UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2007
Commission file number 001-31721

 

AXIS CAPITAL HOLDINGS LIMITED

(Exact name of registrant as specified in its charter)

 

BERMUDA

(State or other jurisdiction of incorporation or organization)

 

98-0395986

(I.R.S. Employer Identification No.)

 

92 Pitts Bay Road, Pembroke, Bermuda HM 08

 (Address of principal executive offices and zip code)

 

(441) 496-2600

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x   Accelerated filer o  Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o   No x

 

As of October 26, 2007 there were 151,285,506 Common Shares, $0.0125 par value per share, of the registrant outstanding.

 

 



 

AXIS CAPITAL HOLDINGS LIMITED

 

INDEX TO FORM 10-Q

 

 

PART I. FINANCIAL INFORMATION

 

 

 

 

Item 1.

Consolidated Financial Statements

4

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

22

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

40

 

 

 

Item 4.

Controls and Procedures

40

 

 

 

 

PART II. OTHER INFORMATION

41

 

 

 

Item 1.

Legal Proceedings

41

 

 

 

Item 1A.

Risk Factors

41

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

42

 

 

 

Item 6.

Exhibits

43

 

 

Signatures

44

 

2



 

Cautionary Statement Regarding Forward-looking Statements

 

This quarterly report contains forward-looking statements within the meaning of the U.S. federal securities laws. We intend these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in the United States securities laws. In some cases, these statements can be identified by the use of forward-looking words such as “may,” “should,” “could,” “anticipate,” “estimate,” “expect,” “plan,” “believe,” “predict,” “potential,” and “intend”. Forward-looking statements contained in this report include information regarding our estimates of losses related to hurricanes and other catastrophes, our expectations regarding pricing and other market conditions, our growth prospects, the amount of our acquisition costs, the amount of our net losses and loss reserves, the projected amount of our capital expenditures, managing interest rate and foreign currency risks, valuations of potential interest rate shifts and foreign currency rate changes and measurements of potential losses in fair values of our investment portfolio. Forward-looking statements only reflect our expectations and are not guarantees of performance. These statements involve risks, uncertainties and assumptions. Actual events or results may differ materially from our expectations. Important factors that could cause actual events or results to be materially different from our expectations include (1) our limited operating history, (2) the occurrence of natural and man-made disasters, (3) actual claims exceeding our loss reserves, (4) the failure of any of the loss limitation methods we employ, (5) the effects of emerging claims and coverage issues, (6) the failure of our cedants to adequately evaluate risks, (7) the loss of one or more key executives, (8) a decline in our ratings with rating agencies, (9) loss of business provided to us by our major brokers, (10) changes in governmental regulations, (11) increased competition, (12) general economic conditions, (13) changes in the political environment of certain countries in which we operate or underwrite business and (14) the other matters set forth under Item 1A, “Risk Factors” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2006 filed with the SEC on March 1, 2007. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

 

3



 

 

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

 

Consolidated Balance Sheets as at September 30, 2007 (Unaudited) and December 31, 2006

5

 

 

Consolidated Statements of Operations for the three and nine months ended September 30, 2007 and 2006 (Unaudited)

6

 

 

Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2007 and 2006 (Unaudited)

7

 

 

Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended September 30, 2007 and 2006 (Unaudited)

8

 

 

Consolidated Statements of Cash Flows for the nine months ended September 30, 2007 and 2006 (Unaudited)

9

 

 

Notes to the Consolidated Financial Statements (Unaudited)

10

 

4



 

AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2007 (UNAUDITED) AND DECEMBER 31, 2006

 

(in thousands)

 

2007

 

2006

 

Assets

 

 

 

 

 

Investments:

 

 

 

 

 

Fixed maturity investments available for sale, at fair value (Amortized cost 2007: $7,837,591; 2006: $6,574,249)

 

$

7,814,855

 

$

6,532,723

 

Other investments, at fair value

 

612,429

 

1,130,664

 

Total investments

 

8,427,284

 

7,663,387

 

Cash and cash equivalents

 

1,830,852

 

1,989,287

 

Accrued interest receivable

 

76,257

 

76,967

 

Insurance and reinsurance premium balances receivable

 

1,385,486

 

1,125,822

 

Reinsurance recoverable balances

 

1,247,720

 

1,293,660

 

Reinsurance recoverable balances on paid losses

 

97,047

 

65,494

 

Deferred acquisition costs

 

331,290

 

251,799

 

Prepaid reinsurance premiums

 

246,027

 

241,821

 

Securities lending collateral

 

861,280

 

794,149

 

Goodwill and intangible assets

 

61,967

 

29,041

 

Other assets

 

146,694

 

133,860

 

Total assets

 

$

14,711,904

 

$

13,665,287

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

Reserve for losses and loss expenses

 

$

5,531,379

 

$

5,015,113

 

Unearned premiums

 

2,433,339

 

2,015,556

 

Insurance and reinsurance balances payable

 

255,922

 

294,374

 

Securities lending payable

 

858,546

 

791,744

 

Senior notes

 

499,234

 

499,144

 

Liability under repurchase agreement

 

 

400,000

 

Net payable for investments purchased

 

49,023

 

62,185

 

Other liabilities

 

140,869

 

174,524

 

Total liabilities

 

9,768,312

 

9,252,640

 

 

 

 

 

 

 

Shareholders’ Equity

 

 

 

 

 

Preferred shares - Series A and B

 

$

500,000

 

$

500,000

 

Common shares (2007: 147,936; 2006: 149,982 shares issued)

 

1,849

 

1,875

 

Additional paid-in capital

 

1,859,067

 

1,929,406

 

Accumulated other comprehensive loss

 

(28,444

)

(44,638

)

Retained earnings

 

2,690,742

 

2,026,004

 

Treasury shares, at cost (2007: 2,226; 2006: nil shares)

 

(79,622

)

 

Total shareholders’ equity

 

4,943,592

 

4,412,647

 

Total liabilities and shareholders’ equity

 

$

14,711,904

 

$

13,665,287

 

 

See accompanying notes to consolidated financial statements.

