We currently rent office space in Hamilton, Bermuda for our holding company and Bermuda operations. For our UK based reinsurance and insurance operations, in June 2003 we entered into a sublease with ACE Global Markets Ltd. to occupy space within their offices at 100 Leadenhall Street, London. The lease covers one and a half floors of the building (up to 14,000 square feet in total) and is for a three-year period with an option to terminate upon 6 months' notice at any time after 18 months. We also license office space within the Lloyd's building on the basis of a renewable twelve-month lease. In addition we lease office space in Boston, Massachusetts, Marlton, New Jersey and Rocky Hill, Connecticut.
The following overview of our 2003 operating results and financial condition is intended to identify important themes and should be read in conjunction with the more detailed discussion further below.
We monitor the ratio of expenses to net earned premium (the "expense ratio") as a measure of the cost effectiveness of our business acquisition, operating and administrative processes. The expense ratio was 25% for 2003 and was the same for 2002. The expense ratio for 2003 includes one percentage point attributable to the expensing of employee options under FAS 123.
We did not pay any dividends to shareholders in 2003 but our board of directors has agreed a policy to commence a quarterly dividend payment of $0.03 per ordinary share starting in the first quarter of 2004.
Management considers that the Company's trading position has been enhanced as a result of its enhanced capital and surplus position which is important in securing the confidence of policyholders and in providing capital to support continued development of the insurance and reinsurance business conducted by our Insurance Subsidiaries.
• the issuance of new shares in connection with the Company's initial public offering on December 4, 2003 which raised $244 million;
• a net increase in currency gains less investment losses accounted for as Other Comprehensive Income of $14.6 million.
Management monitors the liquidity of Aspen Holdings and of each of its Insurance Subsidiaries. In relation to Aspen Holdings, we monitor its ability to service debt, to finance dividend payments to shareholders and to provide financial support to the Insurance Subsidiaries. During 2003, the cash position of Aspen Holdings was significantly enhanced by the payment of $20 million in dividends by Aspen Re to Aspen Holdings and by the retention within Aspen Holdings of part of the proceeds from our initial public offering. As at December 31, 2003, Aspen Holdings held $52.7 million in cash and fixed interest securities and $12.6 million in short-term investments which management considers sufficient to provide us liquidity at this time.
At December 31, 2003, the Insurance Subsidiaries held $765.8 million in cash and short-term investments that are readily realizable securities. Operating cash flow, borrowing and the issuance of additional ordinary shares for cash increased the total cash and cash equivalents held by the Aspen group by $221.2 millions during the twelve months ended December 31, 2003. Management monitors the value, currency and duration of the cash and investments within its Insurance Subsidiaries to
While demand in the marketplace is changing for different business lines, the overall market environment remains encouraging, particularly in the casualty reinsurance and U.K. liability businesses, which are areas in which we have a strong presence. Our initial portfolio comprised 28% casualty risks and in 2003 the casualty business was increased to 40% on a written basis. In 2004, we expect the overall casualty portion of our business to grow to around 44%. We consider this to be an opportune time to devote a substantial part of our overall business to casualty because the environment is now particularly favorable.
With respect to our property reinsurance business, we experienced a strong start to the year. Even though we anticipate that property reinsurance rates will decline this year by about 7%, we still managed to renew our significant January 1 book of business with the same level of rate adequacy as in the prior year, benefiting from our strong focus on complex risks, which command higher margins and tighter terms and which are currently subject to less competition than some other more mainstream areas in the property reinsurance business.
On a written basis, property catastrophe excess of loss reinsurance represented about 16% of our business in 2003 on a written basis. We currently believe that this will decline to around 14% in 2004, as we continue to focus on the strong casualty reinsurance lines and on our insurance businesses.
• the distribution of the renewal dates of the business we write which are fairly evenly distributed through the year for our insurance business but are concentrated at the beginning of quarters (particularly January 1st) for our reinsurance business; and
Revenues also include investment income and realized investment gains offset by realized investment losses. Investment income is derived from holdings of cash and money market deposits and from fixed income investments. Realized investment gains and losses are derived from the sale of fixed income investments all of which are held as marketable securities available for sale. These securities are carried at fair market value and any resulting unrealized gains and losses are not included as revenue in our statement of operations but are included in comprehensive income as a separate component of shareholders' equity.
