We and our subsidiaries currently lease office space in Bermuda, New York and London.
(3)Per share data for 2003, 2002, 2001 and 2000 is based on 75,000,000 shares outstanding prior to the IPO.
(6)Under statutory accounting principles, financial guaranty and mortgage guaranty insurers are required to establish contingency reserves based on a specified percentage of premiums. A contingency reserve is an additional liability reserve established to protect policyholders against the effects of adverse economic developments or cycles or other unforeseen circumstances.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and accompanying notes which appear elsewhere in this Form 10-K. It contains forward-looking statements that involve risks and uncertainties. Please see "Forward-Looking Statements" for more information. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Form 10-K, particularly under the headings "Investment Considerations" and "Forward-Looking Statements."
Investment income is a function of invested assets and the yield that we earn on those assets. The investment yield is a function of market interest rates at the time of investment as well as the type, credit quality and maturity of our invested assets. In addition, we could realize capital gains or losses on securities in our investment portfolio from other than temporary declines in market value as a result of changing market conditions, including changes in market interest rates, and changes in the credit quality of our invested assets.
Our expenses consist primarily of losses and loss adjustment expenses ("LAE"), profit commission expense, acquisition costs, operating expenses, interest expense and income taxes. Losses and LAE are a function of the amount and types of business we write. Losses and LAE are based upon estimates of the ultimate aggregate losses inherent in the portfolio. The risks we take have a low expected frequency of loss and due to our revised underwriting strategy in connection with the IPO, are investment grade at the time we accept the risk. Prior to the IPO, the majority of the risks we underwrote were investment grade, however some risks accepted were below investment grade. Profit commission
Our consolidated financial statements include amounts that, either by their nature or due to requirements of accounting principles generally accepted in the United States of America ("GAAP"), are determined using estimates and assumptions. The actual amounts realized could ultimately be materially different from the amounts currently provided for in our consolidated financial statements. We believe the items requiring the most inherently subjective and complex estimates to be reserves for losses and LAE, valuation of derivative financial instruments, valuation of investments, other than temporary impairments of investments, premium revenue recognition, deferred acquisition costs and deferred income taxes. An understanding of our accounting policies for these items is of critical importance to understanding our consolidated financial statements. The following discussion provides more information regarding the estimates and assumptions used for these items and should be read in conjunction with the notes to our consolidated financial statements.
sector and time until maturity. The severity is defined as the complement of historical recovery/salvage rates gathered by the rating agencies of defaulting issues and is based on the industry sector.
The Company records an incurred loss that is reflected in the statement of operations upon the establishment of portfolio reserves. When we initially record a case reserve, we reclassify the corresponding portfolio reserve already recorded for that credit within the balance sheet. The difference between the initially recorded case reserve and the reclassified portfolio reserve is recorded as a charge in our statement of operations. It would be a remote occurrence when the case reserve is not greater than the reclassified portfolio reserve. Any subsequent change in portfolio reserves or the initial case reserves are recorded quarterly as a charge or credit in our statement of operations in the period such estimates change. Due to the inherent uncertainties of estimating loss and LAE reserves, actual experience may differ from the estimates reflected in our consolidated financial statements, and the differences may be material.
In addition to analyzing the sensitivity of our portfolio reserves to possible changes in frequency and severity, we have also performed a sensitivity analysis on our financial guaranty and mortgage guaranty case reserves. Case reserves may change from our original estimate due to changes in severity factors. An actuarial analysis of the historical development of our case reserves shows that it is reasonably possible that our case reserves could develop by as much as ten percent. This analysis was performed by separately evaluating the historical development by comparing the initial case reserve established to the subsequent development in that case reserve, excluding the effects of discounting, for each sector in which we currently have significant case reserves, and estimating the possible future development. Based on this analysis management believes it is reasonably possible that our current financial guaranty and mortgage guaranty case reserves of $34.2 million could reasonably increase by approximately $3.0 million to $4.0 million in the future. This would cause an increase in incurred losses on our statement of income and comprehensive income.
We also record IBNR reserves for our mortgage guaranty and other segments. IBNR is an estimate of losses for which the insured event has occurred but the claim has not yet been reported to
We believe the guidance of FAS 60 does not expressly address the distinctive characteristics of financial guarantee insurance, so we also apply the analogous guidance of Emerging Issues Task Force ("EITF") Issue No. 85-20, "Recognition of Fees for Guaranteeing a Loan" ("EITF 85-20"), which provides guidance relating to the recognition of fees for guaranteeing a loan, which has similarities to financial guaranty insurance contracts. Under the guidance in EITF 85-20, the guarantor should assess the probability of loss on an ongoing basis to determine if a liability should be recognized under FAS No. 5, "Accounting for Contingencies" ("FAS 5"). FAS 5 requires that a loss be recognized where it is probable that one or more future events will occur confirming that a liability has been incurred at the date of the financial statements and the amount of loss can be reasonably estimated.
The following tables summarize our reserves for losses and LAE by segment, by type of reserve and by segment and type of reserve as of the dates presented. For an explanation of changes in these reserves see "-Consolidated Results of Operations."
(1)These ratings represent the Company's internal assessment of the underlying credit quality of the insured obligations. Our scale is comparable to the nationally recognized rating agencies. Our risk management department is responsible for monitoring our portfolio of credits and maintains a list of closely monitored credits. The closely monitored credits are divided into four categories: Category 1 (low priority; fundamentally sound, greater than normal risk); Category 2 (medium priority; weakening credit profile, may result in loss); Category 3 (high priority; claim/default probable, case reserve established); Category 4 (claim paid, case reserve established for future payments). Credits that are not included in the closely monitored credit list are categorized as fundamentally sound, normal risk. See "Business-Risk Management" for further definition and
discussion of closely monitored credits. The following table provides financial guaranty net par outstanding by credit monitoring category as of December 31, 2004 and 2003:
The Company is aware that there are certain differences regarding the measurement of portfolio loss liabilities among companies in the financial guaranty industry. The Company is not aware of specific methodologies applied by other companies in the financial guaranty industry regarding the establishment of such liabilities. In January and February 2005, the Securities and Exchange Commission ("SEC") staff has had discussions concerning these differences with a number of industry participants. Based on these discussions we understand the FASB staff is considering whether additional guidance is necessary regarding financial guaranty contracts. When and if the FASB staff reaches a conclusion on this issue, the Company and the rest of the financial guaranty industry may be required to change some aspects of their loss reserving policies, but the Company cannot currently assess how the FASB's or SEC staff's ultimate resolution of this issue will impact our reserving policy or other balances, i.e., premiums and DAC. Until the issue is resolved, the Company intends to continue to apply its existing policy with respect to the establishment of both case and portfolio reserves.
portfolio as of December 31, 2004 based upon an assumed parallel shift in interest rates across the entire yield curve:
If we believe a decline in the value of a particular investment is temporary, we record the decline as an unrealized loss on our balance sheet in "accumulated other comprehensive income" in shareholders' equity. If we believe the decline is "other than temporary," we write down the carrying value of the investment and record a realized loss in our statement of operations. Our assessment of a decline in value includes management's current assessment of the factors noted above. If that assessment changes in the future, we may ultimately record a loss after having originally concluded that the decline in value was temporary.
