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
(Registrants 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
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PART I. FINANCIAL INFORMATION |
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4 |
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Managements Discussion and Analysis of Financial Condition and Results of Operations |
22 |
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40 |
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40 |
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41 |
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41 |
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41 |
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42 |
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43 |
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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, Managements 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 |
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6 |
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7 |
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8 |
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9 |
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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 |
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||
Total assets |
|
$ |
14,711,904 |
|
$ |
13,665,287 |
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Liabilities |
|
|
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|
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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 |
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||
Securities lending payable |
|
858,546 |
|
791,744 |
|
||
Senior notes |
|
499,234 |
|
499,144 |
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Liability under repurchase agreement |
|
|
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400,000 |
|
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Net payable for investments purchased |
|
49,023 |
|
62,185 |
|
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Other liabilities |
|
140,869 |
|
174,524 |
|
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Total liabilities |
|
9,768,312 |
|
9,252,640 |
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|
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Shareholders Equity |
|
|
|
|
|
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Preferred shares - Series A and B |
|
$ |
500,000 |
|
$ |
500,000 |
|
Common shares (2007: 147,936; 2006: 149,982 shares issued) |
|
1,849 |
|
1,875 |
|
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Additional paid-in capital |
|
1,859,067 |
|
1,929,406 |
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Accumulated other comprehensive loss |
|
(28,444 |
) |
(44,638 |
) |
||
Retained earnings |
|
2,690,742 |
|
2,026,004 |
|
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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
|
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Three months ended |
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Nine months ended |
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2007 |
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2006 |
|
2007 |
|
2006 |
|
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(in thousands, except per share amounts) |
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||||||||||
Revenues |
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Net premiums earned |
|
$ |
685,845 |
|
$ |
692,780 |
|
$ |
2,065,090 |
|
$ |
2,005,473 |
|
Net investment income |
|
118,908 |
|
98,787 |
|
357,873 |
|
284,018 |
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Net realized investment losses |
|
(1,192 |
) |
(1,722 |
) |
(5,548 |
) |
(22,428 |
) |
||||
Other insurance related income |
|
1,005 |
|
804 |
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3,638 |
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1,866 |
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Total revenues |
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804,566 |
|
790,649 |
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2,421,053 |
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2,268,929 |
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Expenses |
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Net losses and loss expenses |
|
328,193 |
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365,958 |
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1,079,714 |
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1,096,598 |
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Acquisition costs |
|
100,039 |
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103,615 |
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293,923 |
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295,151 |
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General and administrative expenses |
|
79,813 |
|
68,470 |
|
210,993 |
|
181,538 |
|
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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 |
|
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Total expenses |
|
514,772 |
|
549,020 |
|
1,611,394 |
|
1,572,499 |
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Income before income taxes |
|
289,794 |
|
241,629 |
|
809,659 |
|
696,430 |
|
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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 |
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|
||||
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 |
|
||||
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|
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|
||||
Earnings per common share: |
|
|
|
|
|
|
|
|
|
||||
Basic |
|
$ |
1.84 |
|
$ |
1.51 |
|
$ |
5.04 |
|
$ |
4.31 |
|
Diluted |
|
$ |
1.65 |
|
$ |
1.37 |
|
$ |
4.53 |
|
$ |
3.94 |
|
|
|
|
|
|
|
|
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|
||||
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 enterprises 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 companys 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 cedents 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 Stock |
|
Weighted |
|
Number of |
|
Weighted |
|
||
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 Options |
|
Weighted Price |
|
Number of |
|
Weighted Exercise |
|
||
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. MANAGEMENTS 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 Managements 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 |
|