We lease office space in Bermuda, where our executive offices are located. In addition, Stonington leases office space in Addison, Texas, and our other U.S. based subsidiaries lease space in Richmond, Virginia and Raleigh, North Carolina. We also lease office space in Dublin, Ireland. As we anticipate additional growth in our businesses, it is likely that we will need to expand into additional facilities to accommodate this growth.
The following table sets forth our selected financial data and other financial information at the end of and for each of the years in the five-year period ended December 31, 2003. The historical financial information was prepared in accordance with U.S. GAAP. The statement of income data for the years ended December 31, 2003, 2002, 2001, 2000 and 1999 and the balance sheet data at December 31, 2003, 2002, 2001, 2000 and 1999 were derived from our audited consolidated financial statements, which have been audited by Ernst & Young, our independent auditors. You should read the selected financial data in conjunction with our consolidated financial statements and related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in this filing and all other information appearing elsewhere or incorporated into this filing by reference.
Our expenses primarily consist of: 1) claims and claim expenses incurred on the policies of reinsurance and insurance we sell; 2) acquisition costs which typically represent a percentage of the premiums we write; 3) operational expenses which primarily consist of personnel expenses, rent and other operating expenses; and 4) interest and dividend costs related to our debt, preference shares and subordinated obligation to capital trust.
We believe that the most significant accounting judgment made by management is our estimate of the claims and claim expense reserves. Claim reserves represent estimates, including actuarial and statistical projections at a given point in time, of the ultimate settlement and administration costs of claims incurred, and it is likely that the ultimate liability will exceed or be less than such estimates. It is also possible that the ultimate liability may materially exceed or be materially less than such estimates. Such estimates are not precise in that, among other things, they are based on predictions of future developments and estimates of future trends in claim severity and frequency and other variable factors such as inflation.
Adjustments to our prior year estimated ultimate claims reserves will impact our current year net income by increasing our net income if the prior year estimated ultimate claims reserves are determined to be overstated, or by reducing our net income if the prior year estimated ultimate claims reserves prove to be insufficient. During the years ended December 31, 2003, 2002 and 2001, changes to prior year estimated ultimate claims reserves had the following impact on our net income; during 2003, prior years estimated ultimate claims reserves were reduced by $95.1 million and accordingly, our 2003 net income was increased by $95.1 million; during 2002, prior years estimated ultimate claims reserves were reduced by $2.0 million, and our 2002 net income was increased by $2.0 million; and during 2001, prior years estimated ultimate claims reserves were reduced by $16.0 million, and our 2001 net income was increased by $16.0 million. (also see Reserves for Claims and Claim Expenses.)
Because any reserve estimate is simply an insurer's estimate of its ultimate liability, and because there are numerous factors which affect reserves but can not be determined with certainty in advance, our ultimate payments will vary, perhaps materially, from our initial estimate of reserves. Therefore, because of these inherent uncertainties, we have
developed a reserving philosophy which attempts to incorporate prudent assumptions and estimates. In future periods, assuming future reported and paid claims activity is consistent with that of recent quarters, and barring unforeseen circumstances, we believe that, as our reserves on older accident years continue to age, we may experience further reduction to our older accident year reserves.
We book premiums on non-proportional contracts in accordance with the contract terms. Premiums written on losses occurring contracts are typically earned over the contract period. Premiums on risks attaching contracts are generally earned as reported by the cedants, which typically is over double the contract period. Management makes estimates based on judgment and historical experience for periods during which information has not yet been received. Such estimates are subject to adjustment in subsequent periods when actual figures are recorded.
In our Individual Risk business, it is often necessary to estimate portions of premiums written from quota-share contracts and by program managers. Management estimates this premium based on discussions with ceding companies and program managers and also based on historical experience and judgment. Total premiums estimated at December 31, 2003 and 2002 were $103.7 million and $74.6 million, respectively.
