We sold Alleghany Asset Management, Inc. in February 2001 and Alleghany Underwriting Holdings Ltd. in November 2001, and as a result, both of these businesses have been classified as discontinued operations for the year ended 2001. AIHL purchased CATA and Platte River in January 2002. In March 2003, AIHL established Darwin and acquired RSUI in July 2003. On July 1, 2003, AIHL completed the acquisition of Resurgens Specialty which became a subsidiary of RSUI. In connection with the acquisition of Resurgens Specialty, on June 30, 2003, RSUI acquired RIC. On September 2, 2003, RIC purchased Landmark. In 2004, AIHL acquired DNA and in 2005, DNA acquired Darwin Select. We sold Heads & Threads in December 2004. Heads & Threads has been classified as discontinued operations for the four years ended 2004. We sold World Minerals on July 14, 2005. World Minerals has been classified as discontinued operations for the five years presented.
occurs. As a result of this historical pattern, the liability for unpaid losses and LAE includes significant estimates for claims incurred but not yet reported, known as “IBNR.” Additionally, reported claims are in various stages of the settlement process. Each claim is settled individually based upon its merits, and certain claims may take years to settle, especially if legal action is involved. As a result, the liabilities for unpaid losses and LAE include significant judgments, assumptions and estimates made by management relating to the ultimate losses that will arise from the claims. Due to the inherent uncertainties in the process of establishing these liabilities, the actual ultimate loss from a claim is likely to differ, perhaps materially, from the liability initially recorded and could be material to the results of our operations. The accounting policies that our insurance operating units use in connection with the establishment of these liabilities include critical accounting estimates.
Our insurance operating units use a variety of techniques that employ significant judgments and assumptions to establish the liabilities for unpaid losses and LAE recorded at the balance sheet date. These techniques include detailed statistical analyses of past claim reporting, settlement activity, claim frequency, internal loss experience, changes in pricing or coverages and severity data when sufficient information exists to lend statistical credibility to the analysis. More subjective techniques are used when statistical data is insufficient or unavailable. These liabilities also reflect implicit or explicit assumptions regarding the potential effects of future inflation, judicial decisions, changes in laws and recent trends in such factors as well as a number of actuarial assumptions that vary across our insurance operating units and across lines of business. This data is analyzed by line of business, coverage and accident year, as appropriate.
Our loss reserve review processes use actuarial methods and underlying assumptions that vary by company and line of business and produce ranges from which the carried reserve for each class of business is selected. The actuarial methods used by our insurance operating units include the Incurred Development method, Paid Development method, Bornhuetter-
Ferguson method for both paid and incurred, Balanced Incurred method and Ultimate Incurred times Ultimate Claims method. Because of the high level of uncertainty regarding the setting of liabilities for unpaid losses and LAE, it is the practice of each of our insurance operating units to engage, at least annually, an outside actuary to evaluate, and opine on, the reasonableness of these liabilities. Although we are unable at this time to determine whether additional reserves, which could have a material impact upon our financial condition, results of operations and cash flows, may be necessary in the future, we believe that the reserves for unpaid losses and LAE established by our insurance operating units are adequate as of December 31, 2005.
For both asbestos and environmental impairment reinsurance claims, CATA establishes case reserves by receiving case reserve amounts from its ceding companies and verifies these amounts against reinsurance contract terms, analyzing from the first dollar of loss incurred by the primary insurer. In establishing the liability for asbestos and environmental impairment claims, CATA considers facts currently known and the current state of the law and coverage litigation. Additionally, ceding companies often report potential losses on a precautionary basis to protect their rights under the reinsurance arrangement, which generally calls for prompt notice to the reinsurer. Ceding companies, at the time they report potential losses, advise CATA of the ceding companies’ current estimate of the extent of the loss. CATA’s claims department reviews each of the precautionary claims notices and, based upon current information, assesses the likelihood of loss to CATA. This assessment is one of the factors used in determining the adequacy of the recorded asbestos and environmental impairment reserves. Although we are unable at this time to determine whether additional reserves, which could have a material impact upon our results of operations, may be necessary in the future, we believe that CATA’s asbestos and environmental impairment reserves are adequate as of December 31, 2005.
Receivables recorded with respect to claims ceded by our insurance operating units to reinsurers under reinsurance contracts are estimated in a manner similar to liabilities for unpaid losses and, therefore, are also subject to a significant degree of uncertainty. In addition to the factors cited above, reinsurance receivables may prove uncollectible if the reinsurer is unable to perform under the contract. Reinsurance contracts purchased by our insurance operating units do not relieve them of their obligations to their own policyholders. Additional information regarding the use of, and risks related to, the use of reinsurance by our insurance operating units can be found on pages 17 through 19 and pages 24 and 25 of this Form 10-K Report.
We file a consolidated federal income tax return with our subsidiaries. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences
between the financial statement carrying amount of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. At December 31, 2005 a net deferred tax asset of $117.5 million was recorded, including a valuation allowance of $19.6 million for certain foreign tax credits and deferred state tax assets which we believe may not be realized. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. This determination is based upon a review of anticipated future earnings as well as all available evidence, both positive and negative. Deferred tax liabilities at December 31, 2005 were $213.5 million.
The increase in our revenues in 2005 from 2004 was attributable to increases in net gains on investment transactions, net premiums earned and investment income. Net gain on investment transactions in 2005 primarily reflects the sale of 2.0 million shares of common
stock of Burlington Northern which generated $94.8 million of the 2005 net gain and the sale of 1.0 million shares of CIGNA Corporation, or “CIGNA,” which generated $37.8 million of the 2005 net gain. Net gain on investment transactions in 2004 primarily reflected the sale of 2.6 million shares of common stock of CIGNA, which generated $58.6 million of the 2004 net gain. Net gain on investment transactions in 2003 primarily reflected the sale of 8.0 million shares of common stock of Burlington Northern, which generated $137.7 million of the 2003 net gain.
