loss expense ratio for the year ended December 31, 2004 was 61.4% compared to 51.1% for the year ended December 31, 2003. The increase in net losses and loss expenses and the net loss and loss expense ratio was primarily driven by an active hurricane season. We incurred net losses and loss expenses of $266.3 million from Hurricanes Charley, Frances, Ivan and Jeanne, which swept across the Caribbean and Southeastern United States in August and September 2004. Our estimates for the losses incurred from these hurricanes were derived from formal loss advices, the output of industry models, a review of in-force contracts and preliminary indications from clients. Consequently, actual losses from these hurricanes may vary materially from estimated losses. As at December 31, 2004, the Company had $61.1 million included within our net IBNR specifically for the hurricane losses. During the year ended December 31, 2003, we did not experience a major loss as a result of hurricane activity. The impact of the hurricane-related losses was partially mitigated by favorable prior period development of $181.7 million, or 9.0 percentage points, compared to $55.8 million, or 3.9 percentage points, for the year ended December 31, 2003.
Interest Expense. The increase of $3.8 million was due to the issuance of senior unsecured debt in November 2004, which bears interest at a rate of 5.75% per annum. Interest expense consists of interest due on outstanding debt, the amortization of debt offering expenses and offering discounts and fees relating to our credit facility.
Income Tax Expense. The increase of $6.1 million was due to an increase in the level of taxable income generated by our European subsidiaries.
Global insurance operates from offices based in Bermuda and Europe and provides specialty lines coverage predominantly through the London broker network with product lines comprising property, marine, terrorism and war risk, aviation and aerospace, political risk and professional lines and other specialty risks.
U.S. insurance operates through offices throughout the U.S., provides coverage through a variety of channels in the U.S., and covers predominantly U.S. exposures. The product lines are property, professional lines, liability and other specialty and are offered through wholesale brokers, retail brokers and managing general agents and underwriters. Many of our property and casualty insurance products are for nonstandard and complex risks. U.S. insurance has the ability to write business on an admitted basis using forms and rates as filed with state insurance regulators and on a non-admitted, or surplus lines basis, with flexibility in forms and rates not filed with state insurance regulators. Having access to non-admitted carriers provides the pricing flexibility needed to write non-standard coverage.
The decrease in gross premiums written in global insurance was primarily due to a significant reduction in the level of aviation and aviation war renewal business written during the fourth quarter of 2005, which is the primary renewal period for this business. This was due to deterioration in the pricing environment, which resulted in fewer risks meeting our underwriting criteria. Consequently, gross premiums written in our aviation and aerospace line of business decreased by $77.5 million compared to 2004. Our aviation and aerospace line of business was also impacted by our decision to reduce our exposure to satellite business, which led to a $10.2 million decrease in gross premiums written. Our terrorism and war risk line of business decreased by $128.7 million, of which $106.5 million was a decrease in aviation war business and of which $17.2 million was a decrease in terrorism business. The decrease in terrorism business was primarily due to a deterioration in the pricing environment, which resulted in fewer risks meeting our underwriting criteria, and also due to several contracts written in 2004 not being renewed in 2005 because of the non-recurring nature of events covered by this business.
The increase in gross premiums written in U.S. insurance was driven by growth across all lines of business.
professional lines business was driven primarily by an increase of $63.5 million in errors and omissions insurance. This was primarily due to the new appointment of a managing general underwriter effective January 1, 2005.
Premiums ceded increased by $151.0 million. Premiums ceded for U.S. insurance increased by $101.7 million. The ratio of premiums ceded to gross premiums written in U.S. insurance was 48.9% for the year ended December 31, 2005 and 47.8% for the year ended December 31, 2004. During the year ended December 31, 2005, however, we increased our net retention on our professional lines book, the impact of which was offset by an increase in the reinsurance ceded on our property book. This was due to two factors: first, an increase in the cost following the renewal of our reinsurance in May 2005; and second, reinstatement premiums due on hurricane losses ceded to reinsurers. Premiums ceded in global insurance increased by $49.3 million due primarily to reinstatement premiums due on hurricane losses ceded to reinsurers.
Ceded premiums are amortized over the contract term. Ceded premiums amortized for U.S. insurance increased by $125.0 million to $464.7 million for the year ended December 31, 2005 due to an increase in gross premiums earned in the year. The ratio of ceded premiums amortized to gross premiums earned was 50.6% for the year ended December 31, 2005 compared to 49.3% for the year ended December 31, 2004. Ceded premiums amortized in global insurance increased by $106.7 million for the year primarily due to a portion of ceded premiums being fully amortized following the exhaustion of reinsurance protection on some contracts following Hurricanes Katrina, Rita and Wilma.
Net Losses and Loss Expenses. The increase in the loss and loss expense ratio was primarily due to an increase in the level of hurricane related net incurred loss and loss expenses.
we incurred estimated net loss and loss expenses of $50.3 million, or 6.3 percentage points, in respect of Hurricanes Charley, Frances, Ivan and Jeanne.
The net loss and loss expense ratio for U.S. insurance was 86.0% for the year ended December 31, 2005 compared to 67.2% for the year ended December 31, 2004. The increase was due to the impact of Hurricanes Katrina, Rita and Wilma from which we incurred net loss and loss expenses of $117.0 million, or 25.8 percentage points. During the year ended December 31, 2004, we incurred net loss and loss expenses of $46.8 million, or 13.4 percentage points, in respect of Hurricanes Charley, Frances, Ivan and Jeanne.
