The principal offices of Platinum UK are located at 52 Lime Street, London, where Platinum UK subleases from St. Paul approximately 8,462 square feet of office space. The term of this sublease ends on June 24, 2004. We are currently considering other possible locations for the principal offices of Platinum UK.
The following table sets forth certain selected financial data of the Company as of and for the year ended December 31, 2003 and the period ended December 31, 2002 and of St. Paul Re for the period from January 1, 2002 through November 1, 2002 and for the years ended December 31, 2001, 2000 and
1999. The data for the Company as of and for the year ended December 31, 2003 and the period ended December 31, 2002 were derived from the Company's consolidated financial statements beginning on page of this Form 10-K. The data for St. Paul Re for the period ended November 1, 2002 and for the year ended December 31, 2001 were derived from the audited combined financial statements of the reinsurance underwriting segment of St. Paul prior to the Public Offering (the Predecessor Business) beginning on page P-1 of this Form 10-K. The data for the year ended December 31, 2000 were derived from the selected historical combined financial statements of the reinsurance underwriting segment of St. Paul and data for the year ended December 31, 1999 were derived from the unaudited selected historical combined financial statements of the reinsurance underwriting segment of St. Paul not included in this Form 10-K. You should read the selected financial data in conjunction with such financial statements beginning on page P-1 of this Form 10-K. You should also read the selected financial data in conjunction with the Company's consolidated financial statements as of and for the year ended December 31, 2003 and the period ended December 31, 2002 beginning on page of this Form 10-K, and the related "Management's Discussion and Analysis of Financial Condition and Results of Operations" beginning on page 32 of this Form 10-K.
Due to the nature of reinsurance, ceding companies routinely report and remit premiums subsequent to the contract coverage period. Consequently, reinsurance premiums written include amounts reported by the ceding companies, supplemented by estimates of premiums which are earned but not reported ("EBNR"). Along with estimating EBNR the Company records the expenses associated with these premiums in the form of losses, LAE and commissions. As actual premiums are reported by the ceding companies, management evaluates the appropriateness of the premium estimates and any adjustment to these estimates is recorded in the period in which it becomes known. Adjustments to original premium estimates could be material and could significantly impact earnings in the period they are recorded. Due to the time lag inherent in the reporting of premiums by ceding companies, a significant portion of amounts included as premiums written and receivable represents estimated premiums, net of commissions, and is not currently due based on the terms of the underlying contracts.
occurred at or before the balance sheet date. Every quarter, the Company's actuaries prepare estimates of the loss reserves based on established actuarial techniques. Because the ultimate amount of unpaid losses and LAE is uncertain, we believe that quantitative techniques to estimate these amounts are enhanced by professional and managerial judgment. Company management reviews these estimates and determines its best estimate of the liabilities to record in the Company's financial statements.
Under U.S. GAAP, we are not permitted to establish liabilities until the occurrence of an event that may give rise to a loss. When an event occurs of sufficient magnitude we may establish a specific IBNR reserve. Generally, this involves a catastrophe occurrence which affects many ceding company clients. Ultimate losses and LAE are based on management's judgment that reflects estimates gathered from ceding company clients, estimates of insurance industry losses gathered from public sources and estimates from catastrophe modeling software.
Unpaid losses and LAE represent management's best estimates, at a given point in time, of the ultimate settlement and administration costs of claims incurred, and it is possible that the ultimate liability may materially differ from such estimates. Such estimates are not precise because, among other things, they are based on predictions of future developments and estimates of future trends in claim severity and frequency and other factors.
Written premiums, earned premiums, incurred losses and LAE reflect the net effects of assumed and ceded reinsurance transactions. Reinsurance accounting is followed for assumed and ceded transactions when risk transfer requirements have been met. Evaluating risk transfer involves significant assumptions relating to the amount and timing of expected cash flows, as well as the interpretation of underlying contract terms. Reinsurance contracts that do not transfer significant insurance risk are generally accounted for as reinsurance deposit liabilities with interest expense charged to other income and credited to the liability.