For the years ended December 31, 2003 and 2002 our net premiums earned increased by $354.8 million and $427.8 million, respectively, or 47% and 128%, respectively. These increases were primarily due to the market dislocation which occurred after the World Trade Center disaster, and the significant losses stemming from this event. These losses caused an imbalance in the supply and demand for our insurance and reinsurance products, and as a result, we increased our written premiums, in both our established property catastrophe line and our specialty reinsurance line, and also increased our premiums in our Individual Risk operations. Contributing to the increase in Individual Risk operations during 2003 was the continued growth of: 1) our Program Manager distribution channel, where we write primary insurance through specialized program managers; and 2) our Quota Share Reinsurance distribution channel, where we write quota share reinsurance with primary insurers (see below for underwriting results by segment).
half of 2001 we raised $785 million from financing activities which was available for us for investment purposes for the full year of 2002.
The majority of our other income is generated from our 50% equity ownership in Top Layer Re. The increase in property catastrophe business - fee income during 2003 was primarily due to the $4 million annual fee we receive related to services provided to Platinum. The reduction in other items is primarily related to the derivative income we received in 2002 (as noted below), which did not repeat in 2003.
During 2002, the significant increase in our equity earnings from Top Layer Re was due to the increase in the premiums written by Top Layer Re, from $38.8 million in 2001 to $73.0 million in 2002, and the resultant net income from those premiums. Also in 2002, income from other items increased due primarily to $7.2 million of income related to derivative instruments under which recoveries are triggered by an industry loss index or geological or physical variables.
During 2003 and 2002, we wrote a limited amount of business in our U.S. operations, and, therefore, our U.S. net income was minimal and the related tax impact for 2003 and 2002 was also minimal.
We currently plan to continue to increase the business written by our U.S. insurance subsidiary. If, as a result, our U.S. operations begin to generate taxable income, the appropriateness of the valuation allowance will be reassessed and, accordingly, potential profits from our U.S. operations would possibly not have a corresponding offset for tax expenses, up to the $29.3 million valuation allowance recorded at December 31, 2003.
Because our investment portfolio is structured to preserve capital and provide us with a high level of liquidity, a large majority of our investments are invested in the fixed income markets and, therefore, our realized holding gains and losses on investments are highly correlated to fluctuations in interest rates. Therefore, as interest rates decline, as occurred in 2003, 2002 and 2001, we will tend to have realized gains from the turn-over of our investment portfolio, and as interest rates increase, we will tend to have realized losses from the turnover of our investment portfolio, although the actual amount of realized gains (losses) on sales of investments can be reduced depending on which specific securities we choose to sell.
Our Reinsurance operations are comprised of three business units: 1) property catastrophe reinsurance, primarily written through Renaissance Reinsurance and DaVinci; 2) specialty reinsurance, primarily written through Renaissance Reinsurance and DaVinci; and 3) certain activities of Renaissance Underwriting Managers.
The following table summarizes the underwriting results and ratios for the Reinsurance segment for the years ended December 31, 2003, 2002 and 2001:
(1) Excludes combined premium assumed from the Individual Risk segment of $20.8 million and $22.2 million for the years ended December 31, 2003 and 2002, respectively.
During 2004 we expect this market to remain relatively competitive which would cause a corresponding reduction in pricing. Accordingly, we expect that the level of our property catastrophe premiums will decrease in 2004.
Specialty reinsurance - During 2003 our consolidated specialty reinsurance premiums increased by $45 million or 18%. This increase was primarily due to our continued focus on a few targeted areas of this market where we believe we can leverage our expertise. The markets representing the majority of the increase were the catastrophe exposed workers' compensation market and the market for terrorism-specific reinsurance.
During 2002, the factors that caused the improved market conditions in the property catastrophe market also contributed to improving market conditions in the lines of specialty reinsurance which we write, and subsequent to the World Trade Center disaster, we significantly increased our participation in this market. We categorize our specialty reinsurance premiums as reinsurance coverages that are not specifically property catastrophe coverages. Examples of specialty lines of reinsurance coverages provided by us include catastrophe exposed workers' compensation, surety, aviation and terrorism.
