We have executed a lease for office space in Bermuda that contains approximately 4,000 square feet. The lease expires on August 31, 2008. The annual lease payment for this office is approximately $191,161. Effective as of April 1, 2006, we will assign this lease to a third party. In addition, we have entered into a lease for additional office space in Bermuda that contains 8,445 square feet. The lease expires September 30, 2007. The annual lease payment for this office space is approximately $435,000.
We have entered into a lease for office space in London that contains approximately 5,850 square feet. The initial term of the lease expires in June 2006. The annual lease payments for this office is approximately $185,000. We have entered into a lease for office space in Dublin that contains approximately 4,000 square feet. The initial term of the lease expires in April 2030 and may not be terminated prior to April 15, 2015. The annual lease payments for this office is approximately $190,000.
Selected Income Statement Data REVENUES: Net premiums earned $ -- $ -- $ -- $ 1,940 $ 237,140 $ 364,075 Technical services revenues 28,448 28,628 20,350 11,680 32,485 47,265 Net investment income 33 23 13 2,290 14,307 27,181 Net realized gains (losses) -- -- -- 109 228 (13,020) Other income -- -- -- 126 2,995 5,610 Total revenues 28,481 28,651 20,363 16,145 287,155 431,111 EXPENSES: Net losses and loss expenses -- -- -- 1,191 198,916 324,084 Acquisition expenses -- -- -- 164 53,995 69,624 Direct technical services costs 17,576 17,193 12,992 8,637 23,182 37,027 Interest expense -- -- -- -- 71 4,165 General and administrative expenses and depreciation 8,793 8,765 5,971 44,630 65,572 101,919 Total expenses 26,369 25,958 18,963 54,658 341,736 536,819 Net income $ 2,112 $ 2,693 $ 1,400 Net loss before taxes (38,477) (54,581) (105,708) Provision for income taxes -- -- 244 Net loss after taxes $ (38,477) $ (54,581) $ (105,952) Weighted average common shares and common share equivalents outstanding basic 1,093,250 1,093,250 1,093,250 31,369,001 56,798,218 57,205,342 Weighted average common shares and common share equivalents outstanding diluted 1,093,250 1,093,250 1,093,250 31,369,001 56,798,218 57,205,342 Net income (loss) per share basic and diluted (2) $ 1.93 $ 2.46 $ 1.28 $ (1.23) $ (0.96) $ (1.85) PREDECESSOR PRO FORMA DATA (UNAUDITED): Net income as shown above $ 2,112 $ 2,693 $ 1,400 Pro forma provision for income taxes (1) 822 1,048 545 Net income adjusted for pro forma income taxes $ 1,290 $ 1,645 $ 855 Pro forma net income per share basic and diluted (2) $ 1.18 $ 1.51 $ 0.78
PREDECESSOR QUANTA CAPITAL HOLDINGS LTD. (3) ------------------------------ -------------------------------- AS OF DECEMBER 31, AS OF AS OF AS OF AS OF ------------------ SEPTEMBER DECEMBER DECEMBER DECEMBER 2001 2002 3, 2003 31, 2003 31, 2004 31, 2005 ------- -------- --------- -------- -------- ----------
We have incurred estimated net losses of approximately $87.4 million relating to Hurricanes Katrina, Rita and Wilma during the year ended December 31, 2005. These losses include net reinstatement premium expense of approximately $4.1 million. Of these losses, $33.6 million (including reinstatement premium expense of approximately $1.8 million) occurred in our property reinsurance line, $39.9 million (including reinstatement premium income of approximately $0.2 million) occurred in our marine reinsurance lines, $13.7 million (including reinstatement premium expense of approximately $2.5 million) occurred in our technical risk property insurance line and $0.2 million occurred in our fidelity insurance product line. We believe that we will not know our exact losses for some time given the uncertainty around the industry loss estimates, the size and complexity of Hurricanes Katrina, Rita and Wilma, limited claims data and potential legal and regulatory developments related to potential losses. As a result, our losses may continue to develop during the next year and our ultimate losses may vary significantly from our recorded estimates. Below is a summary of the estimated losses and loss expenses incurred for the 2005 hurricanes.
Technical risk property $ 52,245 $ (41,029) $11,216 Fidelity and crime 450 (225) 225 -------- --------- ------- 52,695 (41,254) 11,441 -------- --------- ------- SPECIALTY REINSURANCE:
The above table includes losses incurred from Hurricanes Katrina, Rita and Wilma in 2005 and does not include development on losses incurred from the 2004 hurricanes.
We have recorded estimated gross losses of approximately $189.3 million relating to Hurricanes Katrina, Rita and Wilma during the year ended December 31, 2005. These losses include, and are net of, gross reinstatement premium income of approximately $9.8 million. The difference between our estimated gross and estimated net losses, of $101.9 million, represents the amount of reinsurance or retrocessional insurance recoveries, including ceded reinstatement premium expense of $13.9 million. We obtained this reinsurance and retrocessional insurance as part of our risk management practices to help limit our net loss exposures and control our aggregate exposures to particular classes of risk
Shortly after Hurricane Rita, we discontinued writing new and most renewal business in our technical risk property and property reinsurance lines of business. We did not discontinue or make changes in our program businesses, including our residential builders' and contractors' program, which we refer to as the HBW program. In addition, we retroceded substantially all the in-force business, as of October 1, 2005, in these lines (other than our program business) by a portfolio transfer to a third-party reinsurer, which we refer to as the Property Transaction. The Property Transaction limits our property reinsurance and technical risk property losses occurring after October 1, 2005 to those relating to Hurricane Wilma and those we have incurred through September 30, 2005 (including incurred but not reported losses), which includes losses relating to Hurricanes Katrina and Rita. Under the Property Transaction, we also transferred all future premiums earned for that business and loss and acquisition expenses incurred from and after October 1, 2005 to the third-party reinsurer. Effective October 1, 2005, we also commuted two of our casualty reinsurance treaties back to the insurance company which had reinsured it with us, which we refer to as the Casualty Reinsurance Transaction. We refer to the Property Transaction and the Casualty Reinsurance Transaction collectively as the Transactions.
The property reinsurance and technical risk property product lines subject to the Property Transaction accounted for gross premiums written and net premiums written of approximately $108.0 million and $107.0 million for the year ended December 31, 2004 and approximately $97.1 million and $19.1 million for the year ended December 31, 2005. The net premiums written of $19.1 million for the year ended December 31, 2005 reflect $57.3 million of ceded premiums written during the fourth quarter related to the Property Transaction. Our net underwriting losses for the product lines subject to the Property Transaction were approximately $47.4 million for the year ended December 31, 2004 and approximately $51.6 million for the year ended December 31, 2005.
The two casualty reinsurance treaties subject to the Casualty Reinsurance Transaction accounted for gross premiums written and net premiums written of approximately $36.7 million for the year ended December 31, 2004 and approximately $5.7 million for the year ended December 31, 2005, which is net of $17.0 million of net unearned premium returned to the insurance company under the terms of the Casualty Reinsurance Transaction. Our net underwriting income relating to those two casualty reinsurance treaties was approximately $1.6 million for the year ended December 31, 2004 and approximately $2.1 million for the year ended December 31, 2005, which includes the net expense of the Casualty Reinsurance Transaction of approximately $1.2 million. The impact of the transactions is disclosed in Note 22 to the consolidated financial statements for the year ended December 31, 2005.
As a result of the expected losses from the 2005 hurricanes, on October 5, 2005, A.M. Best placed the "A-" (excellent) financial strength rating assigned to Quanta Bermuda and its subsidiaries and Quanta Europe, under review with negative implications. In response, during the fourth quarter of 2005, we worked closely with A.M. Best on a plan designed to maintain our "A-" rating, which included the retrocession of substantially all the in-force business, as of October 1, 2005, in our technical risk
property and property reinsurance lines of business (other than our program business) by a portfolio transfer to a third-party reinsurer, the commutation of two of our casualty reinsurance treaties back to the insurance company which had reinsured it with us and the completion of the offerings of our common shares and series A preferred shares in the fourth quarter of 2005. On December 21, 2005, A.M. Best affirmed the financial strength rating of "A-" (excellent) of Quanta Bermuda and its subsidiaries, and ascribed a negative outlook to the rating. A.M. Best defines a negative outlook as indicating that a company is experiencing unfavorable financial/market trends, relative to its current rating level and, if continued, the company has a good possibility of having its rating downgraded. In connection with A.M. Best's December 2005 affirmation of our ratings and continued review with negative outlook, A.M. Best cited significant challenges and uncertainties associated with the successful execution of management's revised business plans, management's ability to diversify and grow our business profitably, and the risk for upward development of Hurricanes Katrina, Rita and Wilma losses.