During the year ended December 31, 2005, we experienced favorable prior year development on our property business of $26.4 million, or 5.8 percentage points, compared to $14.3 million, or 4.1 percentage points, during the year ended December 31, 2004.
Acquisition costs in global insurance were $97.9 million, or 13.1% of net premiums earned, for the year ended December 31, 2005 compared to $125.0 million, or 15.7% of net premiums earned, for the year ended December 31, 2004. This decrease was primarily the result of a reduction of $27.4 million in amounts expensed under incentive commission arrangements with brokers for 2004 and an increase in ceded amortization costs as a result of fully amortizing an additional $68.1 million of ceded premium following the 2005 hurricanes. Excluding these factors, the acquisition cost ratio remained consistent at 12.1% for the year ended December 31, 2005 compared to 12.3% in the prior year.
U.S. insurance acquisition costs were $21.1 million, or 4.7% of net premiums earned, for the year ended December 31, 2005 compared to $10.8 million, or 3.1% of net premiums earned, for the year ended December 31, 2004. The ratio was impacted by a reduction of $17.4 million in the amounts expensed under incentive commission arrangements with brokers for 2004. Excluding the incentive commissions, the acquisition cost ratio was 5.5% for the year ended December 31, 2005 compared to (0.9%) for the year ended December 31, 2004. The increase was primarily due to a change of business mix with a higher percentage of premiums derived from our specialty program business, which has a higher level of acquisition costs. We expect acquisition costs to increase as our specialty program business continues to grow.
The following table summarizes the underwriting results and ratios for the insurance segment for the years ended December 31, 2004 and December 31, 2003:
The increase in gross premiums written in global insurance was primarily generated by three lines of business: professional lines and other specialty, political risk and terrorism and war risk. The
Property gross premiums written in global insurance increased by $10.2 million, due primarily to the restructuring of existing participations on renewed business and some new business, which offset the effects of rate reductions. Our marine book experienced a decrease in gross premiums written of $8.3 million primarily due to a reduction of $14.7 million in our energy offshore business due to a combination of shifting renewal dates, rate reductions and our decision not to renew some business. We also experienced an $8.6 million reduction on our marine liability business primarily due to our decision not to renew some contracts. These reductions were partially offset by an increase of $18.0 million in our marine cargo line following the recruitment of a cargo specie underwriting team that began to underwrite premiums in the second quarter of 2004. Gross premiums written on our aviation book remained constant despite our decision not to renew some major accounts; although rates declined in this book of business, gross premiums written remained at a consistent level due to an increase in the level of insured exposures.
The increase in our U.S. insurance property book was primarily due to three reasons: first, we introduced a new product line in mid-2003; second, we increased our maximum line sizes, which enabled our underwriters to access more business; and third, we increased the number of states in which we were able to write business on a non-admitted basis. The increase in our liability book was primarily driven by an increase in our maximum line size for our umbrella and excess coverages, which enabled our underwriters to access more business, and therefore increased market penetration. The increase in our professional lines was primarily driven by the fact that we did not acquire the renewal rights of a book of directors’ and officers’ liability insurance and related lines of business written by the FIS group of Kemper until February 17, 2003. Included within the gross premiums written for the year ended December 31, 2003 was $65.2 million relating to the cancel/rewrite process that followed the acquisition of the renewal rights. Gross premiums written for the year ended December 31, 2004 included $22.5 million of gross premiums written on a new line of business: errors and omissions insurance for professional institutions. These premiums partially offset
The increase in our premiums ceded was primarily due to an increase in the level of reinsurance purchased in order to mitigate volatility in losses as our portfolio grows. In U.S. insurance, the ratio of premiums ceded to gross premiums written decreased to 47.8% for the year ended December 31, 2004 from 49.8% for the year ended December 31, 2003. This reduction was principally driven by our decision to maintain a higher net retention on our professional lines book of business. In addition, included in written premiums ceded for the year ended December 31, 2004 was $6.9 million related to reinstatement premiums on coverages exhausted by losses, primarily emanating from Hurricanes Frances and Ivan.
Other Insurance Related Income. Other insurance related income decreased by $14.2 million due to the movement in the fair value of our insurance contracts that met the definition of a derivative.
Our reinsurance segment operates through offices based in Bermuda, the U.S. and Europe and provides treaty property and casualty reinsurance to insurance companies on a worldwide basis. Treaty reinsurance contracts are contractual arrangements that provide for automatic reinsurance of any agreed upon portion of business written as specified in a reinsurance contract. Contracts can be written on an excess of loss basis or a pro rata basis, also known as proportional. The product lines in this segment are catastrophe, property, professional liability, credit and bond, motor, liability and other.
We experienced a significant increase in gross written premiums in our property account due to several factors. First, our gross premiums written grew by $41.1 million as a result of greater market penetration in Continental Europe following our expansion into this marketplace in 2004. Second, excluding Continental European business, we experienced an increase in the level of pro rata gross premiums written of $65.6 million resulting from a combination of new business, an increase in renewal premiums and also adjustments on prior year premium estimates. Third, excluding Continental European business, our property per risk gross premiums written increased due to an additional $15.0 million of reinstatement premiums and our ability to increase our share on selected renewal business.