Platinum Holdings and Platinum Bermuda are domiciled in Bermuda. The Company also has subsidiaries in the United States, United Kingdom and Ireland that are subject to the tax laws thereof.
The Company applies the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates applicable to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized
in income in the period the change is enacted. A valuation allowance is established for deferred tax assets where it is more likely than not that future tax benefits will not be realized.
During 2003, the Company adopted Statement of Financial Accounting Standards No. 123 "Accounting for Awards of Stock Based Compensation to Employees" ("SFAS 123") and Statement of Financial Accounting Standards No. 148 "Accounting for Stock-Based Compensation-Transition and Disclosure" ("SFAS 148"). SFAS 123 requires that the fair value of shares granted under the Company's share option plan subsequent to adoption of SFAS 148 be amortized in earnings over the vesting periods. The fair value of the share options granted are determined through the use of an option-pricing model. SFAS 148 amends SFAS 123 and provides transitioning guidance for a voluntary adoption of FAS 123 as well as amends the disclosure requirements of SFAS 123. For the period from November 1, 2002 through December 31, 2002, the Company has elected to use the intrinsic value method of accounting for stock-based awards granted to employees established by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). Under APB 25, if the exercise price of the Company's employee share options is equal to or greater than the fair market value of the underlying shares on the date of the grant, no compensation expense is recorded.
The reinsurance industry historically has been cyclical, characterized by periods of price competition due to excessive underwriting capacity as well as periods of favorable pricing due to shortages of underwriting capacity.
As a result of favorable loss levels and strong investment returns beginning in the mid-1990's, the reinsurance industry entered a cycle of increased competition and industry capacity that pushed property and casualty premium rates down. In 1999, there were several significant worldwide catastrophic events that resulted in industry insured losses of approximately $31 billion. These losses, and the subsequent contraction of reinsurance capacity in the market, resulted in improvements in rates, terms and conditions beginning with January 2000 renewals. These improvements continued in 2001 as capacity continued to contract due to a number of catastrophe events, particularly the terrorist attack of September 11, 2001. With insured losses currently estimated to be in excess of $30 billion, the terrorist attack resulted in the largest single insured loss ever experienced by the industry. By comparison, the largest industry insured catastrophic event prior to the attack was Hurricane Andrew in 1992 with $16 billion in estimated losses. Shortly after the property catastrophe events of 1999 and 2001, many reinsurance companies began to recognize poor results in their casualty business stemming from business underwritten from 1997 to 2000. The result was substantial loss reserve charges summing to tens of billions of dollars and a further decrease in industry capacity. In addition the capital of a number of large companies was further reduced by poor investment results. In late 2001 and through 2002 several new companies were started. Some existing companies raised new capital and others exited the business. The new capital invested in the industry was substantially less than the capital reduction from losses, exited companies, and poor investment results. As a result, rate increases in 2002 were significantly higher than 2001. Rates still rose in 2003 though at a lower rate. We believe that the shortage in property reinsurance capacity subsequent to the events of
and 2001 has substantially abated. Effective rate changes for our property business averaged 5-10% through 2003.
We believe that there will be more adverse casualty development from reinsurers who underwrote casualty business in the late 1990s. We believe there will be sustained upward pressure on casualty rates as these reserve shortfalls are recognized. During 2003 our effective rate change for our casualty business was between 25-30%.
Platinum Holdings was incorporated on April 19, 2002 under the laws of Bermuda to hold subsidiaries that provide property, casualty, and other reinsurance to insurers and reinsurers on a worldwide basis and, in November 2002, completed a Public Offering and assumed certain rights and obligations of the reinsurance business from St. Paul Re. Consequently, the 2002 consolidated statements of income and comprehensive income, shareholders' equity and cash flows include all activity from incorporation on April 19, 2002 through December 31, 2002. The underwriting operations, as well as substantially all other operations of the Company commenced in November 2002. Generally, the results of operations reflect the period from November 1, 2002 through December 31, 2002 (the "2002 Period") and are not comparable to the results of operations for the year ended December 31, 2003.