(1) The category "Worldwide (excluding U.S.)" consists of contracts that cover more than one geographic region (other than the U.S.). The exposure in this category for gross written premiums written to date is predominantly from Europe and Japan.
Although we would remain liable to the extent that any of our reinsurers fail to pay our claims, before placing reinsurance we evaluate the financial condition of our reinsurers. At December 31, 2003, the majority of the $149.2 million of net losses recoverable relates to outstanding claims reserves on our books, and, in accordance with the terms of the policies, we generally must wait to collect from our reinsurers until we pay the underlying claims. We expect to fully collect the recorded net balance of the losses recoverable.
The increase in our 2003 net underwriting income from our Reinsurance segment was primarily the result of three factors: 1) the comparably low level of property catastrophe losses during 2003 which contributed approximately $40 million of a reduction in claims and claim expenses; 2) favorable development on prior period reserves which contributed $70 million of a reduction in claims and claim expenses; and 3) the increase in our net reinsurance premiums earned during 2003, as a result of our increase in gross written property catastrophe premiums in 2002 and the increase in our gross written specialty reinsurance premiums in 2002 and 2003 (see "Premiums" above).
The increase in our 2002 net underwriting income from our Reinsurance segment was primarily the result of three factors: 1) the low level of property catastrophe losses during 2002; 2) the increase in our net reinsurance premiums earned during 2002, a result of our increase in gross written property catastrophe and specialty reinsurance premiums; and 3) the inception of DaVinci's operations during 2002.
Also during 2003 and 2002, as discussed in the "Premiums" section above, we significantly increased our specialty reinsurance premiums written. Although specialty reinsurance premiums will normally produce higher claims and claim expenses than the property catastrophe reinsurance business, the reduction in our losses resulting from the low level of catastrophe losses during 2003 and 2002 and the reductions in prior year property catastrophe reserves during 2003 more than offset the increased level of loss activity arising from our specialty reinsurance premiums.
Our underwriting expenses consist of acquisition expenses and operational expenses. Acquisition expenses consist of costs to acquire premiums and are principally comprised of broker commissions and excise taxes. Acquisition expenses are driven by contract terms and are normally a set percentage of premiums and, accordingly, these costs will normally fluctuate in line with the fluctuation in premiums. Operational expenses consist of salaries and other general and administrative expenses. Our reinsurance business operates with a limited number of employees and we were able to grow our written premiums without proportionally increasing our operating expenses during 2002. The increase in underwriting expenses during 2003 was primarily due to an increase in acquisition costs on our specialty reinsurance business, which is attributable to commission costs related to certain quota share premiums written in 2003 which typically carry higher acquisition costs than our excess of loss contracts.
We define our Individual Risk segment to include underwriting that involves understanding the characteristics of the original underlying insurance policy. Our principal products include: 1) commercial and homeowners property coverages, including catastrophe-exposed lines; 2) commercial liability coverages, including general, automobile, professional and various specialty lines; and 3) reinsurance to other insurers on a quota share basis. We operate through the Glencoe Group of companies, whose principal operating subsidiaries are Glencoe, Stonington and Lantana.
(1) Excludes $20.8 million and $22.2 million of premium ceded to Renaissance Reinsurance and DaVinci in 2003 and 2002, respectively.
RenaissanceRe is a holding company, and we therefore rely on dividends from our subsidiaries and investment income to make principal and interest payments on our debt and capital securities, and to make dividend payments to our preference and common shareholders.
The payment of dividends by our Bermuda subsidiaries is, under certain circumstances, limited under U.S. statutory regulations and Bermuda insurance law, which require our Bermuda insurance subsidiaries to maintain certain measures of solvency and liquidity. At December 31, 2003, the statutory capital and surplus of our Bermuda insurance subsidiaries was $2.4 billion, and the amount of capital and surplus required to be maintained was $457.5 million. During 2003, Renaissance Reinsurance, DaVinci and Glencoe declared aggregate cash dividends of $322.3 million, $81.6 million and $18.0 million, respectively, compared with $224.3 million, $3.5 million and $nil, respectively, in 2002.