 

5



 

AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006

 

 

 

Three months ended

 

Nine months ended

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

(in thousands, except per share amounts)

 

Revenues

 

 

 

 

 

 

 

 

 

Net premiums earned

 

$

685,845

 

$

692,780

 

$

2,065,090

 

$

2,005,473

 

Net investment income

 

118,908

 

98,787

 

357,873

 

284,018

 

Net realized investment losses

 

(1,192

)

(1,722

)

(5,548

)

(22,428

)

Other insurance related income

 

1,005

 

804

 

3,638

 

1,866

 

Total revenues

 

804,566

 

790,649

 

2,421,053

 

2,268,929

 

Expenses

 

 

 

 

 

 

 

 

 

Net losses and loss expenses

 

328,193

 

365,958

 

1,079,714

 

1,096,598

 

Acquisition costs

 

100,039

 

103,615

 

293,923

 

295,151

 

General and administrative expenses

 

79,813

 

68,470

 

210,993

 

181,538

 

Foreign exchange (gains) losses

 

(7,202

)

2,738

 

(16,477

)

(25,427

)

Interest expense and financing costs

 

13,929

 

8,239

 

43,241

 

24,639

 

Total expenses

 

514,772

 

549,020

 

1,611,394

 

1,572,499

 

Income before income taxes

 

289,794

 

241,629

 

809,659

 

696,430

 

Income tax expense

 

10,677

 

6,181

 

32,943

 

23,540

 

Net income

 

279,117

 

235,448

 

776,716

 

672,890

 

Preferred share dividends

 

9,142

 

9,226

 

27,573

 

28,083

 

Net income available to common shareholders

 

$

269,975

 

$

226,222

 

$

749,143

 

$

644,807

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares and common share equivalents:

 

 

 

 

 

 

 

 

 

Basic

 

146,845

 

149,884

 

148,753

 

149,657

 

Diluted

 

164,064

 

164,701

 

165,458

 

163,863

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

1.84

 

$

1.51

 

$

5.04

 

$

4.31

 

Diluted

 

$

1.65

 

$

1.37

 

$

4.53

 

$

3.94

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared per common share

 

$

0.165

 

$

0.15

 

$

0.495

 

$

0.45

 

 

See accompanying notes to the consolidated financial statements.

 

6



 

AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006

 

 

 

Three months ended

 

Nine months ended

 

 

 

2007

 

2006

 

2007

 

2006

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

279,117

 

$

235,448

 

$

776,716

 

$

672,890

 

Other comprehensive income, net of tax

 

 

 

 

 

 

 

 

 

Change in unrecognized prior period service cost on the supplemental executive retirement plan (SERP)

 

562

 

 

1,687

 

(384

)

Unrealized gains arising during the period

 

77,803

 

110,046

 

10,109

 

3,670

 

Adjustment for re-classification of investment (gains) losses realized in net income

 

(116

)

1,861

 

4,398

 

19,840

 

Comprehensive income

 

$

357,366

 

$

347,355

 

$

792,910

 

$

696,016

 

 

See accompanying notes to consolidated financial statements.

 

7



 

AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006

 

 

 

2007

 

2006

 

 

 

(in thousands)

 

Common shares (shares outstanding)

 

 

 

 

 

Balance at beginning of period

 

149,982

 

148,869

 

Shares issued, net

 

729

 

1,125

 

Shares repurchased for treasury

 

(2,226

)

 

Shares repurchased and cancelled

 

(2,775

)

 

Balance at end of period

 

145,710

 

149,994

 

 

 

 

 

 

 

Preferred shares - Series A and B

 

 

 

 

 

Balance at beginning and end of period

 

$

500,000

 

$

500,000

 

 

 

 

 

 

 

Common shares (par value)

 

 

 

 

 

Balance at beginning of period

 

1,875

 

1,861

 

Shares issued

 

9

 

14

 

Shares repurchased and cancelled

 

(35

)

 

Balance at end of period

 

1,849

 

1,875

 

 

 

 

 

 

 

Additional paid-in capital

 

 

 

 

 

Balance at beginning of period

 

1,929,406

 

1,886,356

 

Share-based compensation expense

 

25,404

 

19,604

 

Shares issued

 

1,294

 

(28

)

Stock options exercised

 

6,399

 

17,237

 

Shares repurchased and cancelled

 

(103,436

)

 

Balance at end of period

 

1,859,067

 

1,923,169

 

 

 

 

 

 

 

Accumulated other comprehensive loss

 

 

 

 

 

Balance at beginning of period

 

(44,638

)

(77,798

)

Change in unrealized losses on fixed maturity investments

 

15,891

 

23,825

 

Change in unrecognized prior period service cost on the SERP

 

1,687

 

(384

)

Change in deferred taxes

 

(1,384

)

(316

)

Balance at end of period

 

(28,444

)

(54,673

)

 

 

 

 

 

 

Retained earnings

 

 

 

 

 

Balance at beginning of period

 

2,026,004

 

1,201,932

 

Net income

 

776,716

 

672,890

 

Series A and B preferred share dividends

 

(27,573

)

(28,083

)

Common share dividends

 

(84,405

)

(76,161

)

Balance at end of period

 

2,690,742

 

1,770,578

 

 

 

 

 

 

 

Treasury shares, at cost

 

 

 

 

 

Balance at beginning of period

 

 

 

Shares repurchased for treasury

 

(79,622

)

 

Balance at end of period

 

(79,622

)

 

 

 

 

 

 

 

Total shareholders’ equity

 

$

4,943,592

 

$

4,140,949

 

 

See accompanying notes to consolidated financial statements.

 

8



 

AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006

 

 

 

2007

 

2006

 

 

 

(in thousands)

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

776,716

 

$

672,890

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Net realized investment losses

 

5,548

 

23,774

 

Net change in fair value of other investments

 

(14,300

)

(12,545

)

Amortization/accretion of fixed maturity investments

 

(13,808

)

23,569

 

Other amortization and depreciation

 

17,566

 

2,808

 

Share-based compensation expense

 

25,404

 

19,604

 

Changes in:

 

 

 

 

 

Accrued interest receivable

 

710

 

(5,451

)

Reinsurance recoverable balances

 

14,387

 

153,428

 

Deferred acquisition costs

 

(79,491

)

(75,722

)

Prepaid reinsurance premiums

 

(4,206

)

6,607

 

Reserve for loss and loss expenses

 

516,266

 

251,736

 

Unearned premiums

 

417,783

 

406,897

 

Insurance and reinsurance balances, net

 

(298,116

)

(232,937

)

Other items

 

(86,153

)

(4,924

)

Net cash provided by operating activities

 

1,278,306

 

1,229,734

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of available-for-sale fixed maturities

 

(5,579,091

)

(3,861,569

)

Sales and maturities of available-for-sale fixed maturities

 

4,310,846

 

3,384,106

 

Purchases of other investments

 

(65,250

)

(301,267

)

Sales of other investments

 

585,395

 

 

Purchase of assets

 

(38,261

)

 

Net cash used in investing activities

 

(786,361

)

(778,730

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Repayment of repurchase agreement

 

(400,000

)

 

Repurchase of shares

 

(183,093

)

 

Dividends paid - common shares

 

(83,806

)

(68,030

)

Dividends paid - preferred shares

 

(27,573

)

(28,083

)

Proceeds from exercise of stock options

 

6,399

 

 

Proceeds from issuance of common shares

 

1,303

 

17,223

 

Net cash used in financing activities

 

(686,770

)

(78,890

)

 

 

 

 

 

 

Effect of exchange rate changes on foreign currency cash

 

36,389

 

(12,190

)

(Decrease) increase in cash and cash equivalents

 

(158,436

)

359,924

 

Cash and cash equivalents - beginning of period

 

1,989,287

 

1,280,990

 

Cash and cash equivalents - end of period

 

$

1,830,851

 

$

1,640,914

 

 

See accompanying notes to the consolidated financial statements.

 

9



 

AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

1.                                      BASIS OF PRESENTATION AND ACCOUNTING POLICIES

 

Basis of Presentation

 

Our consolidated balance sheet at September 30, 2007 and the consolidated statements of operations, comprehensive income, shareholders’ equity and cash flows for the periods ended September 30, 2007 and 2006 have not been audited. The balance sheet at December 31, 2006 is derived from the audited financial statements.