Net premiums written for the year ended December 31, 2003 and the 2002 Period were $1,172,142,000 and $298,114,000, respectively. The increase is primarily because 2003 includes a full year of underwriting activity and the 2002 Period includes two months. Generally, the last two months of a year have a relatively small amount of net premiums written. However, net premiums written in the 2002 Period include $244,000,000 of unearned premiums assumed from St. Paul under the Quota Share Retrocession Agreements representing the remaining unearned premiums related to contracts written by St. Paul Re during the first ten months of 2002. Premiums written are based partially on estimates of ultimate premiums from reinsurance contracts and the estimates are updated quarterly. Reductions in premiums estimated for the 2002 underwriting year in the Casualty segment, a portion of which was written and earned by St. Paul Re, reduced the Company's net premiums written in 2003 by approximately $35,300,000.
Net investment income was $57,645,000 and $5,211,000 for the year ended December 31, 2003 and the 2002 Period, respectively. The increase is primarily because 2003 includes a full year of investment income and the 2002 Period includes two months. The annualized investment yield for 2003 and the 2002 Period was 3.6% and 2.3%, respectively. The investment yield in 2003 reflects prevailing interest rates during 2003. Net investment income increased during 2003 as the Company's invested assets increased as a result of positive cash flow from operations. The yield in the 2002 Period reflects a delay in the investment of short-term investments and cash into fixed maturities during the 2002 Period pending receipt of certain required regulatory approvals from the United Kingdom and the State of Maryland. Net realized gains on investments were $2,781,000 and $25,300 in 2003 and the 2002 Period, respectively, and are the result of investment sale activity to manage the credit quality and duration of the investment portfolio.
Net foreign currency exchange gains (losses) for the year ended December 31, 2003 and the 2002 Period, were ($114,000) and $2,017,000, respectively. Foreign currency exchange gains and losses arise from the valuation in U.S. dollars of assets and liabilities denominated in foreign currencies. The Company matches foreign currency denominated assets and liabilities to manage exposures to foreign currency exchange rates.
Losses and LAE were $584,171,000 and $60,356,000 for the year ended December 31, 2003 and the 2002 Period, respectively. The increase in losses and LAE is due to the increase in net premiums earned in 2003 over the 2002 Period. The ratios of losses and LAE to premiums earned, also referred to as loss ratios, were 54.7% and 56.4% for the year ended December 31, 2003 and the 2002 Period, respectively. While losses and LAE in 2003 include provisions for various catastrophe losses, the 2002 Period had no catastrophe losses. The United States insurance industry incurred some significant catastrophe losses in 2003. However, catastrophe losses in the Company's portfolio were relatively low as most catastrophe claims remained at the primary or ceding company level. Losses and LAE in 2003 included a reduction is the estimated liability as of December 31, 2002 of $63,966,000 of which $13,100,000 relates to the reduction in 2003 of premiums originally estimated and accrued in 2002 in the Casualty segment. The remaining $50,866,000 relates to favorable development. Unpaid losses and LAE at December 31, 2002 were based largely on initial expected ultimate loss ratios. Throughout 2003 actual reported losses were monitored against expected patterns of reported loss. As actual reported losses continued to be less than expected reported losses, estimates of expected ultimate losses were reduced. This principally affected property coverages in the Property and Marine and Finite Risk segments where a substantial portion of the ultimate losses is expected to be reported to the Company within two years. Additionally, losses and LAE in 2003 were favorably impacted by improved profitability relating to net earned premium in 2003 on business underwritten in 2002.
Operating expenses include other underwriting expenses related to the reinsurance operations as well as costs associated with the holding company operations of Platinum Holdings and were $92,595,000 and $16,334,000 for the year ended December 31, 2003 and the 2002 Period, respectively. The increase in operating expenses results from 2003 representing twelve months of operations whereas the 2002 Period
represents two months, modest growth in staff, fees relating to an agreement with RenaissanceRe and office relocation expenses in 2003. Operating expenses in 2003 include a charge for $9,289,000 for the expenses related to the separation and consulting agreement with the Company's former chief executive officer. Operating expenses in the 2002 Period include one-time expenses of $5,353,000 incurred in connection with the completion of the Public Offering, the formation of the Company and the assumption of business from St. Paul.