The increase in our liability account was primarily driven by new market opportunities in U.S. general liability umbrella excess reinsurance business and our acquiring approved reinsurer status with some U.S. clients that allowed us to write new business.
In 2004, we began to write motor and credit and bond reinsurance business and 2005 has seen continued growth within these lines of business due to our ability to access new markets and increase our share on renewal business. We experienced an increase in our professional lines book during the year with a significant shift in our business from directors’ and officers’ liability insurance to miscellaneous errors and omissions insurance.
Gross premiums are earned over the period of the reinsured risk. Consequently, the level of gross premiums earned increased as the level of gross premiums increased.
Net Losses and Loss Expenses. The increase in the net loss and loss expenses ratio was primarily driven by the impact of Hurricanes Katrina, Rita and Wilma for which we incurred estimated net losses of $613.5 million, or 45.4 percentage points. During the year ended December 31, 2004, we incurred estimated net losses of $169.2 million, or 19.2 percentage points, from Hurricanes Charley, Frances, Ivan and Jeanne.
change in the loss experience that causes us to change our loss ratio is reflected during the quarter in which the loss emergence is experienced. During the year ended December 31, 2005, our loss experience on prior accident years was better than expected, primarily on our property catastrophe business in accident years 2004 and 2003.
Acquisition Costs. The decrease in the acquisition cost ratio was primarily due to a reduction of $9.7 million in the amounts expensed under incentive commission arrangements with brokers for 2004. Excluding incentive commissions, the acquisition cost ratio was 16.6% for the year ended December 31, 2005 compared to 16.1% for the year ended December 31, 2004. The increase was primarily due to a change in business mix with more business coming from product lines other than catastrophe excess of loss, which typically have higher acquisition costs.
The following table summarizes the underwriting results and ratios in our reinsurance segment for the years ended December 31, 2004 and December 31, 2003:
Our gross premiums written increased primarily due to our expansion into Continental Europe and an increase in property and catastrophe business. The increase in our property gross premiums written was primarily due to an increase in the number of contracts written. The increase in our catastrophe book of business was driven by a trend toward counterparty diversification in our target markets, which enabled us to participate on a greater number of programs than in the prior year; this offset some moderate rate reductions and instances where we declined to renew contracts because terms and conditions became unacceptable. Credit and bond was a new line of business in 2004 following the opening of a reinsurance branch in Zurich. The increases in our professional lines book and our liability book were primarily generated by our ability to quote and write contracts that came up for renewal on January 1, 2004. In 2003, we were unable to take part in the January 1, 2003 renewal season because we did not receive regulatory approvals until mid-December 2002. In addition, we increased the statutory capital of AXIS Re U.S. at the end of the first quarter of 2003 to in excess of $500.0 million, which enabled us to participate in more business. The increase in our motor line of business was due to our expansion into Continental Europe during the year.
The following table shows the derivation of net premiums earned for the years ended December 31, 2004 and December 31, 2003:
Gross premiums are earned over the period of the reinsured risk. Consequently, the level of gross premiums earned increased as the level of gross premiums written increased. We expect the level of gross premiums earned to continue to increase in 2005.
Ceded premiums are amortized over the contract term. Consequently, the level of amortized ceded premium increased in 2004 as premiums ceded in 2003 continued to be amortized in 2004.
Net Losses and Loss Expenses. Net losses and loss expenses increased by $322.2 million due primarily to additional net premiums earned and net losses and loss expenses related to Hurricanes Charley, Frances, Ivan and Jeanne.
General and Administrative Expenses. General and administrative expenses increased by $32.6 million. As we did not allocate any of our general and administrative expenses, except for the personnel expenses of our underwriters, prior to January 1, 2004, these amounts and ratios are not comparable.
We are subject to Bermuda regulatory constraints that affect our ability to pay dividends on our common shares and make other payments. Under the Bermuda Companies Act 1981, as amended, AXIS Capital may declare or pay a dividend or make a distribution out of contributed surplus only if it has no reasonable grounds for believing that it is, or would after the payment be, unable to pay its liabilities as they become due or that the realizable value of its assets would thereby be less than the aggregate of our liabilities and issued share capital and share premium accounts.
Following Hurricanes Katrina, Rita and Wilma, we recorded significant reinsurance recoveries that generated an increase of $921.8 million in reinsurance recoverable balances. Of the reinsurance recoverable balances, 96.5% was due from reinsurers rated the equivalent of A- or better by internationally recognized rating agencies. Of the remaining reinsurance recoverable balances, 75% were fully collateralized. For further discussion and analysis on reinsurance recoverable balances refer to note 8 in our Consolidated Financial Statements in Item 8 in this report.
During the year ended December 31, 2005, we generated a net operating cash inflow of $1.6 billion, primarily related to premiums received and investment income. During the same period, we paid gross losses of $856.4 million and received reinsurance recoveries of $235.6 million. At December 31, 2005, we had a cash balance of $1,281.0 million. During the year ended December 31, 2005, net cash of $249.4 million was provided by financing activities. This was primarily due to the issuance of $700.0 million of common and preferred shares offset by the repurchase of 12,783,094 common shares owned by initial investors at the formation of the Company. The average purchase price was $27.38 per common share and the aggregate purchase price was $350.0 million. During the same period, we paid dividends to common shareholders of $94.2 million and interest on our senior notes of $28.7 million.
was generated from financing activities. We paid dividends to common shareholders of $78.3 million and raised $495.7 million from a senior note offering.
