UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
[X]
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES | |
| EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended June 30, 2004
OR
[ ]
|
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Transition Period From to
000-50511
Commission File Number
UNITED NATIONAL GROUP, LTD.
| Cayman Islands | ||
| (State or other jurisdiction | 98-0417107 | |
| of incorporation or organization) | (I.R.S. Employer Identification No.) |
WALKER HOUSE, 87 MARY STREET
P.O. BOX 908GT
GEORGE TOWN, GRAND CAYMAN
CAYMAN ISLANDS
(Address of principal executive office including zip code)
(345) 949-0100
(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 for 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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). YES [ ] NO [X]
As of August 13, 2004, the registrant had outstanding 15,571,684 Class A Common Shares and 12,687,500 Class B Common Shares.
TABLE OF CONTENTS
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| CEO CERTIFICATION PURSUANT TO SECTION 302 | ||||||||
| CFO CERTIFICATION PURSUANT TO SECTION 302 | ||||||||
| CEO CERTIFICATION PURSUANT TO SECTION 906 | ||||||||
| CFO CERTIFICATION PURSUANT TO SECTION 906 | ||||||||
As used in this quarterly report, unless the context requires otherwise, (1) “United National Group” refers to United National Group, Ltd., an exempted company incorporated with limited liability under the laws of the Cayman Islands; (2) “we,” “us” and “our” refer to United National Group and its subsidiaries as a whole; (3) our “U.S. Operations” refers to the insurance and related operations conducted by American Insurance Service, Inc. and its subsidiaries, including American Insurance Adjustment Agency, Inc., Diamond State Insurance Company, J.H. Ferguson & Associates, LLC, United National Casualty Insurance Company, United National Insurance Company and United National Specialty Insurance Company; (4) our “U.S. Insurance Subsidiaries” refers to United National Insurance Company, Diamond State Insurance Company, United National Specialty Insurance Company and United National Casualty Insurance Company; (5) “U.N. Barbados” refers to Wind River Insurance Company (Barbados) Ltd.; (6) “U.N. Bermuda” refers to Wind River Insurance Company, Ltd.; (7) our “Non-U.S. Operations” refers to the insurance and reinsurance and related operations of U.N. Barbados and U.N. Bermuda; (8) “Fox Paine & Company” refers to Fox Paine & Company, LLC and affiliated investment funds; and (9) “$” or “dollars” refers to U.S. dollars.
2
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
UNITED NATIONAL GROUP, LTD.
Consolidated Balance Sheets
| (Unaudited) | ||||||||
| Successor | Successor | |||||||
| as of | as of | |||||||
| June 30, 2004 |
December 31, 2003 |
|||||||
ASSETS |
||||||||
Bonds: |
||||||||
Available for sale securities, at fair value (amortized cost: $591,538 and $540,543) |
$ | 592,565 | $ | 549,966 | ||||
Preferred shares: |
||||||||
Available for sale securities, at fair value (cost: $4,838 and $4,372) |
5,054 | 4,894 | ||||||
Common shares: |
||||||||
Available for sale securities, at fair value (cost: $31,916 and $30,762) |
34,904 | 33,219 | ||||||
Other invested assets |
49,165 | 45,434 | ||||||
Total investments |
681,688 | 633,513 | ||||||
Cash and cash equivalents |
158,364 | 214,796 | ||||||
Agents’ balances, net |
47,515 | 62,374 | ||||||
Reinsurance receivables, net |
1,699,168 | 1,762,988 | ||||||
Accrued investment income |
6,678 | 5,909 | ||||||
Federal income taxes receivable |
5,986 | 4,898 | ||||||
Deferred federal income taxes, net |
28,812 | 25,323 | ||||||
Deferred acquisition costs, net |
20,154 | 8,581 | ||||||
Prepaid reinsurance premiums |
