The following table sets forth our selected financial data and other financial information as at December 31, 2003, 2002 and 2001 and for the years ended December 31, 2003, 2002 and for the period from November 14, 2001 to December 31, 2001. The historical financial information was prepared in accordance with U.S. GAAP. The statement of income data for the periods ended December 31, 2003, 2002 and 2001, and the balance sheet data at December 31, 2003, 2002 and 2001 were derived from our audited consolidated financial statements, which have been audited by PricewaterhouseCoopers, our independent auditors. You should read the selected
financial data in conjunction with our consolidated financial statements and related notes thereto contained in Item 8 - “Financial Statements and Supplementary Data” and
Property Catastrophe - These contracts are typically “all risk” in nature, providing protection against losses from earthquakes and hurricanes, as well as other natural and man-made catastrophes such as floods, tornadoes, fires and storms. The predominant exposures covered are losses stemming from property damage and business interruption coverage resulting from a covered peril. Certain risks, such as war, nuclear contamination and terrorism, are almost always excluded, partially or wholly, from our contracts. Property catastrophe reinsurance is written on an excess of loss basis, which provides coverage to primary insurance companies when aggregate claims and claims expenses from a single occurrence from a covered peril exceed a certain amount specified in a particular contract.
Our expenses consist primarily of three types: loss and loss adjustment expenses, policy acquisition costs and general and administrative expenses.
Loss and loss adjustment expenses are a function of the amount and type of insurance and reinsurance contracts we write and of the loss experience of the underlying risks. We estimate loss and loss adjustment expenses based on an actuarial analysis of the estimated losses we expect to be reported on contracts written. Under U.S. GAAP, we reserve for catastrophic losses as soon as a loss event is known to have occurred. The ultimate loss and loss adjustment expenses will depend on the actual costs to settle claims. We will increase or
decrease our initial loss estimates as actual claims are reported and settled. Our ability to estimate loss and loss adjustment expenses accurately at the time of pricing our contracts will be a critical factor in determining our profitability.
Acquisition costs consist principally of brokerage expenses and commissions that represent a percentage of the premiums on reinsurance contracts written, and vary depending upon the amount and types of contracts written, and to a lesser extent ceding commissions paid to ceding insurers and excise taxes. Under certain contracts we may also pay profit commission to cedents which will vary depending on the loss experience on the contract.
At the discretion of the Compensation and Nominating Committee of the Board of Directors, the Company has awarded, and may in the future award, performance units to executive officers and certain other key employees. For additional information concerning the Company’s Performance Unit Plan, see the Summary of Critical Accounting Policies below.
As part of our formation, we granted 2,040,000 share options to our President and Chief Executive Officer, Anthony Taylor. In September 2002, 510,000 additional options for common shares were granted to other senior executives. From inception, we have adopted FAS 123 “Accounting for Stock-Based Compensation,” which recommends the recognition of compensation expense for the fair value of stock compensation awards on the date of grant. The compensation expense is recognized over the vesting period of each grant, with a corresponding recognition of the equity expected to be issued in additional paid-in capital.
The Company’s consolidated financial statements have been prepared in accordance with U.S. GAAP. The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect reported and disclosed amounts of assets and liabilities, as well as disclosure of contingent assets and liabilities as at the balance sheet date and the reported amounts of revenues and expenses during the reporting period. We believe the following accounting policies are critical to our operations as their application requires management to make the most significant judgments.
Loss and Loss Adjustment Expense Reserves. For most insurance and reinsurance companies, the most significant judgment made by management is the estimation of the loss and loss adjustment expense reserves. Due to the short-tail nature of our property business, generally we expect that the majority of these losses will be paid relatively quickly. However, this can be affected by such factors as the event causing the loss, the location of the loss, and whether our losses are from policies with insurers or reinsurers. Additionally, for our casualty business, there is the potential for long claim reporting lags and for the emergence of new classes or types or losses. Accordingly, it is necessary to estimate, as part of the loss and loss adjustment expense reserve, an amount for IBNR.