In addition to common equity, we depend upon other external sources of finance such as debt, preference shares, letters of credit and other credit facilities to support our operating activities. Having sufficient capital allows us to take advantage of profitable opportunities that may arise in our operating segments. We are also required to maintain adequate capital resources to comply with various statutory regulations in Bermuda, Ireland and the U.S. A strong capital base is also important for maintaining the financial strength ratings of our operating subsidiaries, which is essential in establishing our competitive position.
On November 15, 2004, we completed a public offering of $500 million of senior notes. The notes bear interest at 5.75%, payable semi-annually and, unless previously redeemed, will mature on December 1, 2014. We may redeem the senior notes at any time and from time to time, in whole or in part, at a “make-whole” redemption price, however, we have no current intentions of calling the senior notes. The indenture governing the senior notes contain various covenants, including limitations on liens on the stock of restricted subsidiaries, restriction as to the disposition of the stock of restricted subsidiaries and limitations on mergers and consolidations. We were in compliance with all covenants contained in the indenture at December 31, 2005. For the future expected payments on the senior notes, refer to note 10 (a) in our Consolidated Financial Statements included in Item 8 in this report.
On October 5, 2005, we issued $250.0 million of 7.25% series A preferred shares, par value $0.0125 per share, with a liquidation preference of $25.00 per share. We may redeem the shares on and after October 15, 2010 at a redemption price of $25.00 per share. Dividends on the series A preferred shares are non-cumulative. Consequently, if our board of directors does not authorize and declare a dividend for any dividend period, holders of the series A preferred shares will not be entitled to receive a dividend for such period, and such undeclared dividend will not accumulate and be payable. Holders of series A preferred shares will be entitled to receive, only when, as and if declared by our board of directors, non-cumulative cash dividends from the original issue date, quarterly in arrears on the fifteenth day of January, April, July and October of each year, commencing on January 15, 2006, without accumulation of any undeclared dividends. To the extent declared, these dividends will accumulate, with respect to each dividend period, in an amount per share equal to 7.25% of the liquidation preference per annum.
On October 3, 2005, we filed an unallocated universal shelf registration statement with the Securities and Exchange Commission that was declared effective on October 11, 2005. Under the shelf registration statement, we may issue up to $1.5 billion of equity, debt, trust preferred securities or a combination of these securities. On November 21, 2005, we completed a common share offering of 6,800,000 shares at $29.42 raising aggregate net proceeds of $200.1 million under this shelf registration statement. In addition, the $250.0 million of series B preferred shares were issued under this shelf registration statement.
Please refer to Capital Resources above for details regarding the payment of preferred dividends.
Loss reserves represent estimates, including actuarial and statistical projections at a given point in time of an insurer’s or reinsurer’s expectations of the ultimate settlement and administration costs of claims incurred. As a result, it is likely that the ultimate liability will differ from such estimates, perhaps significantly. Such estimates are not precise in that, among other things, they are based on predictions of future developments and estimates of future trends in loss severity and frequency and other variable factors such as inflation, litigation and tort reform. This uncertainty is heightened by the short time in which our company has operated, thereby providing limited claims loss emergence patterns specifically for our company. This has necessitated the use of industry loss development patterns in deriving IBNR, which despite management’s and the independent actuary’s care in selecting them will differ from actual experience. During the loss settlement period, it often becomes necessary to refine and adjust the estimates of liability on a claim either upward or downward. Even after such adjustments, ultimate liability will exceed or be less than the revised estimates. Similarly, we have limited loss payout pattern information specific to our experience, therefore we have used industry data, on a line by line basis, to estimate our expected payments. Consequently, despite management’s and our independent actuary’s care in selecting them, the actual payment of our reserve for losses and loss expenses will differ from estimated payouts.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of AXIS Capital Holdings Limited and subsidiaries at December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.
AXIS Capital Holdings Limited (“AXIS Capital”) is a holding company organized under the laws of Bermuda. AXIS Capital was incorporated on December 9, 2002. AXIS Specialty Limited (“AXIS Specialty Bermuda”) commenced operations on November 20, 2001. AXIS Capital, through its subsidiaries organized in Bermuda, Ireland and the United States provides a broad range of insurance and reinsurance products on a worldwide basis. AXIS Capital operates through two global underwriting platforms, AXIS Insurance and AXIS Re.
These consolidated financial statements include the accounts of AXIS Capital and all of its subsidiaries (together, the “Company”) and have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). All significant inter-company accounts and transactions have been eliminated. To facilitate period-to-period comparisons and to conform to current period presentation, a reclassification of medium term note investments from other investments to fixed maturity investments has been made for the year ended December 31, 2004. There was no effect on net income available to common shareholders from this change in presentation. The preparation of these consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.
Actual results could differ significantly from those estimates. The major estimates reflected in the Company’s consolidated financial statements include the reserves for losses and loss expenses, the estimate of reinsurance recoverable balances, premium estimates for business written on a line slip or proportional basis and the estimation of fair values for derivative contracts. The terms “FAS” and “FASB” used in these notes refer to Statements of Financial Accounting Standards issued by the United States Financial Accounting Standards Board.
