The following selected financial data is derived from the Company’s consolidated financial statements. The information set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included under
Consolidated earned premiums increased over the three year period ended December 31, 2007 due to gross written premiums growth in 2006 and continuing into 2007. Gross written premiums from new business for the year ended December 31, 2007 were $440.9 million, compared to $512.4 million and $476.8 million for the same periods ended 2006 and 2005, respectively. Gross written premiums from new business for the year ended December 31, 2007 were adversely impacted by increased competition and pricing pressures in all segments. Partially offsetting this decrease in gross written premiums from new business was $26.0 million due to a recent expansion of public entity business (within the Select Markets segment) into the New England area, which began in July 2007. The increase in gross written premiums from new business for the year ended December 31, 2006 as compared to 2005 was primarily attributable to growth in the Excess and Surplus Lines and Select Markets segments. Partially offsetting this growth was a reduction in gross written premiums in the Run-off Lines segment for the risk management products due to the renewal rights sale effective in the third quarter of 2005.
Consolidated gross written premiums from renewal business increased to $638.7 million for the year ended December 31, 2007 as compared to $571.7 million and $534.8 million for the same periods in 2006 and 2005, respectively. The increases in 2007 and 2006 were primarily attributable to a higher base of expiring policies available for renewal partially offset by a reduction in renewal premiums for the risk management products.
Consolidated net investment income increased for the year ended December 31, 2007 as compared to the same periods in 2006 and 2005 due to higher invested balances resulting from positive cash flows from operations and due to invested assets assumed in the Merger. Total invested assets as of December 31, 2007 were $3,555.6 million, including $750.3 million acquired as part of the Merger. Additionally, invested assets totaling $173.5 million were classified as “Assets held for sale” as of December 31, 2007. Total invested assets were $2,514.1 million and $2,173.0 million as of December 31, 2006 and 2005, respectively.
Consolidated losses and loss adjustment expenses were $526.9 million for the year ended December 31, 2007, compared to $477.6 million and $427.2 million for the same periods in 2006 and 2005, respectively. Losses and loss adjustment expenses for the year ended December 31, 2007 included $30.3 million of net favorable development. The favorable development was primarily concentrated in the Excess and Surplus Lines segment due to lower claim counts and severity for the 2004 through 2006 accident years and lower frequency and severity within the Select Markets segment for the 2002 through 2006 accident years. Partially offsetting this favorable development was $22.2 million of reserve strengthening in the Run-off Lines segment, primarily due to the Company strengthening the reserves for the asbestos and environmental exposures by $26.0 million in the third quarter of 2007. Additionally, the Company recorded approximately $32.2 million in additional losses and loss adjustment expenses for the 2007 accident year due to higher than anticipated losses, primarily in the Excess and Surplus Lines and the Select Markets segments, due to current market conditions and an increased net retention due to changes in reinsurance coverages.
Consolidated loss reserves were $2,425.5 million (which excludes $135.7 million of loss reserves which are classified as “Liabilities held for sale”), $2,029.2 million and $1,875.4 million as of December 31, 2007, 2006 and 2005, respectively. Management has recorded its best estimates of loss reserves as of December 31, 2007 based on current known facts and circumstances. Due to the significant uncertainties inherent in the estimation of loss reserves, there can be no assurance that future loss development, favorable or unfavorable, will not occur.
The consolidated provision for income taxes for the year ended December 31, 2007 was $42.3 million compared to $57.0 million for the same period in 2006. The decrease in the provision for income taxes was primarily attributable to the decrease in income before taxes. The consolidated provision for income taxes for the year ended December 31, 2005 was $1.0 million, and includes tax expense of $26.1 million offset by the reversal of the remaining deferred tax valuation allowance of $25.1 million. The reduction of the deferred tax valuation allowance in 2005 was based on management’s consideration of future income in accordance with Statement of Financial Accounting Standard No. 109, “Accounting for Income Taxes” combined with earnings reported in that year. `
During the second quarter of 2007, Argonaut Group evaluated its strategic direction with regards to the Select Market and Public Entity segments. Argonaut Group’s management determined that combining these two segments into one operating segment would better represent Argonaut Group’s distribution strategy and product offerings between the operating entities within this segment. As a result of this integration, Argonaut Group has aggregated the segment previously reported as Public Entity into the existing Select Markets segment. Amounts applicable to prior periods have been reclassified to conform to the presentation followed in 2007.