The increase in net premiums earned in 2005 from 2004 primarily reflects growth in all lines of Darwin’s business, growth in CATA’s property and casualty lines (including in excess and surplus markets) and commercial surety lines and lower reinsurance costs at CATA. The increases at Darwin and CATA were partially offset by a decrease in net premiums earned at RSUI. The increase in net premiums earned in 2004 from 2003 reflects the benefit from RSUI’s first full year of operations as part of the AIHL group of companies. The increase in interest, dividend and other income during the three-year period ended December 31, 2005 reflects a greater amount of invested assets and higher investment yields.
The increase in costs and expenses over the three-year period ended December 31, 2005 primarily reflects a substantial increase in loss and LAE attributable to significant hurricane activity in 2005 and 2004, as well as growth of business (with commissions and brokerage expenses keeping pace with the increases in net premiums earned) and the costs incurred in building Darwin’s organization and transitioning RSUI from a managing agency to an integrated insurance company. The significant increase in loss and LAE in 2005 from 2004 is primarily attributable to the $287.3 million of pre-tax catastrophe losses, net of reinsurance, incurred by RSUI as a result of the substantially more significant hurricane activity in 2005. The significant increase in loss and LAE in 2004 from 2003 is attributable to the $146.7 million of pre-tax catastrophe losses, net of reinsurance, incurred by RSUI as a result of 2004 hurricane activity.
Corporate administration expenses decreased 7 percent in 2005 from 2004, primarily reflecting a decrease in parent level pension plan costs and reductions in legal and consulting expenditures. Corporate administration expenses increased 20 percent in 2004 from 2003, which was primarily attributable to increased expense for stock-based incentive compensation due to a significant increase in the market price of Alleghany’s common stock from $170.60 at December 31, 2002 to $285.25 at December 31, 2004 and a restricted stock award granted in connection with the employment of a senior officer. The fluctuations in interest expense in the three-year period ended December 31, 2005 are attributable to the impact of interest rate changes on $80.0 million of floating rate notes due 2007 of our financing subsidiary Alleghany Funding Corporation.
The comparative contributions to our pre-tax earnings from continuing operations made by AIHL, corporate activities at the parent level and discontinued operations of World Minerals, which we sold in July 2005, and Heads & Threads, which we sold in December 2004, were as follows (in millions except for per share amounts):
Corporate activities consists of Alleghany Properties and corporate activities at the parent level, including strategic equity investments which are available to support the internal growth of subsidiaries and for acquisitions of, and substantial investments in, operating companies.
Earnings from continuing operations before income taxes declined to $148.9 million in 2004 from $219.6 million in 2003 due to a number of factors. The 2004 results reflect a significant increase in the contribution made by AIHL, which benefited from RSUI’s first full year of operations as part of the AIHL group of companies. RSUI posted strong underwriting results and a substantial increase in net gains on investment transactions in 2004. These benefits were partially offset by the catastrophe losses incurred at RSUI caused by the 2004 hurricane activity. The contributions of AIHL’s insurance operating units, however, were not sufficient to make up for the loss from the continuing operations before income taxes of corporate activities, caused by the near absence of net gains on investment transactions at the parent company level in 2004. By comparison, 3.7 million shares of
We had previously announced that we may purchase shares of our common stock in open market transactions from time to time. In 2005, we purchased no shares of our common stock. As of December 31, 2005, we had 7,904,879 shares of our common stock outstanding.
Loss and loss adjustment expenses divided by net premiums earned, all as determined in accordance with GAAP.
the casualty lines, partially offset by rate decreases in the property and general liability lines of business. RSUI reported $1,223.8 million of gross premiums written in 2004, reflecting its first full year of operations as part of the AIHL group of companies and growth in all lines of business except property, with the increase in underwriting expenses in 2004 primarily reflecting costs incurred in transitioning from a managing agency to an integrated insurance company and the growth of the business.
The $931.3 million of gross premiums written by RSUI during the last half of 2003 include $320.8 million of unearned premiums which were acquired with RSUI in July 2003, and $115.7 million of net premiums assumed pursuant to arrangements entered into in connection with the acquisition of RSUI, as well as $494.8 million of direct premiums written. Alleghany acquired RIC to write business underwritten by RSUI on an admitted basis. As RIC did not possess all necessary licenses to be able to write business on an admitted basis in most states at the time of acquisition, the seller of RIC agreed to provide policy issuing services to RIC through June 2004. Under this arrangement and in respect of the unearned premiums acquired with RSUI, RIC assumed the policies and the related premiums (net of reinsurance paid by the seller), from the seller by reinsuring the obligations of the seller’s carrier under the policy.
The significant increase in loss and LAE in 2005 from 2004 primarily reflects $287.3 million of pre-tax catastrophe losses, net of reinsurance, due to the 2005 hurricanes. The significant increase in loss and LAE in 2004 from 2003 primarily reflects $146.7 million of pre-tax catastrophe losses, net of reinsurance, due to the 2004 hurricanes, as well as a full year of operations in 2004. This increase was partially offset by an $18.1 million decrease in property loss reserves due to better than expected loss emergence in the 2003 accident year.
Rates at RSUI in 2005 as compared with 2004 continued to reflect overall industry trends, with flat or marginally decreased rates in RSUI’s casualty lines of business (except for
CATA’s $15.6 million underwriting profit in 2005 primarily reflects favorable loss experience in the 2005 accident year and a $5.2 million pre-tax release of prior year loss reserves in 2005 (compared with $10.6 million of adverse development in prior year loss reserves in 2004) due to lower actual loss emergence for commercial and contract surety claims. In addition, a decrease in reinsurance costs and underwriting expenses, primarily reflecting CATA’s exit from the construction segment of its contract surety line of business, and other expense efficiences had a favorable impact on CATA’s 2005 underwriting profit. CATA’s 2004 underwriting loss of $8.9 million primarily reflects $10.6 million of prior year reserve strengthening upon completion of a reserve analysis during the 2004 fourth quarter which showed higher than expected emergence for construction defect claims, as well as higher underwriting expenses, partially offset by better underwriting margins on the 2004 accident year. With respect to the prior year reserve strengthening, $9.7 million related to commercial multiple peril lines, principally construction defect claims. CATA’s 2003 underwriting loss of $21.4 million reflects $21.9 million of loss reserve strengthening primarily related to assumed reinsurance treaties written by Capitol Indemnity between 1969 and 1976. These assumed reinsurance treaties primarily relate to asbestos and environmental exposures. Information regarding these assumed reinsurance treaties can be found on pages 15 and 16 and page 32 of this Form 10-K Report.