Other than temporary declines in the fair value of fixed maturity securities were $0.1 million and $5.8 million for the years ended December 31, 2003 and 2002, respectively. We did not record any realized losses due to other than temporary declines in 2004.
The following table summarizes, for all securities sold at a loss through December 31, 2004 and 2003, the fair value and realized loss by length of time such securities were in a continuous unrealized loss position prior to the date of sale:
Premiums are received either upfront or in installments. Upfront premiums are earned in proportion to the expiration of the related risk. Each installment premium is earned ratably over its installment period, generally one year or less. For the years ended December 31, 2004, 2003 and 2002, approximately 66%, 34% and 51%, respectively, of our gross written premiums were received upfront, and 34%, 66% and 49%, respectively, were received in installments. For the financial guaranty direct and financial guaranty reinsurance segments, earned premiums related to upfront premiums are greater in the earlier periods of an upfront transaction when there is a higher amount of risk outstanding. The premiums are allocated in accordance with the principal amortization schedule of the related bond issue and are earned ratably over the amortization period. When an insured issue is retired early, is called by the issuer, or is in substance paid in advance through a refunding accomplished by placing U.S. Government securities in escrow, the remaining unearned premium reserve is earned at that time.
Acquisition costs incurred that vary with and are directly related to the production of new business are deferred. These costs include direct and indirect expenses such as ceding commissions, brokerage expenses and the cost of underwriting and marketing personnel. As of December 31, 2004 and 2003, we had deferred acquisition costs of $186.4 million and $178.7 million, respectively. Ceding commissions paid to primary insurers are the largest component of deferred acquisition costs, constituting 79.2% and 80.2% of total deferred acquisition costs as of December 31, 2004 and 2003, respectively. Management uses its judgment in determining what types of costs should be deferred, as well as what percentage of these costs should be deferred. We periodically conduct a study to determine which operating costs vary with, and are directly related to, the acquisition of new business and qualify for deferral. Acquisition costs other than those associated with our credit derivative products are deferred and amortized in relation to earned premiums. Ceding commissions received on premiums we cede to other reinsurers reduce acquisition costs. Anticipated losses, LAE and the remaining costs of servicing the insured or reinsured business are considered in determining the recoverability of acquisition costs. Acquisition costs associated with credit derivative products are expensed as incurred. When an insured issue is retired early, as discussed in the Premium Revenue Recognition section of these Critical Accounting estimates, the related deferred acquisition cost is expensed at that time.
As of December 31, 2004 and 2003, we had a net deferred income tax liability of $40.1 million and $55.6 million, respectively. Certain of our subsidiaries are subject to U.S. income tax. Deferred income tax assets and liabilities are established for the temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities using enacted rates in effect for the year in which the differences are expected to reverse. Such temporary differences relate principally to deferred acquisition costs, reserves for losses and LAE, unearned premium reserves, net operating loss carryforwards ("NOLs"), unrealized gains and losses on investments and derivative financial instruments and statutory contingency reserves. A valuation allowance is recorded to reduce a deferred tax asset to the amount that is more likely than not to be realized.
The following table presents summary consolidated results of operations data for the years ended December 31, 2004, 2003 and 2002.
(2)Prior year segment amounts have been adjusted to reflect current year operating expense allocations for comparability purposes.
Gross written premiums for the year ended December 31, 2003 were $349.2 million compared with $417.2 million for the year ended December 31, 2002. In 2003, we achieved strong results in the financial guaranty reinsurance segment and financial guaranty direct segment as gross written premiums increased $78.5 million, or 93%, and $23.7 million, or 50%, respectively, over 2002. The increase in the financial guaranty reinsurance segment was mainly driven by the public finance reinsurance business, which increased due to large cessions on European project finance transactions as well as an increase in the volume of new issues of insured public bonds. In the financial guaranty direct segment, the growth in gross written premiums was mainly attributable to an increase in structured finance premiums. These gains were offset by a decline in gross written premiums of $147.0 million in the other segment and a $23.2 million reduction in the mortgage guaranty segment. Gross written
Net earned premiums for the year ended December 31, 2004 decreased by $123.0 million, or 40%, compared with the year ended December 31, 2003. Our other segment declined $169.1 million in 2004 compared with 2003 as a result of exiting certain lines of business. This decline was partially offset by recognition of $24.1 million of net earned premiums in the financial guaranty direct segment in first quarter 2004 related to the close out of transaction types in which we no longer participate.
The gain or loss created by the estimated fair value adjustment will rise or fall based on estimated market pricing and may not be an indication of ultimate claims. Fair value is defined as the amount at which an asset or liability could be bought or sold in a current transaction between willing parties. We generally plan to hold derivative financial instruments to maturity. Where we hold derivative financial instruments to maturity, these fair value adjustments would generally be expected to reverse resulting in no gain or loss over the entire term of the contract.
Loss and LAE for the year ended December 31, 2003 were $144.6 million, an increase of $24.3 million, or 20%, compared with the year ended December 31, 2002. The increase is attributable to a $20.4 million increase in the financial guaranty reinsurance segment and a $22.7 million increase in the other segment, partly offset by a $9.1 million decrease in the financial guaranty direct segment and $9.6 million decrease in the mortgage guaranty segment. Loss and LAE increased in the financial guaranty reinsurance segment due to an increase in case reserve activity associated with CDOs assumed through treaties. The increase in loss and loss adjustment expenses for the other segment is primarily due to the increase in a case reserve related to one auto residual value reinsurance contract. The
Profit commissions allow the reinsured to share favorable experience on a reinsurance contract due to lower than expected losses. Profit commissions primarily relate to our mortgage guaranty segment. Profit commissions for the years ended December 31, 2004, 2003 and 2002 were $15.5 million, $9.8 million and $8.5 million, respectively. The increase in profit commission expense for 2004 is due to favorable loss development on experience rated quota share treaties. This favorable loss development causes a reduction in loss and loss adjustment expenses discussed above. Portfolio reserves are not a component of these profit commission calculations. In 2003, profit commission expense related to the mortgage segment declined compared with 2002 due to a reduction in net earned premiums, but were more than offset by an increase in profit commission related to the financial guaranty reinsurance segment.
for all years presented. Our effective tax rate was 21.7%, 12.9% and 12.7% for the years ended December 31, 2004, 2003 and 2002, respectively. Our effective tax rates reflect the proportion of income recognized by each of our operating subsidiaries, with U.S. subsidiaries taxed at the U.S. marginal corporate income tax rate of 35%, UK subsidiaries taxed at the UK marginal corporate tax rate of 30%, and no taxes for our Bermuda holding company and subsidiaries. Accordingly, our overall corporate effective tax rate fluctuates based on the distribution of taxable income across these jurisdictions.
based on total net earned premiums, excluding the net earned premium of retroactive reinsurance agreements entered into with subsidiaries of ACE as part of the IPO. The increase in 2003 from 2002 was primarily due to the increase in required staff levels to support the growth in this segment as well as an increase in costs to establish the required platforms and infrastructure to enter the financial guaranty insurance business.