73,372 | 117,936 | ||||||
Other assets |
14,099 | 12,443 | ||||||
Total assets |
$ | 2,735,836 | $ | 2,848,761 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY |
||||||||
Liabilities: |
||||||||
Unpaid losses and loss adjustment expenses |
$ | 1,995,936 | $ | 2,059,760 | ||||
Unearned premiums |
154,824 | 177,408 | ||||||
Amounts held for the account of others |
16,768 | 20,201 | ||||||
Ceded balances payable |
26,996 | 59,876 | ||||||
Contingent commissions |
4,354 | 5,178 | ||||||
Senior notes payable to related party |
72,848 | 72,848 | ||||||
Junior subordinated debentures |
30,929 | 30,929 | ||||||
Other liabilities |
31,631 | 41,769 | ||||||
Total liabilities |
2,334,286 | 2,467,969 | ||||||
Commitments and contingencies (Note 6) |
— | — | ||||||
Shareholders’ equity: |
||||||||
Common shares, $0.0001 par value, 900,000,000 common
shares authorized, 15,571,684 and 15,105,503 Class A
common shares issued and outstanding and 12,687,500
Class B common shares issued and outstanding |
3 | 3 | ||||||
Preferred shares, $0.0001 par value, 100,000,000
shares authorized, none issued and outstanding |
— | — | ||||||
Additional paid-in capital |
356,302 | 347,487 | ||||||
Accumulated other comprehensive income |
6,449 | 10,031 | ||||||
Retained earnings |
38,796 | 23,271 | ||||||
Total shareholders’ equity |
401,550 | 380,792 | ||||||
Total liabilities and shareholders’ equity |
$ | 2,735,836 | $ | 2,848,761 | ||||
See accompanying notes to consolidated financial statements.
3
UNITED NATIONAL GROUP, LTD.
Consolidated Statements of Operations
(Dollars in thousands, except per share data)
| (Unaudited) | (Unaudited) | (Unaudited) | (Unaudited) | |||||||||||||
| Successor | Predecessor | Successor | Predecessor | |||||||||||||
| Quarter Ended | Quarter Ended | Six Months Ended | Six Months Ended | |||||||||||||
| June 30, 2004 |
June 30, 2003 |
June 30, 2004 |
June 30, 2003 |
|||||||||||||
Revenues: |
||||||||||||||||
Gross premiums written |
$ | 88,138 | $ | 148,493 | $ | 206,076 | $ | 362,953 | ||||||||
Net premiums written |
$ | 68,183 | $ | 45,825 | $ | 126,800 | $ | 99,461 | ||||||||
Net premiums earned |
$ | 59,396 | $ | 47,784 | $ | 104,818 | $ | 94,397 | ||||||||
Net investment income |
4,417 | 4,045 | 8,627 | 9,329 | ||||||||||||
Net realized investment gains |
463 | 4,505 | 393 | 3,116 | ||||||||||||
Total revenues |
64,276 | 56,334 | 113,838 | 106,842 | ||||||||||||
Losses and Expenses: |
||||||||||||||||
Net losses and loss adjustment expenses |
33,383 | 29,015 | 61,526 | 61,846 | ||||||||||||
Acquisition costs and other underwriting expenses |
21,608 | 12,397 | 35,128 | 20,733 | ||||||||||||
Provision for doubtful reinsurance receivables |
— | 875 | — | 1,750 | ||||||||||||
Other operating expenses (income) |
490 | (77 | ) | 1,004 | 367 | |||||||||||
Interest expense |
1,394 | 9 | 2,709 | 12 | ||||||||||||
Income before income taxes |
7,401 | 14,115 | 13,471 | 22,134 | ||||||||||||
Income tax (benefit) expense |
(668 | ) | 3,628 | (1,437 | ) | 5,012 | ||||||||||
Net income before equity in net income of partnerships |
8,069 | 10,487 | 14,908 | 17,122 | ||||||||||||
Equity in net income of partnerships |
38 | 1,074 | 617 | 1,487 | ||||||||||||
Net income |
$ | 8,107 | $ | 11,561 | $ | 15,525 | $ | 18,609 | ||||||||
Per share data: |
||||||||||||||||
Net income: |
||||||||||||||||
Basic |
$ | 0.29 | $ | 115,610 | $ | 0.55 | $ | 186,090 | ||||||||
Diluted |
$ | 0.28 | $ | 115,610 | $ | 0.54 | $ | 186,090 | ||||||||
Weighted-average number of shares outstanding: |
||||||||||||||||
Basic |
28,257,184 | 100 | 28,238,564 | 100 | ||||||||||||
Diluted |
28,823,086 | 100 | 28,854,740 | 100 | ||||||||||||
See accompanying notes to consolidated financial statements.