 

These statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, these financial statements reflect all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of our financial position and results of operations as at the end of and for the periods presented. The results of operations for any interim period are not necessarily indicative of the results for a full year. All significant inter-company accounts and transactions have been eliminated. In these notes, the terms “we,” “us,” “our,” or the “Company” refer to AXIS Capital Holdings Limited and its direct and indirect subsidiaries.

 

The following information is unaudited and should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2006. Tabular dollars and share amounts are in thousands, except per share amounts. Certain reclassifications have been made to prior period amounts to conform to the current period presentation. In particular, we reclassified the additional capital above par value on our Series A and B preferred shares from additional paid-in capital to the preferred shares caption in our Consolidated Balance Sheets and Statements of Changes in Shareholders’ Equity.

 

Adoption of New Accounting Standards

 

The terms “FAS” and “FASB” used in these notes refer to Statements of Financial Accounting Standards issued by the United States Financial Accounting Standards Board.

 

On July 13, 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109” (“FIN 48”).  This Interpretation prescribes detailed guidance for the financial statement recognition, measurement and disclosure of uncertain tax positions recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. Under FIN 48, the tax benefits of uncertain tax positions may only be recognized when the position is more-likely-than-not to be sustained upon audit by the relevant taxing authorities. The amount recognized represents the largest amount of tax benefit that is greater than fifty percent likely of being recognized. We adopted the provisions of FIN 48 on January 1, 2007. There were no unrecognized tax benefits as of the date of adoption and there was no change in the liability for unrecognized tax benefits. Our U.S. subsidiaries are not under examination but remain subject to examination in the U.S. for tax years 2003-2006. Our various European operating subsidiaries and branch operations in Ireland, the United Kingdom, and Switzerland are not under examination in any of these tax jurisdictions, but generally remain subject to examination for tax years 2002-2006.

 

Accounting Standards Not Yet Adopted

 

In September 2006, the FASB issued FAS No. 157, Fair Value Measurement (“FAS 157”). This Statement provides guidance for using fair value to measure assets and liabilities. Under this standard, the definition of fair value focuses on the price that would be received to sell the asset or paid to transfer the liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price). FAS 157 clarifies that fair value is a market-based measurement, not an entity-specific measurement, and sets out a fair value hierarchy with the highest priority being quoted prices in active markets and the lowest priority to unobservable data. Further, FAS 157 requires tabular disclosures of the fair value measurements by level within the fair value hierarchy. FAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Although early adoption was permitted as of January 1, 2007, we have not yet adopted FAS 157 and are evaluating the potential impact of adoption on our financial condition and results of operations.

 

10



 

1.                                      BASIS OF PRESENTATION AND ACCOUNTING POLICIES (Continued)

 

In February 2007, the FASB issued FAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“FAS 159”). This standard permits an entity to irrevocably elect fair value on a contract-by-contract basis as the initial and subsequent measurement attribute for many financial instruments and certain other items including insurance contracts. An entity electing the fair value option would be required to recognize changes in fair value in earnings and provide disclosure that will assist investors and other users of financial information to more easily understand the effect of the company’s choice to use fair value on its earnings. Further, the entity is required to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. This standard does not eliminate the disclosure requirements about fair value measurements included in FAS 157 and FAS 107, Disclosures about Fair Value of Financial Instruments. FAS 159 is effective for fiscal years beginning after November 15, 2007. Although early adoption was permitted as of January 1, 2007, we have not yet adopted FAS 159.

 

2.                                      SEGMENT INFORMATION

 

Our underwriting operations are organized around our two global underwriting platforms, AXIS Insurance and AXIS Re and therefore we have determined that we have two reportable segments, insurance and reinsurance. We do not allocate our assets by segment as we evaluate the underwriting results of each segment separately from the results of our investment portfolio.

 

Insurance

 

Our insurance segment provides insurance coverage on a worldwide basis. In January 2007, we announced the reorganization of AXIS Insurance to further strengthen the global operations of the segment. This reorganization reflects the management of AXIS Insurance along global product lines rather than by geographical location. The new structure enables us to design insurance programs on a global basis in alignment with the global needs of many of our clients. Through December 31, 2006, we subdivided our insurance segment into two sub-segments: global insurance and U.S insurance. However, as a result of the reorganization such sub-segment information is no longer relevant.

 

The following are the lines of business in our insurance segment:

 

       Property: provides physical damage and business interruption coverage primarily for industrial and commercial properties and physical damage, business interruption and liability coverage for onshore energy properties and operations. The book consists of both primary and excess risks, some of which are catastrophe-exposed.

 

       Marine: provides coverage for hull, liability, cargo and specie and recreational marine risks. These risks include property damage or physical loss to ships, pollution damage caused by vessels on a sudden and accidental basis, protection for general cargo and the contents of armored cars, vaults, exhibitions and museums, and specific war related risks. This line of business also provides physical damage, business interruption and liability coverage for offshore energy property and operations.

 

       Terrorism: provides coverage for physical damage and business interruption of an insured following an act of terrorism.

 

       Aviation: includes hull and liability and specific war coverage for passenger and cargo airlines and privately owned aircraft as well as select aviation product liability coverage.

 

       Political risk: generally provides protection against sovereign default or sovereign actions resulting in impairment of cross-border investments for banks and major corporations. It also provides protection on structured credit based transactions where lenders seek to mitigate some of the non-payment risk of their borrowers, both public and private.

 

11



 

2.                                      SEGMENT INFORMATION (Continued)

 

       Professional lines: primarily consists of coverage for directors’ and officers’ liability, errors and omissions liability and employment practices liability.

 

       Liability: primarily targets general liability and umbrella and excess liability in the U.S. excess and surplus lines markets. Target classes include mercantile, manufacturing and building/premises, with particular emphasis on commercial and consumer products, commercial construction and miscellaneous general liability.

 

       Accident & Health: primarily provides employee medical coverage for self-insured, small and medium sized employers for losses in excess of a retention.

 

Reinsurance

 

Our reinsurance segment provides property and casualty reinsurance to insurance companies on a worldwide basis. The following are the lines of business we write on both a treaty and facultative basis in our reinsurance segment:

 

       Catastrophe: provides protection for most catastrophic losses that are covered in the underlying insurance policies written by our ceding company clients. The exposure in the underlying policies is principally property exposure but also covers other exposures including workers compensation, personal accident and life. The principal perils in this portfolio are hurricane and windstorm, earthquake, flood, tornado, hail and fire. In some instances, terrorism may be a covered peril or the only peril. We underwrite catastrophe reinsurance principally on an excess of loss basis, meaning that our exposure only arises when our customers’ claims exceed a certain retained amount.

 

       Property: includes reinsurance written on both a pro rata and a per risk basis and covers underlying personal lines and commercial property exposures. Property pro rata treaty reinsurance covers a cedent’s aggregate losses from all events in the covered period on a proportional basis. Property per risk treaty reinsurance reinsures a portfolio of particular property risks of ceding companies on an excess of loss basis.

