The principal offices of Platinum US are located at Two World Financial Center, New York, New York, where Platinum US leases approximately 49,600 square feet of office space. The term of this lease ends on September 29, 2013. Platinum US also leases 4,000 square feet of office space in Chicago. The term of this lease ends on February 28, 2011. Additionally, Platinum US entered into an assignment of a lease with St. Paul with respect to approximately 6,300 square feet of office space in Miami. The term of this lease ends on November 30, 2006.
The following table sets forth certain selected financial data of the Company as of and for the years ended December 31, 2005, 2004 and 2003, and for the period from April 19, 2002 through December 31, 2002 and of St. Paul Re for the period from January 1, 2002 through November 1, 2002 and for the year ended December 31, 2001. The data for the Company as of and for the years ended December 31, 2005, 2004 and 2003 were derived from the Company’s consolidated financial statements beginning on page of this Form 10-K. The data for the Company as of and for the period from April 19, 2002 through December 31, 2002 were derived from the Company’s audited consolidated financial statements not included in this Form 10-K. The data for St. Paul Re for the year ended December 31, 2001 and the period ended November 1, 2002 were derived from the audited combined financial statements of St. Paul Re prior to the Initial Public Offering (the Predecessor Business) not included in this Form 10-K. You should read the selected financial data in conjunction with the Company’s consolidated financial statements as of December 31, 2005 and 2004 and for each of the three years in the period ended December 31, 2005 beginning on page of this Form 10-K, and the related “Management’s Discussion and Analysis of Financial Condition and Results of Operations” beginning on page 49 of this Form 10-K.
Platinum Holdings is a Bermuda holding company organized in 2002. The Company operates through its three licensed reinsurance subsidiaries: Platinum Bermuda, Platinum US and Platinum UK. The Company provides property and marine, casualty and finite risk reinsurance coverages, through reinsurance intermediaries, to a diverse clientele of insurers and select reinsurers on a worldwide basis.
In November 2002, Platinum Holdings completed the Initial Public Offering. Concurrent with the Initial Public Offering, Platinum Holdings sold 6,000,000 Common Shares to St. Paul, and 3,960,000 common shares to RenaissanceRe in private placements. St. Paul sold its 6,000,000 common shares in June 2004 and RenaissanceRe sold its 3,960,000 in December 2005, in each case in public offerings. As part of the private placements, St. Paul and RenaissanceRe received options to purchase up to 6,000,000 and 2,500,000 of additional Common Shares, respectively, at any time during the ten years following the Initial Public Offering at a price of $27.00 per share. Both of these options were subsequently amended to provide that in lieu of paying $27.00 per share, any option exercise will be settled on a net share basis, which will result in Platinum Holdings issuing a number of Common Shares equal to the excess of the market price per share, determined in accordance with the amendments, over $27.00, less the par value per share, multiplied by the number of common shares issuable upon exercise of the option divided by that market price per share. Also, concurrent with the transactions in November 2002, the Company and St. Paul entered into several agreements for the transfer of continuing reinsurance business and certain related assets of St. Paul. Among these agreements were quota share retrocession agreements effective November 2, 2002 under which the Company assumed from St. Paul unpaid losses and LAE, unearned premiums and certain other liabilities on reinsurance contracts becoming effective in 2002 (the “Quota Share Retrocession Agreements”).
earned but not reported (“EBNR”). The Company also estimates the expenses associated with these premiums in the form of losses, LAE and commissions. The time lag involved in the process of reporting premiums is shorter than the lag in reporting losses. Premiums are generally reported within two years. The net impact on the results of operations of changes in estimated earned premiums is reduced by the losses and acquisition expenses related to such premiums.
triggered by losses and not related to reinstatement of limits and are immediately earned. An allowance for uncollectible premiums is established for possible non-payment of such amounts due, as deemed necessary.
One of the most significant judgments made by management in the preparation of financial statements is the estimation of unpaid losses and LAE, also referred to as “loss reserves.” Unpaid losses and LAE include estimates of the cost of claims that were reported but not yet paid (“case reserves”) and the cost of claims that were incurred but not reported (“IBNR”). These liabilities are balance sheet estimates of future amounts required to pay losses and LAE for reinsured claims for which we are liable and that have occurred at or before the balance sheet date. Every quarter, the Company’s actuaries prepare estimates of the loss reserves based on established actuarial techniques. Because the ultimate amount of unpaid losses and LAE is uncertain, we believe that the quantitative techniques used to estimate these amounts are enhanced by professional and managerial judgment. Company management reviews these estimates and determines its best estimate of the liabilities to record in the Company’s financial statements.
While the Company commenced operations in 2002, the business written is sufficiently similar to the historical business of St. Paul Re such that the Company uses the historical loss experience of this business, which is periodically updated by St. Paul Re, to estimate its initial expected ultimate losses and its expected patterns of reported losses. These patterns can span more than a decade and, given its own limited history, the availability of the St. Paul Re data is a valuable asset of the Company.