4
UNITED NATIONAL GROUP, LTD.
| (Unaudited) | (Unaudited) | (Unaudited) | (Unaudited) | |||||||||||||
| Successor | Predecessor | Successor | Predecessor | |||||||||||||
| Quarter Ended | Quarter Ended | Six Months Ended | Six Months Ended | |||||||||||||
| June 30, 2004 |
June 30, 2003 |
June 30, 2004 |
June 30, 2003 |
|||||||||||||
Net income |
$ | 8,107 | $ | 11,561 | $ | 15,525 | $ | 18,609 | ||||||||
Other comprehensive income (loss) before tax: |
||||||||||||||||
Unrealized gains (losses) on securities: |
||||||||||||||||
Unrealized holding gains (losses) arising during period |
(11,544 | ) | (867 | ) | (5,768 | ) | (825 | ) | ||||||||
Less: |
||||||||||||||||
Reclassification adjustment for gains (losses) included
in net income |
464 | (7,189 | ) | 173 | (7,914 | ) | ||||||||||
Other comprehensive income (loss), before tax |
(12,008 | ) | 6,322 | (5,941 | ) | 7,089 | ||||||||||
Income tax expense (benefit) related to items of other
comprehensive income |
(4,084 | ) | 2,215 | (2,359 | ) | 2,483 | ||||||||||
Other comprehensive income (loss), net of tax |
(7,924 | ) | 4,107 | (3,582 | ) | 4,606 | ||||||||||
Comprehensive income, net of tax |
$ | 183 | $ | 15,668 | $ | 11,943 | $ | 23,215 | ||||||||
See accompanying notes to consolidated financial statements.
5
UNITED NATIONAL GROUP, LTD.
| (Unaudited) | Successor | Predecessor | ||||||||||
| Successor | September 6, 2003 | January 1, 2003 | ||||||||||
| Six Months Ended | through | through | ||||||||||
| June 30, 2004 |
December 31, 2003 |
September 5, 2003 |
||||||||||
Common shares: |
||||||||||||
Number at beginning of period |
27,793,003 | 10,000,000 | 100 | |||||||||
Class A common shares issued in acquisition |
— | 2,500,000 | — | |||||||||
Class A common shares issued under stock
purchase plan |
— | 245,208 | — | |||||||||
Class A common shares issued in IPO |
462,500 | 10,750,000 | ||||||||||
Class A common shares issued in redemption of
Series A preferred shares |
— | 1,610,295 | — | |||||||||
Class A common shares issued to directors |
3,681 | — | — | |||||||||
Class B common shares issued in exchange for
Series A preferred shares |
— | 2,687,500 | — | |||||||||
Number at end of period |
28,259,184 | 27,793,003 | 100 | |||||||||
Common shares: |
||||||||||||
Balance at beginning of period |
$ | 3 | $ | 1 | $ | — | ||||||
Class A common shares issued in IPO |
— | 2 | — | |||||||||
Balance at end of period |
$ | 3 | $ | 3 | $ | — | ||||||
Preferred shares: |
— | |||||||||||
Number at beginning of period |
— | 14,000,000 | — | |||||||||
Preferred shares issued in acquisition |
— | 3,500,000 | — | |||||||||
Preferred shares redeemed |
— | (15,000,000 | ) | — | ||||||||
Preferred shares exchanged for Class B common
shares |
— | (2,500,000 | ) | — | ||||||||
Number at end of period |
— | — | — | |||||||||
Preferred shares: |
||||||||||||
Balance at beginning of period |
$ | — | $ | 2 | $ | — | ||||||
Preferred shares redeemed |
— | (2 | ) | — | ||||||||
Preferred
shares exchanged for Class B common shares |
— | — | — | |||||||||
Balance at end of period |
$ | — | $ | — | $ | — | ||||||
Additional paid-in capital: |
||||||||||||
Balance at beginning of period |
$ | 347,487 | $ | 239,997 | $ | 81,186 | ||||||
Preferred share dividends |
— | 29,250 | — | |||||||||