Operating and administrative expenses. These expenses consist primarily of staff compensation, payroll taxes, accommodation costs, information technology and other operating expenses and professional fees. This heading also includes depreciation of tangible assets. Staff compensation includes salaries, bonuses, stock options and benefits such as medical insurance and pension contributions.
Premiums are recognized as earned evenly over the policy periods using the daily pro rata method.
The proportion of the premium related to the unexpired portion of each policy at the end of the reporting period is included in the balance sheet as unearned premiums.
The following presents our loss reserves by business segment as at December 31, 2003.
Loss reserves presented on an "underwriting year" basis represent claims related to all policies incepting in a given year. In contrast, "accident year" loss reserves represent claims for events that occurred during a given calendar year, regardless of when the policy was written. Loss reserves on an underwriting year basis may include claims from different accident years. For example, a policy written during 2002 may have losses in accident year 2002 and in accident year 2003. Therefore, underwriting year data as of a particular evaluation date is less mature than accident year data.
In the twelve months ended December 31, 2003, there was a reduction of our estimate of the ultimate claims to be paid in respect of the 2002 accident year of $9.6 million. An analysis of this reduction by line of business is as follows:
The favorable development during the twelve months ended December 31, 2003 of $9.6 million in respect of losses incurred during 2002 primarily resulted from the nature of the business earned in 2002. The key elements that gave rise to the changes in the estimated reserves and which enabled the actuarial projections to be refined were as follows:
• The Company only commenced underwriting in 2002 and, although some of the lines of business have been written for a number of years in the Syndicates' operations, some lines were new to the Company. The reserving process requires estimates to be made based on both the current and historical information. For those lines of business new to the Company, the historical information relies to a greater degree on market information. As time progresses, the reserves in respect of these lines of business are refined as additional data is received.
Property reinsurance: The net reserves of the property reinsurance line of business as at December 31, 2002 were $24 million, of which $9 million related to the Wellington quota share arrangements. Premiums and claims information received from the Syndicates and other cedents during the twelve months ended December 31, 2003 has indicated both a reduction in the 2002 underwriting year loss ratio and also an improvement in the accident year loss ratio for 2002. This results from a lower development of the severity of reported claims than is often observed in this line of business and gives rise to a $3.8 million reduction in reserves.
Casualty Reinsurance: The net reserves of the casualty reinsurance line of business as at December 31, 2002 were $10 million. Although we do not receive notice of most of the claims in this line of business until a considerable time has passed, some claims have a shorter notification period due to some of the more catastrophic elements of the business. The development of incurred losses in the twelve months subsequent to December 31, 2002 has enabled a small reduction in the projected loss ratio for this business from that suggested by the actuarial projection at December 31, 2002, giving rise to the reduction in reserves of $0.4 million.
Commercial Property: The net reserves of the property insurance line of business as at December 31, 2002 were $2.4 million. This account had only two years of Syndicates history prior to its being written by the Company. The reserves established as at December 31, 2002 were partly based upon the historical performance experienced in those two years. During the course of 2003, the historical information improved due in particular to the settlement of one claim significantly below its case reserve. This improvement enabled us to reassess the likely level of IBNR claims in respect of the 2002 accident year, resulting in a reduction in reserves of $1.2 million.