Gross written premiums for the years ended December 31, 2004, 2003 and 2002 were $160.3 million, $163.1 million and $84.6 million, respectively, which represent a decrease of $2.8 million, or 2%, and an increase of $78.5 million, or 93%, in 2004 and 2003, respectively. This decrease is mainly attributable to one cedant relationship that was terminated and business from a
second cedant was decreased, effective July 1, 2004, offset by increased facultative business in the fourth quarter of 2004. The principal driver of gross written premium growth in 2003 compared with 2002 was the strong growth in public finance premiums, which contributed 72% of the segment's gross written premiums in 2003 and contributed 57% of the segment's gross written premiums in 2002. Our public finance reinsurance growth has been driven by strong growth in insured U.S. municipal bond issuance over the period as well as the several European Project Finance Infrastructure transactions ceded to us in 2003. Premium rates on European transactions are typically higher than premium rates on U.S. municipal finance transactions. In 2004 and 2003, we assumed $672.7 million and $503.7 million, respectively, of gross par written from European project finance transactions. Structured finance gross written premiums decreased $4.6 million in 2004, and increased $9.5 million in 2003.
For 2004, $79.8 million, $37.4 million and $28.3 million of our gross written premiums was ceded by Financial Security Assurance Inc., Ambac Assurance Corporation and MBIA Insurance Corporation, respectively, compared with $88.4 million, $24.8 million and $37.7 million, respectively in 2003 and $39.7 million, $9.2 million and $27.4 million, respectively in 2002.
For the years ended December 31, 2004, 2003 and 2002, net written premiums were $160.1 million, $162.1 million and $82.6 million, respectively. The year over year decrease of $2.0 million and an increase of $79.5 million in 2004 and 2003, respectively, is consistent with the changes in gross written premium described above.
premiums increased $16.7 million, compared with 2003, due to timing on installment earnings reported by our ceding companies. The public finance line accounted for $10.2 million of the $13.6 million increase in 2003, reflecting higher earned premium and gross par insured as well as a $5.2 million increase in refunding related premiums.
For the years ended December 31, 2004, 2003 and 2002, acquisition costs were $38.8 million, $33.6 million and $29.0 million, respectively. The increases in acquisition costs over the periods are directly related to the increases in earned premium.
Operating expenses for the years ended December 31, 2004, 2003 and 2002, were $28.5 million, $12.0 million and $9.9 million, respectively. Operating expenses in 2004 increased by $16.5 million as compared with 2003 as a result of the increase in holding company expenses discussed earlier. Operating expenses are allocated based on total net earned premiums, excluding the net earned premium of retroactive reinsurance agreements entered into with subsidiaries of ACE as part of the IPO. Operating expenses in 2003 increased by $2.1 million as compared with 2002 as a result of the entry of our Bermuda subsidiary, Assured Guaranty Re International Ltd., into the financial guaranty reinsurance market.
Net written premiums for the years ended December 31, 2004, 2003 and 2002 were $24.4 million, $24.4 million and $47.6 million, respectively. This is consistent with the trend in gross written premiums, as we do not cede a significant amount of our mortgage guaranty business.
Profit commission expense for the years ended December 31, 2004, 2003 and 2002 was $14.1 million, $7.3 million and $8.3 million, respectively. The increase in profit commission in 2004 compared with 2003 is due to favorable loss development on experience rated quota share treaties, which caused a reduction in loss and loss adjustment expenses, mentioned above. Portfolio reserves are not a component of these profit commission calculations. The decline in profit commission expense in 2003 compared with 2002 is due to the decline in net earned premiums related to business that has a profit commission element, including our quota share business.
Acquisition costs for the years ended December 31, 2004, 2003 and 2002 were $3.7 million, $4.1 million and $8.0 million, respectively. The decrease in acquisition costs, including the amortization of deferred acquisition costs for 2004 as compared with 2003 is related to the commutation of an excess of loss reinsurance contract discussed above. The decline in acquisition costs in 2003 as compared with 2002 is primarily due to the shift in business from quota share reinsurance to excess of loss reinsurance, as ceding commissions generally are not paid on excess of loss reinsurance.
•AGRO Affiliate Reinsurance Transaction: AGRO entered into a reinsurance transaction with an affiliate of ACE, which the ACE affiliate fully ceded to a subsidiary of ACE, both effective July 1, 2001. This transaction is reported in the other segment and resulted in both gross and ceded premiums written of $6.0 million, $11.7 million and $73.8 million in 2003, 2002 and 2001, respectively. Accordingly, this transaction had no effect on our net written premiums or our net income
Trade credit reinsurance net earned premiums were negative $25.3 million in 2004 due to the 100% retrocession with an affiliate of ACE, whereby we ceded 100% of the unearned premium reserves and loss and LAE reserves. For the years ended December 31, 2003 and 2002 net earned premiums were $51.2 million and $27.8 million, respectively. The growth in earned premium in 2003 compared with 2002 is a result of steadily increasing writings in this line over the year as a result of several competitors exiting this market.
On April 15, 2004, AGRO sold 100% of the common stock of its subsidiary, ACE Capital Title Reinsurance Company, to ACE Bermuda Insurance Ltd., a subsidiary of ACE, for $39.8 million. There was no gain or loss associated with this transaction. This sale was the primary reason for the decline in net earned premiums in 2004 from 2003 as we only wrote business during the period we owned the subsidiary. Net earned premiums for the title reinsurance business grew to $10.7 million from $7.3 million for years ended December 31, 2003, and 2002, respectively. This business had prior years underwriting results of $6.8 million and $3.3 million in 2003 and 2002, respectively. The $6.8 million of underwriting gain for the year ended December 31, 2003 was primarily due to favorable prior year loss reserve development.
Auto residual value reinsurance net earned premiums were $(32.2) million in 2004 as we commuted our remaining auto residual value reinsurance business and transferred assets with a market value of $108.3 million to a subsidiary of ACE. This transaction caused a $(6.5) million underwriting loss, partially offset by a $6.8 realized gain. For 2003 and 2002 we had net earned premiums of $4.2 million and $2.3 million, and underwriting losses $35.1 million and $8.1 million respectively. The underwriting loss of $35.1 million in 2003 is a result of an increase in reserves for losses and loss adjustment expenses related to a dispute with World Omni (see Note 15 of notes to consolidated financial statements for further discussion).