Preferred shares redeemed |
— | (149,998 | ) | — | ||||||||
Contributed capital from preferred shares |
— | 35,000 | — | |||||||||
Contributed capital from common shares |
7,312 | 193,238 | 5,638 | |||||||||
Other |
1,503 | — | — | |||||||||
Balance at end of period |
$ | 356,302 | $ | 347,487 | $ | 86,824 | ||||||
Accumulated other comprehensive income net of
deferred income tax: |
||||||||||||
Balance at beginning of period |
$ | 10,031 | $ | — | $ | 7,329 | ||||||
Other comprehensive income (loss) |
(3,582 | ) | 10,031 | (1,962 | ) | |||||||
Balance at end of period |
$ | 6,449 | $ | 10,031 | $ | 5,367 | ||||||
Retained earnings: |
||||||||||||
Balance at beginning of period |
$ | 23,271 | $ | — | $ | 180,122 | ||||||
Net income |
15,525 | 52,521 | 24,604 | |||||||||
Preferred share dividends |
— | (29,250 | ) | — | ||||||||
Balance at end of period |
$ | 38,796 | $ | 23,271 | $ | 204,726 | ||||||
Total shareholders’ equity |
$ | 401,550 | $ | 380,792 | $ | 296,917 | ||||||
See accompanying notes to consolidated financial statements.
6
UNITED NATIONAL GROUP, LTD.
Consolidated Statements of Cash Flows
(Dollars in thousands)
| (Unaudited) | (Unaudited) | |||||||
| Successor | Predecessor | |||||||
| Six Months Ended | Six Months Ended | |||||||
| June 30, 2004 |
June 30, 2003 |
|||||||
Cash flows from operating activities: |
||||||||
Net income |
$ | 15,525 | $ | 18,609 | ||||
Adjustments to reconcile net income to net cash
(used for) provided by operating activities: |
||||||||
Amortization of debt issuance costs |
90 | — | ||||||
Restricted stock expense |
242 | — | ||||||
Deferred federal income taxes |
(1,448 | ) | (1,188 | ) | ||||
Amortization of bond premium and discount, net |
1,499 | 1,181 | ||||||
Net realized investment gains |
(393 | ) | 2,453 | |||||
Equity in income of partnerships |
(617 | ) | (1,487 | ) | ||||
Unrealized loss on trading securities |
— | (5,568 | ) | |||||
Provision for doubtful reinsurance receivables |
— | 1,750 | ||||||
Proceeds from sale or maturity of trading securities |
— | 6,825 | ||||||
Purchase of trading securities |
— | (8,197 | ) | |||||
Changes in: |
||||||||
Agents’ balances |
14,859 | (11,709 | ) | |||||
Reinsurance receivables |
63,820 | (110,431 | ) | |||||
Unpaid losses and loss adjustment expenses |
(63,824 | ) | 129,306 | |||||
Unearned premiums |
(22,584 | ) | (31,455 | ) | ||||
Ceded balances payable |
(32,880 | ) | 10,408 | |||||
Other liabilities |
(8,877 | ) | (32,992 | ) | ||||
Amounts held for the account of others |
(3,433 | ) | 1,068 | |||||
Contingent commissions |
(824 | ) | 1,435 | |||||
Federal income tax receivable |
(1,088 | ) | 10,364 | |||||
Prepaid reinsurance premiums |
44,564 | 36,519 | ||||||
Deferred acquisition costs, net |
(11,573 | ) | (1,807 | ) | ||||
Payable for securities |
— | (3,888 | ) | |||||
Other - net |
(1,908 | ) | 340 | |||||
Net cash (used for) provided by operating activities |
(8,850 | ) | 11,536 | |||||
Cash flows from investing activities: |
||||||||
Proceeds from sale of bonds and stocks |
385,792 | 63,772 | ||||||
Proceeds from maturity of bonds |
3,200 | 2,500 | ||||||
Proceeds from sale of other invested assets |
587 | 4,973 | ||||||
Purchase of bonds and stocks |
(443,484 | ) | (82,932 | ) | ||||
Proceeds from sale or repayment of mortgages |