A significant portion of our business is property catastrophe and other classes with high attachment points of coverage. Reserving for losses in such programs is inherently complicated in that losses in excess of the attachment level of our policies are characterized by high severity and low frequency. This limits the volume of industry claims experience available from which to reliably predict ultimate loss levels following a loss event. In addition, there always exists a reporting lag between a loss event taking place and the reporting of the loss, which can sometimes be several years, particularly on longer-tail classes of business such as casualty. During this period, additional facts and trends will be revealed and as these factors become apparent, reserves will be adjusted. These incurred but not reported losses are inherently difficult to predict. Changes to our prior year loss reserves can impact our current underwriting results by improving our results if the prior year reserves prove to be redundant or reducing our results if the prior year reserves prove to be insufficient. Because of the variability and uncertainty associated with loss estimation, it is possible that our individual case reserves for each catastrophic event and other case reserves are incorrect, possibly materially. This volatility will affect our results in the period that the loss occurs because U.S. GAAP does not permit reinsurers to reserve for such catastrophic events until they occur and may give rise to a claim. As a result, no allowance for the provision of a contingency reserve to account for expected future losses can be recorded. Claims arising from future catastrophic events can be expected to require the establishment of substantial reserves from time to time. We expect that increases in the values and concentrations of insured property will increase the severity of worldwide catastrophic losses in the future.
These factors require us to make significant assumptions when establishing loss reserves. For losses which have been reported us, we estimate our ultimate loss using the following: (1) claims reports from insureds; (2) our underwriters and management experience in setting claims reserves; and (3) the use of computer models where applicable. Since we have insufficient past loss experience, management supplements this information with industry data. This industry data may not match our risk profile, which introduces a further degree of uncertainty into the process. For losses which have been incurred but not reported, the reserving process is further complicated.
On pro-rata contracts, including QQS arrangements, we estimate ultimate losses based on loss ratio forecasts as reported quarterly by cedents, which is normally on a quarterly or six month lag. We also review historical loss ratios from prior years as provided by each cedent, as well as public reports. We base our estimate of the ultimate losses on both of these factors. Estimated losses can change, based on revised projections supplied by the underlying cedents and actuarial support of the underwriting year forecasts. The resulting changes in incurred losses are recorded in the period in which they are determined.
These complications, together with the potential for unforeseen developments, may result in loss and loss adjustment expenses significantly greater or less than the reserve provided. Reserving can prove especially difficult should a significant loss event take place near the end of an accounting period, particularly if it involves a catastrophic event.
Management has determined that the best estimate for gross loss and loss adjustment expense reserves at December 31, 2003 was $249.8 million. Management’s best estimate of a range of likely outcomes around this estimate is between $209.0 million and $290.6 million.
Premiums. Premium income is primarily earned ratably over the term of the insurance policy. Premiums derived from pro-rata reinsurance policies and policies written on a risks attaching basis are generally earned over a 24 month period. The portion of the premium related to the unexpired portion of the policy at the end of any reporting period is reflected in unearned premium.
We write both excess of loss and pro-rata contracts. For excess of loss contracts, the deposit premium is defined in the contract wording and this is the amount we record as written premium in the period the underlying risks incept, therefore no management judgment is necessary. Subsequent adjustments, based on reports of actual premium by the ceding companies, or revisions in estimates, are recorded in the period they are determined.
On pro-rata contracts, including QQS arrangements, premiums assumed are estimated to ultimate levels based on information provided by the ceding companies. An estimate of premium is recorded in the period in which the underlying risks incept. When the actual premium is reported by the ceding company, which may be reported on a quarterly or six month lag, it may be significantly higher or lower than the estimate. Adjustments arising from the reporting of actual premium by the ceding companies are recorded in the period in which they are determined. Estimates of premium are based on information available, including previously reported premium and underlying economic conditions. Premiums on pro-rata contracts are earned over the risk periods of the related reinsurance contracts.
