The Company leases office spaces in Hamilton, Bermuda, where the Company’s principal executive offices are located. The Company also leases office space in London, United Kingdom, where the Company’s subsidiary, Montpelier Marketing Services (UK) Limited is located. We have entered into a ten-year lease agreement for new premises in Bermuda where our principal office will be located. We anticipate moving into the new premises during August 2006.
The following table sets forth our selected financial data and other financial information as at December 31, 2005, 2004, 2003 and 2002 and for the years ended December 31, 2005, 2004, 2003, 2002 and for the period from November 14, 2001 to December 31, 2001. The historical financial information was prepared in accordance with U.S. GAAP. The statement of income data for the periods ended December 31, 2005, 2004, 2003, 2002 and 2001, and the balance sheet data at December 31, 2005, 2004, 2003, 2002 and 2001 were derived from our audited consolidated financial statements, which have been audited by PricewaterhouseCoopers, our independent registered public accounting firm. You should read the selected financial data in conjunction with our consolidated financial statements and related notes thereto contained in Item 8 - “Financial Statements and Supplementary Data” and
This discussion contains forward-looking statements that are not historical facts, including statements about the Company’s beliefs and expectations. These statements are based upon current plans, estimates and projections. Our actual results may differ materially from those projected in these forward-looking statements as a result of various factors. See “Cautionary Statement under “Safe Harbor” Provision of the Private Securities Litigation Reform Act of 1995.” and Item 1A “Risk Factors” in this filing.
We also write direct insurance and facultative reinsurance coverage on commercial property risks where we assume all or part of a risk under a single insurance contract. We generally write such coverage on an excess of loss basis. For 2006 we will attempt to reduce our catastrophe exposure on direct and facultative treaty contracts through changes in policy terms and conditions.
We also write property pro-rata reinsurance contracts which are reinsurances of individual property risks written on a proportional basis rather than on an excess of loss basis.
Loss and loss adjustment expenses are a function of the amount and type of reinsurance and insurance contracts we write and of the loss experience of the underlying risks. Loss and loss adjustment expense reserves include a component for outstanding case reserves for claims which have been reported and a component for losses incurred but not reported. The uncertainties inherent in the reserving process, together with the potential for unforeseen developments, may result in loss and loss adjustment expenses significantly greater or less than the reserve provided. Changes to our prior year loss reserves will impact our current underwriting results by improving our results if the prior year reserves prove to be redundant or reducing our results if the prior year reserves prove to be insufficient. As new information becomes known to us, any resulting adjustments will be reflected in income in the period in which they become known. Our ability to estimate loss and loss adjustment expenses accurately at the time of pricing our contracts is a critical factor in determining our profitability.
Acquisition costs consist principally of brokerage expenses and commissions which are driven by contract terms on the reinsurance and insurance contracts we write, and are normally a set percentage of premiums. Under certain contracts we may also pay profit commission to cedants which will vary depending on the loss experience on the contract.
best estimate of ultimate loss and loss adjustment expenses. Our internal actuaries review our reserving assumptions and our methodologies on a quarterly basis and our loss estimates are subject to an annual corroborative review by independent actuaries using generally accepted actuarial principles.
Loss reserve calculations for insurance business are not precise in that they deal with the inherent uncertainty of future contingent events. Estimating loss reserves requires us to make assumptions regarding future reporting and development patterns, frequency and severity trends, claims settlement practices, potential changes in the legal environment and other factors such as inflation. These estimates and judgments are based on numerous factors, and may be revised as additional experience or other data becomes available and reviewed, as new or improved methodologies are developed or as current laws change.
There is a time lag inherent in reporting from the original claimant to the primary insurer to the broker and then to the reinsurer, especially in the case of excess of loss reinsurance contracts. Also, the combination of low claim frequency and high severity make the available data more volatile and less useful for predicting ultimate losses. In the case of proportional contracts, we rely on an analysis of a contract’s historical experience, industry information, and the professional judgment of underwriters in estimating reserves for these contracts. In addition, if available, we also rely partially on ultimate loss ratio forecasts as reported by cedants, which are normally subject to a quarterly or six month lag.