The Company accounts for its other investments at fair value based on the most recently available financial information. The Company has no significant influence and does not participate in the management of these investments. Interest, dividend income, income distributions, changes in net asset values and realized gains and losses are included in net investment income. Any adjustments required due to the change in effective yields and maturities are recognized on a prospective basis through yield adjustments.
slip policies and proportional reinsurance contracts and adjusts its estimates of written premiums to reflect reported premiums on a periodic basis as reliable information becomes available.
In the normal course of business, the Company seeks to reduce the loss that may arise from events that could cause unfavorable underwriting results by reinsuring certain levels of risk in various lines of business with other reinsurers. Reinsurance premiums ceded are expensed over the period the reinsurance coverage is provided. Prepaid reinsurance premiums represent the portion of premiums ceded on the unexpired term of the policies in force. Reinstatement premiums ceded are recorded at the time a loss event occurs where coverage limits for the remaining life of a contract are reinstated under pre-defined contract terms and are expensed over the remaining risk period.
Reinsurance recoverables are based on contracts in force and are presented net of a reserve for uncollectible reinsurance. The method for determining the reinsurance recoverable on unpaid losses and loss expenses involves actuarial estimates of unpaid losses and loss expenses as well as a determination of the Company’s ability to cede unpaid losses and loss expenses under its reinsurance treaties. The reserve for uncollectible reinsurance is based on an estimate of the amount of the reinsurance recoverable balance that will ultimately not be recovered due to reinsurer insolvency, contractual disputes or some other reason. The valuation of this reserve for uncollectible reinsurance includes several processes including a review of the credit ratings of the reinsurance recoverables by reinsurer, an analysis of default probabilities as well as coverage issues. These factors require considerable management judgment and the factors are reviewed in detail on a quarterly basis with any resulting adjustments reflected in net income in the period that collection issues are identified.
Reserves for losses and loss expenses are established by management and the Company’s independent actuaries. They represent an estimate of the total cost of claims that are reported but
IBNR is estimated by management in consultation with the independent actuaries who use actuarial models to derive IBNR. The Bornhuetter-Ferguson method is primarily used although the initial expected loss ratio and chain ladder (“loss emergence”) methods are also utilized for some lines of business. The Bornhuetter-Ferguson method is typically used by companies with limited loss experience. This method takes as a starting point an assumed ultimate loss and loss expense ratio and blends in the loss and loss expense ratio implied by the experience to date.
For the insurance segment, the assumed ultimate loss and loss expense ratios are based on benchmarks derived from the independent actuary’s wider market experience together with our limited historical data. These benchmarks are then adjusted for rating increases or decreases and changes in terms and conditions that have been observed by the market and by the Company. For the reinsurance segment, the assumed ultimate loss and loss expense ratios are based on contract-­by-­contract initial expected loss ratios derived during pricing together with benchmarks derived from the independent actuary’s wider market experience.
While management believes that the reserves for unpaid losses and loss expenses are sufficient to pay losses that fall within coverages assumed by the Company, the actual losses and loss expenses incurred by the Company may be greater or less than the reserve provided. Due to the limited length of time that the Company has been operating, actual loss experience is limited; this increases the potential for significant deviation from currently estimated amounts. The methods of determining such estimates and establishing the resulting reserve are reviewed quarterly and any adjustments are reflected in operations in the period in which they become known.
The functional currency of the Company and its subsidiaries is the U.S. dollar. Monetary assets and liabilities denominated in foreign currencies are translated at year end exchange rates, with the resulting foreign exchange gains and losses recognized in the consolidated statements of operations. Revenues and operating expenses are translated at average exchange rates during the year.
The Company adopted FAS No. 123 effective January 1, 2003 by applying the prospective method permitted under FAS No. 148 “Accounting for Stock-Based Compensation-Transition and Disclosure.” Prior to 2003, the Company followed Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” and related interpretations in accounting for its employee stock compensation. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FAS 123 to all of its stock-based compensation prior to January 1, 2003.
Through December 31, 2004, the Company’s segments were: global insurance; global reinsurance; U.S. insurance; U.S. reinsurance; and corporate. Effective January 1, 2005, the Company created two distinct global underwriting platforms, AXIS Insurance and AXIS Re.
Following this strategic realignment of its organizational structure, the Company has re-evaluated its operating and reportable segments and determined its reporting and operating segments to be: Global and U.S. insurance, reinsurance and corporate. Global insurance and U.S. insurance are often referred to as our insurance segment. The Company’s segments and sub-segments have been determined on the basis of underlying information reviewed by the Company’s chief decision maker, the Chief Executive Officer.
The Company currently uses foreign currency forward contracts in its investment portfolios to minimize the effect of fluctuating foreign currencies and to gain exposure to interest rate differentials between differing market rates. Foreign currency forward contracts purchased are not specifically identifiable against cash, any single security or any groups of securities and, therefore, do not qualify and are not designated as a hedge for financial reporting purposes. Realized and unrealized gains (losses) on foreign currency forward contracts that are purchased as part of the Company’s investment strategies are recognized in realized gains (losses) in the statements of operations.
economic hedges to minimize the effect of fluctuating foreign currencies but are not specifically identifiable against cash, any single security or any groups of securities, insurance and reinsurance premium balances receivable or the reserve for losses and loss expenses and, therefore, do not qualify and are not designated as a hedge for financial reporting purposes. Realized and unrealized gains (losses) on foreign currency forward contracts that are purchased as economic hedges of the Company’s net foreign exposure are recognized in foreign exchange losses (gains) in the statements of operations.
