Platinum Holdings's principal executive offices are located in approximately 7,600 square feet of office space leased by Platinum Bermuda at The Belvedere Building, Pitts Bay Road, Pembroke, Bermuda. A portion of this office space is used by Platinum Bermuda as its principal offices.
THE UNDERWRITING RESULTS AND THE AUDITED HISTORICAL COMBINED FINANCIAL STATEMENTS OF THE REINSURANCE UNDERWRITING SEGMENT OF ST. PAUL PRIOR TO THE PUBLIC OFFERING (THE PREDECESSOR BUSINESS) ARE NOT INDICATIVE OF THE ACTUAL RESULTS OF THE COMPANY SUBSEQUENT TO THE PUBLIC OFFERING. FOR A DETAILED DISCUSSION OF THE COMPANY'S PRO FORMA COMBINED STATEMENTS OF UNDERWRITING RESULTS, SEE "PRO FORMA FINANCIAL STATEMENTS" BEGINNING ON PAGE PF-1 OF THIS FORM 10-K AND "MANAGEMENT'S DISCUSSION AND ANALYSIS OF PRO FORMA FINANCIAL CONDITION AND UNDERWRITING RESULTS" BEGINNING ON PAGE PF-4 OF THIS FORM 10-K.
IN ADDITION TO THE EFFECT OF THE NON-TRANSFER OF CERTAIN PORTIONS OF ST. PAUL RE'S BUSINESS TO THE COMPANY AND THE EXCLUSION OF THE ST. PAUL CORPORATE AGGREGATE EXCESS-OF-LOSS REINSURANCE PROGRAM, OTHER FACTORS MAY CAUSE THE COMPANY'S ACTUAL RESULTS TO DIFFER MATERIALLY FROM ST. PAUL RE'S RESULTS. FOR EXAMPLE, ALTHOUGH THE COMPANY CONTINUES TO BE AFFORDED THE BENEFITS OF ST. PAUL RE'S RETROCESSIONAL PROGRAM FOR THE REMAINDER OF 2002, THE COMPANY MAY ENTER INTO REINSURANCE CONTRACTS WITH SIGNIFICANTLY DIFFERENT TERMS AND CONDITIONS FROM THOSE THAT HAVE BEEN MADE AVAILABLE TO ST. PAUL RE FROM ST. PAUL AND WHICH FORM THE BASIS OF ST. PAUL RE'S RESULTS. FURTHERMORE, THE ADDITIONAL PREMIUMS RECORDED IN 2001 BY ST. PAUL RE'S FINITE RISK BUSINESS PRIMARILY ASSOCIATED WITH THE SEPTEMBER 11, 2001 TERRORIST ATTACK WERE EXCEEDINGLY HIGH AND NOT NECESSARILY INDICATIVE OF THE RECURRING PREMIUM VOLUME THE COMPANY EXPECTS TO WRITE IN THAT BUSINESS SEGMENT.
It is important to understand the Company's accounting policies in order to understand its financial statements. Management considers certain of these policies to be critical to the presentation of the financial results since they require management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosures at the financial reporting date and throughout the period being reported upon. Certain of the estimates result from judgments that can be subjective and complex, and consequently actual results may differ from these estimates. The Company's most critical accounting policies involve written and unearned premium, unpaid losses and LAE, reinsurance, investments, income taxes and stock-based compensation.
Along with the estimated premiums, the Company records the expenses associated with these premiums in the form of losses, LAE and commissions.
Changes in estimates of any written and earned premiums are recorded in the period in which they are determined.
Pursuant to the provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), the Company has elected to use the intrinsic value method of accounting for stock-based awards granted to employees established by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). Under APB 25, if the exercise price of the Company's employee stock options is equal to or greater than the fair market value of the underlying stock on the date of the grant, no compensation expense is recorded.
Platinum Holdings was organized on April 19, 2002 and was capitalized on April 24, 2002 under the laws of Bermuda to hold subsidiaries that provide property, casualty, and other reinsurance to insurers and reinsurers on a worldwide basis. There were no significant operations of the Company until November 1, 2002 when the Company completed the Public Offering. In connection with the Public Offering, the Company entered into several quota share retrocession agreements with St. Paul pursuant to which St. Paul transferred the liabilities, related assets and rights and risks under substantially all of the reinsurance contracts entered into by St. Paul on or after January 1, 2002.
Net premiums written for the period from November 1, 2002 through December 31, 2002 were $298,114,000. Net premiums written includes $292,302,000 of premiums related to reinsurance contracts becoming effective in 2002 and assumed from St. Paul as described above. The following table summarizes net premiums written by the three operating segments for the period from November 1, 2002 through December 31, 2002 ($ in thousands):
This operating segment generated $43,844,000 of net premiums written and $24,731,000 of net earned premium. Losses and LAE incurred for the Finite Risk operating segment was $9,300,000 resulting in a loss ratio of 37.6 percent. This ratio reflects a low level of reported losses. Policy acquisition expenses were $8,407,000 and represent 34 percent of net earned premiums and include $5,227 of profit commission and accruals. Operating expenses were $2,068,000 and include one-time transaction costs of $440,000.
The consolidated sources of funds of the Company consist primarily of premiums written, losses recovered from retrocedents, investment income and proceeds from sales and redemption of investments. The 2002 operating cash flow was impacted materially by the quota share reinsurance agreement with St. Paul under which the Company assumed the liabilities of St. Paul Re reinsurance contracts on
November 2, 2002 and received approximately $288,648,000 in cash. After the deduction of operating expenses, net cash flow provided by operations was $281,393,000. Operating cash flow was used primarily to acquire additional investments.
Invested assets were $1,065,216,000 as of December 31, 2002. The Company's fixed maturity investment portfolio primarily consists of investment grade bonds. The portfolio has an average duration of 3.8 years. Management continually monitors the composition and cash flow of the investment portfolio in order to maintain the appropriate levels of liquidity in order to ensure the Company's ability to satisfy claims.
Platinum Holdings is a holding company that conducts no reinsurance operations of its own. All of its reinsurance operations are conducted through its wholly owned operating subsidiaries Platinum US (which it owns through Platinum Ireland and Platinum Finance), Platinum UK (which it owns through Platinum Ireland) and Platinum Bermuda. As a holding company, the cash flow of Platinum Holdings consists primarily of dividends, interest and other permissible payments from its subsidiaries. Platinum Holdings depends on such payments to receive funds for general corporate purposes and to meet its obligations, including the payment of any dividends to its shareholders. The payment of such dividends is subject to the regulatory requirements described in "Business - Regulation" above.
Periods of moderate economic recession or inflation tend not to have a significant direct effect on the Company's underwriting operations. Management also considers the potential impact of economic trends in estimating its unpaid losses and LAE. Management believes that the underwriting controls it maintains
assist in estimating ultimate claim costs and lessen the potential adverse impact of the economy on the Company. Significant inflationary or recessionary periods can, however, impact the Company's underwriting operations and investment portfolio. A decrease in interest rates will tend to decrease the Company's yield and have a positive effect on the fair value of its invested assets. An increase in interest rates will tend to increase the Company's yield and have a negative effect on the fair value of its invested assets.
We have audited the accompanying consolidated balance sheet of Platinum Underwriters Holdings, Ltd. and subsidiaries as of December 31, 2002, and the related consolidated statement of income and comprehensive income, shareholders' equity, and cash flows for the period April 19, 2002 (date of inception) to December 31, 2002. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Platinum Underwriters Holdings, Ltd. and subsidiaries as of December 31, 2002, and the results of their operations and their cash flows for the period April 19, 2002 (date of inception) to December 31, 2002 in conformity with accounting principles generally accepted in the United States of America.
CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE PERIOD FROM APRIL 19, 2002 (DATE OF INCEPTION) THROUGH DECEMBER 31, 2002
Platinum Underwriters Holdings, Ltd. ("Platinum Holdings" or the "Company") was incorporated on April 19, 2002 and was capitalized on April 24, 2002 under the laws of Bermuda to hold subsidiaries that provide property, casualty, and other reinsurance to insurers and reinsurers on a worldwide basis. As discussed more fully in Note 8, Platinum Holdings completed its initial public offering in November 2002. Concurrent with the initial public offering and as discussed more fully in Note 2, the Company assumed certain rights and obligations of the reinsurance business from The St. Paul Companies, Inc. ("St. Paul"). Consequently, the operations of the Company commenced in November 2002.
In 2001, St. Paul's management decided that its reinsurance business and its primary insurance business should ideally operate as separate entities because of their different risk profiles and business characteristics. As part of this effort, St. Paul also began exiting unprofitable lines of business and reducing the number of reinsurance branch offices outside the United States. As a result, St. Paul became a participant and sponsor in the formation of Platinum Holdings and its subsidiaries.
Prepayment assumptions for mortgage and asset backed securities were obtained from outside investment managers. These assumptions are consistent with the current interest rate and economic environment. The retrospective adjustment method is used to value all securities.
Short-term investments are carried at cost, which approximates fair value. Short-term investments mature within one year from the purchase date. Cash equivalents are carried at amortized cost,
Costs of acquiring business, primarily commissions and other direct underwriting expenses, which vary with and are directly related to the production of business, are deferred and amortized over the same period as the corresponding premiums are recorded as revenues. On a regular basis, an analysis of the recoverability of deferred acquisition costs, in relation to the expected recognition of revenues, including anticipated investment income, is performed. Any adjustments are reflected as period costs. Should the analysis indicate that the acquisition costs are unrecoverable, further analyses are performed to determine if a liability is required to provide for losses which may exceed the related unearned premiums. Deferred acquisition costs amortized in 2002 were $14,449,000.
The net proceeds from the sale of the Company's equity security units were allocated between the purchase contracts and the senior notes based on the underlying fair value of each instrument. The present value of the purchase contract adjustment payments were initially charged to shareholders' equity, with an offsetting credit to liabilities. Subsequent contract adjustment payments will be allocated between this
liability account and interest expense based on a constant rate calculation over the life of the transaction. Costs incurred in issuing debt are capitalized and amortized over the life of the debt. Before the issuance of Common Shares upon settlement of the purchase contracts and if dilutive, the purchase contracts are reflected in diluted earnings per share calculations using the "if converted" method, which assumes that the Common Shares were issued and the proceeds received were used to pay down the senior notes that are part of the Company's equity security units.
Unpaid losses and LAE are subject to the effects of trends in loss severity and frequency. These estimates are reviewed regularly and adjusted as experience develops or new information becomes known. Any such adjustments are reflected in results of operations in the period in which they become known and are accounted for as changes in estimates.
Basic earnings per share is computed by dividing net income by the weighted average number of shares outstanding for the period. Diluted earnings per share reflects the basic earnings per share adjusted for the potential dilution that would occur if the issued options were exercised and considers the outstanding purchase contracts relating to the equity security units. Securities that are convertible into Common Shares that are anti-dilutive are not included in the calculation of diluted earnings per share.
and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established for deferred tax assets where it is more likely than not that future tax benefits will not be realized.
Pursuant to the provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), the Company has elected to continue using the intrinsic value method of accounting for stock-based awards granted to employees established by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). Under APB 25, if the exercise price of the Company's employee stock options is equal to or greater than the fair market value of the underlying stock on the date of the grant, no compensation expense is recorded.
The Company's functional currency is the United States dollar. Transactions conducted in foreign currencies are remeasured to the Company's functional currency, and the resulting foreign exchange gains or losses are included in other income. The remeasurement is calculated using current exchange rates for the balance sheet amounts and average exchange rates for revenues and expenses. Translation adjustments for foreign operations are recorded as a cumulative translation adjustment in a separate component of shareholders' equity, net of applicable deferred income taxes.
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. A summary of the liabilities assumed and assets received are as follows ($ in thousands):
Included in assumed premiums written is $292,302,000 assumed from St. Paul. Premiums assumed from St. Paul includes $244,000,000 of unearned premiums as of November 2, 2002 on reinsurance contracts becoming effective in 2002 and additional assumed premiums written of approximately $48,302,000 for the period from November 2, 2002 through December 31, 2002. While the Company did not cede any premiums in 2002, it assumed business from St. Paul net of retrocessional reinsurance and may be subject to the credit risk related to such retrocessional reinsurance.
The Company entered into an Employee Benefits and Compensation Matters Agreement with St. Paul that provides for the transfer of employees from St. Paul and provides for the allocation of assets and liabilities and certain other agreements with respect to employee compensation and benefit plans. In addition, St. Paul will reimburse the Company for the annual bonuses of the Company's employees prorated for the period from January 1, 2002 through the date of completion of the Public Offering. The
Investment income for the period ended December 31, 2002 is summarized as follows ($ in thousands):
Net realized gains from investments for the period ended December 31, 2002 were all derived from fixed maturities. Gross gains and losses realized on those sales were $423,000 and $398,000, respectively. Proceeds from sales, maturities and calls of fixed maturities were $120,421,000 in the 2002 period.
Activity in the liability for unpaid losses and LAE for the period ended December 31, 2002 is summarized as follows ($ in thousands):
reinsurers by the significant amount of time that often elapses between the occurrence of an insured loss, the reporting of that loss to the primary reinsurer and then to the reinsurer, and the primary insurer's payment of that loss to the insured and subsequent payment by the reinsurer to the primary insurer. Losses and LAE are recorded considering a range of estimates bounded by high and low points. Within that range, management's best estimates are recorded. Unpaid losses and LAE are reviewed continually using a variety of statistical and actuarial techniques to analyze current claim costs, frequency and severity data and prevailing economic, social and legal factors. Unpaid losses and LAE established in prior years are adjusted as loss experience develops and new information becomes available. Adjustments to previously estimated unpaid losses and LAE are reflected in financial results in the periods in which they are made. It should be noted that the process of estimating losses and LAE, by its very nature, involves uncertainty. The level of uncertainty can be influenced by factors such as the existence of long-tail coverage (when loss payments may not occur for several years) and changes in claims handling practices, as well as the factors noted above, and actual claim payments and LAE could be significantly different from the estimates.
Reinsurance is the transfer of risk, by contract, from one insurance company to another for consideration of premium. Retrocessional reinsurance is reinsurance ceded by a reinsurer to insure against all or a portion of its reinsurance written. Retrocessional reinsurance agreements provide the Company with increased capacity to write larger risks, limit its maximum loss arising from any one occurrence and maintain its exposure to loss within its capital resources. Retrocessional reinsurance contracts do not relieve the Company from its obligations under its contracts. Failure of reinsurers to honor their obligations could result in losses to the Company. Consequently, the Company has a contingent liability to the extent of any unpaid losses and LAE ceded to another company. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. The Company monitors all reinsurers by reviewing A.M. Best Company reports and ratings and information from reinsurance intermediaries, and by analyzing financial statements.