CATA experienced lower levels of rate increases in its property and casualty lines of business in 2005 compared with 2004, primarily due to increased competition in its larger accounts, and generally unchanged commercial surety rates for 2005 as compared with 2004. Rates at CATA in 2004 compared with 2003 reflect lower levels of rate increases in property and casualty lines of business, primarily due to increased competition.
Darwin reported an underwriting profit in 2005 compared with an underwriting loss in 2004, primarily reflecting a significant increase in net premiums earned due to increased levels of gross premiums written across all lines of business, partially offset by increased loss and LAE and underwriting expenses primarily attributable to this premium growth. Darwin’s 2004 underwriting loss of $0.1 million and 2003 underwriting loss of $3.3 million reflect organizational build-up expenses incurred to support premium levels, as well as increased competition across all of its lines of business. The increase in gross premiums written at Darwin in 2004 and 2005 reflects significant growth across all Darwin lines of business. Of the $165.8 million of gross premiums written in 2005, approximately $58.9 million was attributable to E&O liability business, $74.0 million was attributable to medical professional liability business and $32.9 million was attributable to D&O liability business.
Changes in Loss and LAE Reserves between December 31, 2004 and December 31, 2003
Total gross and net loss and LAE reserves increased at December 31, 2004 from December 31, 2003, primarily reflecting an increase in business generated by AIHL’s operating units and losses incurred in connection with the 2004 hurricanes. With respect to property lines of business, the increase in gross and net loss and LAE reserves in 2004 primarily reflects unpaid losses on AIHL’s gross property catastrophe losses of $401.8 million from the 2004 hurricanes. The increase in gross and net loss and LAE reserves for casualty line of business reflects increased business generated in 2004 by RSUI, acquired in July 2003 and Darwin, which commenced operations in May 2003. The increase in gross and net loss and LAE reserves for CMP lines primarily reflects strengthening of prior year loss reserves related to higher than expected CMP claims settlements and increased earned premiums.
The increase in interest, dividend and other income at AIHL in 2004 and 2005 primarily reflects the impact of higher interest rates and a larger invested asset base principally due to capital contributions by us, increased premium volume and the acquisition of RSUI in 2003.
AIHL’s 2005 net gain on investment transactions primarily reflects the sale of 404,000 shares of CIGNA, for aggregate cash proceeds of $33.0 million. AIHL’s 2004 net gain on investment transactions primarily reflects the sale of 2.6 million shares of common stock of CIGNA, for aggregate cash proceeds of $169.9 million, while its 2003 pre-tax net gain on investment transactions primarily reflects the sale of 4.3 million shares of common stock of Burlington Northern for aggregate cash proceeds of $118.6 million. These dispositions were made primarily to diversify the investment portfolios of AIHL’s operating units.
Investment Strategy. AIHL’s investment strategy seeks to preserve principal and maintain liquidity while trying to maximize its risk-adjusted, after-tax rate of return. Investment decisions are guided mainly by the nature and timing of expected liability payouts, management’s forecast of cash flows and the possibility of unexpected cash demands, for example, to satisfy claims due to catastrophic losses. AIHL’s investment portfolio currently
consists mainly of highly rated and liquid debt securities and equity securities listed on national securities exchanges. AIHL’s debt securities portfolio has been designed to enable management to react to investment opportunities created by changing interest rates, prepayments, tax and credit considerations or other factors, or to circumstances that could result in a mismatch between the desired duration of portfolio assets and the duration of liabilities, and, as such, is classified as available for sale.
Despite significant catastrophe losses in 2005 and 2004, AIHL produced positive cash flow from continuing operations each quarter during the years ended December 31, 2005 and 2004. AIHL’s positive cash flow from continuing operations reduces the need to liquidate portions of its debt securities portfolio to pay for current claims. This positive cash flow also permits AIHL, as attractive investment opportunities arise, to make investments in debt securities that have a longer duration than AIHL liabilities. This strategy, when used, is designed to grow AIHL’s capital resources. When attractive investment opportunities do not arise, AIHL may maintain higher proportions of shorter duration securities to preserve its capital resources. In this regard, as of December 31, 2005 AIHL held approximately $490.0 million, or 31 percent of its debt securities portfolio, in securities with maturities of five years or less and approximately $492.3 million of short-term investments. AIHL anticipates modestly increasing the proportion of its debt securities portfolio held in securities with maturities of more than five years should the yields of these securities provide sufficient compensation for their increased risk. We do not believe that this strategy would reduce AIHL’s ability to meet ongoing claim payments or to respond to further significant catastrophe losses.
Investment Position Summary. The following tables summarize the investments of AIHL and its subsidiaries on a consolidated basis, excluding cash, as of December 31, 2005 and 2004, with all investments carried at fair value (in thousands, except for percentages):
The following tables summarize, for all securities in an unrealized loss position at December 31, 2005 and 2004, the aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position (in thousands):
Average of amortized cost of fixed maturity portfolio at beginning and end of period.
Net after-tax investment income for the period divided by average investments for the same period.
Rating category used is the lower of Moody’s or Standard & Poors rating.
Includes $152.7 million of securities redeemable within one year at par.
Dividends. We have declared stock dividends in lieu of cash dividends every year since 1987 except 1998 when Chicago Title Corporation was spun off to our stockholders. These stock dividends have helped to conserve our financial strength and, in particular, the liquid assets available to finance internal growth and operating company acquisitions and investments. On April 28, 2006, as our dividend on our common stock for 2006, we will pay to stockholders of record on April 3, 2006 a dividend of one share of our common stock for every 50 shares outstanding.