The Company accounts for intangible assets in accordance with FAS No. 142 “Goodwill and Other Intangible Assets.” The Company does not amortize goodwill or identifiable intangible assets with indefinite lives, but rather re-evaluates on a yearly basis, or whenever changes in circumstances warrant, the recoverability of the assets. If it is determined that an impairment exists, the Company adjusts the carrying value of the assets to the fair value. In respect of intangible assets with definite lives, the Company amortizes the value of the assets over their useful lives.
In November 2005, the FASB issued FSP FAS 115-1 “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments”. This FSP replaces existing guidance and clarifies that an impairment should be recognized as a loss at a date no later than the impairment is deemed other-than-temporary, even if the decision to sell has not been made. FSP FAS 115-1 is effective for other-than-temporary impairment analysis conducted in periods beginning after December 15, 2005. The Company believes that its current policy on other-than-temporary impairments complies with FSP FAS 115-1. Accordingly, the adoption of this standard is not expected to have a significant impact on the Company’s results of operations or financial condition.
The Company evaluates the performance of its insurance and reinsurance segments based on underwriting results. The Company writes business that has loss experience generally characterized as low frequency and high severity. This may result in volatility in both the Company’s and an individual segment’s operating results and cash flows. The Company does not allocate its assets by segment as it evaluates the underwriting results of each segment separately from the results of the investment portfolio.
U.S. insurance provides specialty lines coverage through a variety of channels in the U.S. and covers exposures predominantly in the U.S. The product lines in this segment are property, professional lines, liability and other specialty and are offered through wholesale brokers, retail brokers and managing general underwriters.
The Company’s reinsurance segment provides treaty property and casualty reinsurance to insurance companies on a worldwide basis. Treaty reinsurance contracts are contractual arrangements that provide for automatic reinsurance of any agreed upon portion of business written, as specified in a reinsurance contract. Contracts can be written on an excess of loss basis or a pro rata basis, also known as proportional. The product lines in this segment are catastrophe, property, professional liability, credit and bond, motor, liability and other.
In addition to the loss reserves and related reinsurance recoverable, the assets of AXIS Insurance U.S. included fixed income securities and accrued interest of $18.8 million, cash equivalents of $0.7 million and licenses of $9.0 million. These assets were recorded at their fair values on the date of acquisition. The purchase price has been fully allocated against the fair values of the assets and liabilities; consequently, no goodwill was recorded.
On February 17, 2003, the Company acquired the renewal rights to the directors and officers insurance and related product lines written by the Financial Insurance Solutions Group (“FIS”) of Kemper Insurance Companies in exchange for an agreement to make an override payment. The override payment was based on a percentage of gross written premiums of all FIS accounts that were renewed by the Company. The Company has recorded the fair value of the renewal rights as an intangible asset and will amortize the cost over an estimated useful life of four years. The Company acquired these rights to broaden its U.S. product range within its U.S. insurance segment.
On August 1, 2005, the Company completed the purchase of Fireman’s Fund Insurance Company of Wisconsin, which is licensed in 46 states of the United States and the District of Columbia and the fair value of these licenses was $9.0 million.
The following represents an analysis of gross realized gains (losses) and the change in unrealized gains (losses) on investments included within accumulated other comprehensive income (loss):
All fixed maturity investments are held as available for sale. The amortized cost and fair market values are as follows:
As of December 31, 2005, there were approximately 2,113 securities (2004: 890) in an unrealized loss position with a fair market value of $4,852.7 million (2004: $2,700.9 million). Of these securities, there are 517 securities (2004: 78) that have been in an unrealized loss position for 12 months or greater with a fair market value of $1,259.2 million (2004: $88.6 million). As of December 31, 2005, none (2004: none) of these securities were considered to be other than temporarily impaired. The unrealized losses from these securities were not a result of credit, collateral or structural issues.
The Company has invested in various CLO’s with the investments ranging from the equity to the senior debt tranches. At December 31, 2005, the Company had invested in twenty-one different CLO’s with underlying assets totaling $8.6 billion (2004: $3.7 billion). The investment in investment funds consists of investments in funds of funds, a fund that invests in U.S. dollar high yield credit and funds that primarily invest in senior secured bank loans. The Company accounts for our other investments at estimated fair market value based on the most recent financial information available from various fund managers, underwriters and third party administrators.
and loss expenses at December 31, 2003 and 2003 net favorable prior period development of $27.7 million, or 20.9% of the reserve for losses and loss expenses at December 31, 2002. The favorable development for all years was due to lower than expected losses on short tail lines of business. In 2005, the favorable development was largely generated by the 2004 and 2003 accident years on terror and war risk and property lines of business.
The Company purchases reinsurance to reduce the risk of exposure to loss. The Company’s global insurance sub-segment and reinsurance segment purchase reinsurance to reduce exposure to large losses or series of losses. The Company’s U.S. insurance sub-segment purchases significant reinsurance to reduce the volatility in severity-driven classes of business. The segments purchase three types of reinsurance cover: facultative; excess of loss; and quota share. Facultative covers are typically assumed with the original business. Excess of loss covers provide a contractually set amount of cover after an excess point has been reached. This excess point can be based on the size of an industry loss or a fixed monetary amount. Generally these covers are purchased on a package policy basis, as they provide cover for a number of lines of business within one contract. Quota share covers provide a proportional amount of coverage from the first dollar of loss. All of these reinsurance covers provide for recovery of a portion of losses and loss reserves from reinsurers. Under its reinsurance security policy, the Company predominantly cedes its business to reinsurers rated A- or better by Standard & Poor’s Company (“S&P”) and/or
A.M. Best Company (“A.M. Best”). The Company remains liable to the extent that reinsurers do not meet their obligations under these agreements either due to solvency issues, contractual disputes or some other reason.