— | 8 | ||||||
Proceeds from sale of mortgage |
— | 1,166 | ||||||
Purchase of other invested assets |
(989 | ) | (2,256 | ) | ||||
Net cash (used for) provided by investing activities |
(54,894 | ) | (12,769 | ) | ||||
Cash flows from financing activities: |
||||||||
Borrowing under credit facility |
— | 4,650 | ||||||
Repayments of credit facility |
— | (4,650 | ) | |||||
Net proceeds from IPO of common shares |
7,312 | — | ||||||
Net cash provided by financing activities |
7,312 | — | ||||||
Net change in cash and cash equivalents |
(56,432 | ) | (1,233 | ) | ||||
Cash and cash equivalents at beginning of period |
214,796 | 72,942 | ||||||
Cash and cash equivalents at end of period |
$ | 158,364 | $ | 71,709 | ||||
See accompanying notes to consolidated financial statements.
7
UNITED NATIONAL GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of United National Group, Ltd. and its direct and indirect wholly-owned subsidiaries (“United National Group” or the “Company”): Wind River Insurance Company (Barbados) Ltd. (“U.N. Barbados”), Wind River Insurance Company, Ltd. (“U.N. Bermuda”), U.N. Holdings II, Inc., U.N. Holdings Inc., Wind River Investment Corporation, American Insurance Service, Inc. (“AIS”), American Insurance Adjustment Agency, Inc. (“AIAA”), International Underwriters, Inc. (“IUI”), Unity Risk Partners Insurance Services, Inc. (“URP”), United National Insurance Company (“UNIC”), Diamond State Insurance Company (“Diamond State”), United National Specialty Insurance Company (“United National Specialty”), United National Casualty Insurance Company (“United National Casualty”) and J.H. Ferguson & Associates, LLC (“J.H. Ferguson”). All significant intercompany balances and transactions have been eliminated in consolidation.
The Company acquired all of the outstanding common stock of Wind River Investment Corporation and its subsidiaries (“Wind River” or the “Predecessor”) on September 5, 2003 (the “Acquisition”). As a result of the Acquisition, the capital structure and basis of accounting of the Company differ from those of Wind River prior to the Acquisition. Therefore, the financial data with respect to periods prior to the Acquisition (“Predecessor” period) may not be comparable to data for periods subsequent to the Acquisition (“Successor” period).
The consolidated financial statements as of June 30, 2004 and for the quarter and six months ended June 30, 2004 and 2003 are unaudited, but in the opinion of management have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and on the same basis as the annual audited consolidated financial statements. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The consolidated financial statements include all adjustments that are, in the opinion of management, necessary for a fair statement of results for the interim periods. Results of operations for the quarter and six months ended June 30, 2004 and 2003 are not necessarily indicative of the results of a full year. The accompanying notes to the consolidated financial statements should be read in conjunction with the notes to the consolidated financial statements contained in the Company’s 2003 Annual Report on Form 10-K.
Certain prior period amounts have been reclassified to conform to current period presentation.