Credit Agreement. In addition to our liquid assets, in July 2004, we entered into a three-year unsecured credit agreement with a bank syndicate. This credit agreement provides commitments for revolving credit loans in an aggregate principal amount of up to $200.0 million and scheduled to expire on July 27, 2007. The credit agreement replaced a prior 364-day credit agreement which expired on June 14, 2004 and a three-year credit agreement which was scheduled to expire on June 14, 2005, each of which provided for revolving credit loans in an aggregate principal amount of up to $100.0 million. Wachovia Bank, National Association, serves as administrative agent for the banks under our current credit agreement. At our option, borrowings under the current credit agreement will bear interest at either (x) the higher of (i) the administrative agent’s prime commercial lending rate or (ii) the federal funds rate plus 0.5 percent or (y) the London Interbank Overnight Rate plus a margin (currently 80 basis points) based on our Standard & Poors and/or Moody’s rating. Borrowings under the credit agreement will be available for working capital and general corporate purposes. Our practice is to repay borrowings under our credit agreements promptly in order to keep the facilities available for future acquisitions. We did not borrow any amounts under the credit agreement during the year ended December 31, 2005.
Common Stock Purchases. We have announced that we may purchase shares of our common stock in open market transactions from time to time. In 2005 and 2004, we did not purchase any shares of our common stock. In 2003, we purchased an aggregate of 1,326 shares of our common stock for approximately $0.3 million, at an average cost of $222.24 per share.
Dividends from Subsidiaries. At December 31, 2005, about $242.2 million of the equity of our subsidiaries was available for dividends or advances to us. At that date, approximately $1.6 billion of our total equity of approximately $1.9 billion was unavailable for dividends or advances to us from our subsidiaries, due to limitations imposed by statutes and agreements with lenders to which those subsidiaries are subject. In particular, our insurance subsidiaries are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid by them without prior approval of insurance regulatory authorities. A maximum of $105.5 million was available for dividends without prior approval of the applicable insurance regulatory authorities at 2005 year-end. These limitations have not affected our ability to meet our obligations. In 2005, RSUI paid us a cash dividend of $25.0 million.
Material Off-Balance Sheet Arrangements. We did not enter into any off-balance sheet arrangements during 2005, 2004 or 2003, nor did we have any off-balance sheet arrangements outstanding at December 31, 2005, 2004 or 2003.
Financial strength is also a high priority of our subsidiaries, whose assets stand behind their financial commitments to their customers and vendors. We believe that we and our subsidiaries have and will have adequate internally generated funds, cash resources and unused credit facilities to provide for the currently foreseeable needs of our and their businesses. We and our subsidiaries have no material commitments for capital expenditures.
AIHL. The obligations and cash outflow of AIHL’s insurance operating units include claim settlements, administrative expenses and purchases of investments. In addition to premium collections, cash inflow is obtained from interest and dividend income and maturities and sales of investments. Because cash inflow from premiums is received in advance of cash outflow required to settle claims, AIHL’s insurance operating units accumulate funds which they invest pending the need for liquidity. As an insurance company’s cash needs can be unpredictable due to the uncertainty of the claims settlement process, AIHL’s portfolio (which includes those of its insurance operating units) is composed primarily of debt securities and short-term investments to ensure the availability of funds and maintain a sufficient amount of liquid securities. As of December 31, 2005, investments and cash represented 49.8 percent of the assets of AIHL and its insurance operating units.
At December 31, 2005, we had total unpaid losses and LAE of approximately $2.6 billion and reinsurance recoverables on these total unpaid losses and LAE of approximately $1.5 billion. As of December 31, 2005, AIHL’s investment portfolio had a fair market value of $2.4 billion and consisted primarily of high quality debt securities with an average life of 3.8 years and an effective duration of 5.6 years. Effective duration measures a portfolio’s sensitivity to change in interest rates; a change within a range of plus or minus 1 percent in interest rates would be expected to result in an inverse change of approximately 3.8 percent in the fair market value of the portfolio of AIHL. The overall debt securities portfolio credit quality is measured using the lower of either Standard & Poors or Moody’s rating. The weighted average rating at December 31, 2005 was AAA, with over 98.1 percent of all securities rated investment grade. AIHL’s investment portfolio contains no investments of a derivative nature. Additional information regarding AIHL’s investment portfolio and investment strategy can be found on pages 44 through 49 of this Form 10-K Report.
On July 1, 2003, AIHL acquired Resurgens Specialty from the seller for cash consideration, including capitalized expenditures, of approximately $116.0 million. Resurgens Specialty became a subsidiary of RSUI. In connection with the acquisition of Resurgens Specialty, on June 30, 2003, RSUI acquired RIC, to write admitted business underwritten by Resurgens Specialty, from the seller of RIC for consideration of approximately $19.7 million, $13.2 million of which represented consideration for RIC’s investment portfolio and the balance of which represented consideration for licenses. On September 2, 2003, RIC acquired Landmark, a non-admitted insurance company, to write non-admitted business underwritten by Resurgens Specialty, from the seller of Landmark for cash consideration of $33.9 million, $30.4 million of which represented consideration for Landmark’s investment portfolio and the balance of which represented consideration for licenses. The seller of Landmark provided loss reserve guarantees for all of the loss and LAE liabilities of Landmark that existed at the time of the sale. We capitalized RIC and Landmark in an aggregate amount of approximately $520.0 million.
On July 1, 2003, AIHL acquired Resurgens Specialty Underwriting, Inc. (“Resurgens Specialty”), a specialty wholesale underwriting agency, from Royal Group, Inc., a subsidiary of Royal & Sun Alliance Insurance Group plc (“R&SA”), for cash consideration, including capitalized expenditures, of approximately $116.0 million. Resurgens Specialty became a subsidiary of RSUI Group, Inc. (“RSUI”). In connection with the acquisition of Resurgens Specialty, on June 30, 2003, RSUI Group, Inc. acquired RSUI Indemnity Company (“RIC”) from Swiss Re America Holding Corporation for cash consideration of approximately $19.7 million. On September 2, 2003, RIC purchased Landmark American Insurance Company (“Landmark”) from Guaranty National Insurance Company (“Guaranty National”)for cash consideration of $33.9 million. As a result of these acquisitions, AIHL allocated $21.9 million to goodwill and $102.9 million to intangible assets. AIHL’s results of operations include Resurgens Specialty’s results from July 1, 2003.