Where contract terms require the reinstatement of coverage after a ceding company’s loss, the mandatory reinstatement premiums are recorded as written premiums when the loss event occurs, and are recognized as earned premium ratably over the remaining contract period. Accrual of reinstatement premiums is based on our estimate of loss and loss adjustment expense reserves, which involves management judgment as described below. Reinstatement premiums are not accrued on reserves for losses incurred but not reported.
For the 2002-2004 cycle, the performance target for a 100% harvest of value of the units granted is an average combined ratio of 70% for the financial years 2002, 2003, and 2004. The target for a maximum harvest of 200% of the value of the units granted is a combined ratio of 50% or less. A combined ratio of 95% or more
will result in a harvest of nil. Straight line interpolation is used between these points. To date we have experienced a better than 70% combined ratio for this three-year performance period. During 2003, taking into account our results to date as well as the estimated combined ratio for the 2004 period, we adjusted the harvest ratio for the 2002-2004 performance period from 100.0% to 137.5%. This resulted in an increase in the PUP liability and expense in 2003. Depending on our results in 2004, the harvest ratio may either be increased or decreased which will affect the PUP liability and expense in 2004 for this performance period. Final determination of actual performance and amount of payment is at the sole discretion of the Committee.
For the 2003-2005 and 2004-2006 cycles, the performance target for a 100% harvest of value of the units granted is a combination of the achievement of an average combined ratio of 72% as measured over the period and the achievement of an annual increase in total return to shareholders of 18% as measured over the period. Linear scale collars around the targets provide for payment on performance units to rise to 200% if performance materially exceeds target or to reduce to nil if performance is materially below target. We will reassess the harvest rate used in the calculation of the PUP liability at June 30, 2004 for the 2003-2005 cycle and at June 30, 2005 for the 2004-2006 cycle and each quarter thereafter. Depending on our future results, the harvest ratio may either be increased or decreased which would affect the PUP liability and expense in future years. Final determination of actual performance and amount of payment is at the sole discretion of the Committee.
Despite no QQS business being renewed in 2004, we anticipate that our volume of business will increase in 2004 over that of 2003 based on our experience during the January 2004 renewal period. We anticipate our premium increases in 2004 will be as a result of the following factors:
• A continued increase in general new business and unit growth as a result of the decrease in the supply of market capacity caused by the continued significant reserve strengthening which has taken place in the insurance and reinsurance industries.
Our results for the 2003 year were primarily driven by the following factors:
• The favorable development of net losses related to 2002; and
As we only commenced writing business on December 16, 2001, it is not meaningful to compare 2003 and 2002 results with 2001 results. We only wrote one reinsurance policy during the 2001 period and did not incur any related losses. In addition, we incurred significant start-up expenses which included the results of expensing the fair value of warrants issued to the founding shareholders. Therefore, both the loss ratio and the expense ratio for the period ended December 31, 2001 are not useful for comparative purposes and are not indicative of future results.
(1) Based on total shareholders’ equity divided by basic shares outstanding.
(2) Fully converted book value per share is a non-GAAP measure, based on total shareholder’s equity plus the assumed proceeds from the exercise of outstanding options and warrants of $168.1 million, divided by the sum of shares, options and warrants outstanding (assuming their exercise) of 73,261,757 shares at December 31, 2003 and 2002. The Company believes that fully converted book value per share more accurately reflects the value attributable to a common share.
Details of gross premiums written by line of business are provided below:
(1) During 2002, we refined the classification of gross premiums written for certain pro-rata contracts between the Property Specialty line and the Property Catastrophe and Other Specialty lines. There was no effect on total gross premiums written.
The increase in all classes of business, except QQS as discussed below, as compared to 2002 principally results from the factors described above which have resulted in an increase in our market penetration and have allowed us to capitalize on market opportunities in virtually all lines of business. During 2003 we have continued to experience stable premium rate levels across the major classes of business in which we specialize. In addition, we continued to experience increases in our written line sizes and in our average signing percentages.