(2) Investments
Assets of $411.0 million and $294.7 million as of June 30, 2004 and December 2003, respectively, were on deposit or subject to trusts to meet statutory and other regulatory requirements enacted by states or stipulated by the insurance departments. Assets on deposit or subject to trusts included cash of $54.9 million and $1.9 million and bonds with estimated fair values of $356.1 million and $292.8 million as of June 30, 2004 and December 31, 2003, respectively. In addition, bonds with an estimated fair market value of $5.4 million at June 30, 2004 and December 31, 2003 were held in a trust fund to meet the regulatory requirements of U.N. Bermuda.
The carrying amounts for the Company’s investments approximate their estimated fair value. The Company measures the fair value of investments in bonds and stocks based upon quoted market prices. Other invested assets are comprised primarily of limited liability partnership interests. Partnership interests of 3% ownership or greater are accounted for under the equity method. Partnership interests of less than 3% ownership are carried at their fair value.
The Company’s investments are regularly evaluated to determine if declines in market value below cost are other than temporary. If market value declines are determined to be other than temporary, the security’s cost basis is adjusted to the market value of the security, with the loss recognized in the current period. During the quarter and six months ended June 30, 2003, the Company recorded other than temporary impairment losses of $1.9 million on its bond portfolio and $0.7 million on its investments in limited partnerships. There were no realized losses recorded for the quarter and six months ended June 30, 2004 as a result of the Company’s other than temporary impairment evaluation.
8
(3) Reinsurance
The Company cedes insurance to unrelated insurers in the ordinary course of business to limit its net loss exposure. In addition, there are excess of loss contracts that protect against losses over stipulated amounts. Reinsurance ceded arrangements do not discharge the Company of primary liability as the originating insurer.
As of June 30, 2004, the Company had total reinsurance receivables of $1,699.2 million, including $62.0 million of reinsurance receivables related to paid losses. The carrying value of the receivables is net of a $32.6 million reduction, which is equal to an estimate of potentially uncollectible reinsurance receivables. The Company’s estimate of potentially uncollectible receivables, which was $49.1 million at the date of the Acquisition, has been reduced to $32.6 million as of June 30, 2004 primarily as a result of the commutation agreement with Trenwick America Reinsurance Corp. on October 29, 2003. As of December 31, 2003, the Company had net reinsurance receivables of $1,763.0 million, net of a $33.7 million reduction related to potentially uncollectible receivables.
The U.S. Insurance Subsidiaries have entered into a quota share arrangement with U.N. Barbados and U.N. Bermuda. This reinsurance arrangement stipulates that 60% of the Company’s net retained insurance liability on new and renewal business bound January 1, 2004 and later be ceded to the Company’s Non-U.S. Operations. The agreement also stipulates that 60% of the December 31, 2003 unearned premium be ceded to the Company’s Non-U.S. Operations.
(4) Federal Income Taxes
The following table summarizes the differences between the effective tax rate for financial statement purposes and the U.S. federal statutory rate:
| Successor | Predecessor | |||||||||||||||
| Quarter Ended | Quarter Ended | |||||||||||||||
| June 30, 2004 |
June 30, 2003 |
|||||||||||||||
| % of Pre- | % of Pre- | |||||||||||||||
| (Dollars in thousands) |
Amount |
Tax Income |
Amount |
Tax Income |
||||||||||||
Expected tax expense at the U. S. statutory rate |
$ | 2,590 | 35.0 | % | $ | 4,940 | 35.0 | % | ||||||||
Adjustments: |
||||||||||||||||
Tax exempt interest |
(1,123 | ) | (15.2 | ) | (1,296 | ) | (9.2 | ) | ||||||||
Foreign income not expected to be taxed in the
U.S. |
(2,347 | ) | (31.7 | ) | — | — | ||||||||||
Dividend exclusion |
(31 | ) | (0.4 | ) | (34 | ) | (0.2 | ) | ||||||||
Other |
&nbs | |||||||||||||||