Our liquidity, both on a short-term basis (for the next twelve months) and a long-term basis (beyond the next twelve months), for our non-operating companies is largely dependent upon: (1) the ability of our subsidiaries to pay dividends or make other payments to us and (2) external financings. Our liquidity requirements include the payment of our operating expenses, interest on our debt, and dividends on our common shares. We may also require liquidity to make periodic capital investments in our operating subsidiaries. In the ordinary course of our business, we evaluate our liquidity needs and capital resources in light of holding company expenses, debt-related expenses and our dividend policy, as well as rating agency considerations. Based on the amount of dividends we expect to receive from our subsidiaries and the income we expect to receive from our invested assets, management believes that we will have sufficient liquidity to satisfy our needs over the next twelve months, including the ability to pay dividends on our common shares in accordance with our dividend policy. On September 1, 2004 we paid our first quarterly dividend of $0.03 per common share to shareholders of record on August 17, 2004. Total cash paid in 2004 for dividends to shareholders was $4.6 million, or $0.06 per common share. Beyond the next twelve months, the ability of our subsidiaries to declare and pay dividends may be influenced by a variety of factors including market conditions, insurance and rating agencies regulations and general economic conditions. Consequently, although management believes that we will continue to have sufficient liquidity to meet our debt service and other obligations over the long term, no guaranty can be given that we will not be required to seek external debt or equity financing in order to meet our operating expenses, debt service obligations or pay dividends on our common shares.
Liquidity at our operating subsidiaries is used to pay operating expenses, claims, payment obligations with respect to credit derivatives, reinsurance premiums and dividends to us, as well as, where appropriate, to make capital investments in their own subsidiaries. In addition, certain of our operating companies may be required to post collateral in connection with credit derivatives and reinsurance transactions. Management believes that these subsidiaries' operating needs generally can be met from operating cash flow, including gross written premium and investment income from their respective investment portfolios.
generated $68.7 million of net cash flows from operating activities. These cash flows were primarily provided by premium received and investment income.
During 2004 the Company declared and paid dividends of $4.6 million to shareholders. In March 2005, the Company paid dividends of $2.3 million, or $0.03 per common share. Dividends paid to ACE were $35.0 million and $8.0 million during the years ended December 31, 2003 and 2002, respectively. No such dividends were paid in 2004.
On November 4, 2004, the Company's Board of Directors authorized a $25.0 million share stock repurchase program with no scheduled date to expire. The Company has spent approximately $6.0 million to repurchase approximately 0.3 million shares of its Common Stock at an average price of $18.61 through December 31, 2004.
The following table summarizes our contractual obligations as of December 31, 2004:
AGC is also party to a non-recourse credit facility with a syndicate of banks including Deutsche Bank AG (an affiliate of Deutsche Bank Securities Inc.) which provides up to $175.0 million specifically designed to provide rating agency-qualified capital to further support AGC's claims paying resources. The facility expires in December 2010 and is subject to annual extension for an additional term of one year in order to maintain its term at seven periods.
The Company's failure to comply with certain covenants under our credit facilities could, subject to grace periods in the case of certain covenants, result in an event of default. This could require the Company to repay any outstanding borrowings in an accelerated manner.
Our investment portfolio consisted of $1,965.1 million of fixed maturity securities, $175.8 million of short-term investments and had a duration of 5.0 years as of December 31, 2004. Our investment portfolio consisted of $2,052.2 million of fixed maturity securities, $137.5 million of short-term investments and had a duration of 5.4 years as of December 31, 2003. Our fixed maturity securities are designated as available for sale in accordance with FAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities"("FAS 115") Fixed maturity securities are reported at fair value in accordance with FAS 115, and the change in fair value is reported as part of accumulated other comprehensive income.
Fair value of the fixed maturity securities is based upon quoted market prices provided by either independent pricing services or, when such prices are not available, by reference to broker or underwriter bid indications. Our investment portfolio does not include any non-publicly traded securities. For a detailed description of our valuation of investments see "-Critical Accounting Estimates."
The following table summarizes the ratings distributions of our investment portfolio as of December 31, 2004 and 2003. Ratings are represented by the lower of the Moody's and S&P classifications.
Under agreements with our cedants and in accordance with statutory requirements, we maintain fixed maturity securities in trust accounts for the benefit of reinsured companies and for the protection of policyholders, generally in states where we or our subsidiaries, as applicable, are not licensed or accredited. The carrying value of such restricted balances as of December 31, 2004 and 2003 was $304.4 million and $370.0 million, respectively.
•On April 15, 2004 Assured Guaranty Re Overseas Ltd. ("AGRO") (an indirect subsidiary of Assured Guaranty Ltd.) sold 100% of the common stock of its subsidiary, ACE Capital Title Reinsurance Company ("ACTR"), to ACE Bermuda Insurance Ltd., a subsidiary of ACE, for $39.8 million. There was no gain or loss associated with the sale.
•On April 28, 2004, AGRO commuted its remaining auto residual value reinsurance business and transferred assets with a market value of $108.3 million to a subsidiary of ACE. This transaction caused a $(6.5) million underwriting loss, offset by a $6.8 million realized gain from the asset transfer.
Management believes that the foregoing adjustments and allocations were made on a basis that is a reasonable reflection of the historical results of the Company. However, these results do not necessarily represent what the historical combined financial position, results of operations and cash flows of the Company would have been if the Company had been a separate and stand-alone entity during the periods presented.
declining during the insurance period, upfront premium earnings are greater in the earlier periods thus matching revenue recognition with the underlying risk. The premiums are allocated in accordance with the principal amortization schedule of the related bond issue and are earned ratably over the amortization period. When an insured issue is retired early, is called by the issuer, or is in substance paid in advance through a refunding accomplished by placing U.S. Government securities in escrow, the remaining unearned premium reserves are earned at that time. Unearned premium reserves represent the portion of premiums written that is applicable to the unexpired amount at risk of insured bonds.
Due to the customary lag (ranging from 30 to 90 days) in reporting premium data by some of the ceding companies, the Company must estimate the ultimate written and earned premiums to be received from a ceding company as of each balance sheet date for the reinsurance business. Actual written premiums reported in the consolidated statements of operations and comprehensive income are based upon reports received by ceding companies supplemented by the Company's own estimates of premium for which ceding company reports have not yet been received. Differences between such estimates and actual amounts are recorded in the period in which the actual amounts are determined.
The Company accounts for its investments in fixed maturity securities in accordance with the Financial Accounting Standards Board's ("FASB") Statement of Financial Accounting Standards ("FAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("FAS 115"). Management determines the appropriate classification of securities at the time of purchase. As of December 31, 2004 and 2003, all investments in fixed maturity securities were designated as available-for-sale and are carried at fair value with a corresponding adjustment to accumulated other comprehensive income. The fair values of all the Company's investments are calculated from independent market quotations.