Estimates of IBNR are generally subject to a greater degree of uncertainty than estimates of the cost of settling claims already notified to the Company, where more information about the claim event is generally available. IBNR claims often may not be apparent to the insured until many years after the event giving rise to the claims has happened. Lines of business where the IBNR proportion of the total reserve is high, such as liability insurance, will typically display greater variations between initial estimates and final outcomes because of the greater degree of difficulty of estimating these reserves. Lines of business where claims are typically reported relatively quickly after the claim event tend to display lower levels of volatility between initial estimates and final outcomes. Allowance is made, however, for changes or uncertainties which may create distortions in the underlying statistics or which might cause the cost of unsettled claims to increase or reduce when compared with the cost of previously settled claims including:
In 2002 we derived a significant proportion of our premiums from two quota share contracts under which we reinsured part of the portfolio of risks written by the Syndicates and managed by WUAL (the "Wellington 2002 quota share arrangements"). With effect from January 1, 2003 we renewed reinsurance business and U.K. insurance business previously written by the Syndicates within our own U.K. subsidiary. We did however continue to assume risks in respect of other lines of business written by Syndicate 2020 from January 1, 2003 under a quota share contract under which we accepted 7.5% of most of the classes written by the Syndicate from that date. The 2003 quota share arrangement with Syndicate 2020 is a much less significant part of our business than were the Wellington 2002 quota share arrangements.
Aspen Holdings was formed on May 23, 2002 but did not commence operations until June 21, 2002. The condensed consolidated statement of operations for the period from May 23, 2002 to December 31, 2002 therefore reflects the results of our business operations for only twenty-eight weeks and comparisons with the twelve months ended December 31, 2003 may not be meaningful and therefore, the two periods are not generally compared directly below.
Net premiums written. Net premiums written for the period were $1,092.8 million.
Net premiums earned. Net premiums earned for the period were 812.3 million, representing 74.3% of net premiums written.
Insurance losses and loss adjustment expenses. Insurance losses and loss adjustment expenses for the period were $428.4 million including paid claims of $53.9 million. Of the total gross reserves for unpaid losses of $525.8 million at the balance sheet date a total of $341.0 million represented IBNR claims.
Policy acquisition expenses. Policy acquisition expenses for the period were $152.3 million representing 18.7% of net premiums earned.
Net income. Net income for the period was $152.1 million, equivalent to $2.63 earnings per basic share and $2.56 fully diluted earnings per share on the basis of the weighted average number of shares in issue during the period.
Net investment income. Net investment income of $8.5 million for the period was mainly derived from bank deposits and holdings of money market funds.
Net income. Net income for the period was $28.6 million, equivalent to $0.89 earnings per basic and fully diluted share on the basis of the weighted average number of shares in issue during the period.
Net reserves for loss and loss adjustment expenses as at December 31, 2003 and
Premiums. Gross premiums written for the period were $1,001.9 million, comprising $558.2 million property, $292.3 million casualty and $151.4 million specialty.
Policy acquisition, operating and administration expenses. Total expenses were $165.6 million for the period, equivalent to 22.2% of gross earned premiums.
The following table summarizes gross and net written premiums and underwriting results for each of the lines of business within our reinsurance segment for the period from May 23, 2002 to December 31, 2002:
We write both commercial property and commercial liability insurance. Our commercial property line of business is primarily composed of U.K. commercial property insurance. No major claims have been notified in respect of this business.
Premiums. Gross premiums written for the period were $304.9 million, comprising $81.7 million property and $223.2 million liability.
Losses and loss adjustment expenses. Losses and loss adjustment expenses were $125.4 million for the period, representing 58.1% of net earned premiums for the period.
Policy acquisition, operating and administration expenses. Total expenses were $40.0 million for the period, equivalent to 16.6% of gross earned premiums.
Losses and loss adjustment expenses. Total loss and loss adjustment expenses were $16.0 million representing 68.4% of net premiums earned.
We did not pay any dividends to shareholders in 2003 but our board of directors has agreed a policy to commence a quarterly dividend payment of $0.3 per ordinary share starting in the first quarter of 2004.
Management monitors the liquidity of Aspen Holdings and of each of its Insurance Subsidiaries. In relation to Aspen Holdings, we monitor its ability to service debt, to finance dividend payments to shareholders and to provide financial support to the Insurance Subsidiaries. During 2003, the cash position of Aspen Holdings was significantly enhanced by the payment $20.0 million in dividends by Aspen Re to Aspen Holdings and by the retention within Aspen Holdings of part of the proceeds from our initial public offering. As at December 31, 2003, Aspen Holdings held $52.7 million in cash and fixed interest securities and $12.6 million in short-term investments which management considers sufficient to provide us liquidity at this time.