Estimating loss reserves for our small book of longer tail casualty reinsurance business, which can be either on an excess of loss or proportional basis, involves further uncertainties. In addition to the uncertainties inherent in the reserving process described above, casualty business can be subject to much longer reporting lags than property business, and claims often take many years to settle. During this period, additional factors and trends will be revealed and as these factors become apparent, reserves will be adjusted. There is also the potential for the emergence of new classes of losses or types of losses within the casualty book. Any factors that extend the time until claims are settled add uncertainty to the reserving process. At December 31, 2005, management has estimated gross loss and loss adjustment expense reserves related to our casualty business of $151.3 million.
Since we rely on estimates of paid losses, case reserves, and IBNR provided by ceding companies in order to assist us in estimating our own loss and loss adjustment expense reserves, we maintain certain procedures in order to mitigate the risk that such information is incomplete or inaccurate. At least monthly, management assesses the reporting activities of these companies on the basis of qualitative and quantitative criteria. On a timely basis management takes appropriate follow-up action as required, which may include requests for
Our loss and loss adjustment expense reserves include both a component for outstanding case reserves for claims which have been reported and a component for IBNR reserves.
In general, claims relating to short tail property risks are reported more promptly by third parties than those relating to long tail risks, including the majority of casualty risks. However, the timeliness of reporting can be affected by such factors as the nature of the event causing the loss, the location of the loss, and whether the losses are from policies in force with primary insurers or with reinsurers.
Due to these factors, we do not normally expect to experience significant claims processing back-logs. Following a major catastrophic event, claims processing backlogs may occur. At December 31, 2005, we did not have a significant back-log in either our insurance or reinsurance claims processing.
IBNR reserves are estimated by management using various actuarial methods as well as a combination of our own historical loss experience, historical insurance industry loss experience, our underwriters’ experience, estimates of pricing adequacy trends, and management’s professional judgment. In the case of our reinsurance business, we also take into account ceding company reports on IBNR reserves in making our estimates.
To the extent we rely on industry data to aid us in our reserve estimates there is a risk that the data may not match our risk profile or that the industry’s reserving practices overall differ from our own and those of our cedants. In addition, reserving can prove especially difficult should a significant loss event take place near the end of an accounting period, particularly if it involves a catastrophic event. These factors further contribute to the degree of uncertainty in the reserving process.
The uncertainties inherent in the reserving process, together with the potential for unforeseen developments, including changes in laws and the prevailing interpretation of policy terms, may result in loss and loss adjustment expenses significantly greater or less than the reserves provided. Changes to our prior year loss reserves will impact our current underwriting results by improving our results if the prior year reserves prove to be redundant or reducing our results if the prior year reserves prove to be insufficient. For additional discussion on development of loss and loss adjustment expense reserves related to prior years see Item 7 - “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We expect volatility in our results in periods that significant loss events occur because U.S. GAAP does not permit insurers or reinsurers to reserve for loss events until they have occurred and are expected to give rise to a claim. As a result, we are not allowed to record contingency reserves to account for expected future losses. We anticipate that claims arising from future events will require the establishment of substantial reserves from time to time.
The following table sets forth a breakdown between case reserves and IBNR by line of business at December 31, 2005 ($ in millions):
Premiums. Though we are principally a provider of reinsurance, we write both insurance and reinsurance contracts. Our insurance premium is all written on an excess of loss basis. Our assumed reinsurance premium is written on an excess of loss or on a pro-rata basis. Reinsurance contracts are generally written prior to the time the underlying direct policies are written by cedants and accordingly they must estimate such premiums when purchasing reinsurance coverage. For the majority of excess of loss contracts, including all insurance business, the deposit premium is defined in the contract wording. The deposit premium is based on the ceding companies’ estimated premiums, and this estimate is the amount we record as written premium in the period the underlying risks incept. In the majority of cases, these contracts are adjustable at the end of the contract period to reflect the changes in underlying risks during the contract period. Subsequent adjustments, based on reports by the ceding companies of actual premium, are recorded in the period they are determined, which are normally reported within six months to a one year subsequent to the expiration of the policy. To date these adjustments have not been significant.