Acquisition costs incurred, that vary with and are directly related to the production of new business, are deferred. These costs include direct and indirect expenses such as commissions, brokerage expenses and costs of underwriting and marketing personnel. The Company's management uses judgment in determining what types of costs should be deferred, as well as what percentage of these costs should be deferred. The Company periodically conducts a study to determine which operating costs vary with, and are directly related to, the acquisition of new business and qualify for deferral. Acquisition costs other than those associated with the credit derivative products are deferred and amortized in relation to earned premiums. Ceding commissions received on premiums ceded to other reinsurers reduce acquisition costs. Anticipated losses, loss adjustment expenses and the remaining costs of servicing the insured or reinsured business are considered in determining the recoverability of acquisition costs. Acquisition costs associated with credit derivative products are expensed as incurred. When an insured issue is retired early, as discussed in the Premium Revenue Recognition section of the Significant Accounting Policies, the related deferred acquisition cost is expensed at that time.
Reserves for losses and loss adjustment expenses for non-derivative transactions in our financial guaranty direct, financial guaranty assumed reinsurance and mortgage guaranty business include case reserves and portfolio reserves. See Note 4. Derivatives, for more information on our derivative transactions. Case reserves are established when there is significant credit deterioration on specific insured obligations and the obligations are in default or default is probable, not necessarily upon non-payment of principal or interest by an insured. Case reserves represent the present value of
Portfolio reserves are not established based on a specific event, rather they are calculated by aggregating the portfolio reserve calculated for each individual transaction. Individual transaction reserves are calculated on a quarterly basis by multiplying the par in-force by the product of the ultimate loss and earning factors without regard to discounting. The ultimate loss factor is defined as the frequency of loss multiplied by the severity of loss, where the frequency is defined as the probability of default for each individual issue. The earning factor is inception to date earned premium divided by the estimated ultimate written premium for each transaction. The probability of default is estimated from historical rating agency data and is based on the transaction's credit rating, industry sector and time until maturity. The severity is defined as the complement of historical recovery/salvage rates gathered by the rating agencies of defaulting issues and is based on the industry sector.
We also record IBNR reserves for our mortgage guaranty and other segments. IBNR is an estimate of losses for which the insured event has occurred but the claim has not yet been reported to us. In establishing IBNR, we use traditional actuarial methods to estimate the reporting lag of such claims based on historical experience, claim reviews and information reported by ceding companies. We record IBNR for mortgage guaranty reinsurance on two specific quota-share contracts that are in run-off within our mortgage guaranty segment. We also record IBNR for title reinsurance, auto residual
Under the terms of certain of the Company's reinsurance contracts, the Company is obligated to pay the ceding company at predetermined future dates a contingent commission based upon a specified percentage of the net underwriting profits. The Company's liability for the present value of expected future payments, using a 6% discount rate, is shown on the balance sheet under the caption, "Profit commissions payable". The unamortized discount on this liability was $2.4 million and $4.7 million as of December 31, 2004 and 2003, respectively.
The value of reinsurance business assumed and recorded at the inception of a retrocessional reinsurance contract represents the difference between the estimated ultimate amount of the liabilities assumed under retroactive reinsurance contracts and the consideration received under the contract. The value of reinsurance business assumed was amortized to losses and LAE based on the payment pattern of the losses assumed. The Company no longer carries this asset as it was included in an auto residual value reinsurance commutation contract with a subsidiary of ACE.
Prior to January 1, 2002, goodwill was amortized over twenty-five years on a straight-line basis. Beginning January 1, 2002, goodwill is no longer amortized, but rather is evaluated for impairment at least annually in accordance with FAS No. 142, "Goodwill and Other Intangible Assets". In the year
For restricted stock awards, the Company records the market value of the shares awarded at the time of the grant as unearned stock grant compensation and includes it as a separate component of shareholders' equity. The unearned stock grant compensation is amortized into income ratably over the vesting period.
Since the Company was a subsidiary of ACE during 2003 and 2002, management has determined that disclosing amounts related to these periods would not be meaningful, as the compensation expense determined under FAS 123 would be based on ACE's ordinary share price. The amount of stock-based compensation expense included in reported net income, net of income tax, was $2.0 million and $1.2 million for the years ended December 31, 2003 and 2002, respectively.
In March 2004, the EITF reached a final consensus on EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairments and its Application to Certain Investments" ("EITF 03-1"), which provides guidance on recognizing other-than-temporary impairments on several types of investments including debt securities classified as held-to-maturity and available-for-sale under FAS 115. In September 2004, FASB Staff Position ("FSP") EITF Issue 03-1-1, "Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" was issued, delaying the effective date for the recognition and measurement guidance of EITF 03-1, as contained in paragraphs 10-20, until certain implementation issues are addressed and a final FSP providing implementation guidance is issued. The disclosure requirements of the consensus remain in effect. The Company will continue to monitor this project and, once the final FSP is issued, will evaluate its potential effects on its results of operations.
The Company adopted FAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133") as of January 1, 2001. FAS 133 established accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. FAS 133 requires that an entity recognize all derivatives as either assets or liabilities in the consolidated balance sheets and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as a fair value, cash flow or foreign currency hedge. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. The Company had no derivatives that were designated as hedges, except as described in Note 17, during 2004, 2003 and 2002.
The Company records premiums received from the issuance of derivative instruments in gross written premiums and establishes unearned premium reserves and loss reserves. These loss reserves represent the Company's best estimate of the probable losses expected under these contracts and are calculated in the same manner as our financial guaranty business. See Note 2., Significant Accounting Policies, Reserves for Losses and Loss Adjustment Expenses, for more information. Unrealized gains and losses on derivative financial instruments are computed as the difference between fair value and the total of the unearned premium reserves, losses and LAE reserve, premiums receivable, prepaid reinsurance premiums and reinsurance recoverable on ceded losses. Changes in unrealized gains and losses on derivative financial instruments are reflected in the consolidated statements of operations and comprehensive income. Cumulative unrealized gains and losses are reflected as assets and liabilities, respectively, in the Company's balance sheets. Unrealized gains and losses resulting from changes in the fair value of derivatives occur because of changes in interest rates, credit spreads, recovery rates, the credit ratings of the referenced entities and other market factors. In the event that the Company terminates a derivative contact prior to maturity as a result of a decision to exit a line of business or for risk management purposes, the unrealized gain or loss will be realized through premiums earned and losses incurred.
The Company recorded a pretax net unrealized gain on derivative financial instruments of $52.5 million for the year ended December 31, 2004, a pretax net unrealized gain on derivative financial instruments of $98.4 million for the year ended December 31, 2003, and a pretax net unrealized loss on derivative financial instruments of $54.2 for the year ended December 31, 2002.
As of December 31, 2004 and 2003, net financial guaranty par in force, including insured CDS, was approximately $95.6 billion and $87.5 billion, respectively. The portfolio was broadly diversified by payment source, geographic location and maturity schedule, with no single risk representing more than 1.6% of the total net par in force. The composition of net par in force by bond type was as follows:
Maturities for public finance obligations range from 1 to 40 years, with the typical life in the 12 to 15 year range. Structured finance transactions have legal maturities that range from 1 to 30 years with a typical life of 5 to 7 years. Maturities on single name corporate CDSs range from 1 to 7 years with an average remaining maturity of 1.1 years as of December 31, 2004. CDS transactions are included in all structured finance categories and tax-backed and investor-owned utilities categories in public finance.
(1)These ratings represent the Company's internal assessment of the underlying credit quality of the insured obligations. The Company's scale is comparable to the nationally recognized rating agencies. As part of its financial guaranty business, the Company enters into CDS transactions whereby one party pays a periodic fee in fixed basis points on a notional amount in return for a contingent payment by the other party in the event one or more defined credit events occurs with respect to one or more third party reference securities or loans. A credit event may be a nonpayment event such as a failure to pay, bankruptcy, or restructuring, as negotiated by the parties to the CDS transaction. The total notional amount of insured CDS exposure outstanding as of December 31, 2004 and 2003 and included in the Company's financial guaranty exposure was $23.2 billion and $23.4 billion, respectively.
As of December 31, 2004 and 2003, the Company's net mortgage guaranty insurance in force (representing the current principal balance of all mortgage loans currently reinsured) was approximately $3.6 billion and $3.8 billion, respectively, and net risk in force was approximately $2.3 billion and $2.2 billion, respectively. These amounts are not included in the above table.
The following table summarizes the Company's aggregate investment portfolio as of December 31, 2004:
Included above are 123 fixed maturity securities. The Company has considered factors such as sector credit ratings and industry analyst reports in evaluating the above securities for impairment and has concluded that these securities are not other than temporarily impaired as of December 31, 2004.
Under agreements with its cedants and in accordance with statutory requirements, the Company maintained fixed maturity securities in trust accounts of $304.4 million and $370.0 million as of December 31, 2004 and 2003, respectively, for the benefit of reinsured companies and for the protection of policyholders, generally in states in which the Company or its subsidiaries, as applicable, are not licensed or accredited.
As part of its insured CDS business, the Company is party to certain contractual agreements that require collateral to be posted for the benefit of either party depending on ratings of the parties to the agreement and changes in fair value relative to applicable specified thresholds of the insured swap transactions. As of December 31, 2004 and 2003, the Company posted collateral of $1.9 million and $154.8 million, respectively, for the benefit of CDS customers.
The difference between the portfolio reserves transferred to case reserves and the ultimate case reserve recorded is included in current year incurred amounts.
The financial guaranty case basis reserves have been discounted using a rate of 6% in 2004, 2003 and 2002, resulting in a discount of $18.4 million, $19.8 million and $14.9 million, respectively.
In 2004 the favorable prior year development of $155.8 million is primarily related to the reduction of loss reserves associated with the exiting of certain lines of business in connection with the IPO.
The prior year development in 2003 of $39.0 million is due in part to an increase of $25.0 million in case activity on the structured finance line of business due to credit deterioration in collateralized debt obligations assumed through reinsurance treaties. In addition, prior year development includes an increase in the case reserve on the WorldOmni auto residual value transaction (see Note 15 "Commitments and Contingencies").
The value of reinsurance business assumed represents the change in the value of reinsurance business assumed asset for retroactive reinsurance contracts.
The following table provides the Company's income tax provision and effective tax rates:
operating loss will not be utilized before it expires and has established a $7.0 million valuation allowance related to the net operating loss carry-forward deferred tax asset.
As of December 31, 2004 and 2003, the Company had a current income tax receivable of $4.6 million and a current income tax payable of $2.8 million, respectively. These amounts are included in Other assets and Other liabilities in the Consolidated Balance Sheets, respectively.
To limit its exposure on assumed risks, the Company enters into certain proportional and non-proportional retrocessional agreements with other insurance companies, primarily ACE subsidiaries, that cede a portion of the risk underwritten to other insurance companies.
The following table presents the affiliated and third party reinsurance recoverable balances on ceded losses and provides Standard & Poors ("S&P") ratings for individual reinsurers:
AGC is a Maryland domiciled insurance company and a subsidiary of the Company. Under Maryland's 1993 revised insurance law, the amount of surplus available for distribution as dividends is
AGRI's and AGRO's dividend distribution are governed by Bermuda law. Under Bermuda law, dividends may be paid out of the profits (defined as accumulated realized profits less accumulated realized losses). Dividends to shareholders may also be paid out of statutory capital, but are subject to a 15% limitation without prior approval of the Bermuda Monetary Authority. Dividends are further limited by requirements that the subject company must at all times (i) maintain the minimum share capital required under the Insurance Act of 1978 and (ii) have relevant assets in an amount at least equal to 75% of relevant liabilities, both as defined under the Insurance Act of 1978. Under these restrictions, the maximum allowable dividend payout by AGRI without prior approval of the Bermuda Monetary Authority is $58.4 million (unaudited) as of December 31, 2004. During 2004, AGRI declared dividends of approximately $32.0 million and paid $13.0 million to its parent, Assured Guaranty Ltd. During 2003, AGRI paid dividends of $25.0 million to its parent, ACE Bermuda. No such dividends were paid during 2002.
Going forward, AGC has committed to S&P and Moody's that it will not pay more than $10.0 million per year in dividends.
The following table summarizes the non-affiliated and affiliated components of each line item where applicable in the income statements:
In connection with the IPO, the Company has entered into the following reinsurance agreements with subsidiaries of ACE as follows:
•AGC and AGRO, effective April 1, 2004, entered into 100% quota share retrocession agreement with ACE American. ACE American reinsures both existing and new trade credit reinsurance business written by these entities. The aggregate premium paid under these agreements was approximately $35.4 million in respect of existing business.
•AGRO and ACE INA Overseas Insurance Company entered into a 100% quota share retrocession agreement, effective April 1, 2004, under which AGRO retrocedes to ACE INA Overseas an auto residual value reinsurance transaction. The premium payable under this agreement was approximately $32.2 million.
In September 2001, AGC entered into an excess of loss reinsurance agreement with ACE Bermuda which was effective January 1, 2001. Under the terms of the agreement, the Company paid $52.5 million in premium, in two installments of $27.5 million and $25.0 million in September 2001 and March 2002, respectively, for a 10-year cover with a $150.0 million limit. In June 2003, this agreement was cancelled and the unearned premium of $39.8 million, loss reserves of $12.5 million and profit commission of $1.5 million were returned to AGC. This agreement was not replaced with a third party reinsurance contract. The Company ceded losses of $2.5 million and $10.0 million in 2003 and 2002, respectively, under this cover.