The breakdown of reinsurance by type of cover for the years ended December 31, 2005, 2004 and 2003 is as follows:
Gross premiums written, ceded and net amounts of premiums written and premiums earned for the years ended December 31, 2005, 2004 and 2003 are as follows:
Reinsurance recoverable and the reserve for uncollectible reinsurance by segment as at December 31, 2005 and 2004 is:
On November 15, 2004, the Company issued $500.0 million of senior unsecured debt (“Senior Notes”) at an issue price of 99.785%, generating net proceeds of $495.7 million. The Senior Notes bear interest at a rate of 5.75%, payable semi-annually in arrears on June 1 and December 1 of each year, beginning on June 1, 2005. Unless previously redeemed, the Senior Notes will mature on December 1, 2014. The Company may redeem the Senior Notes at any time and from time to time, in whole or in part, at a “make-whole” redemption price, however, the Company has no current intentions of calling the Senior Notes. The Senior Notes indenture contains various covenants, including limitations on liens on the stock of restricted subsidiaries, restrictions as to the disposition of the stock of restricted subsidiaries and limitations on mergers and consolidations. The Company was in compliance with all the covenants contained in the Senior Note indenture at December 31, 2005. The market value of the Senior Notes at December 31, 2005 was $498.5 million.
Interest expense includes interest payable, amortization of the offering discount and amortization of debt offering expenses. The offering discount and debt offering expenses are amortized over the period of time during which the Senior Notes are outstanding. For the year ended December 31, 2005, the Company incurred interest expense for the Senior Notes of $28.7 million (2004: $3.7 million). Interest payments commenced on June 1, 2005.
provisions limit the allowable holdings of a single issue and issuers. The Company did not have an aggregate exposure in a single entity, other than in U.S. Government and U.S. Government agency securities, of more than 2.0% of shareholders’ equity at December 31, 2005. Concentration of credit risk with respect to reinsurance recoverable balances is limited due to the number of reinsureds used on the Company’s reinsurance programs. As at December 31, 2005, four reinsurers accounted for 34.5% of reinsurance balances recoverable, one of which accounted for 13.2% of reinsurance balances recoverable. Of this percentage, 18.9 percentage points are with reinsurers rated A+ by A.M. Best, 6.7 percentage points are with reinsurers rated A by A.M. Best and 8.9 percentage points are with reinsurers rated A- by A.M. Best.
The Company produces its business through brokers and direct relationships with insurance companies. During the year ended December 31, 2005, three brokers accounted for approximately 52.1% (2004: 58.9%; 2003: 64.5%) of the total gross premiums written by the Company. Marsh, Inc. (including its subsidiary Guy Carpenter and Company) accounted for approximately 28.0% (2004: 30.2%; 2003: 33.7%), Aon Corporation for approximately 15.7% (2004: 19.3%; 2003: 19.3%) and Willis Group Holdings Ltd. for approximately 8.4% (2004: 9.4%; 2003: 11.5%). Each of these brokers is a large, well established company. No other broker and no one insured or reinsured accounted for more than 10% of gross premiums written in the years ended December 31, 2005, 2004 and 2003.
On April 21, 2004, the Company completed a secondary public offering of 20,000,000 common shares held by some founding shareholders at a price of $27.91 per share. On April 27, 2004, the Company completed a secondary public offering of 3,000,000 common shares to cover over-allotments. The Company did not sell any common shares or receive any proceeds in connection with these offerings.
On December 9, 2004, the Company announced that its Board had authorized the repurchase of up to $350.0 million of its common shares, and on February 16, 2005, the Company repurchased 12,783,094 common shares owned by initial investors at the formation of the Company pursuant to its repurchase program. The average purchase price was $27.38 per common share and the aggregate price was $350.0 million.
On March 14, 2005, the Company announced that its Board had authorized an additional repurchase of up to $150.0 million of its common shares under the Company’s share repurchase plan.
On November 21, 2005, the Company completed a common share offering of 6,800,000 shares at a price of $29.42 per share with aggregate net proceeds to the Company of $200.1 million.
On November 23, 2005, the Company issued $250.0 million of 7.50% series B preferred shares with a liquidation preference of $100.00 per share. The Company may redeem the shares on or after December 1, 2015 at a redemption price of $100.00 per share. Dividends on the series B preferred shares if, as and when declared by our board of directors will be payable initially at a fixed rate per annum equal to 7.50% of the liquidation preference on the first day of March, June, September and December of each year, commencing on March 1, 2006, up to but not including December 1, 2015. Commencing on March 1, 2016, the dividend rate on the series B preferred shares will be payable at a floating rate. During a floating rate period, the floating rate per annum will be reset quarterly at a rate equal to 3.4525% plus the 3-month LIBOR Rate. Dividends on the series B preferred shares are non-cumulative. Consequently, if the board of directors does not declare a dividend for any dividend
period, holders of the series B preferred shares will not be entitled to receive a dividend for such period, and such undeclared dividend will not accumulate and will not be payable.
