Our Bermuda offices are located at 44 Church Street, Hamilton, Bermuda, and the telephone number is (441) 296-8560. The principal offices of our U.S. subsidiaries are located at 1845 The Exchange, Suite 200, Atlanta, Georgia 30339, and the telephone number is (770) 916-1908.
Balance sheet data (at end of period): Total investments, excluding real estate $ 67,643 $ 90,078 $ 111,926 $222,418 $327,037 Total assets 230,308 322,520 389,342 514,260 584,160 Unpaid losses and loss adjustment expenses 62,592 137,391 179,164 230,104 321,624 Unearned premiums 48,909 59,768 71,675 99,939 93,798 Loan payable 11,435 16,403 22,182 30,441 13,019 Total liabilities 172,505 262,540 326,890 418,916 475,380 Total shareholders' equity 57,803 59,980 62,452 95,344 108,780
Net earnings for the twelve months ended December 31, 2003 increased to $7.4 million, or $1.42 per diluted share, from $2.5 million, or $.51 per diluted share for the same period of 2002.
Net earnings for the twelve months ended December 31, 2004 are $14.8 million or $2.01 per diluted share, as compared to $7.4 million or $1.42 per diluted share for the same period in 2003.
The increase in net earnings from insurance operations in 2003 was due to strong underwriting profits in the Company’s core environmental, excess and surplus and program business lines. The increase in net earnings from real estate operations was due to increased closings of condominium units and boat slips at Harbour Village. Included in other income is a $3.9 million impairment of a note receivable. Total revenues for the year ended December 31, 2003 increased 35% to $176 million as compared to the same period of 2002 as a result of increased net premiums earned, investment income and realized gains from the sale of investments. Net premiums earned for the year ended December 31, 2003 increased 49% to $109 million from the same period of 2002 due to increases in net premiums earned in the Company’s core lines of business. Net cash flow from operations increased to $80 million for the year ended December 31, 2003 from $38 million in the same period of 2002.
The following table sets forth Company consolidated premium and total revenue information:
2002 2003 to to 2002 2003 2004 2003 2004 (Dollars in thousands) Net premiums written: Environmental $15,187 $ 27,233 $ 35,024 79.3% 28.6% Excess and Surplus 46,194 73,572 77,894 59.3 5.9 Programs 10,217 15,152 17,530 48.3 15.7 Other 15,325 15,521 1,473 1.3 (90.5) Total net premiums written 86,923 131,478 131,921 51.3% 0.3%
Net premiums earned: Environmental $12,796 $ 22,446 $ 32,152 75.4% 43.2% Excess and Surplus 37,162 57,379 79,781 55.4 39.0 Programs 6,724 14,068 16,605 109.2 18.0 Other 16,900 15,441 7,853 (8.6) (49.1) Total net premiums earned 73,582 109,334 136,391 48.6 24.7
Net investment income 4,388 5,801 9,773 32.2 68.5 Net realized gains 685 3,140 208 358.4 (93.4) Real estate income 51,781 57,555 67,967 11.2 18.1 Other income 227 161 318 (29.1) 97.5 Total Revenues $130,663 $175,991 $214,657 34.7% 22.0%
The following table sets forth the components of our GAAP combined ratio for the period indicated:
Excess and Surplus. While there have been signs of market conditions softening with less business being shifted out of the standard market to the excess and surplus market, as well as a general leveling of pricing in the market, the Company continued to capitalize on current market conditions. The Company’s growth strategy allows for increased capacity in this unit, the Company intends to diversify its risk portfolio both geographically and by class of business. The Company also intends to maintain its underwriting and pricing discipline in this changing market. In addition, the Company introduced a new excess coverage product in the second quarter of 2004 to meet the market need for higher limits of liability above the Company’s current policies.
Programs. Historically, the Company has not retained significant portions of risk (<10%) in this line; however, as it sees opportunities to generate underwriting profits on existing programs, it is prepared to take advantage of those opportunities. Hence, effective in 2002, the Company took significant risk (70%) on a pest control operators program and in 2002 and 2003 expanded its risk position in other programs (10-25%). Based on the opportunities available in the marketplace, the Company will continue to look for specialty niche program opportunities where it can take more significant risk positions. The Company had 15 active programs at the end of 2004 producing business as compared to 14 at the end of 2003.