Cash flows from operating activities for 2003 were $820.4 million, which principally consisted of net income of $623.4 million (prior to dividends on preference shares), plus $223.4 million for increases to net reserves for claims and claim expenses. The 2003 cash flows from operations were primarily used to increase the investment portfolio, including fixed income securities and other investments.
As discussed in the Summary of Critical Accounting Policies and Estimates, for insurance and reinsurance companies, the most significant accounting judgment made by management is the estimation of the claims and claim expense reserves. Because of the variability and uncertainty associated with loss estimation, it is possible that our individual case reserves are incorrect, possibly materially.
Our total capital resources at December 31, 2003 and 2002 were as follows:
During 2003, our capital resources increased primarily as a result of three items: 1) our net income available to common shareholders of $604.6 million; 2) the issuance of $100.0 million of 5.875% Senior Notes; and 3) the issuance of $100.0 million of Series B preference shares.
In February 2003, we raised $100 million through the issuance of 4,000,000 Series B preference shares, and in November 2001, we raised $150 million through the issuance of 6,000,000 Series A Preference Shares. The Series B and Series A preference shares may be redeemed at $25 per share at our option on or after February 4, 2008 and
In January 2003, we issued $100 million of 5.875% Senior Notes due February 15, 2013, with interest on the notes payable on February 15 and August 15 of each year, commencing August 15, 2003. In July 2001, we issued $150 million of 7.0% Senior Notes due July 15, 2008 with interest on the notes payable on January 15 and July 15 of each year. The notes can be redeemed by us prior to maturity subject to payment of a "make-whole" premium; however, we have no current intentions of calling the notes. The notes, which are senior obligations, contain various covenants, including limitations on mergers and consolidations, restriction as to the disposition of stock of designated subsidiaries and limitations on liens on the stock of designated subsidiaries. RenaissanceRe was in compliance with the related covenants at December 31, 2003 and 2002.
Our Capital Trust has issued Capital Securities which pay cumulative cash distributions at an annual rate of 8.54%, payable semi-annually. During 2003, RenaissanceRe did not purchase any of the Capital Securities (2002 - $3.0 million purchased). RenaissanceRe has purchased an aggregate $15.4 million of the Capital Securities since their issuance in 1997. The sole asset of the Capital Trust consists of our junior subordinated debentures. The Indenture relating to these junior subordinated debentures contains certain covenants, including a covenant prohibiting us from the payment of dividends if we are in default under the Indenture. We were in compliance with all of the covenants of the Indenture at December 31, 2003. The Capital Securities mature on March 1, 2027.
Effective December 31, 2003, we adopted FASB Interpretation No. 46, "Consolidation of Variable Interest Entities - an interpretation of ARB No. 51" ("FIN 46"). FIN 46 requires consolidation of all Variable Interest Entities ("VIE") by the investor that will absorb a majority of the VIE's expected losses or residual returns. As further discussed in Note 7 to the Consolidated Financial Statements, the Capital Trust was determined to be a VIE under FIN 46 and the Company has been determined not to be the primary beneficiary of the Capital Trust. Accordingly, the Capital Trust has been deconsolidated effective December 31, 2003. As a result, the accounts of the Capital Trust, principally the Capital Securities previously classified as minority interest, are not included in our consolidated balance sheet at December 31, 2003. Our $103.1 million subordinated obligation to the Capital Trust, previously eliminated in consolidation, is recorded on our consolidated balance sheet at December 31, 2003 as a liability.
Under the terms of certain reinsurance contracts, we may be required to provide letters of credit to reinsureds in respect of reported claims and/or unearned premiums. At December 31, 2003, we had outstanding letters of credit aggregating $346.9 million. Also, in connection with our Top Layer Re joint venture we have committed $37.5 million of collateral to support a letter of credit.