On March 2, 2006, A.M. Best announced that it had downgraded the financial strength rating assigned to Quanta Bermuda and its subsidiaries and Quanta Europe, to "B++" (very good), under review with negative implications. The A.M. Best "A" (excellent) rated Lloyd's market, including our Lloyd's syndicate, was not subject to the rating downgrade. We believe that adverse developments during the fourth quarter of 2005 relating to the 2005 hurricane losses and our other reserve increases were significant contributors to the decision by A.M. Best. Based on our discussions with A.M. Best, in order to maintain our rating, we believe that we will be required to demonstrate acceptable results and change our business model appropriately to show that we can grow our business profitably. This, however, will be very difficult to accomplish under a "B++" rating. In addition, we believe we will need to successfully implement a more favorable cost structure and reduce the amount of risk that we assume on a single loss event or catastrophic event based on initiatives that we have begun to implement. We also believe that A.M. Best will continue to evaluate our available capital and the probable loss exposures associated with our business lines to ensure our capital is in compliance with A.M. Best's standards relative to our rating. We intend to continue to work with A.M. Best to understand the different requirements it has for our business in order to maintain or improve our financial strength rating and remove any qualification to our rating. However, the downgrade and qualification of our rating with negative implications has significantly adversely affected our business, our opportunities to write new and renewal business and our ability to retain key employees. Based on the deterioration in our business, A.M. Best may further downgrade our financial strength ratings. We can make no assurances as to what rating actions A.M. Best may take now or in the future or whether A.M. Best will further downgrade our rating or remove any qualification to our rating.
clients will actually exercise such rights or the effect such cancellations will have on our financial condition or future prospects. However, depending on the number of contracts involved, such an effect could be materially adverse. As of March 29, 2006, we had received notice of cancellation on approximately 2.3% of our in-force policies, calculated using original contract gross premiums written related to those cancelled policies as a percentage of total gross premiums written during 2005. Gross unearned premiums relating to these cancellations that we have returned or expect to return to our clients total approximately $5.0 million. We expect that we will receive additional cancellations.
We are also closely analyzing our business lines, their positioning and internal operations, and identifying steps we should take to improve our position. We believe that we currently have sufficient assets to pay our foreseen liabilities as they become due. We maintain a global platform conducting business in the United States, Bermuda and Europe. We also believe we have strong underwriting capabilities and experience in key product lines. We plan to continue to operate our environmental consulting services through ESC and certain program business lines and to continue our operations through the A.M. Best "A" rated Lloyd's market under our existing Lloyd's syndicate. We are evaluating whether we continue to operate our remaining business lines, which may include the use of strategic alliances, fronting agreements and other arrangements. In connection with the evaluation of our business, we are also evaluating the possibility of expanding our business to help diversify our business mix and build our product lines along a middle market strategy that is supportable with a "B++" rating and with customers who can benefit from our underwriting capabilities and risk management capacities. This could include writing policies with lower limits and lower aggregate loss exposures and in markets we believe provide us a greater ability to deal with the broker or insured in establishing policy terms and managing particular claims. We may seek to broaden the number of brokers we do business with, such as by targeting smaller regional brokers who represent smaller companies who can benefit from our underwriting capabilities and risk management capacities. We may also seek to work
with existing broker relationships to reach additional customers that we can serve.
The primary drivers of growth in 2005 in our insurance lines of business and net premiums written were the development of our relationships with insurance and reinsurance brokers and the development of our specialty insurance lines of business, including Syndicate 4000. Traditionally, many reinsurance contracts are entered into at the beginning of a calendar year and that period is often referred to as the January renewal season. As we have exited most of our reinsurance business, we believe that the 2006 renewal season will be much less significant for our 2006 results. Our specialty insurance segment demonstrated premium growth during the year ended December 31, 2005 as compared to the year ended December 31, 2004, especially through Lloyd's, following receipt of regulatory approvals during the fourth quarter of 2004. Our specialty insurance segment became a more significant contributor to our overall business and represented approximately 65.8% of our total net premiums written in the year ended December 31, 2005, compared to 40.6% in the year ended December 31, 2004.
certain risk classes will increase as we evaluate and position our business.
We organize our business along five product lines and three geographies. Our two traditional product lines are specialty insurance and specialty reinsurance. We also have programs and structured products product lines. The products we offer our clients are written either as traditional insurance or reinsurance policies or are provided as a program, a structured product or a combination of a traditional policy with a program or a structured product. Our fifth product line is our technical services line. However, for financial reporting purposes, some of our product lines are aggregated for purposes of the reportable segment disclosure included below:
o Specialty insurance. Our specialty insurance segment includes our traditional, structured and program specialty insurance products. Our traditional specialty insurance products included in our specialty insurance segment results include technical risk property, professional liability, environmental liability, fidelity and crime, surety, trade credit and political risk and marine and aviation. During 2005, our specialty insurance segment wrote business both on a direct basis with insured clients or by reinsuring policies that are issued on our behalf by third-party insurers and reinsurers, and includes our Lloyd's syndicate, which was created in December 2004. During the year ended December 31, 2005, we changed the composition of our reportable segments by aggregating the Lloyd's operating segment with the specialty insurance reportable segment. Our Lloyd's syndicate writes traditional specialty insurance products including professional liability (professional indemnity and directors' and officers' coverage), fidelity and crime (financial institutions) and specie and fine art. Our specialty insurance programs include the HBW program. After the end of the third quarter of 2005, we discontinued the writing of new and most renewal business in our technical risk property line of business. Currently, we are not writing new business in our professional liability, environmental, and marine and aviation specialty insurance product lines and our structured products line and we are running off our surety line.
of new and most renewal business in our property reinsurance of business and commuted a large portion of our casualty reinsurance portfolio. Currently, we are not writing new business in our remaining specialty reinsurance product lines.
We derive the majority of our revenues from three principal sources: premiums from policies written by our underwriting segments, technical services revenues and investment income from our investment portfolios.
We also have revenues generated by our technical services segment, which operates primarily in the environmental area, from technical and risk management services provided under various short-term service contracts and for services performed by subcontractors engaged on behalf of clients. We also generate revenues from the remediation of environmental obligations that we have assumed. The amount of technical services and remediation fees and subcontractor revenues is a function of political and economic conditions and the impact these conditions have on clients' discretionary spending on environmental projects.
Our expenses primarily consist of net loss and loss expenses, general and administrative expenses, acquisition expenses and direct technical services costs.
Acquisition expenses, which are net of expenses recovered under our ceded reinsurance contracts, consist principally of commissions, fees, brokerage and tax expenses that are directly related to obtaining and writing insurance and reinsurance contracts. Typically, acquisition expenses are based on a certain percentage of the premiums written on contracts of insurance and reinsurance. These expenses are a function of the number and type of insurance and reinsurance contracts written.
general and administrative expense ratio is calculated by dividing underwriting related general and administrative expenses by net premiums earned and indicates the level of indirect costs that we incur in acquiring and writing insurance and reinsurance business. During 2005, we have changed the denominator to be used in the calculation of our general and administrative expense ratio to net premiums earned, instead of net premiums written. Our combined ratio is the aggregate of our loss and loss expense, acquisition expense and general and administrative expense ratios. We believe that these financial ratios appropriately reflect the profitability of our underwriting segments. A combined ratio of less than 100% indicates an underwriting profit and over 100%, an underwriting loss. Because we have a limited operating history, our combined ratio may be subject to significant volatility and may not be indicative of future profitability.
Premiums ceded were $218.9 million for the year ended December 31, 2005 an increase of $144.0 million compared to $74.9 million for the year ended December 31, 2004. The increase in premiums ceded primarily reflects the growth in gross premiums written, approximately $57.3 million of premiums ceded resulting from the Property Transaction and approximately $20.8 million in purchased reinsurance and retrocessional protection (including reinstatement premiums) to help limit our net loss exposures to natural catastrophe events. The increase of premiums ceded is attributable to a lesser extent to the development of the reinsurance program for our specialty insurance segment product lines, which was restructured during the year ended December 31, 2005. The restructure involved the commutation of our 2004 reinsurance treaty protection in our professional liability and
Technical services revenues. Technical services revenues were $47.3 million for the year ended December 31, 2005 an increase of $14.8 million, or 45.5%, compared to $32.5 million for the year ended December 31, 2004. This increase in technical services revenues is primarily attributable to increased remediation revenues associated with our liability assumption program in Buffalo, New York.
Net investment income and net realized (losses) gains. Net investment income and net realized (losses) gains totaled $14.2 million for the year ended December 31, 2005, a decrease of $0.3 million, or 2.6%, compared to $14.5 million for the year ended December 31, 2004. The decrease is primarily due to an increase in net investment income of $12.9 million because of our larger amount of invested assets and rises in market interest rates, which is offset by an increase in net realized losses of $13.2 million, of which $10.2 million is attributable to other than temporary impairment losses recognized during the year ended December 31, 2005.
o the number of insurance and reinsurance contracts we entered into and the associated net premiums earned as our insurance and reinsurance portfolios continue to mature;
Our expected ultimate losses during the year ended December 31, 2005 also include estimated gross and net loss estimates of $21.6 million and $13.0 million related to damage caused by an oil pipeline in California which ruptured during a mudslide in the first quarter of 2005, for which the damage is covered by an insurance contract issued by our environmental liability product line. There remains the possibility of further negative development on this loss in the future, particularly if the timing of the completion of the remediation plan for the spill is further delayed. In addition to the hurricanes and the oil pipeline loss, as of December 31, 2005, we have received a limited amount of significant reported losses. However, we participate in lines of business where claims may not be reported for some period of time after those claims are incurred.