The Property and Marine operating segment includes principally property and marine reinsurance coverages that are written in the United States and international markets. This business includes property per-risk excess-of-loss treaties, property proportional treaties and catastrophe excess-of-loss reinsurance treaties. This operating segment generated 30% of the Company's net premiums written in both 2003 and the 2002 Period.
business underwritten in 2003 and 2002 while net premiums earned in 2002 reflect only business underwritten in 2002. Net premiums earned as a percentage of net premiums written for 2003 and the 2002 Period were 101% and 48%, respectively. Generally a growing book of business will produce a ratio of net premiums earned as a percentage of net premiums written of less than 100%. Despite an increase in business underwritten in 2003 over 2002, changes in the mix of business increased the 2003 ratio over 100%. The ratio for the 2002 Period is low due to the commencement of operations in 2002 and the unearned premium assumed from St. Paul recorded as net premiums written in the period.
Losses and LAE for the year ended December 31, 2003 and the 2002 Period were $169,944,000 and $21,558,000, respectively. The increase in losses and LAE is related to the increase in net premiums earned in 2003 over the 2002 Period. The loss ratios for 2003 and the 2002 Period were 47.8% and 50.1%, respectively. Losses and LAE in 2003 were favorably affected by a relatively low level of catastrophe losses, while the 2002 Period had no catastrophe losses. Losses and LAE in 2003 also included favorable development in 2003 of losses and LAE as of December 31, 2002 of approximately $31,600,000. Additionally, the losses and LAE in 2003 were favorably impacted by improved profitability relating to net earned premium in 2003 on business underwritten in 2002.
Net premiums written for the year ended December 31, 2003 and the 2002 Period were $345,234,000 and $43,844,000, respectively. The increase is primarily because 2003 includes a full year of underwriting activity and the 2002 Period includes two months. The Finite Risk portfolio consists of a small number of contracts which can be large in premium size and are written on an intermittent basis. Consequently net premiums written are expected to vary significantly from year to year. A few significant finite quota share treaties were underwritten in the latter part of 2002 and early 2003 that together produced net premiums written of $220,000,000 in 2003.
As the Company's book of business develops, certain assets and liabilities associated with underwriting have increased significantly, some of which include significant estimates. Premiums receivable, deferred acquisition costs, unpaid losses and LAE, unearned premiums and commissions payable have all increased significantly from December 31, 2002. Premiums receivable increased by approximately $481,843,000 from December 31, 2002 to December 31, 2003, of which $395,717,000 represents EBNR. Unpaid losses and LAE, net of reinsurance recoverable on ceded losses and LAE, increased by approximately $450,259,000 from December 31, 2002 to December 31, 2003, of which $357,557,000 represents IBNR.
The consolidated sources of funds of the Company consist primarily of premiums received, losses recovered from retrocessionaires, investment income and proceeds from sales and redemption of investments and actual cash and cash equivalents held by the Company. Net cash flow provided by operations for the year ended December 31, 2003 and the 2002 Period were $383,307,000 and $281,393,000, respectively, and was used primarily to acquire additional investments. Cash flows are derived from our premium volume and the relatively low level of claim payments made to date due, in part, to the start-up nature of our business and the relatively low level of catastrophe losses incurred during the current year. Included in the cash flow from operations is $108,336,000 received from St. Paul relating to the liabilities assumed on November 2, 2002 under the Quota Share Retrocession Agreements. The Company continues to receive cash from St. Paul relating to the ongoing administration of reinsurance contracts assumed. The net cash flows from operating activities in the 2002 Period was impacted materially by the Quota Share Retrocession Agreements, under which the Company assumed reinsurance contract liabilities of St. Paul Re on November 2, 2002 and received approximately $288,648,000 in cash.