The holders of the series A and B preferred shares will have no voting rights except as described below. Whenever dividends payable on the series A and B preferred shares have not been declared by the board of directors and paid for an aggregate amount equivalent to six full quarterly dividends (whether or not consecutive) on all of the series A and B preferred shares or any class or series of parity stock then outstanding, the holders of the series A and B preferred shares, together with the holders of each such class or series of parity stock, will have the right, voting together as a single class regardless of class or series, to elect two directors to the Company’s board of directors. The Company will use its best efforts to effectuate the election or appointment of these two directors. Whenever dividends on the series A and B preferred shares and the parity stock then outstanding have been paid in full, or declared and sufficient funds have been set aside, for at least four dividend periods, the right of holders of the series A and B preferred shares and the parity stock to be represented by directors will cease (but subject always to the same provision for the vesting of such rights in the case of any future suspension of payments in an amount equivalent to dividends for six full dividend periods whether or not consecutive), and the terms of office of the additional directors elected or appointed to the board of directors will terminate.
The Company has several defined contribution plans that are managed externally pursuant to which employees and the Company contribute a percentage of the employee’s gross salary into the plan each month. During the year ended December 31, 2005, pension expenses totaled $6.7 million (2004: $6.0 million; 2003: $3.9 million).
As of December 31, 2005, the following benefit payments are expected to be paid:
Options granted under the plan generally expire 10 years after the date of grant and generally vest ratably on an annual basis over three years from the date of grant. Exercise prices are established at the fair value of the Company’s common shares at the date of grant.
The Company has adopted a Directors Long-Term Equity Compensation Plan that provides for the grant of non-qualified stock options and stock awards (restricted and unrestricted) to non-employee directors of the Company. The maximum number of common shares with respect to which awards may be granted under the plan is 1,200,000. The plan is administered by the Board of Directors. In 2005 and 2004, the directors were awarded a grant of 8,000 stock options plus $20,000 worth of common shares pursuant to a restricted stock grant. In addition, directors may elect to receive their fees in common shares rather than cash. All awards are made at the fair market value of the common shares at the time of grant. As at December 31, 2005, 120,000 (2004: 72,000) stock options, 40,235 (2004: 32,625) common shares and 5,982 (2004: 3,798) restricted stock awards had been granted under the plan.
The Company has an unfunded nonqualified deferred compensation plan that allows participating directors to elect (i) the amount, if any, of cash or stock as fees for services to be deferred and (ii) the form in which payment is to be made. Directors who choose to defer fees
otherwise payable in shares are credited a number of phantom stock units equal in amount to the number of shares of stock deferred. In the event a cash dividend is declared on the stock, the portion of the participant’s deferral account denominated in phantom share units is credited with additional phantom share units (or portions thereof). Directors who choose to defer fees otherwise payable in cash are credited with interest on their cash deferral at a rate for the year of deferral that is 100 basis points above the 12-month LIBOR rate for deposits of U.S. dollars. Generally, benefits are paid upon termination of service as a director. As at December 31, 2005, 38,068 (2004: 27,708) phantom share units had been issued under the plan.
During the year ended December 31, 2005, JPMorgan Chase Bank acted as administrative agent and lender for the Company’s syndicated credit facility. In addition, certain subsidiaries of the Company hold several bank accounts with JPMorgan Chase Bank. During the year ended
December 31, 2005, the Company incurred fees in relation to these transactions of $1,642 (2004: $678; 2003: $678), of which $695 (2004: $37; 2003: $210) was included in accounts payable and accrued expenses.
During the year ended December 31, 2005, HSBC Bank USA acted as a lender for our syndicated credit facility. Some of our subsidiaries also hold several bank accounts with the Bank of Bermuda. During the year ended December 31, 2005, we incurred fees in connection with these transactions of $423 (2004: $134; 2003: $18), of which $55 (2004: $30) was included in accounts payable and accrued expenses.
In connection with its initial public offering, the Company used the investment banking services of JP Morgan Securities and Credit Suisse First Boston LLC. For these services, they received fees of $1.9 million and $2.4 million, respectively. During the year ended December 31, 2004, J.P. Morgan Securities, Inc. and Credit Suisse First Boston LLC acted as underwriters in the Company’s secondary offering for which they received fees of $1.8 million and $1.2 million, respectively. In addition, in connection with the issuance of Senior Notes, the Company used the investment banking services of JP Morgan Securities for which they received fees of $1.1million. During the year ended December 31, 2005, J.P. Morgan Securities, Inc. and HSBC Bank USA acted as underwriters in connection with the Company’s series A and series B preferred shares issuance and each received fees of $129.
In addition, the Company provides insurance in the ordinary course of business to various entities that are affiliated with some of its directors and with some of its principal shareholders. These transactions are negotiated on an arm’s length basis.
Income tax (expense) recovery for the years ended December 31, 2005, 2004 and 2003 was as follows:
The maximum dividends that may be paid by the Company’s U.S. insurance operations are restricted by the regulatory requirements of the domiciliary states. Generally, the maximum dividend that may be paid by each of the Company’s U.S. insurance entities without prior regulatory approval is limited to unassigned surplus (statutory equivalent of retained earnings) and cannot exceed 10% of total statutory capital and surplus. At December 31, 2005, the maximum dividend that the Company’s U.S. insurance operations could pay without regulatory approval was approximately $15.0 million.