We have used the Bornhuetter-Ferguson reserving method as our primary loss reserving methodology as of December 31, 2005 to estimate the ultimate cost of losses for our specialty reinsurance lines and our fidelity and technical risk property specialty insurance lines. The Bornhuetter-Ferguson reserving method uses an initial expected loss and loss expense ratio supplemented by our actual loss and loss expense experience to date. We have used an expected loss ratio method as our primary reserving methodology as of December 31, 2005 to estimate the ultimate cost of losses for our other specialty insurance business lines, whereby earned premiums are multiplied by an expected loss ratio to derive ultimate losses and deducts any paid losses and loss expenses to arrive at estimated losses and loss expense reserves. With respect to the year ended December 31, 2005, in establishing our reserves for losses and loss expenses, we reviewed reserve estimates of an actuary employed with our company and of an external actuary specialist. We recorded these reserves as of the year ended December 31, 2005 based on the highest aggregate reserve amount of the estimates we reviewed. As part of our year-end closing process, we strengthened our loss reserves for 2005 by approximately $7.9 million. Given the immaturity of our business and very limited claims history, we have relied on pricing, loss and expense data accumulated by our consulting actuary, historical industry results, and to a limited extent, our own reported claims history in establishing loss ratios for each line of business. Although we have not experienced significant reported claims in our casualty insurance line, we have worked closely with our independent loss specialist and concluded to generally strengthen our loss ratios in our HBW program, Lloyd's and environmental lines with respect to the year ended December 31, 2005.
We received a claim under our PWIB program relating to tornados occurring in March 2006. Due to the fact that we very recently received this claim, we are still in the process of estimating the amount of losses relating to this claim that we will need to recognize in our financial statement for the first quarter of 2006.
Acquisition expenses. Acquisition expenses were $69.6 million for the year ended December 31, 2005, an increase of $15.6 million, or 28.9%, compared to $54.0 million for the year ended December 31, 2004. The increase in acquisition expenses is due to the increase in the number of insurance and reinsurance contracts we entered into and the associated net premiums earned.
Direct technical services costs. Direct technical services costs were $37.0 million for the year ended December 31, 2005, an increase of $13.8 million, or 59.7% compared to $23.2 million for the year ended December 31, 2004, and were comprised of subcontractor and direct labor expenses. Direct technical services costs, as a percentage of technical services revenues were approximately 78.3% for the year ended December 31, 2005 compared to 71.4% for the year ended December 31, 2004. The increase in direct technical services costs as a percentage of revenues was attributable to a significant increase in the use of subcontractors for environmental projects in 2005 as compared to 2004, which resulted primarily from the Buffalo, New York remediation project.
General and administrative expenses. General and administrative expenses were $97.9 million for the year ended December 31, 2005, an increase of $34.5 million, or 54.5%, compared to $63.4 million for the year ended December 31, 2004. General and administrative expenses were comprised of $58.6 million of personnel related expenses (including $6.4 million of severance costs) and $39.3 million of other general and administrative expenses during the year ended December 31, 2005 compared to $40.7 million of personnel related expenses and $22.7 million of other expenses during the year ended December 31, 2004. The increase in general and administrative expenses is due primarily to an increase in the number of employees as we grew our lines of business, especially in Europe and our severance costs. To a lesser extent, the increase is attributed to increases in auditing fees, fees associated with ongoing efforts relating to Sarbanes-Oxley Section 404 compliance and costs relating to information technology development. General and administrative expenses related to our underwriting segment was $90.3 million for the year ended, which included $3.1 million of expenses charged by our technical services segment for technical and information management services, and $10.7 million of expenses related to our technical services segment.
REVENUES. Total revenues of $16.1 million were comprised of net premiums earned of $1.9 million, technical services revenues of $11.7 million and investment income of $2.4 million, including
Acquisition expenses. Net acquisition expenses for the period ended December 31, 2003 were $0.2 million and were a function of the number of insurance and reinsurance contracts we entered into and the associated net premiums earned.
Direct technical services costs. Direct technical services costs totaled $8.6 million and were comprised of subcontractor and direct labor expenses at ESC. Direct technical services costs, as a percentage of technical services revenues were 70.4% for the period and was consistent with direct technical services costs as a percentage of technical services revenues realized by ESC in prior periods.
General and administrative expenses. General and administrative expenses were $44.2 million for the period and were comprised of $35.6 million of personnel related expenses and $8.6 million of other overhead and start-up related expenses. Included in general and administrative expenses were $41.5 million related to our underwriting segment and $2.7 million of expenses related
to our technical services segment. Personnel expenses, representing salaries and other benefits grew steadily during the period reflecting the ramp-up in our operations, including the growth in the number of our employees. Personnel expenses also included $16.7 million of non-recurring, non-cash stock compensation expense which related to common shares issued to our founding shareholders in connection with our initial capitalization on May 23, 2003 and also to certain of our directors and officers in connection with the private offering of our shares on September 3, 2003. These shares were issued at prices that were below the private offering price and, in accordance with Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees," ("APB 25") we are required to expense the difference between the issue price per share and the fair market value price per share, with a corresponding credit to additional paid-in capital. The private offering price was considered to be an approximation of the fair market price of the shares at the time of their issuance. General and administrative expenses also included approximately $0.6 million of non-recurring start-up related expenses, which were primarily related to legal and other professional costs.
We allocate indirect corporate general and administrative expenses among each of our segments, including those related to underwriting operations, as described above under "Segment Information."
During the year ended December 31, 2005, we changed the composition of our reportable segments to aggregate the Lloyd's operating segment with our specialty insurance reportable segment. We aggregated these segments to reflect that we operate these insurance businesses as one and that the Lloyd's business is very similar to the insurance business we write in the United States. Our Lloyd's operations were previously reported as a separate segment.
2005 2004 CHANGE --------- --------- --------- ($ in thousands) Gross premiums written ............ $ 392,023 $ 242,580 $ 149,443 Premiums ceded .................... (135,460) (72,259) (63,201) --------- --------- --------- Net premiums written .............. $ 256,563 $ 170,321 $ 86,242 ========= ========= =========
Loss and loss expense ratio ....... 73.7% 66.3% (7.4)% Acquisition expense ratio ......... 13.7% 19.0% 5.3% General and administrative expense ratio .................. 33.1% 45.6% 12.5% --------- --------- --------- Combined ratio .................... 120.5% 130.9% 10.6% ========= ========= =========
Premiums. Gross and net premiums written were $392.0 million and $256.6 million for the year ended December 31, 2005 compared to $242.6 million and $170.3 million for the year ended December 31, 2004. The increase in our specialty insurance segment's gross and net premiums written was largely due to the contribution of $80.7 million, or 20.6%, of the specialty insurance segment's gross premiums written, from our Lloyd's syndicate, which commenced in December 2004. The increase also reflected continued growth in all of our specialty insurance segment product lines. However, shortly after Hurricane Rita, we discontinued writing new and most renewal business in our technical risk property line of business (other than our program business), which accounted for approximately $13.4 million, or 3.4%, of our specialty insurance segment's gross premiums written during the year ended December 31, 2005. We also retroceded substantially all the in-force business, as of October 1, 2005, in this line (other than our program business) by a portfolio transfer to a third-party reinsurer.
(2) The gross and net premiums written generated by our Lloyd's syndicate is included in the professional liability product line, and was $79.5 million and $60.6 million and $3.2 million and $2.6 million.
($ in millions) --------------- Casualty........................... $140.3 Warranty*.......................... 15.0 Property........................... 10.6 ------ Total.............................. $165.9 ====== ---------- * Warranty is written as reinsurance.
Approximately 44.9% of our specialty insurance segment gross premiums written of $392.0 million were generated through our program business, of which 42.3% was through our HBW program. The remaining 57.7% of our specialty insurance segment gross premiums written were generated through a number of brokers, only one of which accounted for more than 10% of our total specialty insurance segment gross premiums written.
to a lesser extent to the development of the reinsurance program for our specialty insurance segment product lines, which was restructured during the year ended December 31, 2005, as described above.
Net losses and loss expenses. Net losses and loss expenses were $145.4 million for the year ended December 31, 2005, an increase of $95.6 million compared to $49.8 million for the year ended December 31, 2004. Net losses and loss expenses are a function of our net premiums earned and our expected ultimate losses and loss expenses for reported and unreported claims on contracts of insurance and reinsurance underwritten. The increase in net losses and loss expenses is due to:
o the growth in the number of insurance contracts we entered into and the associated net premiums earned; and
Acquisition expenses. Acquisition expenses were $26.9 million for the year ended December 31, 2005 an increase of $12.6 million, or 88.4%, compared to $14.3 million for the year ended December 31, 2004. The increase in acquisition expenses was due to the increase in the number of insurance contracts we entered into and the associated net premiums earned. These acquisition expenses primarily represented brokerage fees, commission fees and premium tax expenses and were net of ceding commissions earned on purchased reinsurance treaties.
2005 2004 CHANGE --------- --------- --------- ($ in thousands) Gross premiums written......... $ 216,912 $ 251,832 $ (34,920) Premiums ceded................. (83,434) (2,612) (80,822) --------- --------- --------- Net premiums written........... $ 133,478 $ 249,220 $(115,742) ========= ========= ========= Net premiums earned............ $ 166,944 $ 161,973 $ 4,971 Other income................... 1,974 1,571 403 Net losses and loss expenses... (178,887) (149,111) (29,776) Acquisition expenses........... (42,714) (39,708) (3,006) General and administrative expenses(1)................. (25,154) (21,301) (3,853) --------- --------- --------- Net underwriting loss.......... $ (77,837) $ (46,576) $ (31,261) ========= ========= ========= RATIOS: Loss and loss expense ratio.... 107.2% 92.1% (15.1)% Acquisition expense ratio...... 25.6% 24.5% (1.1)% General and administrative expense ratio............... 15.1% 13.2% (1.9)% --------- --------- --------- Combined ratio................. 147.9% 129.8% (18.1)% ========= ========= =========
Premiums. Gross and net premiums written were $216.9 million and $133.5 million for the year ended December 31, 2005 compared to $251.8 million and $249.2 million of gross and net premiums for the year ended December 31, 2004. The decrease in our specialty reinsurance segment's net premiums written reflects the decrease in our property and casualty reinsurance business lines as a result of our decision to discontinue the writing of new and renewal business in our property reinsurance business line and the commutation of two treaties in our casualty reinsurance business line, as described above. The decline was partially offset by growth in our marine reinsurance business line during 2005.
2005 2004 -------------------- ------------------- ($ in thousands) Gross Net Gross Net premiums premiums premiums written written written written premium --------- -------- -------- -------- Property.................. 83,505 21,661 103,311 103,052 Casualty.................. $ 79,376 $ 79,376 $105,405 $105,405 Marine, technical risk and 54,031 32,441 42,660 40,307 aviation............... Structured reinsurance.... -- -- 456 456 --------- -------- -------- -------- Total..................... $ 216,912 $133,478 $251,832 $249,220 ========= ======== ======== ========
Homeowners and commercial property... 87.5% Crop hail............................ 12.5% ----- Total................................ 100.0% =====
Our property reinsurance premiums written include contracts written on excess of loss and quota share bases. Of our total property reinsurance gross premiums written of $83.5 million for the year ended December 31, 2005, 27.2% represents excess of loss contracts that we believe are exposed to losses from natural catastrophe events worldwide. The majority of our property quota share contracts are exposed to natural perils, including natural catastrophes.
Approximately 42.0%, 25.5% and 10.6% of our specialty reinsurance segment gross premiums written of $216.9 million were generated through Guy Carpenter & Company, Inc., Benfield Group and Willis Group.
Net losses and loss expenses. Net losses and loss expenses were $178.9 million for the year ended December 31, 2005 an increase of $29.8 million, or 20.0%, compared to $149.1 million for the year ended December 31, 2004. The increase in net losses and loss expenses incurred was due to increased loss occurrences, particularly those related to the 2005 hurricanes, as well as the increase in the number of reinsurance contracts we entered into and the associated net premiums earned. Net losses and loss expenses were a function of our net premiums earned and our expected ultimate losses and loss expenses for reported and unreported claims on contracts of reinsurance underwritten.
Our specialty reinsurance segment net loss ratio was 107.2% for the year ended December 31, 2005 compared to 92.1% for the year ended December 31, 2004. The increase in the specialty reinsurance segment net loss ratio is due to the magnitude of the loss estimates arising from Hurricanes Katrina, Rita and Wilma described above. However, the extent of the impact of the actual catastrophes in 2005 was mitigated by our purchased retrocessional protection during the year ended December 31, 2005. The 2005 hurricanes contributed 43.7% loss ratio percentage points to the segment loss ratio.
Our acquisition expense ratio was 25.6% for the year ended December 31, 2005, compared to 24.5% for the year ended December 31, 2004. The increase reflects certain contracts with higher commission rates that were written during the second and third quarters of 2005 in our property, casualty and marine, technical risk and aviation reinsurance product lines and the impact of ceded premiums and ceded reinstatement premiums reducing our specialty reinsurance segment's net earned premium.
General and administrative expenses. Direct and allocated indirect general and administrative expenses totaled $25.2 million for the year ended December 31, 2005 an increase of $3.9 million, or 18.1% compared to $21.3 million for the year ended December 31, 2004, reflecting the
PERIOD FROM MAY 23, 2003 (DATE OF INCORPORATION) TO DECEMBER 31, 2003
SPECIALTY SPECIALTY TOTAL INSURANCE REINSURANCE UNDERWRITING --------- ----------- ------------ ($ in thousands) Direct insurance...................... $7,469 $ -- $ 7,469 Reinsurance assumed................... -- 12,996 12,996 ------ ------- -------- Total gross premiums written.......... 7,469 12,996 20,465 Premiums ceded........................ (405) -- (405) ------ ------- -------- Net premiums written.................. $7,064 $12,996 $ 20,060 ====== ======= ======== Net premiums earned................... $ 339 $ 1,601 $ 1,940 Net losses and loss expenses.......... (183) (1,008) (1,191) Acquisition expenses.................. (24) (140) (164) General and administrative expenses... -- -- (24,814) ------ ------- -------- Net underwriting income (loss)........ $ 132 $ 453 $(24,229) ====== ======= ========
Premiums. Gross and net written insurance premiums were $7.5 million and $7.1 million for the period ended December 31, 2003. The table below shows gross and net premiums written by line of business:
For the period ended December 31, 2003 we did not write any other lines of business in our specialty insurance segment. Premiums ceded of $0.4 million relate to proportional facultative reinsurance purchased for certain professional liability insurance policies written. Gross premiums written and ceded premiums are earned over the period of insured risk. Consequently, only $0.3 million of net premiums written were earned during the period reflecting the short period of time between policy inception and our year end.
Net losses and loss expenses. Net losses and loss expenses incurred of $0.2 million reflect a loss and loss expense ratio (calculated as losses and loss expenses incurred divided by net premium earned) of 54.0%. For the period ended December 31, 2003 we adopted an expected loss ratio methodology to estimate our ultimate cost of losses; this method multiplied premiums earned by an expected loss ratio that was derived, for each line of business, from pricing data, industry data and from information provided by brokers and insureds. As of December 31, 2003, we had not received any notifications of reported losses.
Acquisition costs. Acquisition costs for the period were negligible, and primarily represented brokerage expenses.
Gross reinsurance premiums written primarily reflected a limited number of reinsurance contracts that were written during the month of December 2003, and are being earned over the period of reinsured risks. Consequently, only $1.6 million of reinsurance premiums written were earned during the period reflecting the short time period between contract inception and our year end. For the period ended December 31, 2003 we did not write any other reinsurance business.
Acquisition costs. Acquisition costs for the period were not significant, and primarily represented brokerage and reinsurance commission expenses that were in line with market rates.
2005 2004 -------- -------- ($ in thousands) Technical services revenues $ 50,499 $ 34,752 Other income 1,718 586 Direct technical services costs (37,027) (23,182) General and administrative expenses (10,664) (10,055) -------- -------- Net technical services income $ 4,526 $ 2,101 ======== ========
Technical services revenues. Technical services revenues were $50.5 million for the year ended December 31, 2005, an increase of $15.7 million, or 45.3%, compared to $34.8 million for the year ended December 31, 2004. The increase in technical services revenues is primarily attributable to increased remediation revenues associated with liability transfer project in Buffalo, New York. During the year ended December 31, 2005, our liability assumption program in Buffalo generated revenues of $14.8 million and other income of $1.4 million.
Other income. Other income totaled $1.7 million for the year ended December 31, 2005, an increase of $1.1 million, compared to $0.6 million for the year ended December 31, 2004. The increase was primarily generated from our liability assumption program in Buffalo, New York. This income primarily represents the amount of consideration received for the assumption of remediation liabilities in excess of the expected environmental remediation liability which is initially deferred in the consolidated balance sheet and subsequently recognized in earnings over the remediation period using the cost recovery or percentage of completion method.
PRO FORMA YEAR ENDED PERIOD FROM YEAR ENDED ------------ --------------------------------- ------------ SEPTEMBER 3, 2003 TO JANUARY 1, 2003 TO DECEMBER 31, DECEMBER 31, SEPTEMBER 3, 2003 DECEMBER 31, 2004 2003 (PREDECESSOR) 2003 ------------ ------------ ------------------ ------------ ($ in thousands)
As a holding company, we will have continuing funding needs for general corporate expenses, the payment of principal and interest on current and future borrowings, dividends on our preferred shares, taxes, and the payment of other obligations. Funds to meet these obligations will come primarily from dividends, interest and other statutorily permissible payments from our operating subsidiaries. The ability of our operating subsidiaries to make payments to Quanta Holdings is limited by the applicable laws and regulations of the domiciles in which the subsidiaries operate. These laws and regulations subject our subsidiaries to significant restrictions and require, among other things, that some of our subsidiaries maintain minimum solvency requirements and limit the amount of dividends that these subsidiaries can pay to us. Rating agency considerations also limit our ability to transfer capital allocated among our insurance operating subsidiaries. Additionally, there are significant restrictions regarding our ability to remove the funds deposited to support our underwriting capacity of our Lloyd's syndicate. For further information regarding these restrictions, see "Item 1. Business--Regulation" and notes 21 and 23 to our consolidated financial statements. As a result, there are restrictions on our ability to transfer substantially all of the investment balances of our insurance subsidiaries to Quanta Holdings.
We are also subject to constraints under the Companies Act that affect our ability to pay dividends on our shares. We may not declare or pay a dividend or make a distribution if we have reasonable grounds for believing that we are, or will after the payment be, unable to pay our liabilities as they become due or if the realizable value of our assets will thereby be less than the aggregate of our liabilities and our issued share capital and share premium accounts. As a result of our losses, for Bermuda company law purposes, we expect that the realizable value of our assets will no longer exceed the aggregate of our liabilities and our issued share capital and share premium accounts. In order for Quanta Holdings to have the flexibility to pay dividends to shareholders, we are evaluating a proposal to reduce the share premium account and allocate sums to our contributed surplus account.
We estimate that we currently have investments of approximately $1,011.7 million, including cash and cash equivalent balances of approximately $197.1 million. We estimate that our cash and cash equivalents and investment balances include approximately $260.5 million that is pledged as collateral for letters of credit, approximately $169.5 million held in trust funds for the benefit of ceding companies and to fund our obligations associated with the assumption of an environmental remediation liability, $156.4 million that is held by Lloyd's to support our underwriting activities, $52.7 million held in trust funds that are related to our deposit liabilities and $30.7 million that is on deposit with, or has been pledged to, U.S. state insurance departments. After giving effect to these assets pledged or placed in trust, we estimate that we presently have net investments of $341.9 million, including net cash and cash equivalents of approximately $107.9 million. Substantially all of our capital has been distributed among our rated operating subsidiaries based on our assessment of the levels of capital that we believe are prudent to support our business, the applicable regulatory requirements, and the recommendations of the insurance regulatory authorities and rating agencies. We believe our operating subsidiaries have sufficient assets to pay their respective currently foreseen liabilities as they become due. We also believe that our operating subsidiaries can distribute sufficient funds to Quanta Holdings to enable to pay its currently foreseen liabilities as they become due, subject to the constraints under the Companies Act that affect our ability to pay dividends on our shares as described above.
Some of our insurance and many of our reinsurance contracts contain termination rights that are triggered by the A.M. Best rating downgrade. Some of these insurance and reinsurance contracts also require us to post additional security. Further, a downgrade in our rating below "B++" (very good) will trigger termination provisions or require the posting of additional security in certain of our other insurance and reinsurance contracts. As a result, we may be required to post additional security either through the issuance of letters of credit or the placement of securities in trust under the terms of those insurance or reinsurance contracts. In addition, many of our insurance contracts and certain of our reinsurance contracts provide for cancellation at the option of the policyholder regardless of our financial strength rating. Accordingly, we may also elect to post security under these other contracts in order to maintain that business.
transactions, which are defined as a set of derivative, insurance and/or securities transactions that when combined produce the equivalent economic results of an investment meeting our investment guidelines. While we expect that the majority of our investment holdings will be denominated in U.S. dollars, we may make investments in other currency denominations depending upon the currencies in which loss reserves are maintained, or as may be required by regulation or law.
Our investment guidelines require that the average credit quality of the investment portfolio is typically Aa3/AA- and that no more than 5% of the investment portfolio's market value shall be invested in securities rated below Baa3/BBB-. As of December 31, 2005, all of the fixed maturity investments were investment grade, with a weighted average credit rating of "AA+" based on ratings assigned by S&P. Our cash and cash equivalents totaled $260.9 million as of December 31, 2005 compared to $75.3 million at December 31, 2004. The increase in our available-for-sale investments and cash and cash equivalents is primarily due to the net proceeds raised from the sale of our common shares and preferred shares of $131.6 million in December 2005, the growth in our premiums written during the year ended December 31, 2005, the issuance of $20.6 million of junior subordinated debentures, and $20.0 million proceeds from the sale of a mortality-risk-linked security, partially offset by claims notifications and associated loss payments we have made up to and including December 31, 2005.
Our insurance and reinsurance premiums receivable balances totaled $146.8 million as of December 31, 2005 compared to $146.8 million at December 31, 2004. The decrease in premiums receivable reflects our decision to discontinue writing new and renewal business in our property reinsurance and technical risk property lines of business during the fourth quarter of 2005, partially offset by our growth across the specialty insurance segment during the year ended December 31, 2005. Included in our premiums receivable are approximately $104.2 million of written premium installments that are not yet currently due under the terms of the related insurance and reinsurance contracts. As of December 31, 2005, based on our review of the remaining balance of $42.6 million, which represents premiums installments that are currently due, we believe there are no individually significant balances that are delinquent or uncollectible.
Our estimate of our reserves for losses and loss adjustment expenses as of December 31, 2005 of $343.6 million is net of reinsurance recoverable of $190.4 million. The increase in our reinsurance recoverable balance reflects the growth in our business, and includes our estimate of unpaid loss expenses recoverable totaling $106.9 million relating to Hurricanes Katrina, Rita and Wilma and $5.0 million relating to the environmental claim that we incurred during the year ended December 31, 2005. Our estimate of our reinsurance recoverable balance associated with these losses is based on currently available information, claim notifications received to date, industry loss estimates, output from industry models, a detailed review of affected ceded reinsurance contracts and an assessment of the credit risk to which the Company is subject. The actual amount of future loss payments relating to these loss events may vary significantly from this estimate. The average credit rating of the Company's reinsurers as of December 31, 2005 is "A" (excellent) by A.M. Best. As of December 31, 2005, the losses and loss adjustment expenses recoverable from reinsurers balance in the consolidated balance sheet included approximately 22% due from Everest Reinsurance Ltd., a reinsurer rated "A+" (superior) by A.M. Best, and approximately 17% due from various Lloyd's syndicates, which are rated "A" (excellent) by A.M. Best. No other reinsurers accounted for more than 10% of the losses and loss adjustment expense recoverable balance as of December 31, 2005. Less than 10% of the Company's loss and loss adjustment expenses recoverable from reinsurers are due from reinsurers that are rated below "A-" (excellent). Less than 7.4% of our loss and loss adjustment expenses recoverable from reinsurers are due from reinsurers that are rated below "A-" (excellent) and are not collateralized.
The following table lists our largest reinsurers measured by the amount of losses and loss adjustment expenses recoverable at December 31, 2005 and the reinsurers' financial strength rating from A.M. Best:
---------- (1) Amount is fully collateralized by a letter of credit.
On December 14, 2005, we issued 3,000,000 shares of our series A preferred shares at $25.00 per share with a liquidation preference of $25.00 per share. The gross proceeds to the Company were $75.0 million. The series A preferred shares are reflected as redeemable preferred shares on our balance sheet as of December 31, 2005.
We generated net operating cash flow of approximately $156.0 million during the year ended December 31, 2005, primarily related to premiums and investment income received and offset by losses and loss expenses as well as general and administrative expenses paid. In addition, we also generated net proceeds from the issuance of our common shares and preferred shares of $130.1 million and net proceeds from the February 2005 issuance of junior subordinated debt securities of $19.6 million. During the same period, we invested net cash of $165.3 million in our investment assets. Our cash flows from operations for the year ended December 31, 2005 provided us with sufficient liquidity to meet operating cash requirements during that period.
Our sources of cash consist primarily of existing cash and cash equivalents, premiums written, proceeds from sales and redemptions of investment assets, capital or debt issuances, investment income, reinsurance recoveries, and, to a lesser extent, our secured bank credit facility and collections of receivables for technical services rendered to third parties. As a result of our recent ratings downgrade by A.M. Best, the resulting loss of business and business opportunities, our decision to currently cease writing new business in many of our product lines and pending termination of our agreement with the program manager of the HBW program, cash flows associated with the receipt of premiums will decrease substantially in 2006.