Other. The decrease in other premium earnings is attributable to our exiting specific lines of business that no longer fit in our business model. During 2003, the Company made the decision to only offer renewal policies for workers’ compensation business; that line will be in full run-off starting in the second quarter of 2005. In 2002, the Company exited the employee leasing and staffing workers’ compensation line, exited habitational/manufacturing commercial lines, and substantially reduced surety writings due to adverse loss experience and the lack of affordable reinsurance. In 2004, surety net earned premiums and net written premiums increased by approximately $468,000 and $440,000, respectively, compared to 2003. This increase is attributable to the Company’s recent efforts to modestly expand its surety business as a supporting product line to the environmental segment. During the second quarter of 2004 the Company entered into a $2 million per bond 50% quota share reinsurance agreement to facilitate more underwriting opportunities. In addition, the Company’s assumed liability program, currently in run-off, which had net written premiums of $7.5 million and $8.7 million in 2002 and 2003 respectively, and minimal written premiums in 2004.
Real estate income was $68 million in 2004, $58 million in 2003, and $52 million in 2002. This revenue is generated from closings of condominium units and boat slips at our real estate project known as Harbour Village. We do not recognize revenue until a closing occurs and title passes to the buyer. The following chart shows the number of condominium units and boat slips that were closed each year:
Our 2004 ratio increased 8.4 points from 60.2% to 68.6% due to a combination of factors. The excess and surplus segment experienced adverse loss development of $7.7 million. Of this amount $4.7 million was attributable to certain New York contractor risks written in 2001. Exposure to New York contractor risks was significantly reduced during 2002 and 2003. In response to this development and management’s concern that existing reserves for this segment might be inadequate, the Company commenced an actuarial reserve evaluation of this segment. Following completion of this evaluation, the Company changed actuarial reserving methodologies and recorded $3.0 million of additional reserves during the third quarter of 2004. During 2004, the Company experienced adverse loss development of $5.1 million on its other segment. Of this amount $1.6 million related to the Company’s assumed liability program, $2.9 million related to increases in workers’ compensation reserves and $550,000 related to increases in commercial lines reserves. All of these three lines of business are currently in run-off.
Our 2003 ratio increased 3.1 percentage points from 57.1% to 60.2% due to a combination of factors. Negative reserve development contributed an additional 5 percentage points to the 2003 loss ratio. That development was primarily associated with adverse loss experience on our workers’ compensation lines currently in run-off. See discussion under the Loss and Loss Adjustment Expense Reserve heading in Item 1 of this Report for further information. An offsetting factor to such reserve development was the continuing implementation of our growth strategies in our core business lines.
Real estate expenses were $55 million in 2004, $54 million in 2003, and $49 million in 2002. The majority of real estate expenses, including construction costs, capitalized interest and commissions (variable costs) are recognized at the same time as revenue is recognized. General and administrative expenses (fixed costs) are expensed as incurred. The following chart shows the components of costs (in millions):
2002 2003 2004 Variable $44 $50 $47 Fixed 5 4 8 Total $49 $54 $55
Other expenses decreased to $9.6 million in 2004 from $14.6 million in 2003. Other expenses in 2004 include a $2.6 million recovery related to impaired notes receivable and other expenses in 2003 included a $3.9 million impairment charge. Absent these charges other expenses increased to $12.2 million from $10.7 million in 2003, due to additional interest costs, depreciation, audit and travel.
Rescission expenses decreased to a benefit of $230,000 in 2004 from an expense of $255,000 in 2003. The benefit in 2004 includes a $1.8 million payment received in settlement of professional liability claims in the rescission matter. Also included in 2004 are $1.4 million of additional expenses as a result of adverse court rulings in March 2005.
Net Income. Net Income from Bermuda operations increased to $9.2 million in 2004 compared to $1.6 million in 2003 and $1.0 million in 2002. The 2004 increase is attributable to the Company collecting $2.6 million as final settlement of a note receivable for which an allowance was established in 2003 and the reminder of the increase is due to growth in insurance operations. Net income from US operations decreased to $5.5 million in 2004 compared to $5.8 million in 2003 and $1.5 million in 2002. The overall decrease in US operations is primarily resulting from a decrease in insurance operations resulting from adverse loss development off set by an increase in real estate operating results.