Generally, on pro-rata contracts and certain excess of loss contracts where the deposit premium is not specified in the contract, an estimate of written premium is recorded in the period in which the underlying
Management includes an assessment of the creditworthiness of cedants in the review process above, primarily based on market knowledge, the timeliness of cedants’ past payments and the status of current balances owing. In addition, management may also review the financial statements of ceding companies. Based on this assessment, management believes that as at December 31, 2005 no provision for doubtful accounts is necessary.
Montpelier Long-Term Incentive Plan (“LTIP”). The Compensation and Nominating Committee of the Board of Directors (the “Committee”) approved a new Long-Term Incentive Plan which became effective as of January 1, 2005. At the discretion of the Committee, incentive awards, the value of which is based on the Company’s Common Shares, may be made to all eligible plan participants.
For the 2005-2007 performance period, the primary performance target for all participants for a 100% harvest ratio of Performance Shares is the achievement of an underwriting return on an internally generated risk-based capital measure of 16% over the period. Additionally, the performance of certain members of senior management is further measured by reference to the ratio of the actual return on equity to the return on risk based capital. The total number of Performance Share awards outstanding under the LTIP at December 31, 2005 was 400,000 (or up to 800,000 common shares should the maximum harvest of 200% of awards for the 2005-2007 performance period apply). Due to the impact of the natural catastrophes which occurred during the third quarter of 2005 on our results for the quarter and the year-to-date, we estimated the LTIP liability and the LTIP expense using a 0% harvest ratio at December 31, 2005 and therefore there is no estimated payout related to this performance period. We will reassess the harvest ratio used in the calculation of the LTIP liability at the end of each quarter.
We accrue the projected value of the LTIP and PUP units and expense the value in the income statement over the course of each three-year performance period. The accrual is based on the number of units granted, the share price at the end of the respective fiscal period end, plus an adjustment for any dividends paid out during the performance period, and an estimate of an ultimate 100% harvest ratio, unless otherwise adjusted as discussed below. At the end of the sixth quarter, and every subsequent quarter, we reassess the projected results for each three year performance period and adjust the accrued LTIP and PUP liability as necessary. We recalculate the liability under the LTIP and PUP as our financial results evolve and the share price changes, and reflect such adjustments in income in the period in which they are determined. This may result in an adjustment to the harvest ratio used in the liability calculation which may increase or decrease the amount of liability and expense recorded during the period.
For the 2003-2005 and 2004-2006 cycles, the performance target for a 100% harvest ratio is the achievement of an overall combined ratio of 72% over the period or the achievement of an annual total return to shareholders of 18% as measured over the period. Taking into account our results to date as well as the estimated overall combined ratio for the remainder of this performance period, we have adjusted the estimated harvest ratio of 116.4% and 100.0%, respectively, at December 31, 2004 to 0% at December 31, 2005 due to the impact of the 2005 catastrophes.
Outside of the U.S. peak property business zones discussed above and for other classes of business unexposed to peak zone peril limits we believe that there is a surplus of capacity which will restrain rate increases. In addition, in some casualty classes we forsee rate reductions as reinsurers seek to diversify their portfolios.
Currently we believe that it is only a matter of time before the pricing in the catastrophe excess of loss market increases in line with the retrocessional market.
We have purchased more retrocession protection and initiated our first catastrophe bond transaction; and
All of these actions will alter our loss profile going forward. Compared to prior years, we expect that our results of operations will be less sensitive to low frequency large loss events, leading to a narrower range of likely outcomes from extreme events, but our results may be more sensitive to medium sized attritional events.
exceeded the 2004 hurricanes. The overall net loss for the year ended December 31, 2005 was $752.9 million. The main factors driving this decrease were:
A decrease in incentive compensation and profit commission expenses as a result of the 2005 hurricanes;
The decrease in net income for the year ended December 31, 2004 year compared to 2003 was principally driven by losses incurred related to the four major U.S. hurricanes and two Japanese typhoons which occurred during the third quarter of 2004. There were no loss events of a comparable magnitude in the same period in 2003. As at December 31, 2004 we estimated the overall negative impact on net income related to these catastrophes to be approximately $240.0 million, which was as a result of the increase in loss and loss adjustment expenses and related increase in reinstatement premium ceded, partially offset by reinstatement premium written and a reduction in profit commission and incentive compensation expenses.