On December 21, 2004, we participated in a private placement of $40.0 million of floating rate capital securities issued by Quanta Capital Statutory Trust I ("Quanta Trust I"), a subsidiary Delaware trust formed on December 21, 2004. The trust preferred securities mature on March 15, 2035, are redeemable at our option at par beginning March 15, 2010, and require quarterly distributions of interest by Quanta Trust I to the holder of the trust preferred securities. Distributions will be payable at a variable per annum rate of interest, reset quarterly, equal to the London Interbank Offered Rate ("LIBOR") rate plus 385 basis points. Quanta Trust I used the proceeds from the sale of the trust preferred securities and the issuance of its common securities to purchase $41.2 million of junior subordinated debt securities, due March 15, 2035, in the principal amount of $41.2 million issued by us (the "Trust I Debentures").
Some of our insurance and many of our reinsurance contracts contain termination rights that are triggered by the A.M. Best rating downgrade. Some of these insurance and reinsurance contracts also require us to post additional security. As a result, we may be required to post additional security either through the issuance of letters of credit or the placement of securities in trust under the terms of those insurance or reinsurance contracts. We may also elect to post security under other insurance contracts in order to maintain that business. We estimate that we currently have net cash and cash equivalent and investment balances of approximately $341.9 million that are available to post as security or place in trust.
In the near term, our other principal cash requirements are expected to be investments in operating subsidiaries, losses and loss adjustment expenses and other policy holder benefits, brokerage and commissions, expenses to develop and implement our business strategy, including potential severance payments, other operating expenses, premiums ceded, capital expenditures, the servicing of borrowing arrangements (including the Debentures), dividend payments on our series A preferred shares, and taxes. The potential for a large claim under one of our insurance or reinsurance contracts means that we may need to make substantial and unpredictable payments within relatively short periods of time. As a result of the recent downgrade of our financial strength ratings by A.M. Best, we are closely analyzing our business lines, positioning in the market and internal operations and identifying steps we should take to preserve shareholder value and improve our position, including the exploration of strategic alternatives. We may incur substantial costs, including severance payments, in connection with the implementation of any changes based on such analysis. These initiatives and their
We paid additional gross claims of $111.7 million during 2005 relating to the environmental claim and the hurricane events of 2005 and 2004. We expect that our cash requirements for the payment of these and other claims will be significant in future periods as we receive and settle claims, including those relating to these specific claims and in particular, claims related to the hurricanes that occurred in 2005.
As a result of our recent ratings downgrade by A.M. Best, Lloyd's has informed us that in order for Syndicate 4000 to continue underwriting in the Lloyd's of London market during the 2007 underwriting year, Syndicate 4000 must diversify its capital base with one or more third-party capital sources. This capital, including the third-party source, must be in place by November 30, 2006. Based on the amount of capital provided by any third-party source, we believe we will be able to remove some of the funds we have deposited to support our underwriting capacity of our Lloyd's syndicate. However, we can make no assurances that we will be successful in obtaining any third-party source of capital to support our Lloyd's syndicate. If we fail to meet Lloyd's capital diversification requirements by November 30, 2006, we will no longer be able to participate in the Lloyd's of London market in future underwriting years, which will have a material adverse effect on our business.
We incurred capital expenditures of $3.4 million during the year ended December 31, 2005 related primarily to the purchase and development of information technology assets. As we are currently closely analyzing our business lines and our position, and exploring strategic alternatives, we are unable at this time to quantify the amount of future capital expenditures we may incur.
In addition to these cash requirements, under the purchase agreement with ESC, we will be required to pay ESC's former shareholders an earn-out payment of $5.0 million. We may also have substantial liabilities to clients, third parties and government authorities for property damage, personal injuries, breach of contract or breach of warranty claims, fines and penalties and regulatory action that could adversely affect our business arising from the assessment, analysis and assumption of environmental liabilities, and the management, remediation, and engineering of environmental conditions constitute a significant portion of our technical services business. From time to time, we have offered a liability assumption program under which a special-purpose entity assumes specified liabilities associated with environmental conditions for which we provide technical services, which may be insured or guaranteed by us. These businesses involve significant risks, including the possibility that we may have substantial liabilities to clients, third parties and governmental authorities for property damage, personal injuries, breach of contract or breach of warranty claims, fines and penalties and regulatory action that could adversely affect our business.
While insurance regulation differs by location, each jurisdiction requires that minimum levels of capital be maintained in order to write new insurance business. Factors that affect capital requirements generally include premium volume, the extent and nature of loss and loss expense reserves, the type and form of insurance and reinsurance business underwritten and the availability of reinsurance protection from adequately rated retrocessionaires on terms that are acceptable to us. Additionally, we seek to capitalize our insurance operations in excess of the minimum regulatory requirements so that we may maintain our current financial ratings from A.M. Best. These regulatory and rating agency requirements restrict the amount of capital we are able to distribute to Quanta Holdings and other insurance subsidiaries. For further discussion, see "--Adequacy of Regulatory and
While we have had sufficient liquidity to pay the losses we experienced in the past hurricane season, in the future, we may need to raise capital through debt or equity or other securities to further expand our business strategy or enter new lines of business. The amount and timing of any capital raise will depend on many factors, including our ability to write new business successfully and to establish premium rates and reserves at levels sufficient to cover losses. At this time, we are not able to quantify the amount of additional capital we may raise or will require in the future or predict the timing of any other future capital needs. Any future equity or debt financing, if available at all, may be on terms that are not favorable to us. If we raise capital through equity financings, your interest in our company will be diluted, and the securities we issue may have rights, preferences and privileges that are senior to those of the shares that are currently issued and outstanding. If we cannot maintain or obtain adequate capital to manage our business strategy, our business, results of operations and financial condition may be adversely affected.
As a holding company, we depend on future dividends and other permitted payments from our subsidiaries to pay dividends to our common and preferred shareholders. Our subsidiaries' ability to
We are also subject to Bermuda regulatory constraints that affect our ability to pay dividends on our shares, redeem our series A preferred shares and make other payments. Under the Companies Act, even though we are solvent and able to pay our liabilities as they become due, we may not declare or pay a dividend or make a distribution if we have reasonable grounds for believing that we are, or will after the payment be, unable to pay our liabilities as they become due or if the realizable value of our assets will thereby be less than the aggregate of our liabilities and our issued share capital and share premium accounts. Under the Companies Act, when a company issues shares, the aggregate paid in par value of the issued shares comprises the company's share capital account. When shares are issued at a "premium", that is, where the actual sum paid for a share exceeds the par value of the share, the amount paid in excess of the par value must be allocated to and maintained in a capital account called the "share premium account." Currently, Quanta Holdings has approximately $626.8 million in its share premium account. Quanta Holdings has a high share premium account due to the significant difference between the $0.01 par value of our common shares and series A preferred shares and the amounts paid for those shares in recent and historical offerings of the Company. The Companies Act requires shareholder approval prior to any reduction of our share capital or share premium accounts. Bermuda law also provides that we maintain a contributed surplus account, to which we must allocate, among other things, shareholder capital which is unrelated to any share subscription.
We believe that we currently have sufficient assets to pay our foreseen liabilities as they become due. As a result of our losses, for Bermuda company law purposes, we expect that the realizable value of our assets will no longer exceed the aggregate of our liabilities and our issued share capital and share premium accounts. So long as this deficiency continues, we are prohibited by Bermuda company law from paying dividends or making distributions to our shareholders, including our holders of series A preferred shares. In order for Quanta Holdings to have the flexibility to pay dividends to shareholders, we are evaluating a proposal to reduce the share premium account and allocate sums to our contributed surplus account. This reduction of our share premium account and reallocation to the contributed surplus account would require the approval of our common shareholders to be effective. If our common shareholders do not approve any such proposal, we may be restricted by Bermuda company law from declaring or paying dividends to our holders of series A preferred shares and other shareholders. We cannot make any assurances that we will have the ability to declare and pay dividends under Bermuda law to our shareholders in the future. In addition, even if we submit, and our shareholders approve, any proposal and we are permitted by law to declare and pay dividends, we cannot assure you that future losses or other events could not impair our ability to pay dividends to our shareholders.
grounds for believing that we are, or after the payment or redemption would be, unable to pay our liabilities as they become due. We also may not declare or pay a dividend or redeem our shares (including our series A preferred shares) except out of the capital paid up thereon, out of our issued share capital and share premium accounts or, in the case of a redemption, out of the proceeds of a new issue of shares made for the purpose of the redemption. Our secured letter of credit and revolving credit facility also contain provisions prohibiting the payment of dividends on or redemption of our shares under certain circumstances.