Net cash provided from operations was $89.8 million for the year ended December 31, 2004, $80.2 million for the year ended December 31, 2003 and $38.4 million for the year ended December 31, 2002. During 2004, the Company received $2.6 million in final settlement of previously fully reserved notes receivable and also received $1.8 million in settlement of professional liability claims against parties who are involved in the Principal Management rescission litigation.
We anticipate the completion of Harbour Village during 2005. At December 31, 2004, the Company had no outstanding borrowings on a development and construction loan facility. The estimated completion cost for the remainder of Harbour Village is approximately $1.6 million and represents amounts needed to construct a beach club. Management believes that cash on hand will meet the remaining liquidity needs of Harbour Village. See Exhibit 99 for further information regarding Harbour Village.
Our contractual obligations at the end of 2004 were (in thousands):
Less than 1 1-3 3-5 More than Total year Years Years 5 Years Long term debt $ 13,020 $ 126 $ - $ - $ 12,894 Interest 3,365 948 1,896 521 - Operating leases 1,497 587 910 - - Total Contractual Obligations $ 17,882 $ 1,661 $ 2,806 $ 521 $ 12,894
Critical Accounting Estimates The accounting estimates described below are those we consider critical in preparing our financial statements. These policies include significant estimates made by management using information available at the time the estimates are made. However, as described below, these estimates could change materially if different information or assumptions were used.
Percentage decline in value and the length of time during which the decline has occurred,
With respect to reported claims, reserves are established on a case-by-case basis. The reserve amounts on each reported claim are determined by taking into account the circumstances surrounding each claim and policy provisions relating to the type of loss. Loss reserves are reviewed on a regular basis, and as new information becomes available, appropriate adjustments are made to reserves.
In establishing reserves, several methods are employed in determining ultimate losses: the expected loss ratio method; the Bornhuetter-Ferguson method based on expected loss ratios, paid losses and reported losses; and the loss development method based on paid and reported losses. The first method uses industry expected losses adjusted for our experience while the last method relies on industry payment and reporting patterns to develop our actual losses. The Bornhuetter-Ferguson method is a combination of the other two methods, using expected loss ratios to produce expected losses, then applying loss payment and reporting patterns to the expected losses to produce the expected IBNR. We review the ultimate projections from all three methods and, based on the merits of each method, determine our estimated ultimate losses.
Deferred Income Taxes. We are required to establish a valuation allowance for the portion of any deferred tax asset, that we believe will not be realized. The majority of our deferred tax assets associated with the Harbour Village project should be realized in 2005, given current estimates of completion for the project. The majority of our deferred taxes associated with our premium writings will be realized over the policy period and payout of related claims. Given the historical loss position of American Safety RRG, it has established a 100% valuation allowance on its deferred tax assets. Except for the deferred tax assets associated with American Safety RRG described above, we believe it is more likely than not that we will realize the full benefit of our deferred tax assets described herein; therefore no additional valuation allowance has been established.
Income Taxes We are incorporated under the laws of Bermuda and, under current Bermuda law, are not obligated to pay any taxes in Bermuda based upon income or capital gains. We have received an undertaking from the Minister of Finance in Bermuda pursuant to the provisions of The Exempted Undertakings Tax Protection Act 1966, which exempts us and our shareholders, other than shareholders ordinarily resident in Bermuda, from any Bermuda taxes computed on profits, income or any capital asset, gain or appreciation, or any tax in the nature of estate, duty or inheritance until March 28, 2016. Exclusive of our U.S. subsidiaries, we do not consider ourselves to be engaged in a trade or business in the U.S. and accordingly do not expect to be subject to direct U.S. income taxation. Our U.S. subsidiaries are subject to taxation in the U.S.
Forward-looking statements involve risks and uncertainties which may cause actual results to differ materially, and are subject to change based on various insurance industry factors, including, without limitation, competitive conditions in the insurance industry, levels of new and renewal insurance business, developments in loss trends, adequacy and changes in loss reserves and actuarial assumptions, timing or collectibility of reinsurance receivables, market acceptance of new coverages and enhancements, changes in reinsurance costs and availability, potential adverse decisions in litigation and arbitration proceedings (including the outcome of the Principal Management acquisition rescission litigation), and changes in levels of general business activity and economic conditions. With respect to the development of the Harbour Village project, such forward-looking statements involve risks and uncertainties, which may cause actual results to differ materially, and are subject to change, based on various real estate development industry factors, including risks inherent in real estate development and new construction, and litigation.