Fully converted book value per share is a non-GAAP measure, based on total shareholders’ equity divided by common shares outstanding of 89,178,490 at December 31, 2005. Warrants outstanding at December 31, 2005 are not included as the exercise price of $16.67 per common share is greater than book value per share. At December 31, 2004 and 2003, fully converted book value per share is based on total shareholders’ equity plus the assumed proceeds from the exercise of outstanding options and warrants of $157.5 million and $168.1 million, respectively, divided by the sum of shares, options and outstanding warrants (assuming their exercise) of 71,372,892 for 2004 and 73,261,757 for 2003. We believe that fully converted book value per share more accurately reflects the value attributable to a common share.
The change in fully converted book value per share adjusted for dividends, which is a non-GAAP measure was ($8.24) or (37.8%) for the year ended December 31, 2005. It is the internal rate of return of the change in fully converted book value per share from $26.75 at December 31, 2004 to $11.86 at December 31, 2005, giving effect to the dividend of $0.36 for the first three quarters of 2005, $0.075 for the fourth quarter of 2005 and the special dividend of $5.50 per common share and warrant declared during the year ended December 31, 2005. For these purposes fully converted book value per share assumes that the warrants are not exercised if the book value per share is less than the strike price. The Company believes that this measure most accurately reflects the return made by its shareholders as it takes into account the effect of all dilutive securities and the effect of dividends.
Details of gross premiums written by line of business are provided below ($ in millions):
For 2005 $116.3 million related to the 2005 hurricanes and the remainder to the 2004 catastrophes.
In 2005 our mix of business has also changed modestly as compared to the prior year. While our focus is still predominately short-tail excess of loss business, we have written an increased amount of property pro-rata business. Additionally, there has been an increase in our writings of casualty business during 2005. For the years ended December 31, 2005 and 2004, casualty business represented approximately 9.0% and 8.5% of our gross premiums written, respectively. Excluding reinstatement premium, casualty business written increased by 23.8% during 2005 as compared to 2004. Casualty business is included in the Other Specialty category and includes medical malpractice, specialized errors and omissions business, UK employer’s liability and public liability and catastrophe and/or clash layers for general liability and retrocessional accounts, predominantly on an excess of loss basis. We do not expect to write U.K. employers’ liability business in 2006. We expect casualty business to account for a lower percentage of gross written premium in 2006 mainly due to the cancellation of some of our contracts with Aspen affiliates as discussed below.
As expected, we have not written QQS business since 2003. The QQS gross premiums written in 2005 and 2004 related to adjustments in estimates made to the 2003 and 2002 underwriting years mainly as a result of the movement in foreign exchange rates. As expected, during 2005 we commuted all of the 2002 underwriting year QQS contracts and expect to commute all of the 2003 underwriting year contracts during the first or second quarter of 2006.
On December 30, 2005, the Company invested in Blue Ocean Re Holdings Ltd., the holding company that owns 100% of Blue Ocean Reinsurance Ltd. (“Blue Ocean Re”). Blue Ocean Re is a Bermuda-licensed reinsurer formed to write property catastrophe retrocessional protection. Montpelier Agency Ltd., a subsidiary of Montpelier Re Holdings Ltd., provides Blue Ocean Re with underwriting, risk management, claims management, ceded retrocession agreement management, actuarial and accounting services and receives fees for such services. As at December 31, 2005, the Company beneficially owned 1,065,990 shares, or 49% of Blue Ocean Re Holdings’ outstanding common shares and 34% of the preferred shares. Under FIN 46R, Blue Ocean Re Holdings Ltd. is consolidated into the Company’s financial statements and the 51% of Blue Ocean’s earnings and shareholders equity held by third parties is recorded in the consolidated financial statements as minority interest.
Gross premiums written related to the Property Specialty category increased in 2004 only marginally compared to the same period in 2003 mainly as a result of an increase in proportional business. This increase was offset somewhat by the decreases in premium levels on direct and facultative business.
We did not renew a substantial portion of continental European business due to insufficient pricing and terms.
For the years ended December 31, 2005 and 2004, we purchased reinsurance protecting our direct and assumed reinsurance portfolio against large risk losses on our direct and facultative book and certain catastrophes on our overall property writings. In addition, in 2005 we also purchased additional catastrophe and sabotage and terrorism retrocessional protection and specific retrocessional coverage on certain contracts during 2005. We also ceded property catastrophe reinsurance to Rockridge as discussed above in the amount of approximately $6.6 million during the year ended December 31, 2005. During 2005 we purchased Industry Loss Warranty (“ILWs”) reinsurance protection and quota share protection on our property catastrophe excess of loss book. During the fourth quarter of 2005 reinsurance premiums ceded increased by approximately $98.5 million which was due to additional reinstatement premium related to Wilma and the purchase of additional ILWs and quota share reinsurance to protect the fourth quarter of 2005 and for the 2006 year. The impact on net earned premium of these purchases was approximately $17.6 million, with the remaining $80.9 million relating to pre-purchases for the 2006 year. These reinsurance purchases were principally designed to reduce our net exposure to large catastrophes. In 2006, we may purchase more large event protection coverage, including ILWs, as well as additional quota share protection against our 2006 property business and additional specific protection for our direct and facultative business.
Reinsurance premiums ceded for 2004 increased from 2003 primarily because we purchased additional protection against our catastrophe book as compared to the prior year. In addition, in 2004 we also purchased
In addition to the reinsurance protection described above, effective December 30, 2005 the Company purchased fully-collateralized coverage for losses sustained from qualifying hurricane and earthquake loss events. The Company acquired this protection from Champlain Limited, a Cayman Islands special purpose vehicle, which financed this coverage through the issuance of $90 million in catastrophe bonds to investors under two separate bond tranches each of which matures on January 7, 2009. The first $75 million tranche covers large earthquakes affecting Japan and/or the U.S. The remaining $15 million coverage provides second event coverage for a U.S. hurricane or earthquake. Both tranches respond to parametric triggers, whereby payment amounts are determined on the basis of modeled losses incurred by a notional portfolio rather than by actual losses incurred by the Company. For this reason, this cover is accounted for as a weather derivative, rather than a reinsurance transaction.
The following are our net loss ratios by line of business for the periods indicated:
The overall gross loss ratio for the year ended December 31, 2005 was 182.8%.
The overall gross loss ratio for the year ended December 31, 2003 was 21.3%.
The Property Catastrophe, Property Specialty, and Other Specialty groups of business were all heavily impacted by the aforementioned catastrophes. The Property Specialty loss ratio for the year ended December 31, 2005 was 142.4%. All of the Property Specialty lines of business suffered large losses from Hurricane Katrina. Hurricane Rita also contributed significant losses to the Property Risk excess of loss book of business, and Hurricane Wilma significantly impacted the Property Risk and Property Pro Rata lines. The three hurricanes resulted in approximately $303.2 million of net losses for the Property Specialty category in 2005. The Property Catastrophe net loss ratio for the year ended December 31, 2005 was significantly higher
The Qualifying Quota Share loss ratio for the year ended December 31, 2005 is high as a result of a negative impact from foreign currency fluctuations, along with the low earned premium volume for the year. The 2002 underwriting year QQS contracts were commuted during the second quarter of 2005. The Qualifying Quota Share loss ratio for the year ended December 31, 2004 was lower than the same period in 2003 as a result of the QQS syndicates lowering their ultimate loss ratio projections for both the 2002 and the 2003 underwriting years.
The 2005 and 2004 years include approximately $17.1 million and $97.6 million, respectively, of favorable development of net losses from prior years. Favorable prior year development benefited the net loss ratio for the years ended December 31, 2005 and 2004 by approximately 2.0% and 12.4%, respectively.
The favorable development during the year ended December 31, 2005 of losses incurred during prior accident years primarily resulted from the following:
In the Property Specialty category, our net estimated ultimate losses for prior years decreased by $24.3 million during the year ended December 31, 2005. Our gross estimated ultimate losses increased slightly, but this was more than offset on a net basis by an increase in the ceded losses attributable to the 2004 hurricanes. We have continued to see lower-than-expected loss development on the 2003 accident year. As these years develop, we place more weight in the reserving process on the actual loss experience compared with the initial loss ratio expectation. The low level of losses for 2003 and for 2004 (excluding the hurricanes) coupled with the increasing weight on the actual experience have led to the reduction in the ultimate loss projection of $24.3 million during 2005.
We continued to see low claim frequency in the Other Specialty classes of business during 2005. As this business has matured, we have given more weight to the actual loss experience compared to the initial expected loss ratios in our reserving process. This has resulted in reduced projections for prior accident years and lower selected net loss ratios. The low level of loss development, combined with the increasing weight placed on our actual experience in selecting a loss ratio resulted in a reduction in ultimate losses of $17.7 million for prior accident years for the year ended December 31, 2005.
Other than the matters described above, we did not make any significant changes in the assumptions or methodology used in our reserving process during the year ended December 31, 2005.
At December 31, 2005, we estimated our gross and net reserves for loss and loss adjustment expenses using the methodology as outlined in our Summary of Critical Accounting Estimates earlier in this section.
Management has determined that the best estimate for gross loss and loss adjustment expense reserves at December 31, 2005, 2004 and 2003 was $1,781.9 million, $549.5 million and $249.8 million, respectively.
Profit commission expensed was $6.8 million, $7.6 million and $19.6 million for years ended December 31, 2005, 2004 and 2003, respectively. Over each of the past three years profit commission has declined as compared to the prior year, mainly due to the increase in loss and loss adjustment expenses related to the 2005 and 2004 hurricanes. Profit commission will fluctuate as our estimate of loss and loss adjustment expense reserves fluctuates.
Fixed expenses, excluding stock options, are slightly higher in 2005 as compared to 2004, mainly as a result of an increase in office expenses, consistent with the increase in staff numbers which occurred later in 2004.
Performance unit plan (“PUP”) expense and Long-Term Incentive Plan (“LTIP”) expense included in current and deferred incentive compensation were reversed during the year ended December 31, 2005 as a result of the effect that the 2005 catastrophes had on our results. We have used an estimated harvest ratio of 0% for the 2003-2005, 2004-2006 and 2005-2007 performance periods. In addition, current incentive compensation expense was lower for the year ended December 31, 2005 as compared to 2004 due to the reasons described above.
For the year ended December 31, 2004, the performance unit plan (“PUP”) expense included in current and deferred incentive compensation was higher than the same period in 2003 as a result of a combination of factors. The factors that affect the calculation of the PUP expense in 2004 consist of a decrease in the harvest ratio used in calculating the expense for the 2002-2004 performance period from 137.5% at December 31, 2003 to 132.0% at December 31, 2004. This reduction resulted mainly from the effect of the third quarter of 2004 catastrophes, the effect of which was partially offset by an increase in our share price which includes an adjustment for any dividends paid out during the performance period from 2003 to 2004. For the 2003-2005 performance cycle, the expense increased in 2004 due to the increase in the harvest ratio from 100% at the end of 2003 to 116.4% at December 31, 2004, combined with the increase in our share price which includes an adjustment for any dividends paid out during the performance period, from 2003 to 2004. The 2004 year also includes an additional accrual for the 2004-2006 performance period. The overall effect was a net increase in the PUP expense as compared to 2003. On February 28, 2005 we paid out the 2002-2004 PUP accrual of approximately $14.0 million.
In 2005, our investment return decreased compared with the same period in 2004. This is principally a result of the overall market movement in bond prices during each respective period. In addition, the level of the investment portfolio and related investment income was affected by the special dividend we declared on February 25, 2005 of $387.7 million. The size of the investment portfolio and related investment income will be affected by the hurricanes which occurred during 2005 as we have paid out a substantial amount of claims during 2005 and will be paying out substantially more claims over the next twelve months to an extent offset by equity and subordinated debt capital we have raised. Net paid claims were $489.3 million in 2005 as compared to $192.0 million in 2004.
In 2004 compared to 2003, as expected, our investment income increased as a result of our larger investment portfolio. Net paid claims were $192.0 million in 2004 as compared to $53.2 million in 2003.
Fees for the letter of credit facilities relate to the Letters of Credit that we have in place as detailed in the Capital Resources section below. These fees are the same as those incurred during 2004. Fees are higher in 2004 than in 2003 as more reinsureds requested additional security as a result of the 2004 hurricanes.
Net gains realized resulted from the sale of fixed maturity and equity investments, and in particular from the $44.5 million in realized gains from the sales of Aspen shares during year ended December 31, 2005. Offsetting realized gains, we recorded approximately $22.9 million in realized losses, $7.1 million of which related to realized impairments on fixed maturity and equity investments and the remainder due to the sale of investments resulting from the rebalancing of our fixed maturity portfolio.
Minority interest represents the minority shareholders interest of Blue Ocean’s loss for the year ended December 31, 2005.
We are a holding company and conduct no operations of our own. We rely primarily on cash dividends and management fees from Montpelier Re to pay our operating expenses, interest on our debt and dividends to our shareholders and warrant holders. There are restrictions on the payment of dividends from Montpelier Re to the Company, which are described in Item 1 “Business” of this filing. We paid dividends for the first three quarters of 2005 of $0.36 per common voting share and warrant. For the fourth quarter we declared a dividend of $0.075 per common voting share and warrant which was paid on January 15, 2006. In addition, on February 25, 2005 we declared a special dividend in the amount of $5.50 per common voting share and warrant which was paid on March 31, 2005 to shareholders and warrant holders of record at March 15, 2005. Any determination to pay future cash dividends will be at the discretion of our Board of Directors and will be dependent upon our results of operations and cash flows, our financial position and capital requirements, general business conditions, legal, tax, regulatory and any contractual restrictions on the payment of dividends, and any other factors our Board of Directors deems relevant.
Our shareholders’ equity at December 31, 2005 was $1,057.7 million, which is net of an accumulated deficit of $648.3 million. Our capital base has decreased by $694.2 million since December 31, 2004, mainly as a result of the net negative impact of the 2005 hurricanes, resulting in a net loss for the year, combined with the payment of a special dividend of $387.7 million as discussed above, offset by an increase in capital of
On August 4, 2003, we issued $250.0 million aggregate principal amount of senior unsecured debt (the “Senior Notes”) at an issue price of 99.517% of their principal amount. The net proceeds were used in part to repay a term loan facility with the remainder used for general corporate purposes. The Senior Notes bear interest at a rate of 6.125% per annum, payable semi-annually in arrears on February 15 and August 15 of each year. Unless previously redeemed, the Senior Notes will mature on August 15, 2013. We may redeem the Senior Notes at any time and from time to time, in whole or in part, at a “make-whole” redemption price, however, we have no current intention of calling the Notes. The Senior Notes do not contain any covenants regarding financial ratios or specified levels of net worth or liquidity to which we must adhere.
Effective December 30, 2005 we purchased fully-collateralized coverage for losses sustained from qualifying hurricane and earthquake loss events. The Company acquired this protection from Champlain Limited, a Cayman Islands special purpose vehicle, which financed this coverage through the issuance of $90 million in catastrophe bonds to investors under two separate bond tranches each of which matures on January 7, 2009. The first $75 million tranche covers large earthquakes affecting Japan and/or the U.S. The remaining $15 million coverage provides second event coverage for a U.S. hurricane or earthquake. Both tranches respond to parametric triggers, whereby payment amounts are determined on the basis of modeled losses incurred by a notional portfolio rather than by actual losses incurred by the Company. For this reason, this cover is accounted for as a weather derivative, rather than a reinsurance transaction. Fees paid in relation to the catastrophe bond are calculated at 12.75% plus 8 basis points per annum on the first tranche plus 13.5% plus 8 basis points on the second tranche. Fees are payable quarterly, the first payment being due on April 7, 2006. However, in the event that this cover is triggered the amount of fees that we will have to pay will be significantly lower than what is reflected above.
On September 26, 2005 we filed a universal shelf registration statement on Form S-3 with the U.S. Securities and Exchange Commission for the potential future sale of up to $1.0 billion of debt, trust preferred and/or equity securities. We cannot assure you that additional financing under the universal shelf registration statement or elsewhere will be available at terms acceptable to us.