For additional discussion concerning risks relating to our dividend policy and our holding company structure and its effect on our ability to receive and pay dividends, see "Item 1A.--Risk Factors--Risks Related to our Securities--Our holding company structure and certain regulatory and other constraints, including our credit facility, affect our ability to pay dividends on our shares, make payments on our indebtedness and other liabilities and our ability to redeem our series A preferred shares." See also notes 21 and 23 to our consolidated financial statements. For a discussion of certain additional limitations on our ability to pay dividends on our common shares relating to certain preferential rights associated with the Company's series A preferred shares, see "Item 1A.--Risk Factors--Risks Related to our Securities--Our series A preferred shares have rights, preferences and privileges senior to those of holders of our common shares."
Our reserve for losses and loss expenses consists of case reserves and IBNR. In assessing the adequacy of these reserves, it must be noted that the actual costs of settling claims is uncertain as it depends upon future events. Many of these events will be out of our control and could potentially affect the ultimate liability and timing of any potential payment. There is necessarily a range of
possible outcomes and the eventual outcome will certainly differ from the projections currently made. This uncertainty is heightened by the short time in which we have operated, thereby providing limited Company-specific claims loss emergence patterns. Consequently, we must use industry benchmarks, on a line by line basis, in deriving IBNR which, despite management's and our independent actuary's care in selecting them, will differ from actual experience.
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 care in selecting them, the actual payment of our reserve for losses and loss expenses will differ from estimated payouts.
In all of the jurisdictions in which we operate insurers and reinsurers are required to maintain certain minimum levels of capital and risk-based capital, the calculation of which includes numerous factors as specified by the respective insurance regulatory authorities and the related insurance regulations. We capitalize our insurance operations in excess of the minimum regulatory requirements in order to enable us to write more business and to be more selective in the business we underwrite. Accordingly, allocation of capital sufficient to achieve business objectives is a critical aspect of any insurance organization, particularly an insurance operation with a limited operating history such as ours.
On March 2, 2006, A.M. Best announced that it had downgraded the financial strength rating assigned to Quanta Bermuda and its subsidiaries and Quanta Europe, to "B++" (very good), under review with negative implications. The A.M. Best "A" (excellent) rated Lloyd's market, including our Lloyd's syndicate, was not subject to the rating downgrade. On March 2, 2006, A.M. Best announced that it had downgraded the financial strength rating assigned to Quanta Bermuda and its subsidiaries and Quanta Europe, to "B++" (very good), and placed those companies under review with negative implications. The recent downgrade of our financial ratings has had a significant adverse effect on our ability to conduct our business in our current product lines and on our ability to execute our business strategy. For further discussion of these recent developments, see "Item 1. Business--Recent Developments." As a result of the deterioration of our business due to the recent downgrade of our financial strength ratings, A.M. Best may further downgrade our ratings. There is no assurance as to
what rating actions A.M. Best may take now or in the future or whether A.M. Best will further downgrade our rating or will remove any qualification of our rating.
As of December 31, 2005, we have approximately $217.2 million that is pledged as collateral for letters of credit, approximately $134.2 million held in trust funds for the benefit of ceding companies and to fund our obligations associated with the assumption of an environmental remediation liability, $143.2 million that is held by Lloyd's to support our underwriting activities, $51.8 million held in trust funds that are related to our deposit liabilities and $29.7 million that is on deposit with, or has been pledged to, U.S. state insurance departments.
Some of our insurance and many of our reinsurance contracts contain termination rights that are triggered by the A.M. Best rating downgrade. Some of these insurance and reinsurance contracts also require us to post additional security. As a result, we may be required to post additional security either through the issuance of letters of credit or the placement of securities in trust under the terms of those insurance or reinsurance contracts. We may also elect to post security under other insurance contracts in order to maintain that business. We currently have net cash and cash equivalent balances of approximately $107.9 million that are available to post as security or place in trust.
We cannot draw letters of credit or borrow under our existing credit agreement if we have incurred a material adverse effect or if a default exists under the agreement. If we fail to maintain or enter into adequate letter of credit facilities on a timely basis, we may be unable to provide necessary security to cedent companies under our existing retrocessional and reinsurance contracts that have the right to require the posting of additional security by reason of the downgrade of our A.M. Best rating. We cannot assure you that we will be able to increase the commitment under our existing bank credit facility or obtain additional credit facilities at terms acceptable to us. Our inability to maintain or enter into adequate credit facilities would have a material adverse effect on our results of operations.
On March 2, 2006, A.M. Best announced that it had downgraded the financial strength rating assigned to Quanta Bermuda and its subsidiaries and Quanta Europe, to "B++" (very good), and placed those companies under review with negative implications. The recent downgrade of our financial ratings has had a significant adverse effect on our ability to conduct our business in our current product lines and on our ability to execute our business strategy. For further discussion of these recent developments, see "Item 1. Business--Recent Developments." As a result of the deterioration of our business due to the recent downgrade of our financial strength ratings, A.M. Best may further downgrade our ratings. There is no assurance as to what rating actions A.M. Best may take now or in the future or whether A.M. Best will further downgrade our rating or will remove any qualification of our rating. A "B++" (very good) rating is the fifth highest of fifteen rating levels and indicates A.M. Best's opinion of our financial strength and ability to meet ongoing obligations to our future policyholders. We have not been rated by any rating agency other than A.M. Best.
Our significant accounting policies are described in Note 2 of our consolidated financial statements.
Our consolidated financial statements contain certain amounts that are inherently subjective in nature and require management to make certain judgments, estimates and assumptions in the application of accounting policies used to determine inherently subjective amounts reported in the consolidated financial statements. The use of different assumptions and estimates could produce materially different estimates of the reported amounts. In addition, if actual events differ materially from management's assumptions used in applying the relevant accounting policy, there could be a material adverse effect on our results of operations and financial condition and liquidity.
Reinsurance premiums written are recorded based on the type of the associated reinsurance contract. Typically, we write losses occurring and risks attaching contracts on a single year basis. We may on occasion write multi-year reinsurance contracts. Losses occurring reinsurance contracts cover losses that occur during the term of the reinsurance contract. Risks attaching contracts cover claims that arise on underlying insurance policies that incept during the term of the reinsurance contract. Reinsurance premiums written are earned on a pro rata over time basis over the expected term of the contract, typically 12 months for losses occurring contracts. Premiums written on risks attaching
reinsurance contracts are recorded in the period in which the underlying policies or risks are expected to incept. Premiums earned on risks attaching contracts usually extend beyond the original term of the reinsurance contract resulting in recognition of premium earnings over an extended period, typically 24 months.
Reinsurance premiums written on certain types of contracts, notably treaty quota share contracts, may not be known definitively on the inception date of the contract and therefore include estimates of premiums written. These estimates are based on data provided by the ceding companies or brokers, our underwriters' judgment and underlying economic conditions. Our estimates of written premiums are re-evaluated over the term of the contract period as underwriting information becomes available and as actual premiums are reported by the ceding companies or brokers. For certain excess of loss reinsurance contracts we record the minimum premium, as defined in the contract, as our estimated premium written at inception of the contract. Subsequent changes to our premium estimates are recorded as adjustments to premiums written in the period in which they become known and could be material. Adjustments may significantly impact net income in the period in which they are determined, particularly when the subject contract is fully or substantially expired resulting in the premium adjustment being fully or substantially earned.
Premiums written and ceded relating to the unexpired periods of coverage or policy terms are recorded as unearned premium reserves and deferred reinsurance premiums, respectively.
We write non-traditional contracts of insurance and reinsurance. We may account for these transactions as deposits held on behalf of our clients instead of as insurance and reinsurance premiums, as appropriate. Under the deposit method of accounting, revenues and expenses from insurance and reinsurance contracts are not recognized as written premium and incurred losses. Instead, amounts from these contracts are recognized as other income or investment income over the expected contract or service period.
Pursuant to our revenue recognition policy, a contract is non-traditional if it contains certain terms and features or otherwise results in a structure that we believe limits our insurance risks, including timing risks, or that does not provide for a reasonable possibility of significant loss. These terms or features include, among others, experience based adjustable features, consideration of investment income, an amount of funding or financing of a portion of potential expected losses and coverage for the adverse development of previously incurred losses. Non-traditional contracts are also those contracts that are not necessarily intended to provide for the transfer of economic risk but for which coverage is triggered by a non-insurance event or for which coverage is provided to achieve temporary accounting or regulatory relief or other non-economic or risk management benefits. For example, one of our non-traditional contracts is a life surplus relief transaction that provides temporary statutory capital benefit to a U.S. life insurance entity. We use the test set forth in SFAS 113 to ascertain whether we believe our underwriting risk is limited or whether there is not a reasonable possibility of significant loss. These tests include a number of subjective judgments. Because of this subjectivity and in the context of evolving practices and application of existing and future standards, we could be required in the future to adjust our accounting treatment of these transactions. This could have a material effect on our financial condition and results of operations.