 

       Professional Liability: covers directors’ and officers’ liability, employment practices liability, medical malpractice and miscellaneous errors and omissions insurance risks.

 

       Credit and Bond: consists principally of reinsurance of trade credit insurance products and includes both proportional and excess-of loss structures. The underlying insurance indemnifies sellers of goods and services against a payment default by the buyer of those goods and services. Also included in this book is coverage for ceding insurers against losses arising from a broad array of surety bonds issued by bond insurers principally to satisfy regulatory demands in a variety of jurisdictions around the world, but predominantly in Europe.

 

       Motor: provides coverage to insurers for motor liability losses arising out of any one occurrence. The occurrence can involve one or many claimants where the ceding insurer aggregates the claims from the occurrence.

 

       Liability: provides coverage to insurers of standard casualty lines, including auto liability, general liability, personal and commercial umbrella and workers’ compensation.

 

       Other: includes aviation, engineering, marine, personal accident and crop reinsurance.

 

12



 

2.                                      SEGMENT INFORMATION (Continued)

 

The following tables summarize the underwriting results of our operating segments:

 

Three months ended September 30:

 

 

 

2007

 

2006

 

 

 

Insurance

 

Reinsurance

 

Total

 

Insurance

 

Reinsurance

 

Total

 

Gross premiums written

 

$

480,729

 

$

274,495

 

$

755,224

 

$

453,116

 

$

281,794

 

$

734,910

 

Net premiums written

 

315,605

 

268,297

 

583,902

 

323,618

 

282,295

 

605,913

 

Net premiums earned

 

301,925

 

383,920

 

685,845

 

327,701

 

365,079

 

692,780

 

Other insurance related income

 

610

 

395

 

1,005

 

412

 

392

 

804

 

Net losses and loss expenses

 

(113,092

)

(215,101

)

(328,193

)

(182,280

)

(183,678

)

(365,958

)

Acquisition costs

 

(34,721

)

(65,318

)

(100,039

)

(40,796

)

(62,819

)

(103,615

)

General and administrative expenses

 

(43,262

)

(15,828

)

(59,090

)

(36,141

)

(12,162

)

(48,303

)

Underwriting income

 

$

111,460

 

$

88,068

 

199,528

 

$

68,896

 

$

106,812

 

175,708

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate expenses

 

 

 

 

 

(20,723

)

 

 

 

 

(20,167

)

Net investment income

 

 

 

 

 

118,908

 

 

 

 

 

98,787

 

Net realized investment losses

 

 

 

 

 

(1,192

)

 

 

 

 

(1,722

)

Foreign exchange gains (losses)

 

 

 

 

 

7,202

 

 

 

 

 

(2,738

)

Interest expense and financing costs

 

 

 

 

 

(13,929

)

 

 

 

 

(8,239

)

Income before income taxes

 

 

 

 

 

$

289,794

 

 

 

 

 

$

241,629

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss and loss expense ratio

 

37.5

%

56.0

%

47.9

%

55.6

%

50.3

%

52.8

%

Acquisition cost ratio

 

11.5

%

17.0

%

14.6

%

12.4

%

17.2

%

15.0

%

General and administrative expense ratio

 

14.3

%

4.1

%

11.6

%

11.0

%

3.3

%

9.9

%

Combined ratio

 

63.3

%

77.1

%

74.1

%

79.0

%

70.8

%

77.7

%

 

13



 

2.                                      SEGMENT INFORMATION (Continued)

 

Nine months ended September 30:

 

 

 

2007

 

2006

 

 

 

Insurance

 

Reinsurance

 

Total

 

Insurance

 

Reinsurance

 

Total

 

Gross premiums written

 

$

1,529,888

 

$

1,487,337

 

$

3,017,225

 

$

1,519,771

 

$

1,375,259

 

$

2,895,030

 

Net premiums written

 

1,004,536

 

1,474,066

 

2,478,602

 

1,053,794

 

1,365,179

 

2,418,973

 

Net premiums earned

 

915,102

 

1,149,988

 

2,065,090

 

973,985

 

1,031,488

 

2,005,473

 

Other insurance related income

 

1,737

 

1,901

 

3,638

 

1,474

 

392

 

1,866

 

Net losses and loss expenses

 

(432,612

)

(647,102

)

(1,079,714

)

(486,235

)

(610,363

)

(1,096,598

)

Acquisition costs

 

(97,512

)

(196,411

)

(293,923

)

(117,006

)

(178,145

)

(295,151

)

General and administrative expenses

 

(117,952

)

(45,794

)

(163,746

)

(104,069

)

(34,377

)

(138,446

)

Underwriting income

 

$

268,763

 

$

262,582

 

531,345

 

$

268,149

 

$

208,995

 

477,144

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate expenses

 

 

 

 

 

(47,247

)

 

 

 

 

(43,092

)

Net investment income

 

 

 

 

 

357,873

 

 

 

 

 

284,018

 

Net realized investment losses

 

 

 

 

 

(5,548

)

 

 

 

 

(22,428

)

Foreign exchange gains

 

 

 

 

 

16,477

 

 

 

 

 

25,427

 

Interest expense and financing costs

 

 

 

 

 

(43,241

)

 

 

 

 

(24,639

)

Income before income taxes

 

 

 

 

 

$

809,659

 

 

 

 

 

$

696,430

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss and loss expense ratio

 

47.3

%

56.3

%

52.3

%

49.9

%

59.2

%

54.7

%

Acquisition cost ratio

 

10.7

%

17.1

%

14.2

%

12.0

%

17.3

%

14.7

%

General and administrative expense ratio

 

12.9

%

4.0

%

10.2

%

10.7

%

3.3

%

9.1

%

Combined ratio

 

70.9

%

77.4

%

76.7

%

72.6

%

79.8

%

78.5

%

 

14



 

3.                   INVESTMENTS

 

a)                   Gross unrealized losses

 

The following tables summarize fixed maturity investments in an unrealized loss position, including the length of time the security has continuously been in the unrealized loss position:

 

 

 

September 30, 2007

 

 

 

12 months or greater

 

Less than 12 months

 

Total

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Type of Investment

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

 

U.S. government and agency securities

 

$

287,144

 

$

(2,836

)

$

179,718

 

$

(847

)

$

466,862

 

$

(3,683

)

Non-U.S. government securities

 

 

 

461

 

(2

)

461

 

(2

)

Corporate securities

 

280,180

 

(5,765

)

533,348

 

(28,091

)

813,528

 

(33,856

)

Mortgage-backed securities

 

1,260,435

 

(31,734

)

997,024

 

(10,294

)

2,257,459

 

(42,028

)

Asset-backed securities

 

87,689

 

(1,167

)

271,300

 

(4,068

)

358,989

 

(5,235

)

Municipals

 

94,638

 

(718

)

33,352

 

(150

)

127,990

 

(868

)

Total

 

$

2,010,086

 

$

(42,220

)

$

2,015,203

 

$

(43,452

)

$

4,025,289

 

$

(85,672

)

 

 

 