Unpaid losses and LAE represent management’s best estimates, at a given point in time, of the ultimate settlement and administration costs of claims incurred, and it is possible that the ultimate liability may materially differ from such estimates. Such estimates are not precise due to the fact that, among other things, they are based on predictions of future developments and estimates of future trends in claim severity and frequency and other factors. Because of the degree of reliance that the Company necessarily places on ceding companies for claims reporting, the associated time lag, the low frequency/high severity nature of some of the business that the Company underwrites and the varying reserving practices among ceding companies, the Company’s reserve estimates are highly dependent on management judgment and are therefore uncertain. Estimates of unpaid losses and LAE are periodically re-estimated and adjusted as new information becomes available. Any such adjustments are accounted for as changes in estimates and are reflected in results of operations in the period in which they are made.
Generally, initial actuarial estimates of IBNR not related to a specific event are based on the loss ratio method applied to each Underwriting Year for each class of business. Actual paid losses and case reserves (“reported losses”) are subtracted from expected ultimate losses to determine IBNR. The initial expected ultimate losses involve management judgment and are based on: (i) contract by contract expected loss ratios derived from our pricing process, and (ii) historical loss ratios of the Company and St. Paul Re adjusted for rate changes and trends. These judgments will take into account management’s view of past, current and future: (i) market conditions, (ii) changes in the business underwritten, (iii) changes in timing of the emergence of claims and (iv) other factors that may influence expected ultimate losses.
Over time, as a greater number of claims are reported, actuarial estimates of IBNR are based on the Bornhuetter-Ferguson and the chain ladder techniques. The Bornhuetter-Ferguson technique utilizes actual reported losses and expected patterns of reported losses, taking the initial expected ultimate losses into account to determine an estimate of expected ultimate losses. This technique is most appropriate when there are few reported claims and a relatively less stable pattern of reported losses. The chain ladder technique utilizes actual reported losses and expected patterns of reported losses to determine an estimate of expected ultimate losses that is independent of the initial expected ultimate losses. This technique is most appropriate when there are a large number of reported losses with significant statistical credibility and a relatively stable pattern of reported losses.
When estimating unpaid losses and LAE, each of our reinsurance subsidiaries segregates business into classes by type of coverage and type of contract (approximately 80 classes). Within each class the business is further segregated by Underwriting Year, starting with 2002.
important for the Finite Risk segment and the Accident and Health class within the Casualty segment. Once our actuaries make their determinations of the most appropriate point estimate for each class, this information is aggregated and reviewed and approved by executive management. At December 31, 2005 the liability for unpaid losses and LAE that we recorded includes the point estimates of IBNR prepared by our actuaries.
Since we rely on information regarding paid losses, case reserves and IBNR provided by ceding companies in order to assist us in estimating our liability for unpaid losses and LAE, we maintain certain procedures in order to help determine the completeness and accuracy of such information. Periodically, management assesses the reporting activities of these companies on the basis of qualitative and quantitative criteria. In addition to conferring with ceding companies or brokers on claims matters, our claims personnel conduct periodic audits of specific claims and the overall claims procedures of our ceding companies at their offices. We rely on our ability to effectively monitor the claims handling and claims reserving practices of ceding companies in order to help establish the proper reinsurance premium for reinsurance agreements and to establish proper loss reserves. Disputes with ceding companies have been rare and generally have been resolved through negotiation.
Premiums written, premiums earned and losses and LAE reflect the net effects of assumed and ceded reinsurance transactions. Reinsurance accounting is followed for assumed and ceded transactions when risk transfer requirements have been met. Risk transfer analysis evaluates significant assumptions relating to the amount and timing of expected cash flows, as well as the interpretation of underlying contract terms. Reinsurance contracts that do not transfer sufficient insurance risk are generally accounted for as reinsurance deposit liabilities with interest expense charged to other income and credited to the liability.
In accordance with our investment guidelines, our investment portfolio consists of diversified, high quality, predominantly publicly traded fixed maturity securities. Fixed maturity securities for which we may not have the positive intent to hold until maturity are classified as available-for-sale and reported at fair value, with unrealized gains and losses excluded from net income and reported in other comprehensive income as a separate component of shareholders’ equity, net of deferred taxes. Fixed maturity securities for which we have the intent to sell prior to maturity are classified as trading securities and reported at fair value, with unrealized gains and losses included in other income and the related deferred income tax included in income tax expense. Securities classified as trading securities are generally denominated in foreign currencies and are intended to match net liabilities denominated in foreign currencies in order to minimize net exposures arising from fluctuations in foreign currency exchange rates. Realized gains and losses on sales of investments are determined on a specific identification basis. Investment income is recorded when earned and includes the amortization of premiums and accretion of discounts on investments.