Our principal letter of credit facility is a $485 million syndicated secured facility which accepts as collateral shares issued by our subsidiary RIHL. Our participating operating subsidiaries and our managed joint ventures have pledged (and must maintain) RIHL shares issued to them with a sufficient collateral value to support their respective
obligations under the facility, including reimbursement obligations for outstanding letters of credit. The participating subsidiaries and joint ventures also have the option to post alternative forms of collateral. In addition, for liquidity purposes, each participating subsidiary and joint venture must maintain additional unpledged RIHL shares that have a net asset value at least equal to 15% of its facility usage, and in the aggregate the net asset value of all unpledged RIHL shares must be maintained at least equal to 15% of all of the outstanding RIHL shares. In the case of a default under the facility, or in other circumstances in which the rights of our lenders to collect on their collateral may be impaired, the lenders may exercise certain remedies under the facility agreement, in accordance with and subject to its terms, including redemption of pledged shares and conversion of the collateral into cash or eligible marketable securities. The redemption of shares by the collateral agent takes priority over any pending redemption of unpledged shares by us or other holders. In November 2003, the term of this facility was extended through March 31, 2004, and in January 2004, this facility was increased to $485 million from $385 million. On March 12, 2004, we accepted a commitment letter from Wachovia and Wachovia Securities in which Wachovia confirmed its commitment to provide up to $150 million of an amended facility in the amount of $585 million and having a term of 365 days from closing. Wachovia Securities also agreed to use its reasonable best efforts to arrange for a syndicate of lenders to provide the balance of the increased facility. The syndication and closing of the facility are subject to customary terms and conditions for letter of credit facilities of this type and size and Wachovia's commitment is also subject to the receipt of commitments from other lenders for the balance of the increased facility.
On August 8, 2003, we amended and restated our committed revolving credit agreement to increase the facility from $310 million to $400 million and to make certain other changes. The interest rates on this facility are based on a spread above LIBOR. No balance was outstanding at December 31, 2003. As amended, the agreement contains certain financial covenants. These covenants generally provide that consolidated debt to capital shall not exceed the ratio (the "Debt to Capital Ratio") of 0.35:1 and that the consolidated net worth (the "Net Worth Requirements") of RenaissanceRe and Renaissance Reinsurance shall equal or exceed $1 billion and $500 million, respectively, subject to certain adjustments under certain circumstances in the case of the Debt to Capital Ratio and certain grace periods in the case of the Net Worth Requirements, all as more fully set forth in the agreement. The scheduled commitment termination date under the amended agreement is August 8, 2006.
During 2003, shareholders' equity increased by $692.6 million to $2.3 billion at December 31, 2003, from $1.6 billion at December 31, 2002. The significant components of the change in shareholders' equity included net income available to common shareholders of $604.6 million and the issuance of $100 million Series B preference shares.
The $1.1 billion growth in our portfolio of invested assets for the year ended December 31, 2003 resulted primarily from net cash provided by operating activities of $820.4 million, the issuance of $100 million of 5.875% Senior Notes and the issuance of $100 million Series B preference shares.
Because our coverages include substantial protection for damages resulting from natural and man-made catastrophes, we may become liable for substantial claim payments on short notice. Accordingly, our investment portfolio is structured to preserve capital and provide a high level of liquidity which means that the large majority of our investment portfolio consists of highly rated fixed income securities, including U.S. Treasuries, highly-rated sovereign and supranational securities, high-grade corporate securities and mortgage-backed and asset-backed securities. At December 31, 2003, our invested asset portfolio of fixed maturities and short term investments had a dollar weighted average rating of AA, an average duration of 2.0 years and an average yield to maturity of 2.7%.