ACE has historically provided certain general and administrative services to the Company, including information technology ("IT") related services, tax consulting and preparation services, internal audit services and a liquidity facility line of credit. Expenses included in the Company's financial statements related to these services were $0.8 million, $0.6 million and $0.5 million for the years ended December 31, 2004, 2003 and 2002. As of December 31, 2004 the only services performed under this agreement are IT related services and tax consulting and preparation services.
AGRI was party to an intercompany service agreement with affiliates of ACE whereby ACE Financial Solutions International provided IT related services, administrative services, including accounts payable, payroll, human resources and other functions. For the years ended December 31, 2004, 2003 and 2002, the Company incurred expenses of approximately $0.3 million, $0.5 million and $0.3 million, respectively, under these intercompany service agreements. Effective December 31, 2004 all these services, with the exception of IT related services, have been terminated.
Assured Guaranty Finance Overseas Ltd. and AGC (UK) obtained staffing, payroll and related services from ACE INA Services (UK) Ltd. For the years ended December 31, 2004, 2003 and 2002, the Company incurred $1.1 million, $1.1 million and $1.0 million in employee related expenses. Effective December 31, 2004 this arrangement has been terminated.
In addition to these administrative services agreements, the Company had entered into an employee leasing agreement with an affiliate. Under this agreement, effective in 2001, the Company provided staffing services and is reimbursed for compensation costs. For the years ended December 31, 2003 and 2002, the Company was reimbursed approximately $9.6 million and $6.8 million, respectively, under this employee leasing agreement. As of December 31, 2003, this agreement has been terminated.
During 2004, 2003 and 2002, ACE contributed capital of $78.9 million, $3.7 million and $84.2 million, respectively to the Company. These were non-cash contributions. The capital contribution in 2004 is mainly comprised of $75.0 million of cumulative monthly income preferred shares transferred to ACE (see Note 17), $3.5 million of the accelerated vesting of options to purchase ordinary shares, and other items related to the formation transactions due to the IPO. In 2003, the $3.7 million capital contribution was utilized to pay interest on long-term debt. The capital contribution in 2002 was primarily made for the purpose of the repayment of the Company's long-term debt and interest expense of $75.0 million and $6.9 million, respectively. See Note 17 for more details. In addition, $0.3 million of expenses relating to the Company's operations were paid by ACE increasing capital contributions in 2002. All expenses are net of related income taxes.
$2.2 million for 2005, $2.1 million for each of the years 2006 and 2007, $2.0 million in 2008, $0.5 million in 2009 and none thereafter. These payments are subject to escalations in building operating costs and real estate taxes. In addition, the Company is re-negotiating the terms of its Bermuda lease, which expires in April 2005. Rent expense for the years ended December 31, 2004, 2003 and 2002 was approximately $3.2 million, $3.4 million and $2.5 million, respectively.
AGRO and Assured Guaranty Inc. denied World Omni's claims, and contested them vigorously. On February 24, 2004, the parties entered into a separate, confidential arbitration agreement that governs the parties' disputes. On March 1, 2004, the parties submitted a joint motion for a stay of proceedings in the District Court action so that they could pursue arbitration. By Order dated March 5, 2004, the District Court granted the parties' joint motion and stayed further proceedings in the District Court action. No formal discovery had been taken in the District Court action by the time the proceedings were stayed.
At December 31, 2003, the Company carried a reserve for losses and LAE, net of recoveries, of $32.2 million.
On April 28, 2004 the Company entered into a quota share retrocession agreement with ACE INA Overseas Insurance Company Ltd., a subsidiary of ACE, whereby it ceded 100% of any potential losses associated with the above litigation for a premium of $32.2 million.
number of these items could have a material adverse effect on the Company's results of operations or liquidity in a particular quarter or fiscal year.
In the ordinary course of their respective businesses, certain of our subsidiaries assert claims in legal proceedings against third parties to recover losses paid in prior periods. The amounts, if any, we will recover in these proceedings are uncertain, although recoveries in any one or more of these proceedings during any quarter or fiscal year could be material to our results of operations in that particular quarter or fiscal year.
On May 18, 2004, Assured Guaranty US Holdings Inc., a subsidiary of the Company, issued $200.0 million of 7.0% Senior Notes due 2034 for net proceeds of $197.3 million. The proceeds of the offering were used to repay a $200.0 million promissory note issued to a subsidiary of ACE in April 2004 as part of the IPO related formation transactions. The coupon on the Senior Notes is 7.0%, however, the effective rate will be approximately 6.4%, taking into account the effect of a cash flow hedge executed by the Company in March 2004. The Company recorded interest expense of $8.4 million, including $0.4 million of amortized gain on the cash flow hedge, for the year ended December 31, 2004. These Senior Notes are fully and unconditionally guaranteed by Assured Guaranty Ltd.
As of December 31, 2003, the Company's long-term debt included $75.0 million of cumulative monthly income preferred shares issued in 1994 through a former affiliate of the Company, Capital Re LLC, a limited liability company organized under the laws of Turks and Caicos Islands. The amount paid to preferred shareholders for both years ended December 31, 2003 and 2002 was $5.7 million and is shown on the consolidated statements of operations and comprehensive income as interest expense. Upon completion of the IPO, Capital Re LLC and the obligation with respect to the $75.0 million cumulative monthly preferred shares remained with ACE and the after-tax interest of $1.4 million was forgiven.
The Company's long-term debt also consisted of $75.0 million of 7.75% debentures, which became due and were paid off in November 2002. During the year ended December 31, 2002 the Company paid interest expense related to this long-term debt of $4.9 million, which is shown on the consolidated statements of operations and comprehensive income as interest expense.
On April 29, 2004, the Company entered into a $250.0 million unsecured credit facility to replace its general corporate purpose credit facilities ("$250.0 million credit facility"), with a syndicate of banks, for which ABN AMRO Incorporated and Bank of America (an affiliate of Banc of America Securities LLC) acted as co-arrangers to which each of Assured Guaranty Ltd., AGC and Assured Guaranty (UK) Ltd., a subsidiary of AGC organized under the laws of the United Kingdom, is a party, as borrower. The $250.0 million credit facility is a 364-day facility and any amounts outstanding under the facility at its expiration will be due and payable one year following the facility's expiry. Under the $250.0 million credit facility, AGC can borrow up to $250.0 million, Assured Guaranty Ltd. has a borrowing limit not to exceed $50.0 million, and Assured Guaranty (UK) Ltd. has a borrowing limit not to exceed $12.5 million. As of December 31, 2004, no amounts had been drawn under this credit facility.
As of December 31, 2004, the Company was party to a non-recourse credit facility with a syndicate of banks, which provided up to $175.0 million. This facility was specifically designed to provide rating agency qualified capital to further support the Company's claim paying resources. This agreement is due to expire November 2010. As of December 31, 2004, no amounts had been drawn under this credit facility.