December 31, 2006

 

 

 

12 months or greater

 

Less than 12 months

 

Total

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Type of Investment

 

Value

 

Losses

 

Value

 

Losses

 

Value

 

Losses

 

U.S. government and agency securities

 

$

536,403

 

$

(13,909

)

$

364,668

 

$

(2,519

)

$

901,071

 

$

(16,428

)

Non-U.S. government securities

 

4,957

 

(151

)

131,457

 

(2,620

)

136,414

 

(2,771

)

Corporate securities

 

421,943

 

(7,556

)

449,679

 

(2,507

)

871,622

 

(10,063

)

Mortgage-backed securities

 

1,420,196

 

(33,607

)

536,721

 

(3,935

)

1,956,917

 

(37,542

)

Asset-backed securities

 

149,673

 

(1,961

)

166,200

 

(356

)

315,873

 

(2,317

)

Municipals

 

105,832

 

(1,803

)

130,511

 

(457

)

236,343

 

(2,260

)

Total

 

$

2,639,004

 

$

(58,987

)

$

1,779,236

 

$

(12,394

)

$

4,418,240

 

$

(71,381

)

 

At September 30, 2007, 2,010 securities (2006: 1,945) were in an unrealized loss position with a fair value of $4,025 million (2006: $4,418 million) of which 1,416 securities (2006: 1,497) have been in an unrealized loss position for 12 months or greater and have a fair value of $2,010 million (2006: $2,639 million).  The unrealized losses from these securities were not a result of credit, collateral or structural issues.  In the first nine months of 2007, we recorded an impairment charge of $2.1 million (2006: $1.6 million) relating to 11 securities (2006: 33) that we determined to be other than temporarily impaired which were included in net realized investment losses in the Consolidated Statements of Operations.

 

15



 

3.                                      INVESTMENTS (Continued)

 

b)                 Other Investments

 

The table below summarizes the composition of our other investments portfolio:

 

 

 

September 30, 2007

 

December 31, 2006

 

Life settlement contracts

 

$

 

0

%

$

377,767

 

33

%

Hedge funds

 

272,768

 

45

%

235,377

 

21

%

Collateralized loan obligations

 

131,180

 

22

%

263,621

 

23

%

Credit funds

 

154,492

 

25

%

156,337

 

14

%

Short duration high yield fund

 

45,210

 

7

%

97,562

 

9

%

Other

 

8,779

 

1

%

 

0

%

Total other investments

 

$

612,429

 

100

%

$

1,130,664

 

100

%

 

Life Settlement Contracts

 

On December 20, 2006, we purchased a 20-year asset-backed note (“Note”) in the amount of $400.0 million issued by a special-purpose entity (“SPE”). Through the purchase of this Note, we assumed longevity risk on 222 life insurance policies for a period of 20 years. We determined the SPE was a variable interest entity (VIE) and through ownership of the Note we became its primary beneficiary. Accordingly, we consolidated the SPE, as well as the underlying SPEs, in our December 31, 2006 Consolidated Balance Sheet and eliminated all inter-company balances including the Note. At December 31, 2006, the consolidated assets and liabilities of the SPEs consisted primarily of restricted cash of $65.0 million, life settlement contracts portfolio of $377.8 million and other liability of $42.8 million.

 

On September 26, 2007, we sold the Note for a cash consideration of $400.0 million to a related party of the SPE (“buyer”), resulting in the deconsolidation of the SPE (see Note 8). Accordingly, from September 27, 2007, we have not included the results, assets and liabilities of the SPE in our Consolidated Financial Statements. For the three and nine months ended September 30, 2007, we recognized net investment income of $20.6 million and $nil, respectively, relating to the results of the SPE. The $400.0 million repurchase agreement used to finance the purchase of the Note was also terminated on September 26, 2007. For the three and nine months ended September 30, 2007, we recorded interest expense of $6.0 million and $19.2 million, respectively, relating to the repurchase agreement.

 

Collateralized loan obligations (“CLOs”)

 

We have invested in various CLOs with the investments in equity and combination notes.  At September 30, 2007, we had invested in 12 (2006: 26) different CLOs with underlying assets totaling $7.4 billion (2006: $13.6 billion).  During the three and nine months ended September 30, 2007 we sold 11 and 15 CLOs, respectively, at a net realized loss of $3.8 million and $1.3 million, respectively.

 

16



 

3.                                      INVESTMENTS (Continued)

 

c)         Restricted investments

 

We are required to maintain assets on deposit with various regulatory authorities to support our insurance and reinsurance operations. The assets on deposit are available to settle insurance and reinsurance liabilities. We also utilize trust accounts in certain large transactions for the benefit of ceding companies. These trust accounts generally take the place of Letter of Credit requirements. The assets in trust as collateral are primarily highly rated fixed maturity securities. Additionally, prior to its termination on September 26, 2007, the repurchase agreement was securitized by the Note. The components of the fair value of restricted assets are as follows:

 

 

 

September 30

 

December 31

 

 

 

2007

 

2006

 

Assets used for collateral in Trust for inter-company agreements

 

$

763,282

 

$

734,938

 

Life settlement contracts

 

 

377,767

 

Deposits with U.S. regulatory authorities

 

28,668

 

27,934

 

Assets used for collateral in Trust for third party agreements

 

106,582

 

72,321

 

Total restricted investments

 

$

898,532

 

$

1,212,960

 

 

4.                   RESERVE FOR LOSSES AND LOSS EXPENSES

 

The following table represents an analysis of paid and unpaid losses and loss expenses and a reconciliation of the beginning and ending unpaid losses and loss expenses for the nine months ended September 30:

 

 

 

2007

 

2006

 

Gross unpaid losses and loss expenses at beginning of period

 

$

5,015,113

 

$

4,743,338

 

Less reinsurance recoverable balances

 

(1,293,660

)

(1,455,248

)

Less reinsurance recoverable balances on paid losses

 

(65,494

)

(62,862

)

Net balance at beginning of period

 

3,655,959

 

3,225,228

 

 

 

 

 

 

 

Net incurred losses related to:

 

 

 

 

 

Current year

 

1,324,690

 

1,278,704

 

Prior years

 

(244,976

)

(182,106

)

 

 

1,079,714

 

1,096,598

 

Net paid losses related to:

 

 

 

 

 

Current year

 

(99,972

)

(76,579

)

Prior years

 

(479,276

)

(625,237

)

 

 

(579,248

)

(701,816

)

Foreign exchange loss

 

30,187

 

10,382

 

Net unpaid losses and loss expenses at end of period

 

4,186,612

 

3,630,392

 

Reinsurance recoverable balances

 

1,247,720

 

1,315,395

 

Reinsurance recoverable balances on paid losses

 

97,047

 

49,287

 

Gross unpaid losses and loss expenses at end of period

 

$

5,531,379

 

$

4,995,074

 

 

17



 

4.                   RESERVE FOR LOSSES AND LOSS EXPENSES (Continued)

 

Net incurred losses include net favorable prior period reserve development of $245 million and $182 million during the nine months ended September 30, 2007 and 2006, respectively. Prior period development arises from changes to loss estimates recognized in the current period that relate to losses incurred in previous calendar years. These reserve changes were made as part of our regular quarterly reserving process and primarily arose from better than expected emergence of actual claims relative to expectations. The net favorable development in 2007 was predominately related to our short tail lines from accident year 2006 and to a lesser extent, accident years 2005 and 2004. For these lines, accident year 2006 has largely proven to be a benign loss year with limited late reported loss activity and minimal deterioration of previously reported claims. The net favorable development in 2006 was related to our short tail lines of business and was primarily generated from accident years 2004 and 2005.