Gross written premiums from new business declined to $331.3 million for the year ended December 31, 2007 from $443.6 million and $382.2 million for the same periods in 2006 and 2005, respectively. The decrease in gross written premiums from new business in 2007 was primarily attributable to increased competition from the standard markets as well as other excess and surplus line carriers. Argonaut Specialty’s gross written premiums from new business were $73.5 million for the year ended December 31, 2007, compared to $113.8 million and $73.0 million for the same periods in 2006 and 2005, respectively.
Losses and loss adjustment expenses for the year ended December 31, 2007 resulted in a loss ratio of 57.5%, compared to 57.5% and 61.6% for the same periods in 2006 and 2005, respectively. Losses and loss adjustment expense for the year ended December 31, 2007 included $38.5 million in favorable development on prior accident years. This favorable development consisted of $24.3 million favorable development in the general liability and automobile lines, $5.3 million in the property lines, $2.9 million in unallocated loss adjustment expense and $6.0 million across all other lines. Favorable development was primarily the result of lower claim counts and lower severities for the 2004 through 2006 accident years, as the Company initially set reserves during this period considering the rapid growth occurring. Partially offsetting the favorable development related to prior year loss reserves, during 2007 the Company added $21.1 million in losses for the most recent accident year. Of the $21.1 million, $4.8 million was related to higher than expected property losses and the remainder was associated with casualty business resulting from increased severity, rate changes and an increased net retention due to changes in reinsurance coverages.
The increase in earned premiums was due to increased premium writing in all years presented. Gross written premiums from new business increased to $108.1 million for the year ended December 31, 2007, compared to $68.8 million and $77.6 million for the same periods in 2006 and 2005, respectively. Gross written premiums from new business increased $26.0 million due to a recent expansion of public entity business into the New England area, which began in July 2007. Additionally, gross written premiums from new business for the grocery store product line increased $6.5 million, primarily due to a competitor exiting the market. Increased competition across the remaining programs partially offset these increases in gross written premiums from new business. The decline in new business from 2005 to 2006 was attributable primarily to a planned shift from small commercial workers compensation accounts to large deductible accounts within the Company’s specialty workers compensation product line, coupled with increased competition.
Gross written premiums from renewal business decreased to $243.8 million for the year ended December 31, 2007, compared to $258.2 million for the same period in 2006. The decrease was primarily attributable to a large account that was renewed in the fourth quarter of 2006 for a 17-month term with premium of $22.6 million. Partially offsetting this decrease was increased gross written premiums from renewal premiums due to a higher base of expiring policies. Gross written premiums from renewal business for the year ended December 31, 2005 was $238.1 million. The increase from 2005 to 2006 was the result of the large account discussed above.
Included in gross written premiums are workers compensation premiums for insurance programs marketed by certain state funds in jurisdictions where the state funds are not licensed. The Company receives a ceding commission and cedes 100% of the premiums and related losses to the respective state fund. Gross written premiums for state fund business were $63.9 million in 2007, $47.8 million in 2006 and $37.6 million in 2005.
