The Company leases office space in Pembroke, Bermuda where the Company’s principal executive office is located. Additionally, the Company and its subsidiaries lease office space in the United States, the United Kingdom and several other jurisdictions sufficient for the operation of its Insurance and Reinsurance segments. We renew and enter into new leases in the ordinary course of business. For further discussion of our leasing commitments at December 31, 2007, please see Note 11 - ‘‘Commitments and Contingencies’’ of our Audited Consolidated Financial Statements.
Endurance Specialty Holdings Ltd. (‘‘Endurance Holdings’’) was organized as a Bermuda holding company on June 27, 2002. Endurance Holdings has seven wholly-owned operating subsidiaries:
• Endurance Reinsurance Corporation of America (‘‘Endurance U.S. Reinsurance’’), domiciled in Delaware;
• Endurance American Specialty Insurance Company (‘‘Endurance American Specialty’’), domiciled in Delaware;
• American Merchants Casualty Company (‘‘American Merchants’’), domiciled in Ohio; and
The Company writes specialty lines of property and casualty insurance and reinsurance on a global basis, and seeks to create a portfolio of specialty lines of business that are profitable and have
limited correlation with one another. The Company’s portfolio of specialty lines of business is organized into two business segments, Insurance and Reinsurance.
In the Insurance segment, the Company writes property, casualty, agriculture, healthcare liability, workers’ compensation and professional lines insurance. In the Reinsurance segment, the Company writes casualty, property, catastrophe, agriculture, marine, aerospace and surety and other specialty reinsurance.
Marketplace Conditions and Trends. During 2007, the property markets that the Company operates in, which were impacted by the large industry losses in 2005, have become more competitive, with pricing generally falling. In 2008 the Company expects to experience continued competition in certain of its catastrophe-exposed and non-catastrophe-exposed lines of business. This increased competition is primarily expected to emerge as a result of the increased levels of capital held by companies that compete with Endurance, which will increase the supply of insurance and reinsurance available in the market place. This shift has the potential to produce a mismatch between the supply and demand for insurance and reinsurance products and may result in price reductions for some of our products. Competition has increased across all lines of business, and we expect to experience a declining pricing environment. However, the Company continues to see the opportunity to provide needed underwriting capacity at what the Company believes are appropriate rates, terms and conditions.
The Company’s consolidated financial statements contain certain amounts that are inherently subjective in nature and require management to make assumptions and best estimates to determine the reported values and related disclosures. Management considers an accounting estimate to be critical if:
The Company’s reinsurance premiums are earned in proportion to the amount of reinsurance protection provided over the terms of the applicable risk period established in the reinsurance contract. Reinsurance contracts written on a losses occurring basis cover losses which occur during the term of the reinsurance contract, typically 12 months. Accordingly, the Company earns the premium on a losses occurring reinsurance contract evenly over the reinsurance contract term. Losses occurring reinsurance contracts accounted for approximately 32%, 33%, and 33% of the Company’s gross premiums written during the years ended December 31, 2007, 2006 and 2005, respectively. Reinsurance contracts written on a policies attaching basis cover losses from the underlying insurance policies incepting during the terms of the reinsurance contracts. Losses under a policies attaching reinsurance contract may occur after the end date of the reinsurance contract, so long as they are losses from policies which began during the reinsurance contract period. The Company typically earns the premiums for policies attaching reinsurance contracts over a 24 month period in proportion to the amount of reinsurance protection provided to reflect the extension of the risk period past the term of the contract and the varying levels of reinsurance protection provided during the reinsurance contract period. Policies attaching reinsurance contracts accounted for approximately 26%, 35%, and 42% of the Company’s gross premiums written during the years ended December 31, 2007, 2006 and 2005, respectively.
In addition to determining the applicable risk period, the Company’s estimate of its reinsurance premiums written is based on the type of reinsurance contracts underwritten. For excess of loss reinsurance contracts, the deposit premium, as defined in the contract, is generally considered to be the best estimate of the reinsurance contract’s written premium at inception. The Company earns reinstatement premiums upon the occurrence of a loss under the reinsurance contract. Reinstatement premiums are calculated in accordance with the contract terms based upon the ultimate loss estimate associated with each contract. Excess of loss reinsurance contracts accounted for approximately 31%,
36%, and 39% of the Company’s gross premiums written during the years ended December 31, 2007, 2006 and 2005, respectively. For proportional reinsurance contracts, the Company estimates premium, commissions and related expenses based on broker and ceding company estimates. In addition to ceding company estimates, the Company also utilizes its judgment in establishing proportional reinsurance contract premium estimates after considering the following factors:
• anticipated changes in the marketplace and the ceding company’s competitive position therein;
• correspondence and communication between the Company and its brokers, intermediaries and ceding companies.
A portion of the Company’s assumed proportional reinsurance agreements contain occurrence limitations or loss sensitive provisions, such as adjustable or sliding scale commissions, that may impact the ultimate amounts paid to or received from ceding companies based on loss experience. In some loss scenarios, these features would result in the ceding company’s results not being proportional to the Company’s results from the proportional agreement, and such differences may be meaningful.
For the year ended December 31, 2007, the Company entered into a small number of reinsurance contracts that did not fall within the criteria for reinsurance accounting under SFAS No. 113. The Company has accounted for these contracts by the deposit method of accounting specified by Statement of Position 98-7 - ‘‘Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk.’’ Consequently, these contracts were accounted for as contracts which either transfer only significant timing risk or transfer only significant underwriting risk. The determination of the appropriate method of accounting for these contracts requires significant judgment and analysis, particularly with respect to assumptions about the variability and likelihood of potential future losses. Under the deposit method of accounting, revenues and expenses from reinsurance contracts are not recognized as written premium and incurred losses. Instead, income or loss associated with contracts determined to transfer only significant timing risk is recognized as a component of net other underwriting income (loss) over the estimated claim settlement period while income or loss associated with contracts determined to transfer only significant underwriting risk is recognized as net other underwriting income (loss) over the contract risk period.
Although management has determined that accounting for these contracts as deposits is the most appropriate treatment, the Company considers the risk of loss resulting from any one of these contracts to be more than remote, and such loss could be material. For the years ended December 31, 2007, 2006 and 2005, the Company recorded deposit accounting adjustments to gross premiums written of $28.6 million, $159.0 million, and $143.3 million, respectively, associated with contracts not qualifying for reinsurance accounting treatment as noted above.
Reserve for Losses and Loss Expenses. The Company’s reserve for losses and loss expenses includes case reserves and reserves for losses incurred but not reported (referred to as ‘‘IBNR reserves’’). Case reserves are established for losses that have been reported to us, but not yet paid. IBNR reserves represent the estimated ultimate cost of events or conditions that have not been reported to or specifically identified by the Company, but have occurred. Case reserves and IBNR reserves are established by management based on reports from reinsurance intermediaries, ceding companies and insureds and consultations with independent legal counsel. In addition, IBNR reserves are established by management based on reported losses and loss expenses and actuarially determined estimates of ultimate losses and loss expenses.
Since inception, the Company has used reserving methods that are commonly applied when limited loss development experience exists. In order to capture the key dynamics of loss development and expected volatility that may arise within the disclosed amounts for the reserve for losses and loss expenses, the key lines of business within each business segment are aggregated based on their potential expected length of loss emergence. The period over which loss emergence occurs is typically referred to as the tail. The Company has classified its lines of business as either having a ‘‘short,’’ ‘‘long’’ or ‘‘other’’ tail pattern. As the Company has accumulated its own loss reserve history, it has determined it is more appropriate to incorporate the Company’s actual loss experience. As of 2006, the Company determined that its own loss development history in relation to its short tail and other lines of business had reached a level of maturity sufficient to provide a credible basis on which to estimate its reserve for losses and loss expenses related to these lines of buinsess. As such, the Company’s actual reporting patterns were considered when determining the reserve for losses and loss expenses in the short tail and other lines of business in its Reinsurance and Insurance segments for the year ended December 31, 2007. The Company continues to utilize industry loss and development patterns in the establishment of loss and loss expense reserves for its long tail and certain other lines of business in both its Insurance and Reinsurance segments.
In order to verify the accuracy and completeness of the information provided to the Company by its ceding company counterparties, the Company’s underwriters, actuaries, accounting and claims personnel perform underwriting and claims reviews of the Company’s ceding companies. Any material findings are communicated to the ceding companies and utilized in the establishment or revision of the Company’s case reserves and related IBNR reserve. On occasion, these reviews reveal that the ceding company’s reported losses and loss expenses do not comport with the terms of the contract with the Company. In such events, the Company strives to resolve the outstanding differences in an
amicable fashion. The large majority of such differences are resolved in this manner. In the infrequent instance where an amicable solution is not feasible, the Company’s policy is to vigorously defend its position in litigation or arbitration. As of December 31, 2007, the Company was not involved in any material claims litigation or arbitration proceedings.
Potential Volatility in the Reserve for Losses and Loss Expenses. In addition to the factors creating uncertainty in the Company’s estimate of loss and loss expense reserves, the Company’s estimated reserve for losses and loss expenses can change over time because of unexpected changes in the external environment. Potential changing external factors include:
The Company’s estimates of reserves for losses and loss expenses can also change over time because of changes in internal company operations. Potential changing internal factors include:
future. For an illustration of the effect of a 10% change in the Company’s two key inputs used in determining its loss and loss expense reserves - the expected loss ratio and the expected loss reporting pattern - please see ‘‘Reserve for Losses and Loss Expenses’’ below.
Investments. The Company currently classifies all of its fixed maturity investments and short-term investments as ‘‘available for sale’’ and, accordingly, they are carried at estimated fair value. The fair value of fixed maturity securities is estimated using quoted market prices or dealer quotes. For mortgage-backed and other asset-backed debt securities, fair value includes estimates regarding prepayment assumptions, which are based on current market conditions. Amortized cost in relation to these securities is calculated using a constant effective yield based on anticipated prepayments and estimated economic lives of the securities. When actual prepayments differ significantly from anticipated prepayments, the effective yield is recalculated to reflect actual payments to date. Changes in estimated yield are recorded on a retrospective basis, which results in future cash flows being used to determine current book value.
In accordance with Statement of Financial Accounting Standards (‘‘SFAS’’) No. 115, ‘‘Accounting for Certain Investments in Debt and Equity Securities’’ and Financial Statement of Position (‘‘FSP’’) 115-1, ‘‘The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments,’’ the Company periodically reviews its fixed maturity investments and short-term investments to determine whether a decline in the fair value below the amortized cost basis is other-than-temporary. If such a decline in the fair value is judged to be other-than-temporary, the Company would write-down the investment to fair value, thereby establishing a new cost basis. The amount of the write-down is charged to income as a realized loss. The new cost basis is not changed for subsequent recoveries in fair value.
Other investments are accounted for using the equity method of accounting whereby the initial investment is recorded at cost. The carrying amounts of these investments are increased or decreased to reflect the Company’s share of income or loss, which is included in net investment income, and are decreased for dividends.
At each balance sheet date, management assesses the need to establish a valuation allowance that reduces deferred tax assets when it is more likely than not that all, or some portion, of the deferred tax asset will not be realized. The valuation allowance is based on all available information including projections of future taxable income from each tax-paying component in each tax jurisdiction and available tax planning strategies. Estimates of future taxable income incorporate several assumptions that may differ from actual experience. Differences in our assumptions and resulting estimates could be material and have an adverse impact on our financial results of operations and liquidity. Any such differences are recorded in the period in which they become known.
Recent Accounting Pronouncements. See note 2(q), ‘‘Summary of Significant Accounting Policies - Recent Accounting Pronouncements,’’ of the notes accompanying our consolidated financial statements.
The following is a discussion and analysis of the Company’s consolidated results of operations for the years ended December 31, 2007, 2006 and 2005.
Ceded premiums written continued to increase in 2007 from 2006 and 2005 as the Company expanded its risk management strategy to encompass the use of more reinsurance to manage its aggregate exposures due to the continued expansion of the Company’s Insurance segment.
Net premiums earned declined in 2007 compared to 2006 consistent with declines in premiums written year over year. Excluding $46.1 million of reinstatement premiums recorded in 2005 related to Hurricanes Katrina, Rita and Wilma (the ‘‘2005 Hurricanes’’), net premiums earned in 2006 were relatively consistent with 2005.
The annualized net earned yield (which is the actual net earned income from the investment portfolio after adjusting for expenses and accretion and amortization from the purchase price divided by the average book value of assets), total return of the investment portfolio (which includes realized and unrealized gains and losses), market yield (which is the internal rate of return of the security based on the given market price or the single discount rate that equates a security price (inclusive of accrued interest) with its projected cash flows) for the years ended December 31, 2007, 2006 and 2005 and portfolio duration as of December 31, 2007, 2006 and 2005 were as follows:
(1) Includes only cash and cash equivalents and fixed maturity securities held by the Company’s investment managers.
Our investment portfolio is managed to generate attractive economic returns and income while providing the Company with liquidity. Movements in financial markets and interest rates influence the
The Company participates in lines of business where claims may not be reported for many years. Accordingly, management does not believe that reported claims are the only valid means for estimating ultimate obligations. Ultimate losses and loss expenses may differ materially from the amounts recorded in the Company’s consolidated financial statements. These estimates are reviewed regularly and, as experience develops and new information becomes known, the reserves are adjusted as necessary. As a result of the incorporation of the Company’s own loss reporting patterns and loss history related to its short tail business, including catastrophe reinsurance and property insurance and reinsurance business lines, the Company would expect its prior year loss reserve development and adjustments for short tail business to be less than recorded in prior years. Reserve adjustments, if any, are recorded in earnings in the period in which they are determined. The overall loss reserves were established by the Company’s actuaries and reflect management’s best estimate of ultimate losses. See ‘‘Reserve for Losses and Loss Expenses’’ below for further discussion.
The acquisition expense ratio for 2007 was consistent with the 2006 and 2005 ratios.
The Company produced net income of $521.1 million in 2007 compared to $498.1 million in 2006 and a net loss of ($220.5) million in 2005. The increase in net income for 2007 compared to 2006 was due to the absence of catastrophe events outside of Europe, favorable development in reserves related to prior years and strong investment performance partially offset by a modest decline in premiums earned by the Company. The increase in net income in 2006 compared to 2005 was due to the absence of catastrophic events in 2006, the growth of the Company’s premiums, favorable underwriting margins in the Company’s catastrophe exposed business lines and strong investment performance.
For internal management reporting purposes, underwriting results by business segment are presented on the basis of applying reinsurance accounting to all reinsurance contracts written.
The following table summarizes the underwriting results and associated ratios for the Company’s Insurance segment for the years ended December 31, 2007, 2006 and 2005.
Premiums. Gross premiums written in the Insurance segment increased in 2007 by 28.6% over 2006 and 76.0% over 2005 gross premiums written. Gross and net premiums written for each line of business in the Insurance segment for the years ended December 31, 2007, 2006 and 2005 were as follows:
The increase in the Insurance segment gross premiums written in 2007 compared to 2006 and 2005 was primarily a result of growth in the Company’s U.S. insurance operations, including the continued growth of a specialized and targeted workers’ compensation portfolio. The increase in the Insurance segment gross premiums written was also a result of the acquisition of ARMtech in December of 2007, which contributed $42.2 million of gross premiums written in 2007.
During 2006, this segment benefited from strong pricing in the property line following the large hurricane losses experienced by the industry in 2005. These increases were partially offset by declines in the casualty and healthcare liability business lines from 2005 to 2006 due to increased pricing pressures, competition and excess capacity, which resulted in business being declined by the Company due to rates or terms which did not meet the Company’s underwriting standards.
The net premiums earned by the Company in the Insurance segment in 2007 also increased compared to 2006 and 2006 as compared to 2005, although not as quickly as gross premiums written increased in 2007 and 2006, due to the continued earning of gross premiums written in prior periods, offset by the effects of increased ceded premiums written. The Company expects net premiums earned to be impacted by the increases in premiums ceded as discussed above.
Net Losses and Loss Expenses. The net loss ratio in the Company’s Insurance segment in 2007 compared to 2006 and 2005 reflected the favorable development of prior year loss reserves in the current year. During 2007, the Company’s previously estimated losses and loss expense reserve for the Insurance segment for prior accident years were reduced by $80.4 million as compared to reductions of $54.4 million and $58.0 million for the years ended December 31, 2006 and 2005, respectively. Of the lines of business in the Company’s Insurance segment, the Company’s long tail lines experienced the largest net reductions in the Company’s estimated losses for prior accident years in 2007, 2006 and 2005 as claims have not materialized as originally estimated by the company.
premiums written grew substantially in 2007, relative to other lower expense businesses such as professional lines and healthcare liability.
General and Administrative Expenses. The increase in general and administrative expenses in the Insurance segment in 2007 as compared to 2006, and 2006 compared to 2005, resulted from expenditures related to the expansion of the Company’s U.S. insurance operations beginning in the second half of 2005. As the gross premiums written by the U.S. insurance operations continue to increase and the related expansion costs stabilize, the Company expects that the general and administrative expense ratio will correspondingly become more stable.
The decrease in 2007 gross premiums written was primarily due to the non-renewal of certain international property and casualty accounts that no longer met the Company’s underwriting
Gross premiums written in the Reinsurance segment during 2006 compared to 2005 was relatively consistent with a modest decrease in total premiums primarily due to decreased premium writings in the property and aerospace lines.
Net Losses and Loss Expenses. The low level of losses and loss expenses in the Company’s Reinsurance segment in 2007 and 2006 as compared to 2005 reflected the low catastrophic loss activity, specifically outside of Europe, in the current year, while the higher losses and loss expenses in 2005 resulted principally from the significant U.S. hurricane activity occurring in that year. In each year, the Company experienced favorable loss reserve development from prior years in its Reinsurance segment, with the majority of the current year favorable loss reserve development emanating from this segment’s short tail lines. During 2007, 2006 and 2005, the Company’s previously estimated ultimate losses for the Reinsurance segment for prior accident years were reduced by $74.4 million, $5.0 million and $104.5 million, respectively. Favorable prior year loss reserve development resulted as claims have not materialized as originally estimated by the Company.
Acquisition Expenses. The Company’s acquisition expense ratio in the Reinsurance segment decreased for 2007 as compared to 2006 due to growth in catastrophe and agriculture lines with typically lower associated acquisition expenses as compared to other property and casualty businesses, which are often written on a quota share basis. The acquisition expense ratio for 2006 increased compared to 2005 due to increased profit commissions paid to ceding companies as a result of lower loss activity than was experienced in the prior year.
For internal management reporting purposes, underwriting results by business segment are presented on the basis of applying reinsurance accounting to all reinsurance contracts written. The following table presents the activity related to deposit accounted contracts included in the Company’s segment results above, which reconciles the Company’s underwriting results to the Company’s consolidated financial statement presentation for the years ended December 31, 2007, 2006 and 2005.
Under the deposit method of accounting, revenues and expenses from reinsurance contracts are not recognized as gross premium written and losses and loss expenses. Instead, the profits or losses from these contracts are recognized net as other underwriting income or loss over the contract or expected claim payment periods. Income or loss associated with contracts determined to transfer only significant timing risk or only significant underwriting risk are included as a component of net other underwriting income or loss and recognized over the estimated claim settlement period or contract risk period, respectively.
ARMtech contributed $42.2 million of additional gross premiums written to the Insurance segment in December of 2007. In addition, the Company recorded goodwill and other intangible assets of $42.0 million and $96.7 million, respectively, related to certain licenses, internally developed software, non-compete agreements and customer relationships.
Variable Delivery Forward. On September 11, 2007, Endurance Holdings consummated a variable delivery equity forward sale arrangement under which Endurance Holdings is entitled to sell ordinary shares to an affiliate of Deutsche Bank Securities, Inc. (the ‘‘forward counterparty’’) for proceeds of approximately $150 million pursuant to a prospectus supplement to the Shelf Registration Statement on Form S-3ASR (Registration No. 333-130464) filed with the U.S. Securities and Exchange Commission on September 12, 2007. Under the terms of the forward sale agreement, Endurance Holdings will sell an aggregate of between 2,984,772 and 4,786,827 ordinary shares to the forward counterparty, subject to Endurance Holdings’ right to cash settle or net share settle all or a portion of such agreement.
The interest rate for revolving loans under the 2007 Credit Facility is either (i) the higher of (a) the Federal Funds Effective Rate plus 0.5% and (b) the prime commercial lending rate of JPMorgan Chase Bank or (ii) LIBOR, plus a fee ranging from 0.165% to 0.375% depending on the Company’s leverage ratio and if the loan is collateralized or uncollateralized. For letters of credit issued on a collateralized basis, the Company is required to pay a fee ranging from 0.165% to 0.29% on the daily stated amount of such letters of credit. For letters of credit issued on an uncollateralized basis, the Company is required to pay a fee ranging from 0.275% to 0.375% on the daily stated amount of such letters of credit. In addition, the 2007 Credit Facility requires the Company to pay to the lenders a facility fee and a utilization fee.
Endurance Holdings is a holding company that does not have any significant operations or assets other than its ownership of the shares of its direct and indirect subsidiaries, including Endurance Bermuda, Endurance U.K., Endurance U.S. Reinsurance, Endurance American, Endurance American Specialty, American Merchants and ARMtech. Endurance Holdings relies primarily on dividends and other permitted distributions from its insurance subsidiaries to pay its operating expenses, interest on debt and dividends, if any, on its ordinary shares and Series A Preferred Shares. There are restrictions on the payment of dividends by Endurance Bermuda, Endurance U.K., Endurance U.S. Reinsurance, Endurance American, Endurance American Specialty, American Merchants and ARMtech to Endurance Holdings, which are described in more detail below.
As of December 31, 2007 and December 31, 2006, the Company had pledged cash and cash equivalents and fixed maturity investments of $223.2 million and $231.6 million, respectively, in favor of certain ceding companies to collateralize obligations. As of December 31, 2007 and December 31, 2006, the Company had also pledged $594.7 million and $456.4 million of its cash and fixed maturity investments as required to meet collateral obligations for $532.3 million and $409.9 million in letters of credit outstanding under its credit facility, respectively. In addition, at December 31, 2007 and December 31, 2006, cash and fixed maturity investments with fair values of $120.3 million and $40.9 million were on deposit with U.S. state regulators, respectively, and cash and fixed maturity investments with fair values of $33.8 million and $28.5 million were on deposit with Canadian regulators, respectively.
The Company’s contractual obligations as of December 31, 2007 are summarized as follows:
(1) The estimated expected contractual obligations related to our reserves for losses and loss expenses, including reserves related to deposit accounted contracts of $103.0 million, are presented on a gross basis. Due to the inherent complexity of the assumptions used in establishing the Company’s reserve for losses and loss expenses estimates, final claim settlements made by the Company may vary significantly from the present estimates in timing and amount. Approximately 68% of our net reserves were incurred but not reported at December 31, 2007. For a discussion of these uncertainties, see ‘‘Critical Accounting Estimates - Reserve for Losses and Loss Expenses.’’
(2) The Company entered into investment agreements to invest additional amounts in investments in other ventures.
Credit Facility. On May 8, 2007, Endurance Holdings amended its existing credit facility among Endurance Holdings, various designated subsidiary borrowers, various lending institutions and JPMorgan Chase Bank, N.A. as Administrative Agent to, as described above under the section entitled ‘‘Significant Transactions and Events’’.
The 6.15% Senior Notes and the 7% Senior Notes (collectively, the ‘‘Senior Notes’’) are senior unsecured obligations of Endurance Holdings and rank equally with all of Endurance Holdings’
At December 31, 2007, the carrying value of the Senior Notes stood at $447.3 million while the fair value as determined by quoted market valuation was $431.7 million. The Company was in compliance with all covenants contained within the indentures governing the Senior Notes as of December 31, 2007.
Dividends on the Series A Preferred Shares, when, as and if declared by the board of directors of Endurance Holdings or a duly authorized committee of the board, accrue and are payable on the liquidation preference amount from the original issue date, quarterly in arrears on each dividend payment date, at an annual rate of 7.75%. Dividends on the Series A Preferred Shares are not cumulative.
In conjunction with the issuance by the Company of the Series A Preferred Shares, the Company entered into a ‘‘Declaration of Covenant’’ for the benefit of the holders of the 7% Senior Notes. The Covenant states that the Company will redeem its Series A Preferred Shares only if the total redemption price is less than or equal to the proceeds Endurance Holdings or its subsidiaries have received during the six months prior to the date of such redemption from the sale of certain qualifying securities that, among other things, are, with limited exceptions, pari passu with or junior to the Series
A Preferred Shares upon the Company’s liquidation, dissolution or winding-up; perpetual, or have a mandatory redemption or maturity date that is not less than sixty years after the initial issuance of such securities; and provide for dividends or other income distributions that are non-cumulative.
Shackleton, the entity from which Endurance Bermuda purchased $235 million of collateralized catastrophe reinsurance in 2006, is a variable interest entity under the provisions of FASB Interpretation No. 46, ‘‘Consolidation of Variable Interest Entities’’. The Company has a variable interest in Shackleton but is not the primary beneficiary of Shackleton and therefore is not required to consolidate Shackleton in its consolidated financial statements. Please see ‘‘Ceded Reinsurance’’ section below for further details related to this transaction.
As more fully described under ‘‘Reserving Process’’ above, the Company incorporates a variety of actuarial methods and judgments in its reserving process. Two key inputs in the various actuarial methods employed by the Company are initial expected loss ratios and expected loss reporting patterns. These key inputs impact the potential variability in the estimate of the reserve for losses and loss expenses and are applicable to each of the Company’s business segments. The Company’s loss and loss expense reserves consider and reflect, in part, deviations resulting from differences between expected loss and actual loss reporting as well as judgments relating to the weights applied to the reserve levels indicated by the actuarial methods. Expected loss reporting patterns are based upon internal and external historical data and assumptions regarding claims reporting trends over a period of time that extends beyond the Company’s own operating history.
Differences between actual reported losses and expected losses are anticipated to occur in any individual period and such deviations may influence future initial expected loss ratios and/or expected loss reporting patterns as the recent actual experience becomes part of the historical data utilized as part of the ongoing reserve estimation process. The Company has demonstrated the impact of changes in the speed of the loss reporting patterns, as well as changes in the expected loss ratios, within the table under the heading ‘‘Potential Variability in Reserves for Losses and Loss Expenses’’ beginning on page 84.
Losses and loss expenses for the year ended December 31, 2007 are summarized as follows:
Losses and loss expenses for the year ended December 31, 2007 include $159.4 million in favorable development of reserves relating to prior accident years. The favorable loss reserve development experienced during the 2007 year benefited the Company’s 2007 reported loss ratio by approximately 10.0 percentage points. The net reduction in estimated losses for prior accident years reflects lower than expected emergence of catastrophic and attritional losses. Favorable development of prior year reserves for 2007 relates primarily to the Company’s short and long tail lines included in its Insurance segment, as well as the short tail line of business in the Reinsurance segment. The favorable development of reserves related to prior years was primarily due to lower than expected claims across the Company’s reserve categories. For the year ended December 31, 2007, the Company did not materially alter the two key inputs it utilizes to establish its reserve for losses and loss expenses, initial expected loss ratios or loss reporting patterns, for business related to prior years for
the insurance and reinsurance reserve categories as the variances in reported losses in 2007 for those reserve categories were within the range of possible results anticipated by the Company.
Short Tail Insurance. The lower than expected losses and loss expenses related to prior years in the short tail insurance line were principally a result of better than anticipated property claims settlements in 2007 related to the 2005 Hurricanes along with favorable claims emergence in the Company’s property line. As a result, the Company reduced its estimated losses and loss expenses related to prior years in this reserve category during 2007.
Short Tail Reinsurance. The lower than expected losses and loss expenses related to prior years in the short tail reinsurance reserve category was due to lower than expected paid and reported losses.
Long Tail Reinsurance. The lower than expected losses and loss expenses related to prior years in the long tail reinsurance reserve category were principally due to favorable development in the Company’s casualty and surety and other specialty lines. Previously, the Company had been relying more on expected loss methods due to the relative immaturity of the loss activity along with the inherent uncertainty surrounding loss reporting for this line. As actual claims emergence was better than anticipated for these lines, the Company reduced its estimated losses and loss expenses related to prior years in 2007.
Losses and loss expenses for the year ended December 31, 2006 are summarized as follows:
Losses and loss expenses for the year ended December 31, 2006 include $57.7 million in favorable development of reserves relating to prior accident years. The favorable loss reserve development experienced during the 2006 year benefited the Company’s 2006 reported loss ratio by approximately 3.5 percentage points. The net reduction in estimated losses for prior accident years reflects lower than expected emergence of catastrophic and attritional losses. Favorable development of prior year reserves for 2006 relates primarily to the Company’s short and long tail lines included in its Insurance segment, as well as the long and other tail lines of business in the Reinsurance segment. The favorable development of reserves related to prior years was primarily due to lower than expected claims across
the Company’s reserve categories. For the year ended December 31, 2006, the Company did not alter the two key inputs it utilizes to establish its reserve for losses and loss expenses, initial expected loss ratios or loss reporting patterns, for business related to prior years for the short and long tail insurance or other reinsurance reserve categories as the variances in reported losses in 2006 for those reserve categories were within the range of possible results anticipated by the Company. In the short and long tail reinsurance reserve categories, the Company took into account its claims experience in 2006 to make adjustments to its loss reporting patterns as described below.
Long Tail Reinsurance. The lower than expected losses and loss expenses related to prior years in the long tail reinsurance reserve category were principally the result of the Company’s workers’ compensation exposures. Previously, the Company had been relying more on expected loss methods due to the relative immaturity of the loss activity along with the inherent uncertainty surrounding loss reporting for this line. As industry loss experience in the workers’ compensation line matured, and regulatory changes impacting this business stabilized, the Company shortened the loss reporting patterns associated with this business and placed more reliance on experience-based methods, rather than on expected loss methods, which resulted in a reduction in the estimated losses and loss expenses related to prior years in 2006.
Reserves for losses and loss expenses were comprised of the following at December 31, 2007:
Selected quarterly activity in the reserve for losses and loss expenses for the year ended December 31, 2007 is summarized as follows:
The Company’s estimated reserve for losses and loss expenses can change over time because of unexpected changes in the external business environment in which the Company operates or changes in internal Company operations. For a discussion of the factors which can contribute to uncertainty in the reserving process and volatility in the reserve for losses and loss expenses, see ‘‘Critical Accounting Estimates - Reserves for Losses and Loss Expenses’’ above.
Two key inputs utilized in determining loss and loss expense reserves for the Company’s two business segments are the initial expected loss ratio and the speed of the loss reporting pattern. The following tables illustrate the possible percentage effects on current estimates of the reserve for losses and loss expenses due to 10% changes in the initial expected loss ratio and the speed of the loss reporting pattern as of December 31, 2007. The 10% changes in the initial expected loss ratio and the
speed of the loss reporting pattern in the tables below were chosen consistent with commonly accepted actuarial practice, due to the Company’s limited empirical data regarding loss and loss expense reserves variability. In order to capture the key dynamics of loss development and expected volatility that may arise within the disclosed amounts for the reserve for losses and loss expenses, the lines of business within each business segment are aggregated based on their potential expected length of loss emergence or tail.
(1) The Other reserve category of the Insurance segment includes agricultural business written by the Company. Reporting pattern changes are not applicable to agricultural business as it is typically settled at an established time each year.
Each of the impacts set forth in the tables above is estimated individually, without consideration for any correlation among key assumptions or among lines of business. Therefore, it would be inappropriate to take each of the amounts set forth above and add them together in an attempt to estimate volatility for the Company’s loss and loss expense reserves in total. The Company believes the assumed variations in loss and loss expense reserves by individual development tail set forth in the tables above represents a reasonable estimate of the possible loss and loss expense reserve variations by individual development tail that may occur in the future. It is important to note that the variations set forth in the tables above are not meant to be a ‘‘best-case’’ or ‘‘worst-case’’ series of scenarios, and therefore, it is possible that future variations may be more or less than the amounts set forth above.
Ceded premiums written were $206.1 million for the year ended December 31, 2007, $204.1 million for the year ended December 31, 2006, and $49.5 million for the year ended December 31, 2005. The increase in ceded premiums written was due to business written and ceded by our U.S. insurance operations and strategic cessions of business in 2007 and 2006 for the purpose of managing the Company’s catastrophe risk profile. The Company’s U.S. insurance operating subsidiaries use proportional and excess reinsurance to protect larger limits on certain business written by this segment. Excess reinsurance coverage is often purchased in relation to the workers’ compensation line to protect against catastrophic events. ARMtech participates in the federally sponsored multiple crop protection program offered by the U.S. government.
amounts ceded in the event that its reinsurers or retrocessionaires do not meet their obligations. Accordingly, the Company has evaluated the reinsurers and retrocessionaires that are providing reinsurance and retrocessional protection and will continue to monitor the stability of its reinsurers and retrocessionaires. No allowance for uncollectible reinsurance was deemed necessary on the recoverable balances outstanding at December 31, 2007 and 2006.
Goodwill and other intangibles that arise from business combinations are accounted for by the Company in accordance with SFAS No. 141 ‘‘Business Combinations’’ and SFAS No. 142 ‘‘Goodwill and Other Intangible Assets.’’ These standards require that identifiable intangible assets are amortized in accordance with their useful lives and goodwill and intangible assets with indefinite useful lives should not be amortized but should be tested for impairment at least annually.
During 2007, we acquired ARMtech and recorded goodwill of $42.0 and intangible assets of $96.7 million, which included licenses, customer relationships, internally developed software and non-compete agreements. The finite lived intangibles are being amortized over terms ranging from five to fifteen years. In addition, during 2007, we acquired American Merchants and as a result of that transaction recorded an indefinite lived intangible of $2.2 million related to state insurance licenses acquired.
The Company’s balance sheet at December 31, 2007 contains a net deferred tax liability in the amount of $0.9 million (2006 - $54.0 million deferred tax asset). The current year net deferred tax liability consists of gross deferred tax assets of $75.8 million, gross deferred tax liabilities of $66.5 million and a valuation allowance of $10.3 million. Of the Company’s gross deferred tax assets, $14.4 million (2006 - $18.1 million) relates to net operating loss carryforwards that are available to offset future taxable income generated by the Company’s U.S. and U.K. subsidiaries. The Company’s U.S. net operating losses which gave rise to a corresponding deferred tax asset are available for carryforward for 20 years following the loss year. U.K. losses may be carried forward indefinitely. Based on its analysis of various potential tax planning strategies and projected taxable income for the Company’s U.S. and U.K. subsidiaries, management believes that it is more likely than not that the Company’s U.S. and U.K. subsidiaries will generate sufficient taxable income to realize the net operating loss carryforwards in the near term and prior to their expiration, except as provided for as follows.
THE BOARD oF DIRECTORS aND SHAREHOLDERS of ENDURANCE SPECIALTY HOLDINGS LTD.
We have audited Endurance Specialty Holdings Ltd.’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Endurance Specialty Holdings Ltd.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
In our opinion, Endurance Specialty Holdings Ltd. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the COSO criteria.
Notes to the Consolidated Financial Statements for the years ended December 31, 2007, 2006 and 2005
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Endurance Specialty Holdings Ltd. at December 31, 2007 and 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.
Endurance Specialty Holdings Ltd. (‘‘Endurance Holdings’’) was organized on June 27, 2002 under the laws of Bermuda to act as a holding company of providers of property and casualty insurance and reinsurance on a worldwide basis.
Endurance Holdings’ wholly-owned subsidiary, Endurance Specialty Insurance Ltd. (‘‘Endurance Bermuda’’), was organized in Bermuda on November 30, 2001. On December 14, 2001, Endurance Bermuda completed a private offering of 60 million common shares for gross cash proceeds of $1.2 billion. Under the terms of an Exchange Offer dated July 22, 2002, the shareholders of Endurance Bermuda transferred their interest in Endurance Bermuda to Endurance Holdings in exchange for an identical shareholding in Endurance Holdings. The Exchange Offer represented a business combination of companies under common control and was accounted for at historical cost. On March 5, 2003, Endurance Holdings consummated the initial public offering of its ordinary shares resulting in the issuance of an additional 9.6 million ordinary shares for net proceeds of $201.5 million.
The consolidated financial statements have been prepared on the basis of accounting principles generally accepted in the United States (‘‘U.S. GAAP’’) and include the accounts of Endurance Holdings and its wholly-owned subsidiaries, which are collectively referred to herein as the ‘‘Company.’’ All intercompany transactions and balances have been eliminated in consolidation. The following are significant accounting and reporting policies adopted by the Company:
Gross premiums written and net premiums written included $42.2 million and $21.1 million of premiums written by ARMtech, respectively, following its acquisition by the Company. The Company’s gross premiums written and net premiums written excluded $45.3 million and $11.5 million, respectively of unearned premiums acquired through the acquisition of ARMtech. Net acquired unearned premiums are earned by the Company in accordance with the policies stated above.
SFAS No. 113. The Company has accounted for these contracts by the deposit method of accounting specified by Statement of Position 98-7 - ‘‘Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk.’’ Consequently, these contracts were accounted for as contracts which either transfer only significant timing risk or transfer only significant underwriting risk. The determination of the appropriate method of accounting for these contracts requires significant judgment and analysis, particularly with respect to assumptions about the variability and likelihood of potential future losses. Under the deposit method of accounting, revenues and expenses from reinsurance contracts are not recognized as written premium and incurred losses. Instead, income or loss associated with contracts determined to transfer only significant timing risk is recognized as a component of net other underwriting income (loss) over the estimated claim settlement period while income or loss associated with contracts determined to transfer only significant underwriting risk is recognized as net other underwriting income (loss) over the contract risk period.
Other investments, which includes investments in high yield fixed maturity funds and other alternative investment funds, are accounted for using the equity method of accounting whereby the initial investment is recorded at cost. The carrying amounts of these investments are increased or decreased to reflect the Company’s share of income or loss and are decreased for any dividends received. The Company’s share of income or loss is recorded in earnings as a component of net investment income.
Assets and liabilities of foreign operations whose functional currency is not the United States dollar are translated at exchange rates in effect at the balance sheet date. Revenues and
SFAS No. 133 ‘‘Accounting for Derivative Instruments and Hedging Activities,’’ as amended on January 1, 2001, requires the recognition of all derivative financial instruments including embedded derivative instruments, as either assets or liabilities in the Consolidated Balance Sheets and measurement of those instruments at fair value. The accounting for gains and losses associated with changes in the fair value of a derivative and the effect on the financial statements depends on its hedge designation and whether the hedge is highly effective in achieving offsetting changes in the fair value of the asset or liability hedged.
The Company accounts for income taxes in accordance with the Financial Accounting Standards Board’s (‘‘FASB’’) Interpretation No. 48, ‘‘Accounting for Uncertainty in Income Taxes - an interpretation of FASB statement No. 109’’ (‘‘FIN 48’’) for its subsidiaries operating in taxable jurisdictions. Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. FIN 48 allows for the recognition of tax benefits of uncertain tax positions only where the position is more likely than not to be sustained assuming examination by tax authorities. A liability is established for any tax benefit claimed in a tax return in excess of this threshold. Income tax related interest and penalties are included as income tax expense.
subsequently amended by SFAS No. 148 ‘‘Accounting for Stock-Based Compensation -Transition and Disclosure.’’ Awards under the 2007 Equity Incentive Plan vest over periods of up to four years. Effective January 1, 2006, the Company implemented SFAS No. 123(R) under the modified prospective method with no material impact on the Company’s financial position or results of operations.
In September 2006, the FASB issued SFAS No. 157 ‘‘Fair Value Measurements.’’ SFAS No. 157 clarifies the definition of fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.
In February 2007, the FASB issued SFAS No. 159 ‘‘The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115.’’ SFAS No. 159 provides companies with an option to report selected financial assets and liabilities at fair value. The objective of SFAS No. 159 is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently; however, depending on the financial assets and liabilities selected to be carried at fair value, substantial volatility in earnings could result. SFAS No. 159 is effective as of the beginning of the Company’s first fiscal year beginning after November 15, 2007.
The following tables summarizes, for all fixed maturity securities in an unrealized loss position at December 31, 2007 and 2006, the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position.
At December 31, 2007, 1,013 fixed maturity securities were in an unrealized loss position. Of those, 508 securities had been in a continuous unrealized loss position for twelve months or greater. The unrealized loss position of these fixed maturity securities was principally a result of changes in the interest rate environment. During the year ended December 31, 2007, the Company identified securities which were considered to be other-than-temporarily impaired. Consequently, the cost of such securities was written down to fair value at the time of impairment, and the Company realized losses of $17.3 million in relation to these securities for 2007.
The following table summarizes the composition of the fixed maturity portfolio by investment ratings assigned by rating agencies at December 31, 2007 and 2006. In some cases, where bonds are unrated, the rating of the issuer has been applied.
During 2007, the Company’s estimated ultimate losses for prior accident years were reduced by $159.4 million (2006 - $57.7 million; 2005 - $162.5 million) due to lower claims emergence than originally estimated by the Company. During 2007, the Company experienced favorable development in the Insurance segment of $80.4 million in both the Company’s short and long tail lines of business and $79.0 million of favorable development in the Company’s Reinsurance segment primarily in relation to the short tail lines of business. The Insurance segment experienced favorable development in 2006 of $54.4 million across all accident years with the short tail property line and the long tail healthcare liability and professional lines of business representing the largest net reductions. During 2005, the prior accident year development related primarily to the Company’s Reinsurance segment and the lower than expected loss emergence in its short tail lines of business, with the property and catastrophe lines representing the largest net reductions.
Reserves for losses and loss expenses are based in part upon the estimation of losses resulting from catastrophic events. Estimation of the losses and loss expenses resulting from catastrophic events based upon the Company’s historical claims experience is inherently difficult because of the Company’s short operating history and the possible severity of catastrophe claims. Therefore, the Company uses both proprietary and commercially available models, as well as historical reinsurance industry catastrophe claims experience in addition to its own historical data for purposes of evaluating trends and providing an estimate of ultimate claims costs.
During the year ended December 31, 2007, the Company recorded ceded losses of $58.6 million (2006 - $31.1; 2005 - $21.1 million). At December 31, 2007, the Company has no allowance for estimated uncollectible premiums receivable or losses recoverable (2006 - Nil).
on an uncollateralized basis, the Company is required to pay a fee ranging from 0.275% to 0.375% on the daily stated amount of such letters of credit. In addition, the 2007 Credit Facility requires the Company to pay to the lenders a facility fee and a utilization fee.
On July 15, 2004, the Company issued $250 million principal amount of 7% Senior Notes due 2034 (the ‘‘7% Senior Notes’’). The 7% Senior Notes were offered by the underwriters at a price of 99.108% of their principal amount, providing an effective yield to investors of 7.072%, and, unless previously redeemed, will mature on July 15, 2034.
• Reinsurance - The casualty line of business is comprised of third party liability exposures and workers’ compensation coverages. The property line of business includes proportional and excess of loss reinsurance of personal and commercial exposures. Catastrophe coverages include reinsurance for catastrophic perils on a treaty basis. The agriculture line includes coverages for weather related perils as well as protection from yield and price risks. The marine line includes proportional and non-proportional reinsurance of hull and cargo insurance business. Aerospace coverages include the reinsurance of aviation and space business. Surety and other specialty coverages include proportional and excess of loss coverages of contract and commercial surety business as well as personal accident coverages.
of the combined ratio that is obtained by dividing the sum of the losses and loss expenses, acquisition expenses and general and administrative expenses by net premiums earned. General and administrative expenses incurred by segments are allocated directly. Remaining general and administrative expenses not directly incurred by the segments are allocated primarily based on each segment’s proportional share of premiums. Ceded reinsurance and recoveries are recorded within the segment to which they apply. Group reinsurance protection purchased and any subsequent recoveries are allocated to segments based on the underlying exposures covered.
The following table provides a summary of the segment revenues and results for the year ended December 31, 2006, reserve for losses and loss expenses as of December 31, 2006 and the carrying value of goodwill as of December 31, 2006:
(1) Reconciles the Company’s underwriting results by segment to the Company’s financial statement presentation.
The following table reconciles total segment results to income (loss) before income tax (expense) benefit for the years ended December 31, 2007, 2006 and 2005, respectively:
On December 7, 2007, Endurance U.S. Holdings, Inc., an indirect wholly-owned subsidiary of Endurance Holdings acquired all outstanding stock of ARMtech. The base purchase price was $120 million, plus additional amounts as determined in accordance with the terms of the purchase agreement. ARMtech underwrites crop insurance primarily through the U.S. federally sponsored Multiple Peril Crop Insurance Program. In connection with the acquisition of ARMtech, the Company recorded $42.0 million of goodwill and $96.7 million of intangible assets. The intangible assets acquired consisted principally of internally developed software, non-compete agreements, state licenses and customer relationships with expected lives between five and fifteen years.
respectively, and primarily resulted from reinsurance arrangements entered into in the normal course of operations. A credit exposure exists with respect to reinsurance recoverables as they may become uncollectible. The Company manages its credit risk in its reinsurance relationships by transacting with reinsurers that it considers financially sound and, if necessary, the Company may hold collateral in the form of funds, trust accounts and/or irrevocable letters of credit. This collateral can be drawn on for amounts that remain unpaid beyond specified time periods on an individual reinsurer basis. As of December 31, 2007, $117.1 million of losses recoverable (2006: $41.8 million) was due from reinsurers rated A− or better by A.M. Best or Standard & Poors. An additional $67.6 million of losses recoverable was due from a U.S. government sponsored reinsurance program as of December 31, 2007.
Investment commitments. As of December 31, 2007 and 2006, the Company had pledged cash and cash equivalents and fixed maturity investments of $223.2 million and $231.6 million, respectively, in favor of certain ceding companies to collateralize obligations. As of December 31, 2007 and 2006, the Company had also pledged $594.7 million and $456.4 million of its cash and fixed maturity investments as required to meet collateral obligations for $532.3 million and $409.9 million in letters of credit outstanding under its credit facility, respectively. In addition, at December 31, 2007 and 2006, cash and fixed maturity investments with fair values of $120.3 million and $40.9 million were on deposit with U.S. state regulators, respectively, and cash and fixed maturity investments with fair values of $33.8 million and $28.5 million were on deposit with Canadian regulators, respectively.
The Company is subject to certain commitments with respect to other investments at December 31, 2007 and 2006. The Company is generally subject to redemption restriction provisions of between one to three years from the date of acquisition. With respect to the balance of the Company’s other investments at December 31, 2007 and 2006, $144.3 million and $107.8 million were ineligible for redemption, respectively. The remaining other investments may be redeemed by the Company subject to certain notice and limit provisions. In addition, as of December 31, 2007, the Company was committed to investing a further $29.4 million (2006 - $6.2 million) in various investment funds classified as other investments.
Total rent expense under operating leases for the year ended December 31, 2007 was $10.2 million (2006 - $8.4 million; 2005 - $7.1 million).
The Company’s initial share repurchase program was authorized in May 2004 and expired in February 2007, at which time the Company’s Board of Directors authorized the repurchase of up to 2,000,000 ordinary shares or share equivalents through February 2009. On May 9, 2007, the Company’s Board of Directors approved an increase in the number of ordinary shares authorized for repurchase to 18 million ordinary shares or share equivalents. During 2007 and 2006, the Company repurchased 8,081,199 and 329,100 of its ordinary shares and share equivalents under this program in open market and privately negotiated transactions at an average price of $38.61 and $30.41 per share, respectively. Total authorized repurchases remaining under the plan at December 31, 2007 was approximately 10.2 million shares (2006 - 1.4 million).
On September 11, 2007, Endurance Holdings consummated a variable equity forward sale arrangement under which Endurance Holdings is entitled to sell ordinary shares to an affiliate of Deutsche Bank Securities, Inc. (the ‘‘forward counterparty’’) for proceeds of approximately $150 million pursuant to a prospectus supplement to the Shelf Registration Statement on Form S-3ASR (Registration No. 333-130464) filed with the U.S. Securities and Exchange Commission on September 12, 2007. Under the terms of the forward sale agreement, Endurance Holdings will sell an aggregate of between 2,984,772 and 4,786,827 ordinary shares to the forward counterparty, subject to Endurance Holdings’ right to cash settle or net share settle all or a portion of such agreement.
Endurance Holdings did not receive any proceeds from the sale of the ordinary shares by the forward counterparty, but Endurance Holdings will receive proceeds upon any prepayment, and may receive proceeds upon settlement of the forward sale agreement. The forward sale agreement will be physically settled by delivery of the requisite number of Endurance Holdings’ ordinary shares beginning July 20, 2010. The forward counterparty will pay Endurance Holdings approximately $150 million upon settlement of the forward sale agreement. The number of Endurance Holdings’ ordinary shares to be delivered to the forward counterparty varies depending upon the price of Endurance Holdings’ ordinary shares over a forty trading-day period beginning July 15, 2010 subject to an aggregate maximum of 4,786,827 and an aggregate minimum of 2,984,772 ordinary shares. The costs associated with the variable delivery forward were charged to additional paid in capital and the underlying shares were considered in the calculation of diluted earnings per share using the treasury stock method.
At December 31, 2007 and 2006, 7,094,727 and 7,202,347 warrants were outstanding. Such warrants are exercisable for ordinary and class A shares as follows:
Diluted earnings (loss) per common share are based on the weighted average number of common shares and dilutive potential common shares outstanding during the period of calculation using the treasury stock method.
Certain founding shareholders, including Aon Corporation and its affiliates (‘‘Aon’’), received warrants in conjunction with the capitalization of the Company (see Note 12). During 2006, Aon transferred all of the warrants it had received from the Company to third parties and thus, was no longer an affiliate of the Company at December 31, 2006.
The Company also issues restricted share and restricted share unit awards to employees and non-employee directors for which the fair value is equal to the fair market value of the Company’s ordinary shares on the grant date. Compensation equal to the fair market value of the shares at the measurement date is amortized and charged to income over the vesting period. Restricted share and restricted share unit awards granted prior to September 1, 2007, generally vest over a four or five-year period as follows: 12.5% in years one and five and 25% in years two through four; 25% per year; or 20% per year. Certain restricted shares and restricted share units, which did not require future service, would be forfeited if the holder departed the Company and violated the terms of a non-compete provision. Restricted shares granted to employees and non-employee directors beginning in 2007 vest pro rata over a four-year period and are forfeited upon departure from the Company for any reason. Restricted shares granted to non-employee directors vest twelve months following the date of grant.
During the years ended December 31, 2007, 2006 and 2005, the Company granted an aggregate of 565,321, 397,763 and 351,952 restricted share and restricted share unit awards with weighted average grant date fair values of $22.7 million, $12.7 million and $12.7 million. During the years ended December 31, 2007, 2006 and 2005, the aggregate fair value of restricted shares and units that vested was $7.8 million, $6.3 million and $8.7 million, respectively.
For the years ended December 31, 2007, 2006 and 2005, compensation costs recognized in earnings for all restricted shares and restricted share units were $10.9 million, $6.2 million, and $9.4 million, respectively. At December 31, 2007, compensation costs not yet recognized related to
On October 26, 2005, Endurance Holdings’ shareholders approved the Employee Share Purchase Plan (the ‘‘ESPP’’) and the 2005 Sharesave Scheme. Neither the ESPP nor the 2005 Sharesave Scheme is subject to any provisions of the Employee Retirement Income Security Act of 1974 as amended, and neither plan is a qualified plan within the meaning of Section 402(a) of the Internal Revenue Code of 1986, as amended (the ‘‘Code’’) the ESPP is a qualified plan under 423 of the code. Total expenses related to these plans for the year ended December 31, 2007 was approximately $148,000 (2006 - $123,000).
Following approval by the Company’s shareholders, 200,000 of Endurance Holdings’ ordinary shares, par value $1.00 per share, were reserved for issuance under the ESPP. Under the terms of the ESPP, employees of Endurance Holdings and certain of its subsidiaries may purchase Endurance Holdings’ ordinary shares at a 15% discount to the closing market price on the purchase date. Participants are eligible to receive dividends on the shares purchased in the ESPP and are also entitled to vote such shares at any annual or special meeting of shareholders. These shares are restricted from sale, transfer or certification for one year from the purchase date.
As a holding company, Endurance Holdings relies on dividends from Endurance Bermuda to provide cash flow required for debt service and dividends to shareholders. Endurance Bermuda’s ability to pay dividends and make capital distributions is subject to certain regulatory restrictions
based principally on the amount of Endurance Bermuda’s premiums written and net reserves for losses and loss expenses, subject to an overall minimum capital and surplus requirement of $100 million. As of December 31, 2007, Endurance Bermuda can pay approximately $1,042 million (2006: $826 million) to Endurance Holdings without prior approval under Bermuda law.
In addition, Endurance Bermuda is required to maintain a minimum statutory liquidity ratio and solvency margin. At December 31, 2007, Endurance Bermuda’s statutory capital and surplus was approximately $2.8 billion (2006 - $2.6 billion). Endurance Bermuda is currently completing 2007 statutory income (loss) statements. Endurance Bermuda recorded statutory net income (loss) of $483.8 million and ($62.8) million for the years ended December 31, 2006 and 2005.
Endurance U.S. Reinsurance, Endurance American, and Endurance American Specialty are subject to regulation by the Delaware Department of Insurance. ARMtech is subject to regulation by the Texas Department of Insurance and American Merchants is subject to regulation by the Ohio Department of Insurance. Dividends for each U.S. operating subsidiary are limited to the greater of 10% of policyholders’ surplus or statutory net income, excluding realized capital gains. In addition, dividends may only be declared or distributed out of earned surplus. At December 31, 2007, Endurance U.S. Reinsurance, Endurance American and Endurance American Specialty did not have earned surplus and thus were precluded from declaring or distributing dividends during 2008 without the prior approval of the applicable insurance regulator. If the parent company is also an insurer, as is the case with Endurance American, Endurance American Specialty and American Merchants, the parent company or companies must also meet their own dividend eligibility requirements in order to pass along any dividends received from subsidiary insurance companies. At December 31, 2007, American Merchants and ARMtech (with notice to the Texas Department of Insurance) could pay dividends of $5.4 million and $6.3 million, respectively, without prior regulatory approval. Endurance U.S. Reinsurance recorded statutory net income (loss) of $26.3 million, $63.4 million and ($66.7) million for the years ended December 31, 2007, 2006 and 2005, respectively. Endurance American recorded statutory net (loss) income of ($0.2) million and $0.4 million for the years ended December 31, 2007 and 2006, respectively. Endurance American Specialty recorded statutory net (loss) income of ($12.4) million, $2.0 million and ($16.3) million for the years ended December 31, 2007, 2006 and 2005, respectively. American Merchants recorded statutory net income of $1.1 million for the year ended December 31, 2007. ARMtech recorded statutory net income of $6.3 million for the year ended December 31, 2007.
The Company’s subsidiaries based in Canada, the United Kingdom and United States are subject to income taxes in their respective jurisdictions.
Of the 2007 current income tax expense, $10.8 million related to taxes incurred in the United States (2006 - $7.4 million; 2005 - $0.9 million). Of the deferred income tax (expense) benefit, $3.0 million and ($11.8) million related to deferred income tax benefits (expenses) in the United States and the United Kingdom, respectively (2006 - ($15.9) million and ($5.7) million; 2005 - $30.7 million and $21.3 million).
The Company paid income taxes totaling $25.7 million, $7.1 million, and $4.5 million for the years ended December 31, 2007, 2006 and 2005, respectively. Net operating loss carryforwards in the amount of $50.5 million are available for application against future taxable income in the United Kingdom. These net operating loss carry forwards have no expiration date. There were no income taxes payable at December 31, 2007 or 2006.
Certain comparative information in the unaudited quarterly financial data for the years ended December 31, 2007 and 2006, have been reclassified to conform to current year presentation.