 

5.                   STOCK-BASED COMPENSATION

 

In May 2007, our shareholders approved the AXIS Capital Holdings Limited 2007 Long-Term Equity Compensation Plan (“2007 Plan”). The 2007 Plan provides for, among other things, the grant of restricted stock awards and units, non-qualified and incentive stock options, and other equity based awards to our employees and directors. The maximum number of our common shares that may be delivered under our 2007 Plan is 5,000,000. As a result of the adoption of the 2007 Plan, the 2003 Long-Term Equity Compensation and 2003 Directors Long-Term Equity Compensation Plan were terminated, except that all related outstanding awards will remain in effect.

 

During the three months ended September 30, 2007 and 2006, we incurred compensation costs of $8.9 million and $6.9 million, respectively, for all stock compensation plans, and recorded tax benefits thereon of $1.6 million and $0.9 million, respectively. For the first nine months of 2007 and 2006, we incurred compensation costs of $25.4 million and $19.6 million, respectively, for all stock compensation plans, and recorded tax benefits thereon of $5.2 million and $3.6 million, respectively.

 

The following is a summary of activity under our existing stock compensation plans for the first nine months in 2007 and 2006:

 

Restricted Stock

 

 

 

2007

 

2006

 

 

 

Number of
Restricted

Stock

 

Weighted
Average
Grant Date
Fair Value

 

Number of
Restricted
Stock

 

Weighted
Average
Grant Date
Fair Value

 

Unvested - beginning of year

 

2,229

 

$

29.95

 

1,176

 

$

28.40

 

Granted

 

1,594

 

33.02

 

1,298

 

31.00

 

Vested

 

(440

)

29.67

 

(119

)

27.61

 

Forfeited

 

(41

)

31.25

 

(104

)

21.01

 

Unvested - end of period

 

3,342

 

$

31.43

 

2,251

 

$

30.28

 

 

At September 30, 2007, there was $55.3 million of unrecognized compensation cost related to restricted stock awards, which is expected to be recognized over a weighted average period of 1.4 years. The total fair value of shares vested during the first nine months of 2007 was $13.0 million.

 

18



 

5.                   STOCK-BASED COMPENSATION (Continued)

 

Stock Options

 

 

 

2007

 

2006

 

 

 

Number of
Stock

Options

 

Weighted
Average
Exercise

Price

 

Number of
Stock
Options

 

Weighted
Average

Exercise
Price

 

Outstanding - beginning of year

 

5,147

 

$

18.75

 

6,174

 

$

19.11

 

Granted

 

 

 

45

 

26.90

 

Exercised

 

(289

)

22.12

 

(912

)

18.91

 

Forfeited

 

(5

)

28.02

 

(113

)

29.09

 

Outstanding - end of period

 

4,853

 

$

18.54

 

5,194

 

$

18.99

 

 

At September 30, 2007, there was $0.2 million of unrecognized compensation cost related to the stock option awards which will be fully recognized during the remainder of 2007. The total intrinsic value of options exercised during the first nine months of 2007 was $4.2 million, for which we received proceeds of $6.4 million.

 

6.                   EARNINGS PER COMMON SHARE

 

The following table sets forth the comparison of basic and diluted earnings per common share:

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 30

 

September 30

 

 

 

2007

 

2006

 

2007

 

2006

 

Basic earnings per common share

 

 

 

 

 

 

 

 

 

Net income available to common shareholders

 

$

269,975

 

$

226,222

 

$

749,143

 

$

644,807

 

Weighted average common shares outstanding

 

146,845

 

149,884

 

148,753

 

149,657

 

Basic earnings per common share

 

$

1.84

 

$

1.51

 

$

5.04

 

$

4.31

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per common share

 

 

 

 

 

 

 

 

 

Net income available to common shareholders

 

$

269,975

 

$

226,222

 

$

749,143

 

$

644,807

 

Weighted average common shares outstanding

 

146,845

 

149,884

 

148,753

 

149,657

 

Share equivalents:

 

 

 

 

 

 

 

 

 

Warrants

 

13,124

 

11,782

 

12,937

 

11,474

 

Options

 

2,385

 

2,010

 

2,354

 

1,941

 

Restricted stock

 

1,710

 

1,025

 

1,414

 

791

 

Weighted average common shares outstanding - diluted

 

164,064

 

164,701

 

165,458

 

163,863

 

Diluted earnings per common share

 

$

1.65

 

$

1.37

 

$

4.53

 

$

3.94

 

 

For the nine months ended September 30, 2006, there were 1,175,973 restricted shares and options, which would have resulted in the issuance of common shares that were excluded in the computation of diluted earnings per share because the effect would be anti-dilutive. There were no such anti-dilutive restricted shares or options for the three months ended September 30, 2006 or the three and nine months ended September 30, 2007.

 

19



 

7.                   SHAREHOLDERS’ EQUITY

 

On May 10, 2007, we repurchased from Trident II, L.P and affiliated entities, an aggregate of 2,700,000 shares of our common stock at $37.25 per share, for a total purchase price of $100.6 million.   These shares were subsequently cancelled.  During August, 2007, we repurchased from the open market, a further 2,224,833 shares at an average price of $35.77 per share, for a total cost of $79.6 million, which are held as treasury shares at September 30, 2007.

 

8.                   DERIVATIVE INSTRUMENTS

 

Insurance & Reinsurance Contracts

 

On September 26, 2007, following the sale of the Note (see Note 3b), we entered into an insurance contract with the buyer whereby we agreed to indemnify the buyer in the event of non payment on the principal of its investment in a new $400.0 million asset-backed note. The asset-backed note has a 10 year term with the full principal amount due at maturity and is collateralized by a portfolio of life settlement contracts and cash held by the same SPE as disclosed in Note 3b. Through our insurance contract, we hold an implicit variable interest in the SPE; but management has determined that the Company is not its primary beneficiary.

 

We have recorded the insurance contract as a derivative contract, with an initial fair value of $nil. The fair value was determined by calculating the present value of the estimated loss payment on September 26, 2017, and estimated risk margin, net of the present value of the contractual insurance premiums. At September 30, 2007, the fair value of the derivative contract remained at $nil and our maximum exposure to a loss is $400.0 million on an undiscounted basis.

 

9.                   COMMITMENTS AND CONTINGENCIES

 

a)                                      Legal Proceedings

 

Except as noted below, we are not a party to any material legal proceedings. From time to time, we are subject to routine legal proceedings, including arbitrations, arising in the ordinary course of business. These legal proceedings generally relate to claims asserted by or against us in the ordinary course of insurance or reinsurance operations. In our opinion, the eventual outcome of these legal proceedings is not expected to have a material adverse effect on our financial condition or results of operations.