We believe the arrangement, including the client's option to recapture, and the assumption of the life insurance contracts constitute one contract with minimal mortality, credit or other insurance or economic risk which results in deposit accounting. Although the Company believes its client will exercise the recapture, it is not assured that this will be the case. If the Company's client does not recapture the underlying insurance contracts in the future, the Company may be viewed as having had the risks described above and, as a result, the Company could be deemed to have retained life reinsurance risk and, as a result, may be required to account for some or all of the underlying insurance contracts as life insurance, recognizing life premiums written and life benefit reserves in the consolidated statement of operations. If deposit accounting had not been used with respect to this particular arrangement, the Company would have recognized gross life reinsurance premiums written of approximately $16.8 million and $5.6 million for the years ended December 31, 2005 and 2004. At this time, the Company believes that the recognition of these premiums written would not have had a material effect on the Company's financial position and results of operations. However, as the underlying life insurance contracts mature the effect on the Company's financial condition and results of operations may become material.
The remaining $1.6 million and $0.3 million of other income derived from non-traditional contracts recognized during the years ended December 31, 2005 and 2004 relates to revenues earned from five and one reinsurance contracts accounted for as deposits. Although these contracts did possess some underwriting and timing risks as prescribed by SFAS No. 113, the Company does not believe it is exposed to a reasonable possibility of significant loss. Included in the remaining $1.6 million and $0.3 million of other income are $1.1 million and $0.3 million related to one surplus relief life reinsurance agreement. Underlying treaties attach to this contract on a coinsurance basis. As of December 31, 2005 and 2004, the Company has provided approximately $33.2 million and $13.9 million of statutory surplus relief to a U.S. insurance company under this contract.
Acquisition costs are policy issuance related costs that vary with and are directly related to the acquisition of new and renewal insurance and reinsurance business, and primarily consist of commissions, third-party brokerage and insurance premium taxes. Ceding commission income consists of commissions we receive on insurance and reinsurance business that we cede to our reinsurers. Typically acquisition costs and commission income are based on a fixed percentage of the premium written or ceded. This percentage varies for each line or class of business and each type of contract written. Acquisition expenses and commission income are recorded and deferred at the time premium is written or ceded and are subsequently amortized in earnings as the premiums to which they relate are earned or expensed. Acquisition expenses are reflected in the consolidated statement of operations net of ceding commission income from our reinsurers. Acquisition costs relating to unearned premiums are deferred in the balance sheet as deferred acquisition costs net of commission income relating to deferred reinsurance premiums ceded.
Net deferred acquisition costs are carried at their estimated realizable value and are limited to the amount expected to be recovered from future net earned premiums and anticipated investment income. Any limitation is referred to as a premium deficiency. A premium deficiency exists if the sum of our anticipated losses, loss expenses and unamortized acquisition costs exceeds the recorded unearned premium reserve and anticipated net investment income. A premium deficiency is recognized by charging any deferred acquisition costs to acquisition expenses to the extent required to eliminate
the deficiency. If the deficiency exceeds the deferred acquisition cost asset then a liability is accrued within loss and loss expense reserves for the excess deficiency.
statement of operations and comprehensive (loss) income as a realized loss. The new cost basis would not be changed for subsequent recoveries in fair value. Some of the factors that we consider in determining whether an impairment is other than temporary include (1) the amount of the impairment, (2) the period of time for which the fair value has been below the amortized cost, (3) specific reasons or market conditions which could affect the security, including the financial condition of the issuer and relevant industry conditions or rating agency actions, and (4) our ability and intent to hold the security for sufficient time to allow for possible recovery.
Investments are recorded on a trade date basis. Our net investment income is recognized when earned and consists primarily of interest, the accrual of discount or amortization of premium on fixed maturity securities and dividends, and is net of investment management and custody expenses. Gains and losses realized on the sale of investments are determined on the first-in, first-out basis.
As of December 31, 2005, approximately 71.8% and 95.9% of the amortized cost of our available-for-sale investment portfolio was assigned an "AAA" credit rating and an "A" credit rating or above by S&P.
We cease the capitalization of costs as soon as the project is substantially complete and ready for its intended purpose. We review the carrying value of capitalized software costs whenever events or changes in circumstances indicate that its carrying amount may not be recoverable, and a loss is recognized when the value of estimated undiscounted cash flow benefit related to the asset falls below the unamortized cost.
As an insurance and reinsurance company we are required, under GAAP and applicable insurance regulations, to establish reserves for losses and loss expenses for estimates of future amounts to be paid in settlement of our ultimate liabilities for claims arising under the terms of written insurance and reinsurance policies that have occurred at or before the balance sheet date. Under GAAP, we are only permitted to establish loss and loss expense reserves for actual losses that have occurred before the balance sheet date. We do not record contingency reserves for expected future loss occurrences, nor do we discount our reserves for losses and loss expenses to be paid in the future.
The estimation of unpaid loss liabilities will be affected by the type or structure of the policies we have written. In the case of our direct insurance business we often assume risks for which claims experience will tend to be frequency driven. As a result, historical loss development data may be available and traditional actuarial methods of loss estimation may be used. Conversely, the available
The estimation of unpaid loss liabilities will also vary in subjectivity depending on the lines or class of business involved. Short-tail business describes lines of business for which losses become known and paid in a relatively short period time after the loss actually occurs. Typically, there will be less variability in the ultimate amount of losses from claims incurred in the short-tail lines that we write such as technical risk property, property, marine, and aviation. Long-tail business describes lines of business for which actual losses may not be known for some time or for which the actual amount of loss may take a significantly longer period of time to emerge or develop. Our casualty, professional and environmental lines of business are generally considered longer tail in nature. Because loss emergence and settlement periods can be many years in duration, these lines of business will have more variability in the estimates of their loss and loss expense reserves.
As of December 31, 2005 and 2004, the primary reserving method we used to estimate the ultimate cost of losses for our specialty reinsurance lines and our fidelity and technical risk property specialty insurance business lines was the Bornhuetter-Ferguson actuarial method. The Bornhuetter-Ferguson actuarial method selects an initial expected loss and loss expense ratio supplemented with our actual loss and loss expense experience to date to support the estimation of losses and loss adjustment expenses. Our initial expected loss and loss expense ratio for our specialty reinsurance business lines is derived from loss exposure information provided by brokers and ceding companies and from loss and loss expense ratios established during the pricing of individual contracts. Our initial expected losses and loss expense ratios selected for our fidelity and technical risk property specialty insurance lines are based on benchmarks derived by our underwriters and actuaries during the initial pricing of the business and from comparable market information. These benchmarks are then adjusted for any rating increases and changes in terms and conditions that have been observed in the market.
premiums are multiplied by an expected loss ratio to derive ultimate losses and deducts any paid losses and loss expenses to arrive at estimated loss and loss expense reserves. This method is commonly applied when there is insufficient historical loss development experience available. The initial expected loss ratios were derived from pricing, loss and exposure information provided by brokers, ceding companies and insureds and supplemented by available industry data.
services are performed. Included in technical services revenue is accrued but unbilled revenue that arises mainly due to a time lag in billing cycle and special billing arrangements with customers.
From time to time, we retain subcontractors to perform certain services under contracts with our technical services customers. Technical services revenue is recognized on a gross basis when we are the primary obligor in the arrangement and we bear the ultimate risks of providing such subcontracted services. In assessing whether gross revenue reporting is appropriate, we consider a number of factors such as whether we act as principal in the transaction, retain the general risks of loss for collection, delivery, or returns, or whether we have control over contract pricing and vendor selection. For the years ended December 31, 2005 and 2004 and the period from September 3, 2003 to December 31, 2003, we incurred approximately $24.9 million, $12.3 million and $5.5 million of direct costs, exclusive of mark-up, respectively, related to subcontractor arrangements. Our technical services revenue would be significantly reduced if these arrangements were recorded on a net of direct cost basis.
The Company plans to adopt SFAS 123(R) using the modified prospective method under which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS 123(R) for all share-based payments granted after the effective date and (b) based on the
requirements of SFAS 123 for all awards granted to employees prior to the effective date of SFAS 123(R) that remain unvested on the effective date.
We recognize all standalone derivative instruments as either other assets or liabilities and embedded derivatives as part of their host instruments in our consolidated balance sheet and we measure all derivative instruments at their fair value. The fair values of derivative instruments are based on market prices and equivalent data provided by independent third parties. When market data is not readily available, we use analytical models to estimate the fair values of these instruments based on their structure, terms and conditions and prevailing market conditions. We recognize changes in the fair value of derivative instruments in our consolidated statement of operations in other income. The nature of derivative instruments and estimates used in estimating their fair value, changes in fair value of derivatives and realized gains and losses on settled derivative instruments may create significant volatility in our results of operations in future periods.
See Note 2(x) to the consolidated financial statements which are included in "Item 8. Financial Statements and Supplementary Data" for a discussion of recent accounting pronouncements.