In March 2003, AIHL established a new specialty liability insurance underwriting company, Darwin Professional Underwriters, Inc. (“Darwin”). On May 3, 2004, AIHL acquired U.S. AEGIS Energy Insurance Company, subsequently renamed Darwin National Assurance Company (“DNA”), from Aegis Holding Inc. for cash consideration of approximately $20.4 million. On May 2, 2005, DNA purchased Ulico Indemnity Company, subsequently renamed Darwin Select Insurance Company (“Darwin Select”), from Ulico Casualty Company for cash consideration of $25.3 million. As a result of these acquisitions, AIHL allocated $3.0 million to intangible assets. Throughout 2005, AIHL owned 80 percent of the currently outstanding shares of common stock of Darwin. The remaining 20 percent of the shares of common stock of Darwin were held by members of Darwin’s management pursuant to a restricted stock plan. In 2005, certain conditions were achieved, and as a result, minority interest reflecting management’s ownership interest was recorded in 2005. There was no minority interest recorded in 2004 or 2003. Effective January 1, 2006, the Company reorganized Darwin and, as a result, AIHL owns 90 percent of Darwin and management’s ownership interest was reduced to 10 percent.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those reported results to the extent that those estimates and assumptions prove to be inaccurate.
Reinsurance recoverables (including amounts related to claims incurred but not reported (“IBNR”)) and prepaid reinsurance premiums are reported as assets. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured business. Ceded premiums are charged to income over the applicable terms of the various reinsurance contracts with third party reinsurers. Reinsurance contracts that do not result in a reasonable possibility that the reinsurer may realize a significant loss from the insurance risk assumed and that do not provide for the transfer of significant insurance risk generally do not meet the conditions for reinsurance accounting and are accounted for as deposits.
During 2005, the Company performed the impairment tests using the fair value approach required by SFAS 142. Based on these tests, there was no impairment to goodwill or intangible asset values during 2005.
The Company follows Statement of Financial Accounting Standards No. 123 (SFAS 123), “Accounting for Stock-Based Compensation Transition and Disclosure.” SFAS 123 establishes accounting and reporting standards for stock-based employee compensation plan, and allows companies to choose between the “fair value based method of accounting” as defined in SFAS 123 and the “intrinsic value based method of accounting” as prescribed by Accounting Principles Board Opinion No. 25 (APB 25), “Accounting for Stock Issued to Employees.” The Company has elected to continue to follow the “intrinsic value based method of accounting” for awards granted prior to 2003 and accordingly no expense is recognized on stock option grants. Effective January 1, 2003, the Company adopted the “fair value based method of accounting” of SFAS 123, using the prospective transition method for awards granted after January 1, 2003.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: no cash dividend yield for all years; expected volatility ranges of 17.4 to 19.1 percent; risk-free interest rates ranging from 3.21 to 4.40 percent and expected lives of up to eight years.
In June 2005 FASB Statement 154, “Accounting Changes and Error Corrections,” was issued. This Statement applies to all voluntary changes in accounting principle and changes the requirements for, and reporting of, a change in accounting principle. The new standard requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impracticable. The new standard does not change the transition provisions of any existing accounting pronouncements such as Statement 123 (revised). Statement 154 is effective for accounting changes and corrections of errors made in reporting periods beginning after December 15, 2005.
The Company’s insurance operating units, domiciled principally in the States of New Hampshire, Delaware, Wisconsin, Nebraska, Arkansas and Oklahoma, prepare statutory financial statements in accordance with the accounting practices prescribed or permitted by the insurance departments of the states of domicile. Prescribed statutory accounting practices are those practices that are incorporated directly or by reference in state laws, regulations and general administrative rules applicable to all insurance enterprises domiciled in a particular state. Permitted statutory accounting practices include practices not prescribed by the domiciliary state, but allowed by the domiciliary state regulatory authority. The impact of any permitted accounting practices on statutory surplus of the Company is not material.
On July 14, 2005, Alleghany sold its world-wide inddustrial minerals business, World Minerals, to Imerys USA, Inc. (the “Purchaser”), a wholly owned subsidiary of Imerys, S.A., pursuant to a Stock Purchase Agreement, dated as of May 19, 2005, by and among Imerys USA, Inc., Imerys, S.A. and Alleghany (the “Stock Purchase Agreement”). Under the terms of the Stock Purchase Agreement, the purchase price was $230.0 million, which was reduced by $13.2 million reflecting contractual obligations to be paid by the Purchaser after the closing, resulting in an adjusted purchase price of $216.8 million (the “Adjusted Purchase Price”). $206.8 million of the Adjusted Purchase Price was paid in cash by the Purchaser to Alleghany on the closing date, with the remaining $10.0 million being held by the Purchaser as security for certain indemnification obligations undertaken by Alleghany pursuant to the Stock Purchase Agreement. The $10.0 million holdback will bear interest at the U.S. Treasury 10-year note rate and is scheduled to be released to Alleghany (to the extent not applied toward such indemnification obligations) during the period covering the fifth through the tenth anniversaries of the closing date. Alleghany is carrying a receivable in the amount of $9.3 million on its balance sheet in respect of the holdback, equal to the $10.0 million face amount less an interest rate discount of $0.7 million. As described in more detail in Note 14, Alleghany established a $0.6 million reserve in connection with its indemnification obligations under the Stock Purchase Agreement during the 2005 second quarter. Such reserve was reduced by $54 thousand in the 2005 fourth quarter for payments made by the purchaser on Alleghany’s behalf.
The balance sheet accounts shown above are before inter-company eliminations made in the preparation of the Company’s consolidated balance sheets.
World Minerals was unprofitable in 2005 primarily due to competitive pricing pressures, rising energy and other operating costs, a $5.7 million after-tax write-off related to foreign tax credits that will not be used, $3.9 million for foreign tax expense and a $2.8 million after-tax write-off related to the termination of a major systems project in connection with the sale of World Minerals.
The proceeds from sales of available-for-sale securities were $922.2 million, $944.0 million and $751.6 million in 2005, 2004 and 2003, respectively. The amounts of gross realized gains and gross realized losses of available-for-sale securities were $152.3 million and $3.9 million in 2005, $90.8 million and $3.9 million in 2004 and $159.4 million and $7.5 million in 2003.