Included in the Other Specialty category is a small but growing level of casualty business which accounts for some of the increase as compared to 2002. We expect to write a larger amount of casualty reinsurance in 2004 versus 2003 due to improving terms and conditions. We estimate that casualty gross premiums written will
Due to the leveraged effect of these contracts, modest reductions of the syndicate’s ultimate premium estimates resulted in significant reductions in estimated premium for us. This has resulted in a substantial decrease in 2003 QQS premiums written as compared to 2002. During the year ended December 31, 2003 we recorded gross premiums written for the QQS business related to the 2002 underwriting year of approximately $ (23.7) million, which was comprised of a reduction in estimated ultimate premium of $39.4 million, offset by gross premiums written of $15.5 million. During the year we recorded gross premiums written for the QQS business related to the 2003 underwriting year of approximately $76.6 million. Ultimate premiums written for the QQS business will depend on the volume of premiums actually written by the syndicates. We have not written any QQS contracts in 2004.
Loss and loss adjustment expenses were $164.1 million and $133.3 million for the years ended December 31, 2003 and 2002, respectively. Reinsurance recoveries of $(8.4) million and $16.7 million were netted against loss and loss adjustment expenses for the years ended December 31, 2003 and 2002, respectively. Reinsurance recoveries for the years ended December 31, 2003 and 2002 related to QQS only. Based on additional information received from the syndicates, we reduced our estimated recovery ratio on reinsurance purchased by the QQS syndicates which has resulted in the negative reinsurance recovery amount for the year. We paid net losses of $53.2 million and $4.2 million for the years ended December 31, 2003 and 2002, respectively.
(2) The overall gross loss ratio for the year ended December 31, 2002 was 41.0%.
reserve analysis and, accordingly, we relied more heavily on industry experience and professional judgment to estimate our loss and loss adjustment expense reserves. As our business has developed in 2003, we have supplemented industry information with our own specific experience in our actuarial analysis. This has led to reduced projections of ultimate losses, particularly in the Property Specialty classes of business. In market loss terms, 2003 was an active year for catastrophes, especially in North America where there was a significant frequency of tornado, hurricane, and brushfire events in the market loss range of $1 billion to $2.5 billion. However, since our portfolio of business generally attaches in the middle and higher layers of programmes, our largest event in the year was $10 million and we have benefited from a very low level of catastrophe activity during 2003. The Other Specialty loss ratio for 2003 is higher than for the year ended December 31, 2002, partially due to the mix of business, as there is a higher percentage of proportional business in 2003, which has a longer reporting pattern and is usually reserved using a loss ratio approach at this early stage. In addition, we have written some additional casualty business which traditionally experiences high loss ratios due to the longer-tail nature of the casualty business.
The following tables set forth a reconciliation of our gross and net loss and loss adjustment expense reserves by line of business for the year ended December 31, 2003 ($ in millions):
The 2003 year includes approximately $58.2 million of favorable development on net losses from the prior year. This positive prior year development benefited the net loss ratio in the year by approximately 7.2%.
The favorable development during the year ended December 31, 2003 on losses incurred during 2002 primarily resulted from the following:
• In the Property Specialty Category, reported losses on 2002 occurrences during the year ended December 31, 2003 decreased by $1.7 million. Both the frequency and severity of reported losses have been lower than the assumed reporting pattern of losses established for this class of business at December 31, 2002. Many of the proportional contracts have continued to have little or no reported loss activity. We have received additional information from many of the proportional cedents, enabling us to do more projections on an individual contract basis rather than for the class as a whole. The reduction in reported losses during 2003, combined with the increasing weight placed on our actual experience, has led to the reduction in ultimate losses of $37.1 million or 29% of the total reserve balance at December 31, 2002.