Losses and loss adjustment expenses for the year ended December 31, 2007 resulted in a loss ratio of 60.3%, compared to 60.6% and 62.8% for the same periods in 2006 and 2005, respectively. Included in losses and loss adjustment expenses for the year ended December 31, 2007 was $14.8 million in net favorable development on prior accident years. The favorable development consisted of $7.6 million in workers compensation reserves primarily for accident years 2004 through 2006 due to lower loss frequency and lower losses on the large deductible policies and $4.1 million for workers compensation occupational disease for accident years 1998 and prior. Favorable development for general liabilities and automobile lines totaled $7.2 million for accident years 2002 through 2005 and $0.4 million for property lines due to lower than expected frequency and severity. Partially offsetting this favorable development on prior accident years was $4.5 million in unfavorable development due to the unwinding of the workers compensation reserve discount. Included in losses and loss adjustment expenses for the 2007 accident year was $2.5 million in reserve increases for storm losses which occurred in December 2007 in the Northwest and Midwest. Workers compensation reverses for the 2007 accident year include $4.4 million of additional reserves due to increased frequency of claims, including $0.5 million in reserves for a Utah mining accident. Loss reserves for the 2007 accident year within the public entity products were increased by $2.5 million for the property lines and $1.7 million for the automobile and other lines.
Included in losses and loss adjustment expenses for the year ended December 31, 2006, was favorable development on prior accident years of $10.8 million primarily attributable to a $6.7 million reduction in 2005 and prior accident year reserves within the public entity product lines for general liability, automobile and property lines, a $3.0 million reduction in a lead paint reserves due to claims settlements and $4.0 million of favorable loss development from ongoing actuarial reviews, offset by unfavorable prior year development of $2.3 million from the unwinding of workers compensation discount and $0.6 million of unallocated loss adjustment expenses. Partially offsetting this net favorable development was a $4.8 million addition due to higher than expected property losses for the current accident year. Included in losses and loss adjustment expenses for the year ended December 31, 2005, was $0.6 million in catastrophe losses resulting from the hurricanes that made landfall during 2005. Loss reserves for the Select Market segment were $481.7 million, $425.9 million and $389.4 million as of December 31, 2007, 2006 and 2005, respectively.
The expense ratio for the year ended December 31, 2007 was 28.4%, compared to 28.8% and 29.7% for 2006 and 2005, respectively. The improvement in the expense ratio for the year ended December 31, 2007 as compared to 2006 was primarily attributable to increased earned premiums in the public entity products, without a corresponding increase in fixed costs. The decrease in the expense ratio in 2006 as compared to 2005 was primarily related to a regulatory windstorm assessment refund received in 2006 associated with the 2005 hurricanes. The original assessment was included in the expense ratio for the year ended December 31, 2005 contributing to the difference in the expense ratio for the year ended December 31, 2006 as compared to 2005.
Underwriting expense increased for the year ended December 31, 2007 as compared to 2006 due to the inclusion of the results of operations of Peleus Re, which totaled $2.9 million. Additionally, new programs in 2007 resulted in an increase in fixed costs associated with the management of these programs.
The recognition of investment income for the year ended December 31, 2007 was the result of the inclusion of $5.0 million in investment income attributable to Peleus Re, coupled with positive cash flows due to the growth of premiums under these reinsurance programs. Invested assets were $304.0 million at December 31, 2007.
Run-off Lines. The Company has discontinued underwriting of certain lines of business, including those lines which were previously reported in Argonaut Group’s Risk Management segment. The Risk Management segment has not written any new or renewal policies since the sale of the renewal rights in third quarter of 2005. All activity associated with the former Risk Management segment is related to the management of claims and other administrative functions. All amounts applicable to the Risk Management segment for the years ended December 31, 2006 and 2005 have been reclassified to the Run-off Lines segment to conform to the 2007 presentation.
Also included in the Run-off Lines segment are liabilities associated with other liability policies written in the 1960s, 1970s and into the 1980s, and include asbestos and environmental liabilities as well as medical malpractice liabilities. These lines are characterized by long elapsed periods between the occurrence of a claim and ultimate payment to resolve the claim. The Company utilizes a specialized staff dedicated to administer and settle these claims. Additionally, the Company performs an extensive actuarial analysis of the asbestos and environmental reserves on at least an annual basis.
Earned premiums for the year ended December 31, 2007 were primarily attributable to adjustments resulting from final audits and other adjustments on policies previously written. Earned premiums for the years ended December 31, 2006 and 2005 were primarily attributable to the run-off of premiums written prior to the renewal rights sale.