An investment in a debt or equity security is impaired if its fair value falls below its book value and the decline is considered to be other-than-temporary. Factors considered in determining whether a decline is other-than-temporary include: (1) the duration of time and the relative magnitude to which fair value has been below cost; (2) the financial condition and near-term prospects of the issuer; (3) extraordinary events including negative news releases and rating agency downgrades and (4) the Company’s ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery. A debt security is impaired if it is probable that the Company will not be able to collect all amounts due under the security’s contractual terms. Equity investments are impaired when it becomes apparent that the Company will not recover its cost over the expected holding period. Further, for securities expected to be sold, an other-than-temporary impairment charge is recognized if the Company does not expect the fair value of a security to recover the cost prior to the expected date of sale.
As of December 31, 2005, the Company held 739 individual debt and equity investments that were in an unrealized loss position, of which 221 investments were in an unrealized loss position continuously for six months or more. Of the 221 positions, 203 investments relate to debt securities and 18 relate to equity securities.
Notes receivable is comprised of a $91.5 million note due January 2007 bearing interest at a rate equal to the 30-day commercial paper rate plus 0.0625 percent. At December 31, 2005 such rate was 4.31 percent and at December 31, 2004, the rate was 2.32 percent. This note fully secures Alleghany Funding’s borrowings. See Note 7.
In the ordinary course of business, AIHL’s operating units purchase reinsurance for purposes of risk diversification and limiting primary maximum net loss exposure. If the assuming reinsurers are unable or unwilling to meet the obligations assumed under the applicable reinsurance agreements, AIHL’s insurance operating units would remain liable to their policyholders for such reinsurance portion not paid by their reinsurers. Reinsurance recoverables at December 31, 2005, 2004 and 2003 consist of the following (in thousands):
of binders, policies and contracts of insurance issued by Platte River to the date of closing under the Stock Purchase Agreement. AIHL recorded a reinsurance recoverable and a corresponding loss reserve liability in the amount of $181.3 million at the time it acquired Platte River. Such reinsurance recoverables and loss reserve liability may change as losses are reported. Such amounts were $51.6 million, $72.0 million and $92.0 million for Platte River at December 31,2005, 2004 and 2003, respectively.
In general, AIHL’s insurance operating units obtain reinsurance on a treaty and facultative basis. RSUI uses surplus share, quota share and excess of loss reinsurance treaties, as well as facultative reinsurance, on an extensive basis in order to build stable capacity and to provide protection against accumulations of catastrophe risk. In 2005, RSUI ceded 50 percent of its gross premiums written to reinsurers. Although the net amount of loss exposure retained by RSUI varies by line of business, in general, as of December 31, 2005, RSUI retained a maximum net exposure for any single property risk of $7.5 million and any single casualty risk of $8.0 million, with the exception of losses arising from acts of foreign terrorism. With respect to RSUI’s property lines of business, RSUI reinsures through a program consisting of surplus share treaties, facultative placements, per risk and catastrophe excess of loss treaties. Under it surplus share treaties, RSUI is indemnified on a pro rata basis against covered property losses. The amount indemnified is based on the proportionate share of risk ceded after consideration of a stipulated dollar amount or “line” for RSUI to retain in relation to the entire limit written. RSUI ceded approximately 36 percent of its property gross premiums written in 2005 under these surplus share treaties. Under RSUI’s property per risk reinsurance program, RSUI is reinsured for $95.0 million in excess of a $5.0 million net retention per risk after the application of the surplus share treaties and facultative reinsurance. RSUI’s property catastrophe reinsurance program provides $360.0 million of aggregate limits on net losses after application of the surplus share treaties, facultative reinsurance and per risk covers. After deducting all recoveries from these reinsurance programs, RSUI retains $40.0 million of net losses before the catastrophe reinsurance program attaches. Once net losses exceed $40.0 million, RSUI has a 5 percent co-participation in losses in excess of the $40.0 million retention up to $400.0 million of net losses (or $18.0 million). RSUI retains 100 percent of the net losses above $400.0 million.
With respect to its other lines of business, RSUI reinsures through quota share treaties. For umbrella, its quota share treaty provides reinsurance for policies with limits up to $30.0 million, with RSUI ceding 50 percent of the premium and loss for policies with limits up to $10.0 million and ceding 75 percent of the premium and loss for policies with limits in excess of $10.0 million up to $30.0 million. For professional liability, its treaty provides reinsurance for policies with limits up to $5.0 million, with RSUI ceding 25 percent of the premium and losses for policies with limits up to $1.0 million and ceding 50 percent of the premium and loss on policies with limits greater than $1 million up to $5.0 million. Its primary casualty lines treaty provides reinsurance for policies with limits up to $2.0 million, with RSUI ceding 25 percent of the premium and loss. Finally, its D&O liability line treaty provides reinsurance for policies with limits up to $20.0 million, with RSUI ceding 40 percent of the premium and loss for all policies with limits up to $10.0 million, ceding 60 percent of the premium and loss for policies classified as “for profit” with limits in excess of $10.0 million up to $15.0 million, and ceding 60 percent of the premium and loss for policies classified as “not for profit” with limits in excess of $10.0 million up to $20.0 million.
In general, Darwin purchases excess of loss reinsurance on a treaty basis to stop its loss from a single occurrence on any one coverage part of any one policy. For its D&O and the majority of its E&O liability lines of business, Darwin generally retains $2.75 million of loss on policies written at Darwin’s maximum offered limit of $10.0 million. For Darwin’s managed care E&O line, where Darwin has written limits up to $20.0 million, Darwin generally retains
Ceded loss recoveries for AIHL included in the Company’s consolidated statements of earnings are approximately $1.3 billion, $567.1 million and $107.2 million for the three years ended December 31, 2005.
hurricanes. Casualty lines of business increased $426.9 million reflecting increased business generated by RSUI, acquired in July 2003 and Darwin, which commenced operations in May 2003. Gross loss and loss adjustment expense reserves also declined by $33.5 million due to the settlement in 2004 by the sellers of Platte River and Landmark of loss reserves acquired in connection with the acquisition of those companies. Information regarding such acquired reserves is contained in Note 5. With respect to losses and loss adjustment expenses incurred related to prior years, 2005 and 2004 amounts are indicative of overall favorable loss experience, whereas the 2003 amount reflects a reserve strengthening by CATA on its assumed reinsurance treaties related to asbestos and environmental impairment liabilities. Reserves acquired in 2003 are those reserves acquired in connection with the acquisition of Platte River and Landmark, as described in Note 5.