 

In 2005, a putative class action lawsuit was filed against our U.S. insurance subsidiaries. In re Insurance Brokerage Antitrust Litigation was filed on August 15, 2005 in the United States District Court for the District of New Jersey and includes as defendants numerous insurance brokers and insurance companies. The lawsuit alleges antitrust and Racketeer Influenced and Corrupt Organizations Act (“RICO”) violations in connection with the payment of contingent commissions and manipulation of insurance bids and seeks damages in an unspecified amount. On October 3, 2006, the District Court granted, in part, motions to dismiss filed by the defendants, and ordered plaintiffs to file supplemental pleadings setting forth sufficient facts to allege their antitrust and RICO claims. After plaintiffs filed their supplemental pleadings, defendants renewed their motions to dismiss. On April 15, 2007, the District Court dismissed without prejudice plaintiffs’ complaint, as amended, and granted plaintiffs thirty (30) days to file another amended complaint and/or revised RICO Statement and Statements of Particularity. In May 2007, plaintiffs filed (i) a Second Consolidated Amended Commercial Class Action complaint, (ii) a Revised Particularized Statement Describing the Horizontal Conspiracies Alleged in the Second Consolidated Amended Commercial Class Action Complaint, and (iii) a Third Amended Commercial Insurance Plaintiffs’ RICO Case Statement Pursuant to Local Rule 16.1(B)(4). On June 21, 2007, the defendants filed renewed motions to dismiss. On September 28, 2007, the District Court dismissed with prejudice plaintiffs’ antitrust and RICO claims and declined to exercise supplemental jurisdiction over plaintiffs’ remaining state law claims. On October 10, 2007, plaintiffs filed a notice of appeal of all adverse orders and decisions to the United States Court of Appeals for the Third Circuit. We believe that the lawsuit is completely without merit and we continue to vigorously defend the filed action.

 

20



 

9.                   COMMITMENTS AND CONTINGENCIES (Continued)

 

b)                                      Dividends for Common Shares and Preferred Shares

 

On September 7, 2007 the Board of Directors declared a dividend of $0.165 per common share to shareholders of record at September 28, 2007 and payable on October 15, 2007. Additionally, the Board of Directors declared a dividend of $0.453125 per Series A 7.25% Preferred share and a dividend of $1.875 per Series B 7.5% Preferred share. The Series A Preferred share is payable on October 15, 2007, to shareholders of record at September 28, 2007 and the Series B Preferred share is payable on December 3, 2007 to shareholders of record at November 16, 2007.

 

c)                                      Reinsurance Purchase Commitment

 

During 2007, we purchased reinsurance coverage for our insurance lines of business. The minimum reinsurance premiums are contractually due on a quarterly basis in advance. Accordingly at September 30, 2007, we have an outstanding reinsurance purchase commitment of $98 million (2006: $47 million).

 

d)                                      Life Premiums Commitment

 

At December 31, 2006, we had a commitment of $637 million relating to the estimated life insurance premiums due on our life settlement contracts portfolio. This was due to be paid over the life of the underlying contracts. Following the sale of the Note on September 26, 2007 (see Note 3b), we have no remaining commitment to pay estimated life insurance premiums.

 

e)                                      Investment Commitment

 

During September 2007, we made an investment commitment of $75 million in an alternative investment fund, which was fully outstanding at September 30, 2007.  We expect to fund this commitment over the next 12 months

 

21



 

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following is a discussion and analysis of our financial condition and results of operations. This should be read in conjunction with the consolidated financial statements and related notes included in Item 1 of this report and also our Management’s Discussion and Analysis of Results of Operations and Financial Condition contained in our Annual Report on Form 10-K for the year ended December 31, 2006. Tabular dollars are in thousands, except per share amounts. Amounts in tables may not reconcile due to rounding differences.

 

Financial Measures

 

We believe the following financial indicators are important in evaluating our performance and measuring the overall growth in value generated for our common shareholders:

 

Annualized return on average common equity (‘ROACE’): ROACE represents the level of net income available to common shareholders generated from the average of the opening and closing common shareholders’ equity during the period. Our objective is to generate superior returns on capital that appropriately reward our shareholders for the risks we assume and to grow revenue only when we deem the returns meet or exceed our requirements. ROACE was 25.0% and 23.9 % for the three and nine months ended September 30, 2007, respectively, compared to 26.0% and 25.8% for the same periods of 2006.

 

Diluted book value per common share: This is a non-GAAP financial measure; for further information refer to “Non-GAAP Financial Measures” at the end of Item 2. We consider diluted book value per common share an appropriate measure of our returns to common shareholders, as we believe growth in our book value on a diluted basis ultimately translates into growth of our stock price. Diluted book value per share increased from $24.02 at December 31, 2006 to $27.52 at September 30, 2007. The increase was substantially due to earnings generated in the first nine months of 2007.

 

Cash dividends per common share: Our dividend policy is an integral part of the value we create for our shareholders. Our quarterly cash dividend was $0.165 per common share in the first three quarters of 2007 compared to $0.15 per common share in the first three quarters of 2006. In December 2006, our Board of Directors authorized a 10% increase in the quarterly dividend.

 

22



 

RESULTS OF OPERATIONS: THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006

 

Overview

 

The following tables break out our net income to common shareholders:

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 30

 

September 30

 

 

 

2007

 

2006

 

Change

 

2007

 

2006

 

Change

 

Underwriting income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Insurance

 

$

111,460

 

$

68,896

 

62

%

$

268,763

 

$

268,149

 

0

%

Reinsurance

 

88,068

 

106,812

 

(18

)%

262,582

 

208,995

 

26

%

Net investment income and net realized losses

 

117,716

 

97,065

 

21

%

352,325

 

261,590

 

35

%

Other revenues and expenses

 

(38,127

)

(37,325

)

2

%

(106,954

)

(65,844

)

62

%

Net income

 

279,117

 

235,448

 

19

%

776,716

 

672,890

 

15

%

Preferred share dividends

 

(9,142

)

(9,226

)

(1

)%

(27,573

)

(28,083

)

(2

)%

Net income available to common shareholders

 

$

269,975

 

$

226,222

 

19

%

$

749,143

 

$

644,807

 

16

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ratios:

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss ratio

 

47.9

%

52.8

%

(4.9

)%

52.3

%

54.7

%

(2.4

)%

Acquisition cost ratio

 

14.6

%

15.0

%

(0.4

)%

14.2

%

14.7

%

(0.5

)%

General and administrative expense ratio

 

11.6

%

9.9

%

1.7

%

10.2

%

9.1

%

1.1

%

Combined ratio

 

74.1

%

77.7

%

(3.6

)%

76.7

%

78.5

%

(1.8

)%

 

 

The main factors contributing towards the 19% increase in income in the third quarter of 2007 compared to the third quarter of 2006 were:

 

                  Additional underwriting income in our insurance segment. This was driven by an 18.1 percentage point reduction in the segment loss ratio due to better loss experience in the current accident year (7.2 percentage points) and  higher net favorable prior period reserve development (10.9 percentage points).