Losses and loss adjustment expenses for the year ended December 31, 2007 included $23.1 million in unfavorable development on prior accident years for the year ended December 31, 2007. The unfavorable development included $26.0 million for the Company’s asbestos and environmental exposure. Workers compensation claims recorded $7.0 million in unfavorable development, primarily due the settlement of one claim for $5.5 million, coupled with $2.0 million due to unwinding of the reserve discount. Loss reserves for involuntary pools and unallocated loss adjustment expenses increased $0.8 million for prior accident years. Favorable development of $8.7 million was recognized on the general liability and automobile lines, primarily related to the 2000 through 2004 accident years. Favorable development on the general liability lines includes reserve take downs due to the Company closing its last open construction defect claim and the corresponding reversal of the construction defect bulk reserve.
Net investment income increased to $43.1 million for the year ended December 31, 2007, compared to $33.7 million and $31.9 million for the years ended December 31, 2006 and 2005, respectively. The increase in 2007 as compared to 2006 was attributable to the inclusion of $13.1 million of investment income attributable to the former PXRE entities. Invested assets as of December 31, 2007 were $1,079.0 million, and included $466.5 million from the Merger with PXRE. Invested assets were $766.1 million and $743.4 million as of December 31, 2006 and 2005, respectively.
The Company, through its subsidiary Argonaut Insurance Company, is exposed to asbestos liability at the primary level through claims filed against its direct insureds, as well as through its position as a reinsurer of other primary carriers. Argonaut Insurance Company has direct liability arising primarily from policies issued from the 1960s to the early 1980s which pre-dated policy contract wording that excluded asbestos exposure. The majority of the direct policies were issued on behalf of small contractors or construction companies. The Company believes that the frequency and severity of asbestos claims for such insureds is typically less than that experienced for large, industrial manufacturing and distribution concerns.
Argonaut Insurance Company also assumed risk as a reinsurer, primarily for the period from 1970 to 1975, a portion of which was assumed from the London market. Argonaut Insurance Company also reinsured risks on policies written by domestic carriers. Such reinsurance typically provided coverage for limits attaching at a relatively high dollar amount which are payable only after other layers of reinsurance are exhausted. Some of the claims now being filed on policies reinsured by Argonaut Insurance Company are on behalf of claimants who may have been exposed at some time to asbestos incorporated into buildings they occupied, but have no apparent medical problems resulting from such exposure. Additionally, lawsuits are being brought against businesses that were not directly involved in the manufacture or installation of materials containing asbestos. The Company believes that a significant portion of claims generated out of this population of claimants may result in incurred losses generally lower than the asbestos claims filed over the past decade and could be below the attachment level of Argonaut Insurance Company.
The following table represents a reconciliation of total gross and net reserves for the Run-off Lines for each of the years in the three-year period ended December 31, 2007. Amounts in the net column are reduced by reinsurance recoverables:
The number of claims opened during the three years ended December 31, 2007 were from the following sources:
The following table represents gross payments on asbestos and environmental claims for each of the years in the three-year period ended December 31, 2007:
Because of the types of coverages within the Run-off Lines of business still being serviced by Argonaut Insurance Company, a significant amount of subjectivity and uncertainty exists in establishing the reserves for losses and loss adjustment expenses. Factors that increase these uncertainties are: (1) lack of historical data, (2) inapplicability of standard actuarial projection techniques, (3) uncertainties regarding ultimate claim costs, (4) coverage interpretations, and (5) the judicial, statutory and regulatory environments under which these claims may ultimately be resolved. Significant uncertainty remains as to the ultimate liability to the Company due to the potentially long waiting period between exposure and emergence of any bodily injury or property damage and the resulting potential for involvement of multiple policy periods for individual claims. Additionally, recent industry trends show an increasing number of claims being filed by individuals who claim asbestos exposure, but who have no apparent symptoms of asbestos-related disease. Due to these uncertainties, the current trends may not be indicative of future results. Although management has determined and recorded its best estimate of the reserves for losses and loss adjustment expenses for Run-off Lines, current judicial and legislative decisions continue to broaden liability, expand policy scopes and increase the severity of claims payments. As a result of these and other recent developments, the uncertainties inherent in estimating ultimate loss reserves are heightened, further complicating the already complex process of determining loss reserves. The industry as a whole is involved in extensive litigation over these coverages and liability issues, and must contend with the continuing uncertainty in its effort to quantify these exposures.