• Property Catastrophe net loss and loss adjustment expense reserves as at December 31, 2002, included approximately $28.0 million in respect of the European Floods which occurred in August 2002, and Hurricane Lili which occurred in October 2002. The remainder of the Property Catastrophe loss reserve balance at December 31, 2002 related to smaller loss events and several proportional contracts. During the year ended December 31, 2003, the development of European Flood losses, Hurricane Lili losses and losses from our proportional catastrophe contracts has been significantly lower than our initial assumptions. These factors led to a reduction in net ultimate losses of $12.3 million during 2003.
• The lack of development in the year ended December 31, 2003, combined with the increasing weight placed on our actual experience in selecting a loss ratio, led to a decrease in our expected loss ratio attributable to the Other Specialty business during 2003. The lower selected loss ratio resulted in a reduction of $5.0 million in net loss and loss adjustment expense reserves for our Other Specialty business.
Other than the matters described above, we did not make any significant changes in the assumptions or methodology used in our reserving process during the year ended December 31, 2003. Because of our short operating history, our loss experience is limited and reliable evidence of changes in trends of numbers of claims incurred, average settlement amounts, numbers of claims outstanding and average losses per claim will necessarily take years to develop.
Management has determined that the best estimate for gross loss and loss adjustment expense reserves at December 31, 2003 and 2002 was $249.8 million and $ 146.1 million, respectively.
Management has determined that the best estimate for net loss and loss adjustment expense reserves at December 31, 2003 and 2002 was $242.1 million and $129.5 million, respectively.
Net loss and loss adjustment expense reserves at December 31, 2003
A significant portion of our business is property catastrophe and other classes with high attachment points of coverage. Reserving for losses in such programs is inherently complicated in that losses in excess of the attachment level of our policies are characterized by high severity and low frequency. In addition, as a broker market reinsurer, we must rely on loss information reported to such brokers by primary insurers who must estimate their own losses at the policy level, often based on incomplete and changing information. It is conceivable that in view of the high attachment points of most of our business that there could be no increase in the reserve for losses already incurred at December 31, 2003, and in addition that there may be no further losses reported. Therefore, the IBNR element of the above reserve ranges could turn out to be minimal. By contrast, a minimal amount of new loss advices could cause our ultimate incurred losses to significantly exceed the high end of the reserve ranges. Additionally, the reporting lag associated with our proportional business, including the QQS contracts, further increases the uncertainty of our ultimate loss estimates.
Net foreign exchange gains (losses) result from the effect of the fluctuation in foreign currency exchange rates on the translation of foreign currency assets and liabilities combined with realized gains (losses) resulting from the receipt of premium installments in foreign currencies. The foreign exchange gain in 2003 is primarily due to the weakening of the U.S. dollar resulting in gains on translation arising out of receipts of non-U.S. dollar premium installments. Our premiums receivable and liabilities for losses incurred in currencies other than the U.S. dollar are exposed to the risk of changes in value resulting from fluctuations in foreign exchange rates and may affect our financial results in the future.
include costs related to our performance unit plan and bonuses. Acquisition costs are generally driven by contract terms and are normally a set percentage of premiums.
Acquisition costs, excluding reinsurance and profit commission as a percentage of premiums earned, were 16.5% and 16.7% for the years ended December 31, 2003 and 2002, respectively. The 2003 ratio is slightly lower as a result of the lower proportion of QQS business written which traditionally has higher acquisition costs. We anticipate that the acquisition cost ratio, excluding profit commissions, will modestly reduce in 2004 as the proportion of QQS premiums earned decreases further.
Because we provide short-tail insurance and reinsurance coverage for losses resulting mainly from natural and man-made catastrophes, it is possible that we could become liable to pay substantial claims on short notice. Accordingly, we have structured our investment portfolio to preserve capital and provide us with a high level of liquidity, which means that the large majority of our investment portfolio contains shorter term fixed maturity investments, such as U.S. government bonds, corporate bonds and mortgage-backed and asset-backed securities.