 

                  An increase in net investment income driven by a combination of a larger average investment base and higher yields on our fixed maturity investments.

 

These favorable factors were partially offset by a reduction in underwriting income in our reinsurance segment. This was driven by a 5.7 percentage point increase in the segment loss ratio which was mostly associated with a higher incidence of mid-sized natural catastrophe events.

 

The main factors contributing towards the 16% increase in income in the first nine months of 2007 compared to the same period in 2006 were:

 

                  An increase in net investment income driven by a combination of a higher average investment balances and average investment yields across our investment portfolio.

 

                  Additional underwriting income in our reinsurance segment, primarily due to increased net favorable prior period reserve development.

 

These favorable factors were partially offset by higher interest and income tax expenses and lower foreign exchange gains (all included in other revenues and expenses).

 

23



 

Underwriting Results

 

Premiums: Gross and net premiums written by segment were as follows:

 

 

 

Gross Premiums Written

 

 

 

Three months ended September 30

 

Nine months ended September 30

 

 

 

2007

 

2006

 

Change

 

2007

 

2006

 

Change

 

Insurance

 

$

480,729

 

$

453,116

 

6

%

$

1,529,888

 

$

1,519,771

 

1

%

Reinsurance

 

274,495

 

281,794

 

(3

)%

1,487,337

 

1,375,259

 

8

%

Total

 

$

755,224

 

$

734,910

 

3

%

$

3,017,225

 

$

2,895,030

 

4

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

% ceded

 

 

 

 

 

 

 

 

 

 

 

 

 

Insurance

 

34

%

29

%

5

%

34

%

31

%

3

%

Reinsurance

 

2

%

0

%

2

%

1

%

1

%

0

%

Total

 

23

%

18

%

5

%

18

%

16

%

2

%

 

 

 

Net Premiums Written

 

 

 

Three months ended September 30

 

Nine months ended September 30

 

 

 

2007

 

2006

 

Change

 

2007

 

2006

 

Change

 

Insurance

 

$

315,605

 

$

323,618

 

(2

)%

$

1,004,536

 

$

1,053,794

 

(5

)%

Reinsurance

 

268,297

 

282,295

 

(5

)%

1,474,066

 

1,365,179

 

8

%

Total

 

$

583,902

 

$

605,913

 

(4

)%

$

2,478,602

 

$

2,418,973

 

2

%

 

The increase in gross premiums written in the third quarter of 2007 over the same quarter in 2006 was related to the expansion of our professional lines and political risk insurance businesses. This was partially offset by a reduction in catastrophe reinsurance business which was largely due to the fact that in 2006 we reallocated catastrophe capacity from the beginning of the year to mid-year to take advantage of stronger mid-year pricing. The year-to-date increase in gross premiums written was driven by our increased participation in the U.S and European reinsurance markets, mainly during the January 1 renewal season. Approximately 3.6 percentage points of the increase in reinsurance for the nine months related to the impact of exchange rate movements.

 

The increase in premiums ceded in the three and nine months ended September 30, 2007 compared to the same periods of 2006 largely relates to business mix changes and additional cover purchased in our insurance segment.

 

Net premiums earned by segment were as follows:

 

 

 

Net Premiums Earned

 

 

 

Three months ended September 30

 

Nine months ended September 30

 

 

 

2007

 

%

 

2006

 

%

 

2007

 

%

 

2006

 

%

 

Insurance

 

$

301,925

 

44

%

$

327,701

 

47

%

$

915,102

 

44

%

$

973,985

 

49

%

Reinsurance

 

383,920

 

56

%

365,079

 

53

%

1,149,988

 

56

%

1,031,488

 

51

%

Total

 

$

685,845

 

100

%

$

692,780

 

100

%

$

2,065,090

 

100

%

$

2,005,473

 

100

%

 

Changes in net premiums earned reflect period to period changes in net premiums written and business mix, together with normal variability in premium earning patterns. Although net premiums earned were relatively stable in the three and nine months ended September 30, 2007 compared to the same periods in 2006, we experienced a shift in mix from insurance to reinsurance business. Our reinsurance segment benefited from continued growth, as discussed above, while changes in business mix and an expansion of our reinsurance coverage had the effect of reducing net premiums earned in our insurance segment.

 

24



 

Loss ratio: The tables below show the components of our net loss and loss expense ratio (“loss ratio”) for the periods indicated:

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 30

 

September 30

 

 

 

2007

 

2006

 

2007

 

2006

 

Current year

 

59.9

%

61.0

%

64.2

%

63.8

%

Prior period development

 

(12.0

)%

(8.2

)%

(11.9

)%

(9.1

)%

Loss ratio

 

47.9

%

52.8

%

52.3

%

54.7

%

 

Our current year loss ratio can vary from period to period depending on a number of variables that include the level of estimated losses, changes in our mix of business and changes in the benchmark assumptions used to establish our loss ratios. These benchmarks are developed by our independent actuaries primarily using broader market data that is adjusted for changes in underlying rates, terms and conditions.

 

Prior period development was the net favorable result of several underlying reserve developments from prior accident years, identified during our quarterly reserving process. The following tables present our prior period development by segment for the periods indicated:

 

 

Three months ended

 

Nine months ended

 

 

 

September 30

 

September 30

 

 

 

2007

 

2006

 

2007

 

2006

 

Insurance

 

$

58,607

 

$

27,940

 

$

143,148

 

$

152,073

 

Reinsurance

 

23,585

 

28,626

 

101,828

 

30,033

 

Total

 

$

82,192

 

$

56,566

 

$

244,976

 

$

182,106

 

 

For further detail on the prior period development refer to the segment discussions below. While we believe that our loss reserves at September 30, 2007 are adequate, new information may lead to future developments in ultimate loss and loss expenses significantly greater or less than the reserves currently provided. In addition, conditions and trends that affected the development of liabilities in the past may not necessarily occur in the future. Accordingly, it is inappropriate to anticipate future redundancies or deficiencies based on historical experience.

 

General and Administrative ratio: The increases in our general and administrative ratio reflect the costs associated with supporting the growth of our business. In particular, we incurred higher staffing costs in 2007 relating to the expansion of our insurance operations in the U.S., including those related to our acquisition of the Media Pro business in the second quarter.

 

25



 

Net Investment Income and Net Realized Investment Losses

 

Our investment portfolio is structured to preserve capital and provide us with a high level of liquidity. Additionally, we invest our portfolio with a focus on total return rather than establishing yield or income targets.

 

The following table provides a breakdown of net investment income and net realized investment losses for the periods indicated:

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 30

 

September 30

 

 

 

2007

 

2006

 

Change

 

2007

 

2006

 

Change

 

Interest income on fixed maturity investments

 

$

94,902

 

$

76,609

 

24

%

$

264,902

 

$

215,385

 

23

%

Interest income on cash and cash equivalents

 

25,280

 

20,870

 

21

%

71,512

 

51,850

 

38

%

Investment income on other investments

 

1,856

 

3,446

 

(46

)%

30,523