(i) The Company participated in a liquidity facility established for the benefit of ACE and certain of its subsidiaries. The overall facility was a 364-day credit agreement in the amount of $500.0 million with a syndicate of banks. The Company had a $50.0 million participation in the facility. In connection with the IPO, as of April 29, 2004, the Company's participation in this facility was replaced by the $250.0 million credit facility.
(ii) The Company also participated in a liquidity facility established for the benefit of AGC. The overall facility was a 364-day credit agreement in the amount of $140.0 million with a syndicate of banks. Under the terms of this liquidity facility, AGC would have been required to pledge collateral to one of the syndicate banks, if the amount of collateral posted for the benefit of AGC credit default swap counterparties exceeded 11% of AGC shareholders' equity. In such case an amount equal to that excess was to have been pledged for the benefit of the syndicate banks. As of December 31, 2003, AGC had not posted any collateral under this covenant. In connection with the IPO, as of April 29, 2004 the Company's participation in this facility was replaced by the $250 million credit facility.
(iii) The Company had a $75.0 million line of credit facility and a $50.0 million line of credit facility from subsidiaries of ACE. Due to the IPO, as of April 29, 2004 these facilities were replaced. As of December 31, 2003, no amounts had been drawn under these credit facilities.
The Company has an authorized share capital of $5.0 million divided into 500,000,000 shares, par value U.S. $0.01 per share, of which 75,000,000 common shares were issued and outstanding and beneficially owned by ACE prior to the IPO. On April 28, 2004, subsidiaries of ACE completed the IPO of 49,000,000 of their 75,000,000 common shares of Assured Guaranty Ltd., with the remaining 26,000,000 common shares beneficially owned by ACE. Additional common shares were issued to the Company's officers and employees in connection with the IPO-see Note 19. Except as described below, the Company's common shares have no preemptive rights or other rights to subscribe for additional common shares, no rights of redemption, conversion or exchange and no sinking fund rights. In the event of liquidation, dissolution or winding-up, the holders of the Company's common shares are entitled to share equally, in proportion to the number of common shares held by such holder, in the Company's assets, if any remain after the payment of all the Company's debts and liabilities and the liquidation preference of any outstanding preferred shares. Under certain circumstances, the Company has the right to purchase all or a portion of the shares held by a shareholder at fair market value. All of the common shares are fully paid and non-assessable. Holders of the Company's common shares are entitled to receive such dividends as lawfully may be declared from time to time by the Company's Board of Directors.
The following table presents changes in the Company's common stock issued and outstanding from the IPO date through December 31, 2004.
Under the Company's Bye-Laws and subject to Bermuda law, if the Company's Board of Directors determines that any ownership of the Company's shares may result in adverse tax, legal or regulatory consequences to us, any of the Company's subsidiaries or any of its shareholders or indirect holders of shares or its Affiliates (other than such as the Company's Board of Directors considers de minimis), the Company has the option, but not the obligation, to require such shareholder to sell to the Company or to a third party to whom the Company assigns the repurchase right the minimum number of common shares necessary to avoid or cure any such adverse consequences at a price determined in
the discretion of the Board of Directors to represent the shares' fair market value (as defined in the Company's Bye-Laws). See also Note 19 for common shares held in trust.
During 2004 the Company paid dividends of $4.6 million, or $0.06 per common share. In March 2005, the Company paid dividends of $2.3 million, or $0.03 per common share. Any determination to pay cash dividends will be at the discretion of the Company's Board of Directors, and will depend upon the Company's results of operations and cash flows, its financial position and capital requirements, general business conditions, legal, tax, regulatory, rating agency and any contractual restrictions on the payment of dividends and any other factors the Company's Board of Directors deems relevant. For more information concerning regulatory constraints that will affect the Company's ability to pay dividends, see Note 13.
The Incentive Plan authorizes the grant of incentive stock options, non-qualified stock options, stock appreciation rights, and full value awards that are based on the Company's common shares. The grant of full value awards may be in return for a participant's previously performed services, or in return for the participant surrendering other compensation that may be due, or may be contingent on the achievement of performance or other objectives during a specified period, or may be subject to a risk of forfeiture or other restrictions that will lapse upon the achievement of one or more goals relating to completion of service by the participant, or achievement of performance or other objectives. Awards under the Incentive Plan may accelerate and become vested upon a change in control of Assured Guaranty.
The fair value of options issued is estimated on the date of grant using the Black-Scholes option-pricing model, with the following weighted-average assumptions used for grants in 2004: dividend yield of 0.7%; expected volatility of 17.03%, risk free interest rate of 4.4% and an expected life of five years.
*Balance related to ACE restricted stock awards prior to the IPO Defined Contribution Plan
Prior to the IPO, Assured Guaranty's officers and employees participated in ACE's long-term incentive plans. The Company's officers and employees have been covered under additional benefit plans, including retirement programs providing 401(k) plan benefits, health and life insurance benefits; medical, dental and vision benefits for active employees; disability and life insurance protection; and severance. Prior to the IPO, these additional benefits had been provided to the Company's employees and officers who work in the United States by plans maintained by AGC and to the Company's employees and officers who work in Bermuda and the United Kingdom through plans maintained by ACE covering ACE employees in those locations. Since the completion of the IPO, the Company's
(2)Based on shares outstanding immediately prior to the IPO. 21. Fair Value of Financial Instruments
The Company has four principal business segments: (1) financial guaranty direct, which includes transactions whereby the Company provides an unconditional and irrevocable guaranty that indemnifies the holder of a financial obligation against non-payment of principal and interest when due, and includes credit support for credit default swaps; (2) financial guaranty reinsurance, which includes agreements whereby the Company is a reinsurer and agrees to indemnify a primary insurance company against part or all of the loss which the latter may sustain under a policy it has issued; (3) mortgage guaranty, which includes mortgage guaranty insurance and reinsurance whereby the Company provides protection against the default of borrowers on mortgage loans; and (4) other, which includes several lines of business in which the Company is no longer active, including trade credit reinsurance, title reinsurance, auto residual value reinsurance and the credit protection of equity layers of CDOs, as well as life, accident and health reinsurance.
(1)Excludes $11.3 million of operating expenses, included in other operating expenses in the consolidated statements of operations and comprehensive income, related to the accelerated vesting of stock awards at the IPO date.
The following tables present the condensed consolidated financial information for Assured Guaranty Ltd, Assured Guaranty US Holdings Inc. and other subsidiaries as of December 31, 2004 and 2003 and for the years ended December 31, 2004, 2003 and 2002.
The Company's cash paid during the periods presented for federal income taxes and interest, and non-cash financing activities were as follows:
(2)Per share amounts for the quarters and the full years have each been calculated separately. Accordingly, quarterly amounts may not add to the annual amounts because of differences in the average common shares outstanding during each period and, with regard to diluted per share amounts only, because of the inclusion of the effect of potentially dilutive securities only in the periods in which such effect would have been dilutive.