The equity investments in reinsurance company relate to our November 1, 2002 purchase of 3,960,000 common shares of Platinum in a private placement transaction. In addition, we received ten-year warrants to purchase up to 2.5 million additional common shares of Platinum for $27.00 per share. We purchased the common shares and warrants for an aggregate price of $84.2 million. At December 31, 2003, we owned 9.2% of Platinum's outstanding common shares. We have recorded our investment in Platinum at fair value, and at December 31, 2003 the aggregate fair value was $145.5 million. The aggregate unrealized gain of $61.3 million on the Platinum investment is included in accumulated other comprehensive income, of which $26.7 million represents our best estimate of the value of the warrants.
At December 31, 2003, $56.4 million of cash and cash equivalents and investments were invested in currencies other than the U.S. dollar, which represented 1.3% of our invested assets.
A portion of our investment assets are directly held by our subsidiary RIHL, a Bermuda company we organized for the primary purpose of holding the investments in high quality marketable securities for RenaissanceRe, our operating subsidiaries and certain of our joint venture affiliates. We believe that RIHL permits us to consolidate and substantially facilitate our investment management operations. RenaissanceRe and each of our participating operating subsidiaries and affiliates have transferred to RIHL marketable securities or other assets, in return for a subscription of RIHL equity interests. Each RIHL share is redeemable by the subscribing companies for cash or in marketable securities. Over time, the subsidiaries and joint ventures which participate in RIHL are expected to both subscribe for additional shares and redeem outstanding shares, as our and their respective liquidity needs change. RIHL is currently rated AAAf/S2 by S&P.
We have committed capital to private equity partnerships of $109.1 million, of which $20.3 million has been contributed at December 31, 2003.
At December 31, 2003, we have not entered into any off-balance sheet arrangements, as defined by Item 303 (a)(4) of Regulation S-K.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based Compensation - Transition and Disclosure" ("SFAS 148"), which amends SFAS 123, "Accounting for Stock-Based Compensation" ("SFAS 123") and provides transitional disclosure requirements. For the years ended December 31, 2002 and for the prior years, we followed Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25")
In accordance with the transitional disclosure provisions of SFAS 148, the following table sets out the effect on our net income and earnings per share for all reported periods had the compensation cost been calculated based upon the fair value method recommended in SFAS 123:
Effective December 31, 2003, we adopted FASB Interpretation No. 46, "Consolidation of Variable Interest Entities - an interpretation of ARB No. 51" ("FIN 46"). FIN 46 requires consolidation of all Variable Interest Entities ("VIE") by the investor that will absorb a majority of the VIE's expected losses or residual returns. As further discussed in Note 7 to the consolidated financial statements, the Capital Trust was determined to be a VIE under FIN 46 and has been deconsolidated effective December 31, 2003. This has resulted in reclassifying certain balances. The adoption of FIN 46 did not have a material impact on our financial condition and results of operations.
We expect prices in the property insurance markets to decrease in 2004, and prices in certain specialty casualty insurance markets to continue to increase in 2004. Accordingly, in 2004 we expect our property insurance premiums to decrease and our premiums from the casualty insurance market to increase. Also, we believe that our strong infrastructure, our strong credit ratings and our financial strength will enable us to attract additional program managers who control attractive books of business and who are currently concerned with the credit ratings of their current insurance carriers. Because of these opportunities, we believe that our premiums in our Individual Risk segment for the full year 2004 will increase as compared with the total Individual Risk premiums for 2003.
Recognizing that there are many segments of the casualty market that remain unattractive even after recent price increases, we intend to be selective and write business only in those segments that we believe can produce an acceptable return on capital.
The current market environment is also providing us with increased opportunities for our joint venture and structured product initiatives. In evaluating these initiatives, we may consider opportunities in other areas of the insurance and reinsurance markets, or in other financial markets, either through organic growth, the formation of new joint ventures, or the acquisition of other companies or books of business of other companies. We are currently in the process of reviewing certain opportunities and periodically engage in discussions regarding possible transactions, although there can be no assurance that we will complete any such transactions or that any such transaction would contribute materially to our results of operations or financial condition.
(2) The interest on this facility is based on a spread above LIBOR. We have reflected the interest due in 2004 and 2005 based upon the current interest rate on the facility.