We believe we have the ability to hold any specific security to maturity. This is based on current and anticipated future positive cash flow from operations that is expected to generate sufficient liquidity in order to meet our obligations. However, in the course of managing investment credit risk, asset liability duration or other aspects of the investment portfolio, the Company may decide to sell any specific security. The Company routinely reviews its available-for-sale investments to determine whether unrealized losses represent temporary changes in fair value or are the result of “other-than-temporary impairments.” The process of determining whether a security is other than temporarily impaired is subjective and involves analyzing many factors. These factors include, but are not limited to, the overall financial condition of the issuer, the duration and magnitude of an unrealized loss, specific credit events and the Company’s intent to hold a security for a sufficient period of time for the value to recover the unrealized loss. If the Company has determined that an unrealized loss on a security is other than temporary, the Company writes down the carrying value of the security to its current fair value and records a realized loss in the statement of operations. During 2005, as a result of the routine evaluation of investments, we wrote down the carrying value of our other invested asset to its estimated net realizable value and recorded a realized loss of $1,769,000. Other than this adjustment, we do not believe our investment portfolio contains any securities with an unrealized loss that is other than temporary.
taxable income in the years in which the taxes related to 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 the change is enacted. A valuation allowance is established for deferred tax assets where it is more likely than not that future tax benefits will not be realized.
During 2003, we adopted Statement of Financial Accounting Standards No. 123 “Accounting for Awards of Stock Based Compensation to Employees” (“SFAS 123”) and Statement of Financial Accounting Standards No. 148 “Accounting for Stock-Based Compensation-Transition and Disclosure” (“SFAS 148”). SFAS 123 requires that the fair value of shares granted under our share option plan subsequent to adoption of SFAS 148 be amortized in earnings over the vesting periods. The fair value of the share options granted is determined through the use of an option-pricing model. SFAS 148 amends the disclosure requirements of SFAS 123 and provides transition guidance for a voluntary adoption of SFAS 123. In accordance with the transition rules of SFAS 148, we elected to continue using the intrinsic value method of accounting for its share-based awards granted to employees established by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) for share options granted in 2002. Under APB 25, if the exercise price of our share options is equal to or greater than the fair market value of the underlying shares on the date of the grant, no compensation expense is recorded.
The fair value of restricted share awards is determined on the grant date and is amortized into earnings over the vesting period. There are limits on the transferability of the restricted shares and such restricted shares may be forfeited in the event of certain types of termination of the recipient’s employment. The unearned or unvested portion of the restricted shares issued is presented as a separate component of shareholders’ equity.
Net income (loss) for the years ended December 31, 2005 and 2004 was as follows ($ in thousands):
As a result of losses arising from these catastrophic events, certain reinsurance contracts generated additional premiums and adjustments to accrued profit commissions. The aggregate net adverse impact on our net income (loss) for the years ended December 31, 2005 and 2004 from the above mentioned hurricanes is summarized as follows ($ in thousands):
The increase in net premiums written in 2005 as compared with 2004 is attributable to growth in Property and Marine and Casualty segments offset by a decline in the Finite Risk segment. Net premiums written and earned in 2005 include approximately $49,451,000 and $46,666,000, respectively, of additional premiums related to losses arising from the 2005 Hurricanes. Net premiums written and earned in 2004 include approximately $29,265,000 of additional premiums related to losses arising from the 2004 Hurricanes. Net premiums written and earned in 2005 also include $2,268,000 of net additional premiums relating loss development of prior years. There were no significant premium adjustments relating to loss development in 2004. The remaining increase in net premiums earned is related to the growth in current and prior periods’ net premiums written and is also affected by changes in the mix of business and the structure of the underlying reinsurance contracts.
Net investment income for the years ended December 31, 2005 and 2004 was $129,445,000 and $84,532,000, respectively. Net investment income increased during 2005 primarily due to increased invested assets attributable to positive cash flow from operations, excluding trading securities activities, which was $618,909,000 and $698,223,000 in 2005 and 2004, respectively. Also contributing to the increase in the invested assets in 2005 are the net proceeds from the issuances of: debt of $246,900,000, Preferred Shares of $168,162,000 and Common Shares of $426,293,000. The book basis yields on fixed maturity securities were 4.4% and 4.3% at December 31, 2005 and 2004, respectively. Net investment income included $8,172,000 and $2,651,000 of interest earned on funds held for the years ended December 31, 2005 and 2004, respectively. Net realized gains (losses) on investments were ($3,046,000) and $1,955,000 for the years ended December 31, 2005 and 2004, respectively. Net realized losses in 2005 include $1,769,000 relating to the write-down of our investment in Inter-Ocean Holdings, Ltd. The remaining net realized gains and losses on investments in 2005 and 2004 were the result of investment sale activity to manage the quality, diversity, currency exposure, duration and tax profile of the investment portfolio.
Other income (expense) for the years ended December 31, 2005 and 2004 were ($586,000) and $3,211,000, respectively. Other expense in 2005 includes $102,000 of net unrealized losses relating to changes in fair value of fixed maturity securities classified as trading, and $53,000 of net expense on reinsurance contracts accounted for as deposits. Other income in 2004 includes $1,036,000 of net unrealized gains relating to changes in fair value of fixed maturity securities classified as trading, $758,000 of earnings on reinsurance contracts accounted for as deposits and a gain of $1,000,000 on the sale of assets.