As an insurance holding company, the Company is largely dependent on dividends and other permitted payments from its insurance and reinsurance subsidiaries to pay cash dividends to its shareholders, for debt service and for its operating expenses. The ability of the Company’s insurance and reinsurance subsidiaries to pay dividends to the Company is subject to certain restrictions imposed by the jurisdictions of domicile that regulate the Company’s immediate insurance and reinsurance subsidiaries and each jurisdiction has calculations for the amount of dividends that an insurance and reinsurance company can pay without the approval of the insurance regulator.
In addition, the Company’s ability to receive dividends from its downstream subsidiaries is subject to the ability of each parent corporation within the corporate ownership structure to receive dividends from its respective subsidiary(ies), based upon the subsidiary’s domiciliary regulations. Peleus Re is the primary direct subsidiary of Argo Group and is subject to Bermuda insurance laws. PXRE Ireland is directly owned by Peleus Re and is a mid-level holding company subject to Irish laws, and its primary subsidiary is Argonaut Group. Argonaut Group is a second tier mid-level holding company subject to Delaware laws. Argonaut Group is the parent of all of the Company’s U.S. insurance and reinsurance subsidiaries.
The payment of dividends by Peleus Re is limited under Bermuda insurance laws, which require Peleus Re to maintain certain measures of solvency and liquidity. As of December 31, 2007, Peleus Re’s solvency and liquidity margins and statutory capital and surplus were in excess of the minimum levels required by the Insurance Act. As of December 31, 2007, the unaudited statutory capital and surplus of Peleus Re was estimated to be $1.2 billion and the amount required to be maintained was estimated to be $100.0 million, thereby allowing Peleus Re the potential to pay dividends or capital distributions within the parameters of the solvency and liquidity margins. The Company believes that the dividend and capital distribution capacity of Peleus Re will provide the Company with sufficient liquidity to meet its operating and debt service commitments, as well as other obligations that may arise from time to time.
As a mid-level holding company, PXRE Ireland is largely dependent on dividends or other permitted payments from Argonaut Group to fund its operating expenses or to fund dividends to Peleus Re. Argonaut Group is a mid-level holding company owned by PXRE Ireland and is largely dependent on dividends and other permitted payments from its insurance and reinsurance subsidiaries to fund its operating expenses, fund debt service, or to fund dividends to PXRE Ireland. Each holding company is subject to their respective domiciliary regulations and tax laws. The Company believes that PXRE Ireland along with Argonaut Group have sufficient dividend and capital distribution capacity to meet the operating and capital needs of their parents.
The Company reorganized its corporate structure effective December 31, 2007. Argonaut Group and PXRE Corporation, two intermediate holding companies merged, resulting in PXRE Corporation becoming the surviving entity which was renamed Argonaut Group, Inc. Argonaut Group became the parent of all of the Company’s U.S. insurance and reinsurance subsidiaries.
During 2008, based on the state of domicile’s ordinary dividend calculation, Argonaut Insurance Company may be permitted to pay dividends of up to approximately $23.9 million in cash to Argonaut Group without approval from the Illinois Bureau of Insurance, while Colony Insurance Company may be permitted to pay dividends of up to approximately $3.0 million in cash without approval from the Virginia Bureau of Insurance. Business and regulatory considerations may impact the amount of dividends actually paid, and prior approval of dividend payments may be required.