Platinum Holdings had a 364-day committed credit facility with a group of banks which provided $100,000,000 of aggregate borrowing capacity. The credit facility expired on August 19, 2003. Platinum Holdings did not renew its credit facility because the Company believes its financial position and operations are able to provide adequate liquidity. As part of the Company's ongoing business strategy, we may, from time to time, seek to secure external financing and may also access the public capital markets.
The principal consolidated cash requirements of the Company are the payment of losses and LAE, commissions, brokerages, operating expenses, dividends to its shareholders, the servicing of debt (including interest payments on the senior notes and contract adjustment payments on the purchase contracts included in the Company's equity security units), the acquisition of and investment in businesses, capital expenditures, premiums retroceded and excise taxes.
Platinum UK and Platinum Bermuda are not licensed, approved or accredited as reinsurers anywhere in the United States and, therefore, under the terms of most of their contracts with United States ceding companies, they are required to provide security to their ceding companies for unpaid ceded liabilities in a form acceptable to state insurance commissioners. Typically, this type of security takes the form of a letter of credit issued by an acceptable bank, the establishment of a trust, or a cash advance. Platinum UK and
The payment of dividends and other distributions from the Company's regulated reinsurance subsidiaries is limited by applicable laws and statutory requirements of the jurisdictions in which the subsidiaries operate, including Bermuda, the United States and the United Kingdom. Based on the regulatory restrictions of the applicable jurisdictions, the maximum amount available for payment of dividends or other distributions by the reinsurance subsidiaries of the Company in 2004 without prior regulatory approval is estimated to be $139,190,000.
Periods of moderate economic recession or inflation tend not to have a significant direct effect on the Company's underwriting operations. Significant inflationary or recessionary periods can, however, impact the Company's underwriting operations and investment portfolio. Management considers the potential impact of economic trends in estimating its unpaid losses and LAE. Management believes that the underwriting controls it maintains assist in estimating ultimate claim costs and lessen the potential adverse impact of the economy on the Company.
We believe that our markets continue to provide strong opportunities. Currently, we believe that premium rates in certain casualty reinsurance markets have strengthened to attractive levels. We believe that premiums in our Casualty segment will grow. Because there are areas of the casualty market where pricing remains inadequate, we are being selective and write business only when we believe it will be profitable. We believe we have necessary expertise in our U.S. operations to support our strategies. We believe that our reputation for prompt service as well as our financial strength will help achieve our goal.
We believe that the additional capacity provided to the reinsurance market subsequent to September 11, 2001, as well as light catastrophe losses in 2002 and 2003 have begun to cause pricing in the property catastrophe market to decrease. Decreases to date have been modest and we believe that rates remain at attractive levels. Significant time and effort has been invested in developing sophisticated catastrophe modeling tools that assist us in identifying profitable business opportunities. We believe we can improve the risk/reward relationship in our portfolio and grow the Property and Marine segment while managing our catastrophe exposure risk within acceptable levels.
We believe that the Finite Risk segment has performed exceptionally well in 2003. Profitability was favorably influenced by a relatively low level of current losses and contractual terms and conditions that provided for greater profit opportunity as a result of significant losses incurred in prior periods by St. Paul Re. We believe opportunities to write finite contracts will remain though the terms and conditions of the contracts will not allow the same profit opportunity as we move farther away from the adverse loss experience of St. Paul Re.
OUR RESULTS COULD BE ADVERSELY AFFECTED BY OUR STATUS AS A RELATIVELY NEW COMPANY.
compete with certain types of reinsurance, such as property catastrophe. Over time, these numerous initiatives could significantly affect supply, pricing and competition in our industry.
Best's has assigned a financial strength rating of "A" (Excellent) to our operating subsidiaries. This is the third highest of sixteen rating levels. According to Best's, a rating of "A" indicates Best's opinion that a company has an excellent ability to meet its ongoing obligations to policyholders.
It is increasingly common for our reinsurance contracts to contain terms that would allow the ceding companies to cancel the contract if we are downgraded below our current rating level. Whether a client would exercise this cancellation right would depend, among other things, on the reason for such downgrade, the extent of the downgrade, the prevailing market conditions and the pricing and availability of replacement reinsurance coverage. It is impossible to predict in advance whether and how many of our clients would actually exercise this right or what effect such cancellations would have on our financial condition or future operations, but such effect could potentially be material.