Net foreign currency exchange gains (losses) for the years ended December 31, 2005 and 2004 were ($2,111,000) and $725,000, respectively. We routinely do business in various foreign currencies. Foreign currency exchange gains and losses result from the re-valuation into U.S. dollars of assets and liabilities denominated in foreign currencies. We periodically monitor our largest foreign currency exposures and purchases or sells foreign currency denominated invested assets to match these exposures. Net foreign currency exchange gains and losses arise as a result of fluctuations in the amounts of assets and liabilities denominated in foreign currencies as well as fluctuations in the currency exchange rates.
The income tax benefit in 2005 as compared with income tax expense in 2004 is due to the loss before income tax benefit in 2005. The effective tax rate in any given year is based on income before tax expense of our subsidiaries that operate in several jurisdictions with varying corporate income tax rates. Platinum Holdings and Platinum Bermuda are not subject to corporate income tax. In 2005, approximately 45.0% of the net loss before tax benefit was derived from Platinum Holdings and Platinum Bermuda. In 2004, approximately 16.9% of the net income before income tax expense was derived from Platinum Holdings and Platinum
Net income for the years ended December 31, 2004 and 2003 was as follows ($ in thousands):
The decrease in net income in 2004 as compared with 2003 is attributable to a decline in underwriting income of $115,429,000. The decline in underwriting income was due primarily to the 2004 Hurricanes, partially offset by growth of profitable business in all segments and net favorable development of $55,520,000. Net favorable development includes the development of prior years’ unpaid losses and LAE and the related impact on premiums and profit commissions. Net income in 2004 as compared with 2003 was also favorably impacted by an increase in investment income of $26,887,000 and reductions in corporate expenses of $9,871,000 and income tax expense of $18,526,000.
The increase in net premiums written and earned in 2004 as compared with 2003 is attributable to growth in all segments, and includes approximately $29,265,000 of additional premiums related to losses arising from the 2004 Hurricanes. The increase in net premiums earned is related to the growth in current and prior periods’ net premiums written and is affected by changes in the mix of business and the structure of the underlying reinsurance contracts.
Net investment income for the years ended December 31, 2004 and 2003 was $84,532,000 and $57,645,000, respectively. Net investment income increased during 2004 primarily due to increased invested assets attributable to positive cash flow from operations, excluding trading securities activities, which were $698,223,000 and $469,168,000 in 2004 and 2003, respectively. Fixed maturity securities were $2,240,202,000 and $1,678,138,000 at December 31, 2004 and 2003, respectively. The book basis yields on fixed maturity securities were 4.3% and 4.1% at December 31, 2004 and 2003, respectively. Net investment income included $2,651,000 and $776,000 of interest earned on funds held for the years ended December 31, 2004 and 2003, respectively. Net investment income for the year ended December 31, 2003 included $1,357,000 of interest received from St. Paul on balances due relating to the Quota Share Retrocession Agreements. Net realized gains on investments of $1,955,000 and $2,781,000 for the years ended December 31, 2004 and 2003, respectively, were the result of investment sale activity to manage the quality, diversity, currency exposure, duration and tax profile of the investment portfolio.
Other income for the years ended December 31, 2004 and 2003 was $3,211,000 and $3,343,000, respectively. Other income in 2004 includes $1,036,000 of net unrealized gains relating to changes in fair value of fixed maturity securities classified as trading, $758,000 of earnings on reinsurance contracts accounted for as deposits and a gain of $1,000,000 on the sale of assets. Other income in 2003 includes $1,282,000 of net unrealized losses relating to changes in fair value of fixed maturity securities classified as trading and, $4,625,000 of earnings on reinsurance contracts accounted for as deposits. Earnings on reinsurance contracts accounted for as deposits decreased in 2004 from 2003 due to a fewer number of such contracts.
The increase in acquisition expenses in 2004 as compared with 2003 is consistent with the growth in business in all segments, partially offset by reductions of profit commissions under reinsurance contracts that incurred losses from the 2004 Hurricanes. The decrease in the acquisition expense ratio in 2004 from 2003 is primarily due to changes in the mix of business as well as reductions of profit commissions related to losses from the 2004 Hurricanes.
Income taxes and the effective tax rate for the years ended December 31, 2004 and 2003 were as follows ($ in thousands):
Income taxes decreased in 2004 from 2003 due to the decline in income before income tax expense. The effective tax rate in any given year is based on income before tax expense of our subsidiaries that operate in several jurisdictions with varying corporate income tax rates. Platinum Holdings and Platinum Bermuda are not subject to corporate income tax. While the effective income tax rates in 2004 and 2003 are comparable, both years include events that increased the effective income tax rate. In 2004 approximately 80% of the losses from the 2004 Hurricanes were incurred by Platinum Bermuda without tax benefit and in 2003 expenses
We conduct our worldwide reinsurance business through three operating segments: Property and Marine, Casualty and Finite Risk. In managing our operating segments, management uses measures such as underwriting income and underwriting ratios to evaluate segment performance. Management does not allocate by segment its assets or certain income and expenses such as investment income, interest expense and certain corporate expenses. Segment underwriting income is reconciled to income before income taxes. The measures used by management in evaluating our operating segments should not be used as a substitute for measures determined under U.S. GAAP. The following table summarizes underwriting activity and ratios for the three operating segments for the years ended December 31, 2005, 2004 and 2003 ($ in thousands):
The Property and Marine operating segment includes principally property (including crop) and marine reinsurance coverages that are written in the United States and international markets. This business includes catastrophe excess-of-loss treaties, per-risk excess-of-loss treaties and proportional treaties. This operating segment generated 33.5%, 30.6% and 30.1% of our net premiums written in 2005, 2004 and 2003, respectively.