On January 6, 2006, we raised $100.0 million through a private sale of trust preferred securities. The trust preferred securities were issued by a newly formed statutory trust, Montpelier Capital Trust III, which we wholly-own. The securities have a fixed rate of interest of 8.55% per annum through March 30, 2011, and thereafter a floating interest rate of 3-month LIBOR plus 380 basis points, reset quarterly. The securities mature on March 30, 2036, and may be called at par by the Company at any time after March 30, 2011.
The following table details the Company’s and Montpelier Re’s credit facilities as at December 31, 2005 (in thousands):
On August 4, 2005, Montpelier Re renewed Tranche A of its syndicated collateralized, 364-day facility in the amount of $250.0 million, in order to fulfill the requirements of Lloyd’s for open years of account. This facility was originally arranged in 2003. On August 4, 2005, Montpelier Re amended and restated Tranche B of the syndicated collateralized facility from a $250.0 million three-year facility to a $225.0 million five-year facility with a revised expiry date of August 2010.
On November 15, 2005, Montpelier Re entered into a new Letter of Credit Reimbursement and Pledge Agreement with Bank of America, N.A. and a syndicate of commercial banks for the provision of a letter of
All of the Company’s letter of credit facilities contain covenants that limit the Company’s and Montpelier Re’s ability, among other things, to grant liens on their assets, sell assets, merge or consolidate. The Letter of Credit Facility Agreement for the syndicated collateralized facility also requires the Company to maintain debt leverage of no greater than 30% and Montpelier Re to maintain an A.M. Best financial strength rating of no less than B++. If the Company or Montpelier Re fails to comply with these covenants or meet these financial ratios, the lenders could declare a default and begin exercising remedies against the collateral, Montpelier Re would not be able to request the issuance of additional letters of credit and the Company would not be able to borrow under the revolving line of credit. For the year ended December 31, 2005, each of the Company and Montpelier Re was in compliance with all covenants.
Effective January 10, 2006 Blue Ocean entered into a Standing Agreement for Letters of Credit with the Bank of New York for the provision of a letter of credit facility for the account of Blue Ocean Re in an amount up to $75 million. There were no letters of credit issued under this facility at December 31, 2005.
We expect these letter of credit facilities to be sufficient to support Montpelier Re’s estimated obligations for the next 12 months in the absence of another very major catastrophe.
We are not party to any off-balance sheet transaction other than the catastrophe bond, agreement or other contractual arrangement to which an entity unconsolidated with us is a party that management believes is reasonably likely to have a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
Because a significant portion of our contracts provide short-tail reinsurance coverage for losses resulting mainly from natural and man-made catastrophes, we could become liable for a significant amount of losses on short notice. Accordingly, we have structured our investment portfolio to preserve capital and provide us with significant liquidity, which means that our investment portfolio contains a significant amount of relatively
The market value of our portfolio of fixed maturity investments is comprised of the following:
We previously had an investment in the common shares of Aspen Insurance Holdings Limited (“Aspen”), the Bermuda-based holding company of Aspen Insurance UK Limited (“Aspen Re”). During 2005 in four separate sales we sold our investment of 4 million shares in Aspen for total proceeds of $105.3 million resulting in a total gain of $44.5 million.
Our cash flows from operations represent the difference between premiums collected and investment earnings realized, loss and loss adjustment expenses paid, underwriting and other expenses paid and investment gains realized. Cash flows from operations may differ substantially, however, from net income.
We have written certain business that has loss experience generally characterized as having low frequency and high severity. This results in volatility in both our results and our operational cash flows. The potential for large claims or a series of claims under one or more of our insurance or reinsurance contracts means that we may need to make substantial and unpredictable payments within relatively short periods of time. As a result, cash flows from operating activities may fluctuate, perhaps significantly, between individual quarters and years.
On January 6, 2006, the Company raised $100.0 million through a private sale of trust preferred securities. The trust preferred securities were issued by a newly formed statutory trust, Montpelier Capital Trust III, which is wholly-owned by the Company. The securities have a fixed rate of interest of 8.55% per annum through March 30, 2011, and thereafter a floating interest rate of 3-month LIBOR plus 380 basis points, reset quarterly. The securities mature on March 30, 2036, and may be called at par by the Company at any time after March 30, 2011.