Accordingly, we monitor our exposure to events that affect these regions, such as hurricanes and earthquakes in the United States, windstorms in Europe and typhoons and earthquakes in Japan.
IF WE ARE REQUIRED TO INCREASE OUR LIABILITIES FOR LOSSES AND LAE, OUR OPERATING RESULTS WILL BE ADVERSELY AFFECTED.
The liabilities established on our consolidated balance sheet do not represent an exact calculation of liability, but rather are estimates of the expected cost of the ultimate settlement of losses. All of our liability estimates are based on actuarial and statistical projections at a given time, of facts and circumstances known at that time and estimates of trends in loss severity and other variable factors, including new concepts of liability and general economic conditions. Changes in these trends or other variable factors could result in claims in excess of the liabilities that we have established.
Under U.S. GAAP, Platinum US, Platinum UK and Platinum Bermuda are not permitted to establish liabilities until an event occurs which may give rise to a loss. Once such an event occurs, liabilities are established based upon estimates of the total losses incurred by the ceding companies and an estimate of the portion of such loss our three operating subsidiaries have reinsured. As a result, only liabilities applicable to losses incurred up to the reporting date may be established, with no allowance for the provision of a contingency reserve to account for expected future losses. Losses arising from future events will be estimated and recognized at the time the loss is incurred and could be substantial.
The September 11, 2001 terrorist attack, threats of further terrorist attacks and the military initiatives and political unrest in Afghanistan, Iraq, the Middle East and the surrounding regions have adversely affected general economic conditions, increasing many of the risks of our business. This may have an enduring or increasingly adverse effect on our financial condition and results of operations. Significant inflationary or recessionary periods can impact the Company's underwriting operations and investment portfolio.
THE PROPERTY AND CASUALTY REINSURANCE BUSINESS IS HISTORICALLY CYCLICAL, AND WE EXPECT TO EXPERIENCE PERIODS WITH EXCESS UNDERWRITING CAPACITY AND UNFAVORABLE PRICING.
Historically, property and casualty reinsurers have experienced significant fluctuations in operating results. Demand for reinsurance is influenced significantly by underwriting results of primary insurers and prevailing general economic and market conditions, all of which affect ceding companies' decisions as to the amount or portion of risk that they retain for their own accounts and consequently reinsurance premium rates. The supply of reinsurance is related to prevailing prices, the levels of insured losses and levels of industry surplus which, in turn, may fluctuate in response to changes in rates of return on investments being earned in the reinsurance industry. As a result, the property and casualty reinsurance business historically has been a cyclical industry characterized by periods of intense price competition due
We believe that Platinum Holdings, Platinum UK, Platinum Bermuda and Platinum Ireland each operate in such a manner that none of these companies is subject to U.S. corporate income tax because they are not engaged in a trade or business in the U.S. Nevertheless, because definitive identification of activities which constitute being engaged in a trade or business in the U.S. is not provided by the tax authorities, the U.S. Internal Revenue Service might contend that any of these companies is engaged in a trade or business in the U.S., which would subject such company to U.S. tax at regular corporate rates on the income that is effectively connected with the U.S. trade or business, plus an additional 30% "branch
THE REGULATORY SYSTEM UNDER WHICH WE OPERATE, AND POTENTIAL CHANGES THERETO, COULD SIGNIFICANTLY AND ADVERSELY AFFECT OUR BUSINESS.
The consolidated financial statements of the Company as of December 31, 2003 and 2002 and for the year ended December 31, 2003 and the period from April 19, 2002 (date of inception) through December 31, 2002, together with the independent auditors' report thereon, are set forth on pages through. The combined statements of the reinsurance underwriting segment of St. Paul prior to the Public Offering (the Predecessor Business), together with the independent auditors' report thereon, are set forth on pages P-1 through P-11 hereto.