The increase in acquisition expenses in 2005 as compared with 2004 is consistent with the growth in business. The increase in the acquisition expense ratio is primarily due to increases in commissions of $6,489,000 in 2005 related to the net favorable development of non-catastrophe losses and LAE, partially offset by commission reductions of $3,654,000 in 2005 related to reinsurance contracts with catastrophe losses. There were no significant commission adjustments in 2004. The acquisition expense ratios in 2005 and 2004 are also affected by changes in the mix of business.
written and earned also include approximately $16,198,000 of additional premiums from reinsurance contracts that incurred losses arising from the 2004 Hurricanes.
The increase in losses and LAE and the related losses and LAE ratio in 2004 is due to losses of $169,652,000 from the 2004 Hurricanes as compared with the low level of catastrophe losses in 2003. Also contributing to the increase in losses and LAE in 2004 as compared with 2003 is the growth in business. Partially offsetting the increased losses and LAE relating to the 2004 Hurricanes is approximately $48,478,000 of net favorable development of prior years’ unpaid losses and LAE in 2004 representing 10.0% of net premiums earned in 2004 as compared with approximately $31,600,000 of net favorable development in 2003 representing 8.9% of net premiums earned in 2003. During 2004 and 2003, actual reported losses were significantly less than expected for the short-tailed non-catastrophe property lines resulting in reductions in estimated ultimate losses for such lines.
Net premiums written and net premiums earned for the years ended December 31, 2005 and 2004 were as follows ($ in thousands):
premiums written and earned in 2005 as compared with 2004 were affected by revisions of prior years’ estimates resulting in increases in net premiums written and earned in 2005 of approximately $55,500,000 and $37,600,000, respectively. This increase is due to growth in the casualty business and increased ultimate premiums from prior underwriting years’ excess-of-loss classes due to greater than expected premiums being reported from ceding companies. This compares with revisions of prior years’ estimates resulting in reductions of net premiums written and earned in 2004 of approximately $21,300,000 and $14,300,000, respectively. These adjustments were based on reported premiums from ceding companies and revised projections of ultimate premiums written under reinsurance contracts. The net effect of changes in premium estimates, after considering corresponding changes in related expenses, did not have a significant net effect on underwriting income. The increase in net premium earned is related to the growth in current and prior years’ written premiums and is affected by changes in the mix of business and the structure of the underlying reinsurance contracts.
The increase in losses and LAE in 2005 as compared with 2004 is consistent with the growth in net premiums earned. Losses and LAE in 2005 included net favorable loss development of approximately $15,913,000, representing 2.0% of net premiums earned in 2005, and approximately $675,000 of net unfavorable loss development, representing 0.1% of net premiums earned in 2004. The decrease in the loss and LAE ratio in 2005 is also due, in part, to changes in the mix of business toward classes with lower loss ratios.
Other underwriting expenses for the years ended December 31, 2005 and 2004 were $24,690,000 and $19,086,000, respectively. The increase in other underwriting expenses is due to the growth of business in the segment as well as the allocation of a greater percentage of common operating and administrative costs to the segment due to a decline in underwriting activity in the Finite Risk segment. The other underwriting expense ratios in 2005 and 2004 remained comparable at 3.1%.
The increase in premiums written and earned is due to the growth in contracts bound in both 2003 and 2004 and rate increases in certain lines of business in 2004 that together generated net premiums written in 2004. We continue to expand our treaty participation with existing clients and form new client relationships.
Additionally, in 2004 we expanded our participation in surety and trade credit business. In response to deteriorating market conditions in 2004 in the directors and officers liability line of business, we began to significantly decrease our involvement in that line. Also, increases in premiums written were offset by revisions of estimates of Casualty premiums that resulted in reductions of net premiums written and earned in 2004 of approximately $21,300,000 and $14,300,000, respectively, as compared with similar reductions of net premiums written and earned in 2003 of $35,300,000 and $16,100,000, respectively. The revisions to estimates are based on reported premiums from ceding companies and revised projections of ultimate premiums written under reinsurance contracts. The net effect on underwriting income of the revisions of estimates, after reductions in related losses, LAE and acquisitions expenses, was not significant. The increase in net premiums earned is related to and consistent with the increase in net premiums written and is affected by changes in the mix of business and the structure of the underlying reinsurance contracts.
Losses and LAE and the resulting loss ratios for the years ended December 31, 2004 and 2003 were as follows ($ in thousands):
The increase in acquisition expenses is due primarily to the increase in net premiums earned in 2004 as compared with 2003. The decrease in acquisition expense ratios for the year ended December 31, 2004 as compared with 2003 is due to changes in the mix of business toward lines with higher expected loss ratios and lower acquisition expense ratios.