In June 2004, Alleghany’s 364-day revolving credit facility expired and was not renewed. In July 2004, Alleghany entered into a new three-year revolving credit facility in the amount of $200.0 million to replace its previous three-year revolving credit facility. Under the revolving credit facility, at Alleghany’s option, borrowings bear interest at a rate based on the prevailing rates for dollar deposits in the London interbank market or the greater of the federal funds rate and the administrative agent bank’s prime rate plus applicable margins. No amounts were outstanding at the 2005 and 2004 year ends. A commitment fee of 1/4 of 1 percent per annum of the unused commitment is charged. The revolving credit agreement requires Alleghany, among other things, to maintain tangible net worth of not less than $1.17 billion, limit the amount of certain other indebtedness, and maintain certain levels of unrestricted liquid assets. Such agreement also contains restrictions with respect to mortgaging or pledging any of Alleghany’s assets and the consolidation or merger with any other corporation. At December 31, 2005, Alleghany was in full compliance with these requirements and restrictions.
Regarding Alleghany’s interest rate swaps, the impact of Alleghany’s hedging activities has been to increase (decrease) its weighted average borrowing rates by 1.3 percent, (0.6) percent and (1.0) percent, and to increase (decrease) reported interest expense by $1.6 million, $0.1 million and $(0.5) million for the years ended 2005, 2004 and 2003, respectively.
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2005 and 2004 are as follows (in thousands):
As described in Note 2.b., Alleghany sold World Minerals on July 14, 2005. As a result of the sale and Section 338(h)(10) election, Alleghany was able to retain certain tax benefits, including foreign tax credit carryovers of $19,247 thousand generated by World Minerals. A full valuation allowance was established for the foreign tax credits as Alleghany does not currently anticipate generating sufficient foreign source income to absorb these credits.
As of December 31, 2004, the comparable amount of the foreign tax credit deferred tax asset was $13,008 thousand with a valuation allowance of $8,829 thousand. Such amounts are included in the Assets of discontinued operations in the Company’s consolidated balance sheet.
AIHL’s insurance operating units are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid without prior approval of insurance regulatory authorities. In 2005, a maximum amount of $73.9 million $20.1 million and $11.5 million was available without prior approval of the New Hampshire, Wisconsin and Oklahoma insurance departments, respectively. In 2005, no dividends were available to be paid without regulatory authority approval in Delaware, Nebraska and Arkansas.
Additionally, payments of dividends (other than stock dividends) by Alleghany to its stockholders are limited by the terms of its revolving credit facility which provide that Alleghany can pay dividends up to the sum of cumulative net earnings after December 31, 2003, proceeds from the issuance of stock after December 31, 2003, and $50.0 million, provided that Alleghany maintains certain financial ratios as defined in the agreement. At December 31, 2005, approximately $223.8 million of common stockholders’ equity was available for dividends by Alleghany to its stockholders.
Compensation cost that has been charged against income for Alleghany’s incentive and stock-based plans was $16.7 million, $16.7 million and $7.7 million, in 2005, 2004 and 2003, respectively.
In October 1997, options outstanding under the 1993 Stock Option Plan of Underwriters Re Group were exchanged for Alleghany options under the Underwriters Re Group 1997 Stock Option Plan, which is still in effect. No options were issued in 2005. At December 31, 2005, options to purchase 6,717 shares were outstanding and vested at an average option price of $113.45.
Statutory net (loss) income of the Company’s insurance operating units was $(44.9) million and $99.5 million for the years ended December 31, 2005 and 2004, respectively. Statutory capital and surplus of the Company’s insurance operating units was $1,232.1 million and $854.0 million at December 31, 2005 and 2004, respectively.
Alleghany has two unfunded noncontributory defined benefit pension plans for executives and a funded noncontributory defined benefit pension plan for employees. Under the executive plans, defined benefits are based on years of service and the employee’s highest average annual base salary over a consecutive three-year period during the last ten years or, if shorter, the full calendar years of employment, plus one-half of the highest average annual cash bonus over a consecutive five-year period during the last ten years of employment, or, if shorter, the full calendar years of employment. With respect to the funded employee plan, Alleghany’s policy is to contribute annually the amount necessary to satisfy the Internal Revenue Service’s funding requirements. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future.
During 2004, Alleghany’s executive plan was amended and changed from a funded to an unfunded plan resulting in the distribution of all accrued benefits to vested participants.
Alleghany’s investment policy with respect to its defined benefit plans is to provide long-term growth combined with a steady income stream. The target allocation is 100 percent in debt securities. The overall long-term, rate-of-return-on-assets assumptions are based on historical investments.
The measurement date used to determine pension and other postretirement benefit plans is December 31, 2005.
Alleghany provides supplemental retirement benefits through deferred compensation programs and profit sharing plans for certain of its officers and employees for which earnings were charged $6.6 million in 2005, $6.7 million in 2004 and $2.7 million in 2003.
The components of accumulated other comprehensive income at December 31 are as follows (in thousands):
Contingently issuable shares of 69,185, 105,202 and 81,875 were potentially available during 2005, 2004 and 2003, respectively, but were not included in the computations of diluted earnings per share because the impact was anti-dilutive to the earnings per share calculation.
The Company leases certain facilities, furniture and equipment under long-term lease agreements. In addition, certain land, office space and equipment are leased under noncancelable operating leases that expire at various dates through 2016. Rent expense was $8.2 million, $6.7 million and $3.8 million, in 2005, 2004 and 2003, respectively.
Talbot Holdings Ltd., the new owners of Alleghany Underwriting Holdings Ltd., raised new capital in the Lloyd’s insurance market. In January 2003, Alleghany agreed to provide a $15.0 million letter of credit to support the business written by a new syndicate of Talbot Holdings Ltd. during 2003 and 2004. Such letter of credit was reduced to $10.0 million in December 2003 and was extinguished on June 29, 2005.