Cash flows for the period from incorporation on May 23, 2002 to December 31, 2002. In the period from May 23, 2002 to December 31, 2002, we received $836.9 million in cash from a private placement of our ordinary shares, net of equity raising costs of $28.1 million. During this period, we generated an operating net cash inflow of $78.1 million, primarily relating to net premiums received by Aspen Re We did not make any significant capital expenditures during the period from inception to December 31, 2002. We made net investments of $899.7 million in market securities in the period, and had a cash balance of $9.6 million at December 31, 2002.
Aspen Bermuda is subject to the solvency requirements of the Insurance Act. See Item 1, "-Regulatory Matters - Bermuda Regulation" elsewhere in this report. Aspen Bermuda's fully paid up share capital was $1.0 million and statutory capital and surplus was $357.5 million at December 31, 2003.
For these purposes, we have specifically established a facility for the issuance of letters of credit in the amount of $50 million with Citibank, N.A. As at December 31, 2003, letters of credit totaling $24.5 million had been issued by Citibank. In addition, Barclays Bank plc has issued letters of credit totaling £47.4 million to policyholders of the Company. The Company has provided collateral to Citibank and Barclays Bank plc for the full value of the letters of credit issued on its behalf. On June 23, 2003 we established a trust fund at the Bank of New York which will be used as an alternative to letters of credit to satisfy our obligations to provide security to certain U.S.-domiciled cedents. As at December 31, 2003 the balance on this fund was $45.6 million. On July 16, 2003 we established an additional trust fund at the Bank of New York, with a balance of $5.4 million, which will serve a similar purpose with respect to certain U.S. insurance clients of Aspen Re for whom we provide surplus lines insurance.
The Credit Agreements include covenants which require the Company to (i) maintain a ratio of consolidated debt to consolidated debt plus consolidated tangible net worth of no greater than 30% as at the last day of any period of four consecutive fiscal quarters of the Company for any period of four consecutive fiscal quarters; (ii) maintain consolidated tangible net worth at all times of no less than the sum of (a) $700 million, (b) 100% of the first $200 million of net cash proceeds of the issuance by Aspen Holdings of ordinary shares after the closing date of the Credit Facilities and (c) 50% of the net cash proceeds of all other issuances by Aspen Holdings of ordinary shares after the closing date; and (iii) maintain a solvency ratio for each of Aspen Holdings and any insurance subsidiary which is a Material Subsidiary on the last day of any period of four consecutive fiscal quarters of no more than 135%. Other covenants include restrictions on the types and amounts of indebtedness Aspen Holdings and any subsidiary may create or incur, prohibitions on the disposition of property by Aspen Holdings and any subsidiary and restrictions on investments, loans and advances by Aspen Holdings and any subsidiary. As of December 31, 2003, we were in compliance with these covenants. Aspen Holdings and its subsidiaries are also prohibited from paying any dividends or making any payments on account of a sinking or other analogous fund for the purchase, redemption or other acquisition of any share capital or capital stock of Aspen Holdings or any subsidiary; provided, however, that any such payments may be made by any subsidiary to Aspen Holdings or another subsidiary (other than an Insurance Subsidiary) and so long as no default or event of default exists under the Credit Agreements or would result from such payment, Aspen Holdings may during any fiscal year pay cash dividends in an aggregate amount not to exceed 50% of its consolidated net income for such fiscal year.
The amounts outstanding under our credit facilities are the only material debt that we have outstanding. Management monitors the ratio of debt to total capital, defined as shareholders' equity plus outstanding debt. At December 31, 2003 this ratio was 3% (2002 - Nil). Management considers this to be well under the level at which it would expect rating agencies or customers to be concerned about excessive financial leverage.
We expect that the proceeds of our initial public offering, together with the capital base we established in the private placement, the proceeds drawn under our credit facilities and internally generated funds, to be sufficient to operate our business.