The Finite Risk operating segment includes principally structured reinsurance contracts with ceding companies whose needs may not be met efficiently through traditional reinsurance products. The classes of risks underwritten through finite risk contracts are generally consistent with the classes covered by traditional products. Typically, the amount of losses we might pay is finite or capped. In return for this limit on losses, we often accept a cap on the potential profit margin specified in the treaty and return profits above this margin to the ceding company. Due to the significant inverse relationship between losses and commissions for this segment, we believe it is important to evaluate the overall combined ratio, rather than its component parts of loss and loss adjustment expense ratios. The finite risk contracts that we underwrite generally provide prospective protection, meaning coverage is provided for losses that are incurred after inception of the
The Finite Risk portfolio consists of a small number of contracts that can be large in premium size and, consequently, overall premium volume may vary significantly from year to year. Net premiums written decreased significantly in 2005 as compared with 2004 as fewer contracts are in force. The decrease in net premiums written is primarily attributable to several large accident and health capped quota share contracts that were written in 2004 and not renewed in 2005. The resulting decline in finite accident and health net premiums earned was offset by an increase in finite casualty net premiums earned. Net premiums earned are related to current and prior years’ net premiums written and are affected by changes in the mix of business and the structure of the underlying reinsurance contracts. Net premiums written and earned in 2005 and 2004 include approximately $4,042,000 and $13,067,000 of additional premiums resulting from losses arising from the 2005 Hurricanes and 2004 Hurricanes, respectively. Additionally in 2005, favorable development of losses in this segment related to the 2004 Hurricanes resulted in a reduction of net premiums written and earned of $4,953,000.
Effective January 1, 2006 a finite quota share contract was canceled on a cut-off basis. During the first quarter of 2006 we will reflect the effect of the cancellation by recording a reduction of unearned and written premiums of approximately $58,164,000. The premiums were previously reported as written in 2005. The net impact of all adjustments related to this cancellation will have no impact on previously reported underwriting results of this segment.
Losses and LAE, acquisition expenses and the resulting ratios for the years ended December 31, 2005 and 2004 were as follows ($ in thousands):
The decrease in losses, LAE and acquisition expenses and the losses, LAE and acquisition expense ratio in 2005 as compared with 2004 is primarily due to the more significant losses arising from the 2004 Hurricanes than from the 2005 Hurricanes. Losses, LAE and acquisition expenses arising from the 2005 Hurricanes were $31,000,000 representing 8.7% of net premiums earned in 2005 as compared with losses, LAE and acquisition expenses arising from the 2004 Hurricanes of $50,580,000 representing 14.4% of net premiums earned in 2004. Net favorable development impacting both losses and LAE and acquisition expenses occurred in both 2005 and 2004. Net favorable development in 2005 and 2004 amounted to $21,187,000 representing 5.6% of net premiums earned in 2005 as compared with $7,717,000 representing 2.2% of net premiums earned in 2004. Exclusive of hurricane losses and net favorable development, the overall loss, LAE and acquisition expense ratio increased in 2005 as compared with 2004 due to the shift toward casualty business that generally has a higher combined ratio.
Other underwriting expenses for the years ended December 31, 2005 and 2004 were $4,905,000 and $6,224,000, respectively. The decrease in other underwriting expenses is due to the allocation of a greater percentage of direct and common operating costs to the Casualty segment due to a decline in underwriting activity in the Finite Risk segment.
The increase in losses, LAE and acquisition expenses and the losses, LAE and acquisition expense ratio in 2004 as compared with 2003 is primarily due to losses of $60,823,000 from the 2004 Hurricanes, partially offset by a reduction in profit commissions of $10,243,000. There were no catastrophe losses in 2003. In addition, several capped quota share contracts were written in 2004 that included primarily casualty business as compared with business written in 2003 that included a higher percentage of finite property business with lower loss ratios. Favorable development impacting both losses and LAE and acquisition expenses occurred in both 2004 and 2003. Net favorable development in 2004 was approximately $7,717,000 representing 2.2% of net premiums earned in 2004 as compared with approximately $17,900,000 representing 5.6% of net premiums earned in 2003.
Cash and cash equivalents and investments as of December 31, 2005 and 2004 were as follows ($ in thousands):
The increase in cash and cash equivalents in 2005 as compared to 2004 is due to the completion of the offerings of common and preferred shares at the end of 2005. The total increase in cash and cash equivalents and investments is due in part to positive cash flow from operations, excluding trading securities activities, which was $618,909,000 and $698,223,000 in 2005 and 2004, respectively. Also contributing to the increase in the invested assets in 2005 are the net proceeds from the issuances of: debt of $246,900,000, Preferred Shares of $168,162,000 and Common Shares of $426,293,000, including common shares issued upon settlement of the purchase contracts that formed a part of the ESU’s. Our available-for-sale and trading portfolios are primarily composed of diversified, high quality, predominantly publicly traded fixed maturity securities. The investment portfolio, excluding cash and cash equivalents, had a weighted average duration of 3.5 years as of December 31, 2005. We maintain and periodically update our overall duration target for the portfolio and routinely monitor the composition of, and cash flows from, the portfolio to maintain liquidity necessary to meet our obligations. Other invested asset represents an investment in Inter-Ocean Holdings, Ltd., a non-public reinsurance company. As a result of routine evaluations of investments during 2005, we wrote down the carrying value of the investment in Inter-Ocean Holdings, Ltd. to its estimated net realizable value and recorded a realized loss of $1,769,000. The Company has no ceded or assumed reinsurance business with Inter-Ocean Holdings, Ltd.