During 2004 through 2005, Argonaut Group, through a series of statutory trusts (non-consolidated), sold $83.0 million of Floating Rate Capital securities (the “Capital Securities”) (liquidation amount $1,000 per Capital Security) in a series of private sales. In conjunction with the sales of the Capital Securities, the trusts sold $2.6 million of Floating Rate Common Securities to Argonaut Group. The trusts used the proceeds from these sales to purchase $85.6 million of Floating Rate Junior Subordinated Debentures (the “Debentures”) from the Company. The Debentures are unsecured and are subordinate in right of payment to all of the Company’s future senior indebtedness. The interest rates on the Debentures and the Capital Securities are equal to the 3-Month LIBOR plus a margin ranging from 3.55% to 3.85%, reset quarterly. For selected Debentures, the interest rates are not to exceed 12.5% prior to the coupon cap date, which is approximately 5 years after the issuance date. The remaining debentures have interest rates that are not to exceed the highest rate permitted by New York Law prior to the coupon cap date. The Debentures are due 30 years after issuance, but may be redeemed after the five-year anniversary at a price equal to 100% of the principal amount of the Debentures, plus accrued and unpaid interest on the date of redemption. The Debentures may be redeemed prior to the five-year anniversary date upon the occurrence of specific events at a price equal to 107.5% to 101% plus accrued and unpaid interest to the date of redemption.
During 2003, Argonaut Group, through a series of statutory trusts (non-consolidated), sold $27.0 million of Floating Rate Capital securities (the “2003 Capital Securities”) (liquidation amount $1,000 per Capital Security) in a series of private sales. In conjunction with the sales of the 2003 Capital Securities, the trusts sold $0.8 million of Floating Rate Common Securities to the Company. The trusts used the proceeds from these sales to purchase $27.8 million of Floating Rate Junior Subordinated Debentures (the “2003 Debentures”) from Argonaut Group. The 2003 Debentures are unsecured and are subordinate in right of payment to all of the Company’s future senior indebtedness. The interest rates on the 2003 Debentures and the 2003 Capital Securities are equal to the 3-Month LIBOR plus a margin of 4.10%, reset quarterly. The interest rates are not to exceed 12.5% prior to the coupon cap date, which is approximately 5 years after the issuance date. The 2003 Debentures are due 30 years after issuance, but may be redeemed after the five-year anniversary at a price equal to 100% of the principal amount of the 2003 Debentures, plus accrued and unpaid interest on the date of redemption. The 2003 Debentures may be redeemed prior to the five-year anniversary date upon the occurrence of specific events at a price equal to 107.5% to 100.95% plus accrued and unpaid interest to the date of redemption.
The Company has four additional LOCs that allow it to provide LOCs to its ceding companies if such LOC is required under the terms of the contract. All of the facilities require the Company to provide collateral in the form of fixed maturity securities or cash to the issuing bank as security for outstanding LOCs. The first is a $110.0 million committed facility with Barclays Bank plc under which the Company pays the issuing bank an annual standby commitment fee of 0.15% per annum. The second and third are a pair of $100.0 million committed facilities with Citibank Ireland Financial Services plc under which the Company pays the issuing bank an annual standby commitment fee of 0.10% per annum. The fourth is an uncommitted facility with Merrill Lynch that allows for LOCs to be issued subject to satisfactory collateral being provided to the issuing bank by the Company. There is no commitment fee for the fourth facility. The Company must transfer eligible assets to collateral accounts prior to each respective bank issuing an LOC. Since eligible assets include fixed income investments, such securities need not be sold in order to qualify as eligible collateral. As of December 31, 2007, the Company has pledged assets with a fair value of $241.6 million to support outstanding letters of credit.
The Company’s insurance subsidiaries require liquidity and adequate capital to meet ongoing obligations to policyholders and claimants, and to fund operating expenses. During the three years ended December 31, 2007, the Company’s liquidity generated from operations and investment income were sufficient to meet obligations. Adequate levels of liquidity and surplus are maintained to manage the risks inherent with any differences between the duration of its liabilities and invested assets. The Company believes it maintains sufficient liquidity to pay claims and expenses, as well as satisfy its commitments in the event of unforeseen events such as reinsurer insolvencies, inadequate premium rates, or reserve deficiencies.