For the years ended December 31, 2003 and 2002, interest expensed relating to the term loan facility and revolving loan facility represented an average rate of 1.7% and 2.8%, respectively.
Fees for the letter of credit facilities relates to the Letters of Credit that we have in place with Fleet Bank and Barclay’s Bank are as detailed in “Financial Condition and Liquidity - Capital Resources”.
Net realized gains (losses) on investments for the years ended December 31, 2003 and 2002 were $7.6 million and $7.7 million, respectively, which were due to net gains (losses) realized from the sale of fixed maturity and equity investments and a realized loss of $1.0 million during 2003 which resulted from the termination of the interest rate swap contract, cancelled simultaneously with the repayment of the term loan facility on August 4, 2003.
We are a holding company that conducts no operations of its own. We rely primarily on cash dividends and management fees from Montpelier Re to pay our operating expenses, interest on our debt and dividends. There are restrictions on the payment of dividends from Montpelier Re to the Company, which are described in more detail below. We have initiated a regular dividend program of $0.34 per share per quarter and declared our first dividend to shareholders of record at December 31, 2003. We expect to continue the payment of dividends in the future but we cannot assure you that such payments will continue. Any determination to pay any future cash dividends will be at the discretion of our Board of Directors and will be dependent upon our results of operations and cash flows, our financial position and capital requirements, general business conditions, legal, tax, regulatory and any contractual restrictions on the payment of dividends, and any other factors our Board of Directors deems relevant.
On August 4, 2003, we issued $250.0 million aggregate principal amount of senior unsecured debt (the “Senior Notes”) at an issue price of $99.517. The net proceeds were used to repay the term loan facility with the remainder used for general corporate purposes. The Senior Notes bear interest at a rate of 6.125%, payable semi-annually in arrears on February 15 and August 15 of each year, beginning on February 15, 2004. Unless previously redeemed, the Senior Notes will mature on August 15, 2013. We incurred $2.1 million in expenses related to the issuance of the Senior Notes, which have been expensed during the year ended December 31, 2003. We may redeem the Senior Notes at any time and from time to time, in whole or in part, at a “make-whole” redemption price. The Senior Notes do not contain any covenants regarding financial ratios or specified levels of net worth or liquidity to which we must adhere.
We may issue additional debt or equity as circumstances warrant. In this regard, on February 12, 2004 we filed a universal shelf registration statement on Form S-3 with the U.S. Securities and Exchange Commission for the potential future sale of up to $500.0 million of debt, trust preferred and/or equity securities. The registration statement has been declared effective and should provide us with significant flexibility with respect to our access to the public capital markets. Also included in the registration statement are 31,665,460 common shares which may be offered for sale by our shareholders, and from the sale of which we will receive no proceeds. We cannot assure you that additional financing under the universal shelf registration statement or elsewhere will be available at terms acceptable to us.
2004. Subsequent to the Project’s completion, which is estimated to be thirty months from the commencement of construction, we expect to enter into a 22 year long-term lease for the major portion of the Project. We will be required to pay rent in the amount of $300,000 per annum during the construction period. Upon finalization of the Project and occupation of the building, we will be required to pay rent in the amount of $400,000 per annum.
The Company and its subsidiaries lease office space in the countries in which they operate under operating leases, which expire at various dates. The Company has also entered into operating leases for office equipment and furniture. Future minimum annual commitments under existing leases are expected to be as follows: 2004-$1,071,347; 2005-$901,938; 2006-$107,273; 2007-$107,273; and 2008-$107,273.
The Company’s loss and loss adjustment reserves represent a best estimate of amounts which may fall due to pay policyholders and are not fixed amounts payable pursuant to contractual commitments. Therefore, have not been included in the table above.