Premiums receivable include significant estimates. Premiums receivable as of December 31, 2005 of $567,449,000 include $496,603,000 that is based upon estimates. Premiums receivable as of December 31, 2004 of $580,048,000 include $530,066,000 that is based upon estimates. An allowance for uncollectible premiums is established for possible non-payment of such amounts due, as deemed necessary. As of December 31, 2005, no such allowance was made based on the Company’s historical experience, the general profile of its ceding companies and its ability in most cases to contractually offset premiums receivable with losses and loss adjustment expense or other amounts payable to the same parties.
Unpaid losses and LAE as of December 31, 2005 of $2,323,990,000 include $1,812,245,000 of IBNR. Unpaid losses and LAE as of December 31, 2004 of $1,380,955,000 includes $1,151,501,000 of IBNR.
In November 2002, the Company issued the ESU’s each of which consisted of a contract to purchase common shares of the Company in 2005 and an ownership interest in a Senior Guaranteed Note. On August 16, 2005, Platinum Finance successfully completed the remarketing of $137,500,000 aggregate principal amount of the Senior Guaranteed Notes due November 16, 2007 at a price of 100.7738% with a reset interest rate of 6.371% (the “Remarketed Notes”). Interest is payable on the Remarketed Notes on May 16 and November 16 of each year, commencing November 16, 2005. The Remarketed Notes are unconditionally guaranteed by Platinum Holdings. The remarketing was conducted on behalf of holders of the ESU’s and neither Platinum Holdings nor Platinum Finance received any cash proceeds from the remarketing. Proceeds from the remarketing were used to purchase a portfolio of U.S. Treasury securities to collateralize the obligations of the holders of the ESU’s under the related common share purchase contract and to pay the remarketing fee. There were no excess proceeds distributed to holders of the ESU’s in connection with the remarketing. On November 16, 2005, Platinum settled the purchase contract component by issuing 5,008,850 common shares, which generated cash proceeds to the Company of $137,500,000, less related fees and expenses. As a result of the settlement of the purchase contract component of the ESUs, the ESUs ceased to exist and are no longer traded on the New York Stock Exchange.
In May 2005, Platinum Finance issued $250,000,000 aggregate principal amount of Series A Notes due June 1, 2017, unconditionally guaranteed by Platinum Holdings. The Series A Notes were issued in a transaction exempt from the registration requirements under the Securities Act. The proceeds of the Series A Notes were used primarily to increase the capital of Platinum Bermuda and Platinum US. Interest at a per annum rate of 7.5% is payable on the Series A Notes on each June 1 and December 1 commencing on December 1, 2005. Platinum Finance may redeem the Series A Notes, at its option, at any time in whole, or from time to time in part, prior to maturity. The redemption price will be equal to the greater of: (i) 100 percent of the principal amount of the Series A Notes, or (ii) the sum of the present values of the remaining scheduled payments of principal and interest, discounted to the redemption date on a semiannual basis at a comparable treasury rate plus 50 basis points, plus in each case, interest accrued but not paid to the date of redemption. In the fourth quarter of 2005, Platinum Holdings and Platinum Finance completed an exchange offer through which they exchanged all $250,000,000 aggregate principal amount of the outstanding Series A Notes for $250,000,000 aggregate principal amount of Series B Notes which have substantially the same terms and which have been registered under the Securities Act (the “Series B Notes”) pursuant to a separate prospectus.
On October 21, 2005 the Company entered into a three-year $200,000,000 credit agreement with a syndicate of lenders. The credit agreement consists of a $100,000,000 senior unsecured credit facility available for revolving borrowings and letters of credit, and a $100,000,000 senior secured credit facility available for letters of credit. The revolving line of credit will be available for the working capital, liquidity and general corporate requirements of the Company and its subsidiaries. The interest rate on borrowings under the credit facility is based on the election of the Company of either: (1) LIBOR plus 50 basis points or (2) the higher of the prime interest rate of the lead bank providing the credit facility and the federal funds rate plus 50 basis points. The LIBOR rate can decrease by 10 basis points or increase by 12.5 basis points should our credit rating on our senior unsecured debt increase or decrease.
Platinum Bermuda and Platinum UK are not licensed, approved or accredited as reinsurers anywhere in the United States and therefore, under the terms of most of their contracts with United States ceding companies, they are required to provide collateral to these ceding companies for unpaid ceded liabilities in a form acceptable to state insurance commissioners. Typically, this type of collateral takes the form of a letter of credit issued by a bank, the establishment of a trust, or funds withheld. Platinum Bermuda and Platinum UK have obtained letters of credit through commercial banks and may be required to provide the banks with a security interest in certain investments of Platinum Bermuda and Platinum UK.