The effects of reinsurance on premiums, losses and LAE for the period from November 1, 2002 through December 31, 2002 are as follows ($ in thousands):
Concurrently with the completion of the Public Offering, Platinum Holdings completed the initial public offering of 5,500,000 equity security units at a price of $25 per unit (the "ESU Offering"). Each equity security unit consists of a contract to purchase common shares of the Company ("Common Shares") in 2005, and an ownership interest in a senior note, due 2007, of Platinum Finance. Platinum Holdings will make quarterly contract adjustment payments under the purchase contracts of 1.75 percent per year of the stated amount of $25 per unit. In addition, Platinum Finance will make quarterly interest payments on the senior notes at an annual rate of 5.25 percent. The senior notes are guaranteed by Platinum Holdings on a senior, unsecured basis and are pledged as collateral to secure the holders' obligations to acquire Common Shares in 2005. As of December 31, 2002, the fair value of the equity
security units was $155,925,000 and was based on quoted market prices. There were no cash payments of interest in 2002.
Platinum Holdings has entered into a 364-day committed credit facility with a group of banks which provides $100 million of aggregate borrowing capacity. The credit facility contains various covenants and agreements, including the requirement to maintain a specified tangible net worth and leverage ratios, and terminates on June 20, 2003 unless extended with the consent of the banks. As of and for the period ended December 31, 2002, there were no amounts outstanding pursuant to the credit facility.
The Company provides income taxes based upon amounts reported in the financial statements and the provisions of currently enacted tax laws. Platinum Holdings and Platinum Bermuda are incorporated under the laws of Bermuda and are subject to Bermuda law with respect to taxation. Under current Bermuda law, they are not taxed on any Bermuda income or capital gains taxes and they have received an undertaking from the Bermuda Minister of Finance that, in the event of any Bermuda income or capital gains taxes being imposed, they will be exempt from those taxes until 2016. Platinum Holdings has subsidiaries based in the United States, the United Kingdom and Ireland that are subject to the tax laws thereof.
Income tax expense for the period ended December 31, 2002 is comprised of current and deferred as follows ($ in thousands):
A reconciliation of expected income tax expense, computed by applying a 35 percent income tax rate to income before income taxes, to income tax expense for the period ended December 31, 2002 is as follows ($ in thousands):
The Company's initial capitalization of $120,000 was provided by an organizing trust. On May 29, 2002, Platinum Holdings completed a 100-for-1 split of its Common Shares, resulting in 135,000,000 Common Shares authorized and 1,200,000 Common Shares issued and outstanding, all with a par value of $0.01 per share. On October 28, 2002, the shareholder of Platinum Holdings increased the number of Common Shares authorized to 200,000,000 Common Shares and 25 million preferred shares. Concurrent with the Public Offering, the 1,200,000 Common Shares were redeemed and canceled.
RenaissanceRe received an option to purchase up to 2,500,000 additional Common Shares at any time during the ten years following the Public Offering at a purchase price of $27.00 per share.
The Company has elected to continue using the intrinsic value method of accounting for stock-based awards granted to employees established by APB 25. The fair value of each option grant used for pro forma disclosure in Note 1 is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:
These assumptions would have resulted in a stock-based compensation expense, net of tax, of $1,070,000 in 2002.
In 2003, the Company adopted an employee savings plan as a defined contribution plan intended to qualify under Section 401(a) of the Internal Revenue Code and covering substantially all U.S. employees. The savings plan allows eligible employees to contribute up to 50 percent of their annual compensation on a tax-deferred basis up to limits under the Code and the Company will match up to the first four percent. In addition, the Company may, at its discretion, make additional contribution.
anniversary, adjusted to 3.5 percent of the Company's gross written non-marine non-finite property catastrophe premium for the previous annual period, if such amount is greater than $4 million. Either party may terminate this agreement if the other is deemed impaired or insolvent by applicable regulatory or judicial authorities or is the subject of conservation, rehabilitation, liquidation, bankruptcy or similar insolvency proceedings. Included in operating expenses for the period ended December 31, 2002 is $46,000 of accrued fees.
The following table summarizes underwriting activity and ratios for the three operating segments together with a reconciliation of underwriting profit or loss to income before income tax expense for the period ended December 31, 2002 ($ in thousands):
Corporate expenses, interest expenses, net investment income, net realized investment gains and other income or expense items that are not specifically attributable to operating segments are not allocated.