Effective June 20, 2003, Montpelier Re entered into a new Letter of Credit Reimbursement and Pledge Agreement with Fleet National Bank and a syndicate of lending institutions for the provision of a letter of credit facility in favor of Lloyd’s in an amount of up to $250.0 million, and in favor of certain U.S. ceding companies in an amount of up to $200.0 million. Simultaneously, the previously existing Pledge Agreement was superseded by the Letter of Credit Reimbursement and Pledge Agreement, and the letters of credit issued under the previous facility are now issued under the new facility agreement. Letters of credit issued under this facility at December 31, 2003 were $245.7 million and are secured by cash and investments of approximately $270.3 million. We expect to renewal this facility at expiration. We consider this letter of credit facility sufficient to support Montpelier Re’s estimated obligations for the next 12 months.
Montpelier Re is registered under The Insurance Act 1978 (Bermuda), Amendments Thereto and Related Regulations (the “Act”). Under the Act, Montpelier Re is required annually to prepare and file Statutory Financial Statements and a Statutory Financial Return. The Act also requires Montpelier Re to meet minimum solvency requirements. For year ended December 31, 2003 and 2002, Montpelier Re satisfied these requirements.
We are not party to any transaction, agreement or other contractual arrangement to which an entity unconsolidated with us is a party that management believes is reasonably likely to have a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
The table below shows the aggregate amounts of investments available for sale, other investments and cash and cash equivalents comprising our portfolio of invested assets ($ in thousands):
As described in the Summary of Critical Accounting Policies, for most insurance and reinsurance companies, the most significant judgment made by management is the estimation of the loss and loss adjustment expense reserves. Due to the short-tail nature of our business, generally we expect that the majority of our losses will be paid relatively quickly. However, this can be affected by such factors as the event causing the loss, the location of the loss, and whether our losses are from policies with insurers or reinsurers. Accordingly, it is necessary to estimate, as part of the loss and loss adjustment expense reserve, an amount for IBNR. Net loss and loss adjustment expense reserves at December 31, 2003 was $242.1 million.
In the year ended December 31, 2003, we generated an operating net cash inflow of $581.5 million, primarily relating to premiums net of acquisition costs received by Montpelier Re. We paid losses of $53.2 million during the year ended December 31, 2003. We invested a net amount of $701.4 million during the year ended December 31, 2003, and had a cash balance of $139.6 million at December 31, 2003. The increase in liquidity has resulted from premiums received and a low level of paid claims as this has been a year with a relatively low level of catastrophes that affected our portfolio combined with the net cash received of $98.8 million from the issuance of the Senior Notes and the repayment of our term-loan facility.
Our sources of funds primarily consist of the receipt of premiums written, investment income and proceeds from sales and redemptions of investments.
Cash is used primarily to pay loss and loss adjustment expenses, brokerage commissions, excise taxes, general and administrative expenses, to purchase new investments, to pay dividends, to pay for any premiums retroceded and future authorized share repurchases. In 2003 we purchased specific retrocessional protection for our direct facultative insurance and reinsurance programs and the property programs, excluding most other specialty lines. In 2004 we expect to purchase reinsurance protecting ourselves against large risk losses on our direct and facultative and small to medium-size catastrophes on our overall property business written. For 2004 we expect that our purchase of reinsurance may rise modestly but is expected to be less than 5% of gross premiums written.
excess of our operating commitments. To the extent that capital is not utilized in our reinsurance we will consider using such capital to invest in new opportunities.
The Financial Accounting Standards Board issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”) an interpretation of ARB No. 51 “Consolidated Financial Statements”, in January 2003. FIN 46 clarifies the accounting and reporting for certain entities in which equity investors do not have the characteristics of a controlling financial interest. The December 31, 2002 consolidated financial statements were previously prepared on a combined basis as a result of the fact that Montpelier Re’s and the Company’s bye-laws include certain restrictions relating to the election of directors of Montpelier Re. FIN 46 became effective in the first quarter of 2003 and the impact of adoption of FIN 46 was that the Company’s financial statements are now presented on a consolidated basis instead of on a combined basis. There is no impact on the Company’s net income or shareholders’ equity as presented in the consolidated financial statements as a result of the adoption of FIN 46.