Platinum US is obligated to collateralize the liabilities assumed from St. Paul under the Quota Share Retrocession Agreements. Platinum Bermuda and Platinum US have reinsurance and other contracts that also require them to provide collateral to ceding companies should certain events occur, such as a decline in the rating by A.M. Best below specified levels or a decline in statutory equity below specified amounts, or when certain levels of liabilities assumed from ceding companies are attained. Some reinsurance contracts also have special termination provisions that permit early termination should certain events occur.
The payment of dividends and other distributions from the Company’s regulated reinsurance subsidiaries is limited by applicable laws and statutory requirements of the jurisdictions in which the subsidiaries operate, including Bermuda, the United States and the United Kingdom. Based on the regulatory restrictions of the applicable jurisdictions, the maximum amount available for payment of dividends or other distributions by the reinsurance subsidiaries of the Company in 2006 without prior regulatory approval is estimated to be $197,000,000.
On August 4, 2004, the board of directors of the Company approved a plan to purchase up to $50,000,000 of its common shares. During the year ended December 31, 2004 the Company purchased 349,700 of its common shares in the open market at an aggregate amount of $9,985,000 at a weighted average price of $28.55 per share. The shares purchased by the Company were canceled. No repurchases of the Company’s common shares were made during the year ended December 31, 2005.
Management believes that the cash flow generated by the operating activities of the Company’s subsidiaries will provide sufficient funds for the Company to meet its liquidity needs over the next twelve months. Beyond the next twelve months, cash flow available to the Company may be influenced by a variety of factors, including economic conditions in general and in the insurance and reinsurance markets, legal and regulatory changes as well as fluctuations from year to year in claims experience and the presence or absence of large catastrophic events. If the Company’s liquidity needs accelerate beyond our ability to fund such obligations from current operating cash flows, the Company may need to liquidate a portion of its investment portfolio or raise additional capital in the capital markets. The Company’s ability to meet its liquidity needs by selling investments or raising additional capital is subject to the timing and pricing risks inherent in the capital markets.
Periods of moderate economic recession or inflation tend not to have a significant direct effect on the Company’s underwriting operations. Significant unexpected inflationary or recessionary periods can, however, impact the Company’s underwriting operations and investment portfolio. Management considers the potential impact of economic trends in the estimation process for establishing unpaid losses and LAE.
The Company does not have any off-balance sheet arrangements, as defined for purposes of SEC rules, which are not accounted for or disclosed in the consolidated financial statements as of December 31, 2005.
There are generally no stated amounts related to reinsurance contracts. Both the amounts and timing of future loss and LAE payments are estimates and subject to the inherent variability of legal and market conditions affecting the obligations and make the timing of cash outflows uncertain. The ultimate amount and timing of unpaid losses and LAE could differ materially from the amounts in the table above. Further, the gross unpaid losses and LAE do not represent all of the obligations that will arise under the contracts, but rather only the estimated liability incurred through December 31, 2005. There are reinsurance contracts that have terms extending into 2006 under which additional obligations will be incurred.
A number of new Bermuda-based reinsurance companies were formed after the 2005 Hurricanes. We believe that most of these companies were in the process of assembling their underwriting staff and
establishing their market presence during the renewal season for contracts effective on January 1, 2006 (the “January 1 renewal season”). The January 1 renewal season is generally considered the most significant underwriting period of the year for the reinsurance industry.
We believe the January 1 renewal season was more contentious than usual. We experienced account turnover across all lines of business. However, terms and conditions on most of our renewed treaties improved or remained substantially unchanged depending on the line of business. We expect these conditions to continue during 2006, but the competitive landscape is still evolving and the depth and breadth of market changes for the balance of 2006 remain uncertain.
During the January 1 renewal season we wrote more property catastrophe excess-of-loss business and less property risk excess-of-loss and pro-rata business. Property risk excess-of-loss and pro-rata business typically generates relatively more premium than property catastrophe excess-of-loss business having a similar risk level. However, we believe property catastrophe excess-of-loss business generally provides more quantifiable catastrophe exposure and is currently priced more attractively.
For the Casualty segment, we believe that losses from the 2005 Hurricanes and enhanced rating agency capital requirements will cause certain insurance and reinsurance companies to review their strategies for business which is not generally exposed to catastrophes. During the January 1 renewal season, ceding companies were willing to increase retentions and reinsurers competed for participation on the best treaties. However, rates stabilized in certain lines of business where they had been declining. As a result, we believe that the business underwritten during the January 1 renewal season has approximately the same level of expected profitability as the business we wrote during the comparable period in 2005. We have written more commercial liability and less professional liability, trade credit, accident and health and clash business. We have written approximately the same amount of surety, political risk, medical malpractice and regional business as we did during the comparable period in 2005. We believe that financial security remains a significant concern for buyers of long-tailed reinsurance protection, who typically seek reinsurers with strong balance sheets, quality ratings, and a proven claims-paying record. We believe that our rating, capitalization and reputation as a lead casualty reinsurer positions us well to write profitable business as the opportunities arise. We expect these conditions to persist through 2006 and that the casualty market will remain attractive.