AIHL’s reserve for unpaid losses and loss adjustment expenses includes $25.6 million and $26.4 million of gross and net reserves at December 31, 2005 and 2004, respectively, for various liability coverages related to asbestos and environmental impairment claims that arose from reinsurance assumed by a subsidiary of CATA between 1969 and 1976. This subsidiary exited this business in 1976. Reserves for asbestos and environmental impairment claims cannot be estimated with traditional loss reserving techniques because of uncertainties that are greater than those associated with other types of claims. Factors contributing to those uncertainties include a lack of historical data, the significant periods of time that often elapse between the occurrence of an insured loss and the reporting of that loss to the ceding company and the reinsurer, uncertainty as to the number and identity of insureds with potential exposure to such risks, unresolved legal issues regarding policy coverage, and the extent and timing of any such contractual liability. Loss reserve estimates for such environmental and asbestos exposures include case reserves, which also reflect reserves for legal and other loss adjustment expenses and IBNR reserves. IBNR reserves are determined based upon historic general liability exposure base and policy language, previous environmental loss experience and the assessment of current trends of environmental law, environmental cleanup costs, asbestos liability law and judgmental settlements of asbestos liabilities.
For both asbestos and environmental reinsurance claims, CATA establishes case reserves by receiving case reserve amounts from its ceding companies and verifies these amounts against reinsurance contract terms, analyzing from the first dollar of loss incurred by the primary insurer. In establishing the liability for claims for asbestos related liability and for environmental impairment claims, management considers facts currently known and the current state of the law and coverage litigation. Additionally, ceding companies often report potential losses on a precautionary basis to protect their rights under the reinsurance arrangement, which generally calls for prompt notice to the reinsurer. Ceding companies, at the time they report such potential losses, advise CATA of the ceding companies’ current estimate of the extent of such loss. CATA’s claims department reviews each of the precautionary claims notices and, based upon current information, assesses the likelihood of loss to CATA. Such assessment is one of the factors used in determining the adequacy of the recorded asbestos and environmental reserves. Although Alleghany is unable at this time to determine whether additional reserves, which could have a material impact upon its results of operations, may be necessary in the future, Alleghany believes that CATA’s asbestos and environmental reserves are adequate at December 31, 2005.
In connection with the sale of World Minerals, Alleghany undertook certain indemnification obligations pursuant to the Stock Purchase Agreement including a general indemnification provision for breaches of representations and warranties set forth in the Stock Purchase Agreement (the “Contract Indemnification”) and a special indemnification provision related to products liability claims arising from events occurring during pre-closing periods (the “Products Liability Indemnification”). The representations and warranties to which the Contract Indemnification applies survive for a two-year period (with the exception of certain representations and warranties such as those related to environmental, real estate and tax matters, which survive for periods longer than two years) and generally, except for tax and certain other matters, apply only to aggregate losses in excess of $2.5 million, up to a maximum of approximately $123.0 million.
During the Alleghany Period, World Minerals was named in approximately 30 lawsuits that included product liability claims, many of which have been voluntarily dismissed by the plaintiffs. In most cases, plaintiffs claimed various medical problems allegedly stemming from their exposure to a wide variety of allegedly toxic products at their place of employment, and World Minerals was one among dozens of defendants that had allegedly supplied such products to plaintiffs’ employers. Through the date of sale, World Minerals did not incur any significant expense in respect of such cases. Based on Alleghany’s experience to date and other analyses, Alleghany established a $600 thousand reserve in connection with the Products Liability Indemnification for the Alleghany Period. Such reserve was $546 thousand at December 31, 2005.
The estimated carrying values and fair values of the Company’s financial instruments are as follows (in thousands):
Investments: The fair value of equity securities and debt securities is based upon quoted market prices. The fair value of short-term investments approximates amortized cost. The fair value of other invested assets is based upon quoted market prices for the securities owned by the partnerships.
Information related to Alleghany’s reportable business operating segments is shown in the tables below (in thousands). Alleghany’s reportable segments are reported in a manner consistent with the way management evaluates the businesses. As such, insurance underwriting activities are evaluated separately from investment activities. Realized investment gains are not considered relevant in evaluating investment performance on an annual basis.
a. The amount of goodwill included in the Company’s consolidated balance sheets at December 31, 2005 and 2004 is as follows (in thousands):
b. The amount of other intangible assets, net of amortization, included in the Company’s consolidated balance sheets at December 31, 2005 and 2004 is as follows (in thousands):
The economical useful lives of intangible assets are as follows: agency relationships (15 years) state insurance licenses (indefinite), trade name (indefinite), broker and reinsurance relationships (15 years) and renewal rights (5.5 years).
c. Other assets shown in the Company’s consolidated balance sheets include the following amounts at December 31, 2005 and 2004 (in thousands):
e. Other liabilities shown in the Company’s consolidated balance sheets include the following amounts at December 31, 2005 and 2004 (in thousands):
Quarterly results for June 30 and September 30, 2005 have been restated to correctly account for a $4.2 million increase in a deferred tax valuation allowance which had been established at June 30, 2005, and was subsequently reversed at September 30, 2005. In accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes”, the effect of a change in valuation allowance should be classified as part of continuing operations. Accordingly, the table above reflects the restatement of such amounts from discontinued operations to continuing operations and its impact on earnings per share. This restatement had no impact on the Company’s net earnings or financial position for any period during 2005.
Earnings (loss) per share by quarter may not equal the amount for the full year due to rounding.
During 2003, Alleghany made an investment of $10.0 million in Broadfield Capital, L.P., an investment fund formed and managed by a limited liability company owned by Jefferson W. Kirby. This fund invests in small and mid-cap public equities, private equities and distressed debt. Such investment was valued at $10.8 million at December 31, 2005 and $11.1 million at December 31, 2004. Mr. Kirby was a Vice President of Alleghany until June 30, 2003, and is a son of F.M. Kirby, Chairman of the Board of Alleghany. Alleghany’s Board of Directors has nominated Mr. Kirby for election as a director at the 2006 Annual Meeting of Stockholders.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Alleghany Corporation and subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.
In our opinion, management’s assessment that Alleghany Corporation maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Alleghany Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).