Basic book value per share is defined as total shareholders’ equity available to ordinary shareholders divided by the number of ordinary shares outstanding as at the end of the period, giving no effect to dilutive securities. Diluted book value per share is defined as total shareholders’ equity available to ordinary shareholders divided by the number of ordinary shares and ordinary share equivalents outstanding at the end of the period, calculated using the treasury stock method for all potentially dilutive securities. When the effect of dilutive securities would be anti-dilutive, these securities are excluded from the calculation of diluted book value per share.
MANAGEMENT’S DISCUSSION AND ANALAYIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Alternatively, if the insurer or reinsurer hires a third party, such as Enstar, to manage its run-off business, the insurer or reinsurer will, unlike in a sale of the business, receive little or no cash up front. Instead, the management arrangement may provide that the insurer or reinsurer will share in the profits, if any, derived from the run-off with certain incentive payments allocated to the run-off manager. By hiring a run-off manager, the insurer or reinsurer can outsource the management of the run-off business to experienced and capable individuals, while allowing its own management team to focus on the insurer’s or reinsurer’s core businesses. Enstar’s desired approach to managing run-off business is to align its interests with the interests of the owners through both fixed management fees and certain incentive payments. Under certain management arrangements to which Enstar is a party, it only receives a fixed management fee and does not receive incentive payments.
Enstar’s future environmental loss development may also be influenced by other factors including:
Enstar follows FAS No. 142 “Goodwill and Other Intangible Assets” which requires that recorded goodwill be assessed for impairment on at least an annual basis. In determining goodwill, Enstar must determine the fair value of the assets of an acquired company. The determination of fair value necessarily involves many assumptions. Fair values of reinsurance assets and liabilities acquired are derived from probability-weighted ranges of the associated projected cash flows, based on actuarially prepared information and Enstar’s management run-off strategy. Fair value adjustments are based on the estimated timing of loss and loss adjustment expense payments and an assumed interest rate, and are amortized over the estimated payout period, as adjusted for accelerations on commutation settlements, using the constant yield method options. Interest rates used to determine the fair value of gross loss reserves are based upon risk free rates applicable to the average duration of the loss reserves. Interest rates used to determine the fair value of reinsurance receivables are increased to reflect the credit risk associated with the reinsurers from who the receivables are, or will become, due. If the assumptions made in initially valuing the assets change significantly in the future, Enstar may be required to record impairment charges which could have a material impact on its financial condition and results of operations.
In February 2007, the FASB issued FAS No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115” (“FAS 159”). FAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This statement is expected to expand the use of fair value measurement, which is consistent with the FASB’s long-term measurement objectives for accounting for financial instruments. The fair value option established will permit all entities to choose to measure eligible items at fair value at a specified election dates. An entity shall record unrealized gains and losses on items for which the fair value option has been elected through net income in the statement of operations at each subsequent reporting date. This statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. We are currently evaluating the potential impact of FAS 159 on its financial statements when adopted.
The average return on the cash and fixed maturities investments for the year ended December 31, 2005 was 3.2%, as compared to the average return of 2.1% for the year ended December 31, 2004. The increase in yield was primarily the result of increasing interest rates in 2005. The weighted average Standard & Poor’s credit rating of Enstar’s fixed income investments at December 31, 2005 was AAA.
Enstar’s sources of funds primarily consist of the cash and investment portfolios acquired on the completion of the acquisition of an insurance or reinsurance company in run-off. These acquired cash and investment balances are classified as cash provided by investing activities. Enstar expects to use these funds acquired, together with collections from reinsurance debtors, consulting income, investment income and proceeds from sales and redemption of investments, to pay losses and loss expenses, salaries and benefits and general and administrative expenses, with the remainder used for acquisitions, additional investments and, in the past, for dividend payments to shareholders. Enstar expects that its reinsurance segment will have a net use of cash from operations as total net claim settlements and operating expenses will generally be in excess of investment income earned. Enstar expects that its consulting segment operating cash flows will generally be breakeven. Enstar expects its operating cash flows, together with its existing capital base and cash and investments acquired on the acquisition of its insurance and reinsurance subsidiaries, to be sufficient to meet cash requirements and to operate its business. Enstar currently does not intend to pay cash dividends on its ordinary shares.
Net cash used in financing activities was $13.6 million during the year ended December 31, 2006 compared to $0.8 million during the year ended December 31, 2005. The increase in cash used in financing activities for Enstar was primarily attributable to the combination of redemption of shares and dividends paid and vendor loans offset by net loan finance receipts and capital contributions by the minority interest shareholder of a subsidiary.
At December 31, 2006, the maturity distribution of the company’s investment portfolio was as follows:
On October 4, 2006, Enstar entered into a loan agreement for $17.5 million with a subsidiary of its equity owned affiliate, B.H. Acquisition. The proceeds of the loan were used to partially fund the acquisition of Unione Italiana (U.K.) Reinsurance Company Limited. The interest rate on the loan is 6.75% per annum and the loan is repayable within 3 years. As of December 31, 2006, $17.8 million of principal and accumulated interest was payable to Enstar’s equity owned affiliate.
On October 4, 2006 and November 20, 2006, Enstar completed the acquisitions of Cavell Holdings Limited (“Cavell”), a U.K. Company, which owns a U.K. and Norwegian reinsurer, for total consideration of $60,899 and Unione Italiana (UK) Reinsurance Company (“Unione”), a reinsurance company based in the U.K., for total consideration of $17,369. The acquisitions were funded from available cash on hand and approximately $42,000 in new debt.
As at December 31, 2006 and 2005, the number of securities in an unrealized loss position was 70 and 70, respectively, with a fair value of $298,775 and $268,870, respectively. Of these securities, the number of securities that have been in an unrealized loss position for 12 months or longer was 59 and 57, respectively, with a fair value of $185,332 and $137,143, respectively. As of December 31, 2006 and 2005, none of these securities were considered to be other than temporarily impaired. Management has the intent and ability to hold these securities until their maturities. The unrealized losses from these securities were not a result of credit, collateral or structural issues.
The Company did not hold any investments classified as trading securities as of December 31, 2005.
In December 2005 the Company invested $24,532 in New NIB which was formed to hold 100% of the share capital of NIB Capital. Mr. Flowers serves on the supervisory board of NIB Capital. Several officers and directors of the Company made personal investments in New NIB.
In March 2006, Castlewood (US) Inc. purchased a condominium in New York and the spouse of one of its directors received a realtor commission of $74 from the vendor.
The actual income tax rate for the years ended December 31, 2006, 2005 and 2004, differed from the amount computed by applying the effective rate of 0% under the Bermuda law to earnings before income taxes as a result of the following: