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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
/x/ Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended December 31, 2003,
or
/ / Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the transition period from to
Commission file number 1-31599
ENDURANCE SPECIALTY HOLDINGS LTD.
(Exact name of registrant as specified in its charter)
Bermuda 98-0392908
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
Wellesley House
90 Pitts Bay Road
Pembroke HM 08, Bermuda
(Address of principal executive offices, including postal code)
Registrant's telephone number, including area code: (441) 278-0400
Securities registered pursuant to Section 12(b) of
the Act:
Name of Each Exchange
Title of Each Class on Which Registered
------------------------------------- --------------------------------
Ordinary Shares, par New York Stock Exchange
value $1.00 per share
Securities registered pursuant to Section 12(g) of the Act: None
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 periods 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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in the definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. / /
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes / / No /x/
The aggregate market value of the ordinary shares held by non-affiliates of the
registrant, as of June 30, 2003, was $1,907,862,750.
As of March 5, 2004, 63,915,000 ordinary shares were outstanding.
Certain portions of the registrant's definitive proxy statement relating to its
2004 annual general meeting of shareholders are incorporated by reference into
Part III of this report and certain portions of the registrant's annual report
to shareholders for the fiscal year ended December 31, 2003 are incorporated by
reference into Parts II and IV of this report.
ENDURANCE SPECIALTY HOLDINGS LTD.
Table of Contents
Page
Item Number
PART I
1. Business.....................................................................................................4
2. Properties..................................................................................................48
3. Legal Proceedings...........................................................................................48
4. Submission of Matters to a Vote of Security Holders.........................................................48
PART II
5. Market for the Registrant's Ordinary Shares and Related Shareholder Matters.................................49
6. Selected Financial Data.....................................................................................50
7. Management's Discussion and Analysis of Financial Condition and Results of Operation........................50
7A. Quantitative and Qualitative Disclosures about Market Risk..................................................50
8. Financial Statements and Supplementary Data.................................................................51
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........................51
9A. Controls and Procedures.....................................................................................51
PART III
10. Directors and Executive Officers of the Registrant..........................................................52
11. Executive Compensation......................................................................................52
12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters..............52
13. Certain Relationships and Related Transactions..............................................................52
14. Principal Accountant Fees and Services......................................................................53
PART IV
15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.............................................54
PART I
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under "Item 1. Business," "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations and
elsewhere in this Annual Report on Form 10-K may include forward-looking
statements which reflect our current views with respect to future events and
financial performance. Such statements include forward-looking statements both
with respect to us in general and the insurance and reinsurance sectors
specifically, both as to underwriting and investment matters. Statements which
include the words "expect," "intend," "plan," "believe," "project,"
"anticipate," "seek," "will," and similar statements of a future or
forward-looking nature identify forward-looking statements for purposes of the
federal securities laws or otherwise.
All forward-looking statements address matters that involve risks and
uncertainties. Accordingly, there are or will be important factors that could
cause actual results to differ materially from those indicated in such
statements. We believe that these factors include, but are not limited to, the
following:
o the effects of competitors' pricing policies, and of changes in
laws and regulations on competition, including industry
consolidation and development of competing financial products;
o the impact of acts of terrorism and acts of war;
o the effects of terrorist related insurance legislation and laws;
o greater frequency or severity of claims and loss activity,
including as a result of natural or man-made catastrophic events,
than our underwriting, reserving or investment practices have
anticipated;
o decreased level of demand for property and casualty insurance or
reinsurance or increased competition due to an increase in
capacity of property and casualty insurers and reinsurers;
o the inability to obtain or maintain financial strength or
claims-paying ratings by one or more of our subsidiaries;
o uncertainties in our reserving process;
o Endurance Specialty Holdings Limited ("Endurance Holdings") or
Endurance Specialty Insurance Limited ("Endurance Bermuda")
becomes subject to income taxes in the United States or the United
Kingdom;
o changes in regulations or tax laws applicable to us, our
subsidiaries, brokers or customers;
o acceptance of our products and services, including new products
and services;
o the inability to renew business previously underwritten or
acquired;
o changes in the availability, cost or quality of reinsurance or
retrocessional coverage;
o loss of key personnel;
o political stability of Bermuda;
o changes in accounting policies or practices; and
o changes in general economic conditions, including inflation,
foreign currency exchange rates, interest rates, and other
factors.
The foregoing review of important factors should not be construed as
exhaustive and should be read in conjunction with the other cautionary
statements that are included in this Annual Report on Form 10-K. We undertake no
obligation to publicly update or review any forward-looking statement, whether
as a result of new information, future developments or otherwise. The
information constitutes forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995.
3
Item 1. Business
Overview
Endurance Holdings is a holding company domiciled in Bermuda. Through our
operating subsidiaries based in Bermuda, the United Kingdom and the United
States, we focus on underwriting specialty lines of personal and commercial
property and casualty insurance and reinsurance on a global basis. We define
specialty lines as those lines of insurance and reinsurance that require
dedicated, specialized underwriting skills and resources in order to be
profitably underwritten. Our portfolio of specialty lines of business is
organized into the following segments: property per risk treaty reinsurance,
property catastrophe reinsurance, casualty treaty reinsurance, property
individual risk, casualty individual risk and aerospace and other specialty
lines.
We seek to create a portfolio of specialty lines which are profitable and
have limited correlation with one another. We believe that a well constructed
portfolio of diversified risks will produce less volatile results than each of
the individual lines of business independently, allow for greater capital
efficiency and provide a superior risk-adjusted return on capital. We identify
and underwrite attractive insurance and reinsurance business through our
experienced underwriting staff and apply a centralized quantitative framework of
risk analysis across all of our business segments. We produce our business
through the leading worldwide insurance and reinsurance brokers and
intermediaries.
We began operations on December 17, 2001 after Endurance Bermuda
completed a private placement of $1.2 billion of its equity securities. Initial
investors in Endurance Bermuda included Aon Corporation ("Aon"), Zurich
Financial Services Group ("Zurich"), Thomas H. Lee Partners, L.P., Texas Pacific
Group, Capital Z Financial Services Fund II, L.P., Perry Capital, Metro Center
Investments Pte Ltd., General Motors Asset Management, Lightyear Capital, Credit
Suisse First Boston Private Equity, Golden Gate Capital, Reservoir Capital and
TIAA CREF. Since our inception in December, 2001, we have been able to achieve
significant success in the development of our business. Our accomplishments
include:
o building our business from a startup in 2001 to $1.6 billion in
gross premiums and $263.4 million in net income for the year ended
December 31, 2003;
o generating an 18.4% return on average equity for the year ended
December 31, 2003;
o successfully launching multiple specialty business segments;
o building a substantial client base around the world;
o recruiting a highly experienced management team and building a
staff of approximately 250;
o licensing insurance subsidiaries in Bermuda, the United Kingdom
and the United States;
o acquiring renewal rights to the property catastrophe business of
LaSalle Re Limited ("LaSalle");
o acquiring renewal rights to the majority of the reinsurance
business of The Hartford Fire Insurance Company and HartRe
Company, L.L.C. (collectively, "HartRe");
o establishing a $192 million multi-year term loan facility and a
$108 million one-year revolving credit facility that was expanded
to a $500 million letter of credit and revolving credit facility;
and
o successfully completing our initial public offering in February
2003 and obtaining a NYSE listing.
Current conditions in the global insurance and reinsurance markets
continue to present an attractive opportunity for us to deploy our capital. Many
global property and casualty insurers and reinsurers are currently experiencing
significantly reduced capital resulting from several years of excessively
competitive pricing, expanding coverage terms, significant increases in losses
from asbestos liability, under-reserving and poor investment performance. In
addition, Standard & Poor's and A.M. Best have lowered the financial strength
ratings of a significant number of reinsurers in 2002 and 2003, further reducing
available reinsurance capacity with sufficient financial security.
4
Endurance Specialty Insurance Ltd. ("Endurance Bermuda")
Endurance Bermuda was incorporated on November 30, 2001. Endurance
Bermuda is registered with the Bermuda Monetary Authority ("BMA") as a Class 4
Bermuda insurance and reinsurance company. Among other matters, Bermuda
statutes, regulations and policies of the BMA require Endurance Bermuda to
maintain minimum levels of statutory capital, statutory capital and surplus, and
liquidity to meet solvency standards, to obtain prior approval of ownership and
transfer of shares and to submit to certain periodic examinations of its
financial condition. Endurance Bermuda, headquartered in Pembroke, Bermuda,
focuses on property and casualty insurance and reinsurance business that is of a
low frequency, high severity nature. Endurance Bermuda is headed by Thomas D.
Bell.
Endurance Worldwide Insurance Limited ("Endurance U.K.")
Endurance U.K. was incorporated on April 10, 2002. On December 4, 2002,
Endurance U.K. was authorized by the FSA to begin writing certain lines of
insurance and reinsurance in the United Kingdom. Endurance U.K., which is
headquartered in London, is able to operate throughout the European Union,
subject to compliance with certain notification requirements of the FSA and in
some cases, certain local regulatory requirements, and will focus on the
origination of property and casualty insurance and reinsurance from non-North
American markets. We have capitalized Endurance U.K. with(pound)100 million of
initial capital. Endurance U.K. is headed by Mark W. Boucher.
Endurance Reinsurance Corporation of America ("Endurance U.S.")
Endurance U.S. was incorporated on September 5, 2002. On December 18,
2002, Endurance U.S. received a license in the State of New York from the New
York Department to conduct business as a property and casualty reinsurer.
Certain reinsurance business, known as working layer, is characterized by higher
frequency and lower severity of losses as compared to the type of reinsurance
business targeted by Endurance Bermuda. We believe that this business, which
requires a higher degree of client contact including underwriting, claims,
actuarial and accounting reviews, would be difficult to underwrite from a
Bermuda location. Endurance U.S. focused on such working layer business and
provides us with access to classes of reinsurance business and types of
reinsurance clients which we would not otherwise be able to effectively access
from Bermuda. We initially capitalized Endurance U.S. with $336 million in
equity capital and during 2003 added an additional $135 million of equity
capital. Endurance U.S. is headed by William M. Jewett.
Endurance Services Limited ("Endurance Services")
Endurance Services was incorporated on January 12, 2004. Endurance
Services has been established to provide administrative support to and to
improve operational efficiencies among Endurance Bermuda, Endurance U.S. and
Endurance U.K. Endurance Services is headed by Steven W. Carlsen.
Our Competitive Strengths
We believe certain characteristics distinguish us from our competitors,
including:
o Extensive Specialized Underwriting and Risk Management
Capabilities. We have made significant investments in our
technical capabilities, including hiring 103 experienced
underwriters and an actuarial, risk analysis and modeling staff of
28.
o Underwriting and Risk Management Discipline. We remain highly
selective in our underwriting approach. All of our underwriting
activity is supported by detailed, upfront pricing analyses
through which we seek to limit our exposure to any single contract
and any single geographic or catastrophic peril. In 2003, despite
significant expansion of our business, we provided insurance
quotes on 36.7% of the 8,637 submissions we received. Our
quotation rate in 2002 was similar to that in 2003.
o Experienced Management Team. Our senior management team averages
over 20 years of experience in the insurance and reinsurance
industry and participates in our stock-based compensation plan
that ties compensation to the achievement of goals aligned with
those of our shareholders.
o Strong Market Relationships. The underwriting expertise and
extensive industry relationships previously developed by our
senior management team and underwriters have allowed us to quickly
establish our presence in the global insurance and reinsurance
markets. We have strong relationships with major insurance and
reinsurance brokers, including: Aon, Marsh, Willis, Benfield and
Towers Perrin. In the year ended December 31, 2003, we wrote
business with more than 1,150 clients.
5
o Bermuda-Based Operations. Bermuda is our principal base of
operations. As one of the leading centers of the global insurance
industry, Bermuda provides us with ready access to clients who
increasingly seek Bermuda-based capacity to meet their insurance
and reinsurance needs. Bermuda also has a well developed network
of insurance and reinsurance brokers, an experienced pool of
employees with significant insurance expertise and a responsive
regulatory environment which allows for rapid innovation in
insurance and reinsurance products.
o Conservative Investment Policy. We have a conservative investment
policy aimed at minimizing the volatility of our investment
results. At December 31, 2003, 100% of our invested assets were
held in cash and cash equivalents and fixed maturity securities,
87% of which were rated AAA and 100% were rated A or better, with
an average duration of 3.08 years.
o Excellent Financial Strength. The Company's operating subsidiaries
are rated "A" (Excellent) by A.M. Best and "A-" (Strong) by
Standard & Poor's. We were one of a small number of companies to
be upgraded by A.M. Best in 2003 when we received an upgrade to
"A" ("Excellent"). These ratings reflect A.M. Best's and Standard
& Poor's opinions of our financial strength and are not applicable
to the ordinary shares of the Company are not recommendations to
buy, sell or hold such shares.
o Unencumbered Capital Base. At December 31, 2003, we had total
shareholders' equity capital of approximately $1.6 billion. As a
recently formed company, we are unencumbered by any historical
losses relating to asbestos liabilities, the World Trade Center
tragedy and other pre-December 31, 2001 liability exposures
currently affecting many of our competitors. By choosing to form
and license new subsidiaries rather than assuming unknown
liabilities through the acquisition of existing licensed "shell"
companies, we have no risk that loss reserve development relating
to historical exposures prior to our formation will negatively
impact our future financial results. We believe that our
unencumbered capital will allow us to distinguish ourselves from
many of our competitors and help to attract clients who are
seeking long- term financial stability from their insurers and
reinsurers.
Business Strategy
Our goal is to generate a superior long-term return on capital by
leveraging our competitive strengths and successfully executing our strategy.
The key elements of our strategy are:
o Maintain a Portfolio of Profitable Specialty Lines. We believe
there are significant opportunities in a number of lines of
business in the current market environment. We participate in
those specific specialty lines that we believe have the potential
to offer the highest risk-adjusted return on capital and in which
we believe we can establish a competitive advantage through our
specialized teams of expert underwriters. We intend to use our
ability to participate in multiple lines of business to deploy
capital and resources to the most attractive business lines at the
most opportune times.
o Utilize Monoline Level of Expertise in Each Line of Business. We
have formed teams of highly experienced professionals to manage
each of our specific lines of business. Each team is led by a
senior executive and is supported by highly experienced
underwriting personnel who are specialists in their unique
business line.
o Apply Extensive Technical Analysis to Our Underwriting. We manage
our portfolio of risks through the utilization of catastrophe
modeling and dynamic financial analysis techniques that provide a
quantitative basis for the management of risk aggregation and
correlation. We license a broad array of catastrophe modeling
products available from EQE, AIR and RMS. We have also launched
our own proprietary underwriting risk management system and have
built a proprietary suite of individual contract, portfolio,
capital allocation and market risk management and price monitoring
tools around this system. We proactively monitor market trends to
look for competitive threats to the lines of business in which we
are operating as well as analyze potential new lines that may
provide attractive opportunities.
We require significant amounts of data in our underwriting
process. All major accounts are underwritten with dedicated
actuarial involvement. We avoid writing business for which we
believe sufficient underwriting data is not available, and
therefore, to date have written no qualifying quota shares and
only a limited amount of retrocessional business. We also limit
the use of retrocessional protection, relying upon our
underwriting analysis and portfolio diversification for risk
management purposes.
6
o Maintain an Efficient Expense Structure. We believe an efficient
expense structure will allow us to produce more profitable results
and more easily deploy our resources to those lines of business
that become more attractive as market conditions change. Several
factors contribute to our low cost structure, including our
utilization of variable cost brokerage distribution, our presence
in the Bermuda market which targets large insurance and
reinsurance programs for clients, our current emphasis on high
severity, low frequency lines which can be underwritten by
relatively small teams, and our centralized risk management
structure which limits redundant expenses and systems.
o Proactively Manage Our Capital Base. We actively manage our
capital by allocating resources to underwriting opportunities
which we believe will offer the highest risk-adjusted return on
capital. Over the long term, we will seek to return excess capital
to our shareholders rather than use excess capital to underwrite
business at unattractive pricing levels. We have already
undertaken a number of capital management initiatives including
two acquisitions at prices which were accretive to our earnings,
selective repurchases of our ordinary shares on favorable terms,
and the payment of shareholder dividends.
Business Segments
Our commitment to specialized underwriting requires market knowledge,
analytic capabilities and experience more typically found in monoline companies.
Accordingly, we have organized our company by business segment, under the
direction of managers for each line of business who are recognized leaders in
their respective fields. We support these managers with centralized and state of
the art analytic expertise and technology. Our six business segments and the
related gross premiums written and acquired for the year ended December 31, 2003
are as follows:
Gross Premiums
Written and Acquired % of
Business Segment (in millions) Total
-------------------- -------------------- --------
Property Per Risk Treaty Reinsurance.......... $ 469.3 29.3%
Property Catastrophe Reinsurance.............. 183.6 11.4
Casualty Treaty Reinsurance................... 390.3 24.4
Property Individual Risk...................... 85.9 5.4
Casualty Individual Risk...................... 214.4 13.4
Aerospace and Other Specialty Lines........... 258.5 16.1
------------ ------
Total......................................... $ 1,602.0 100.0%
=========== ======
These segments and their associated lines of business are described in greater
detail below.
Property Per Risk Treaty Reinsurance. Our Property Per Risk Treaty
Reinsurance business segment reinsures individual property risks of ceding
companies on a treaty basis. This segment is comprised of a diversified
portfolio of property per risk reinsurance contracts covering claims from
individual insurance policies issued by our ceding company clients and including
both personal lines and commercial exposures (principally covering buildings,
structures, equipment, contents and time element coverages). Loss exposures in
this segment include the perils of fire, explosion, collapse, riot, vandalism,
wind, tornado, flood and earthquake. This segment is comprised of proportional
and excess of loss reinsurance agreements. Our current mix of business, as
measured by gross premiums written during the year ended December 31, 2003, is
approximately 75% excess of loss and 25% proportional. Currently, 82% of the
exposures reinsured in this segment are in the United States, although we expect
this percentage to gradually decline as we expand our activities in Europe and
the United Kingdom through Endurance U.K. The remaining reinsured risks
represent worldwide exposures, including the United States. This segment is
underwritten by Endurance U.S., Endurance U.K. and Endurance Bermuda. We
currently have 20 underwriters dedicated to this segment.
Because the reinsurance contracts written in this segment are exposed to
losses on an individual policy basis, we underwrite and price the agreements
based on anticipated claims frequency. We use actuarial techniques to examine
our ceding companies' underwriting results as well as the underwriting results
from the ceding companies with comparable books of business and pertinent
industry results. These experience analyses are compared against actuarial
exposure analyses to refine our pricing assumptions. Our pricing also takes into
account our variable and fixed expenses and our assessment of an appropriate
return on the capital required to support each individual contract relative to
our portfolio of risks.
7
Reinsurance contracts that provide coverage through individual underlying
insurance policies may contain significant risk of accumulation of exposures,
both to natural and other perils. Our underwriting process explicitly recognizes
these exposures. Natural perils, such as windstorm, earthquake and flood, are
analyzed through our catastrophe modeling systems. Other perils, such as fire
and terrorism events, are considered on a contract-by-contract basis and
monitored for cumulative aggregate exposure. All of our excess of loss
agreements have occurrence limits and many have limited reinstatement rights.
Proportional contracts can be particularly prone to accumulations of exposure
and losses in catastrophic events. Most of our proportional contracts in force
at December 31, 2003 are also subject to occurrence limits. The only exceptions
made to our occurrence limits requirements are a result of explicit approval by
executive management and have been based on complete and ongoing disclosures by
our ceding companies of the underlying policies. We do not currently write any
qualified quota share agreements emanating from Lloyd's or the London market.
This business segment operates as a subscription market, with the
reinsurance intermediaries seeking participation for specific treaties among a
number of reinsurers. Those reinsurers that ultimately subscribe to any given
treaty participate at substantially the same pricing and terms and conditions.
Our maximum capacity on any one program is $30 million on any one risk and our
average commitment has been approximately $6 million.
Our Property Per Risk Treaty Reinsurance business is produced principally
by Aon, Benfield, Willis and Marsh. Our principal competitors in this segment
include Arch Capital Group Ltd. ("Arch"), Converium Holding AG ("Converium"),
GeneralCologne Re ("General Re"), Montpelier Re Holdings Ltd. ("Montpelier Re"),
Munchener Ruckversicherungs-Gesellschaft Aktiengesellschaft ("Munich Re"),
PartnerRe Ltd. ("PartnerRe"), Transatlantic Reinsurance Company ("Transatlantic
Re") and XL Capital Ltd ("XL").
Property Catastrophe Reinsurance. Our Property Catastrophe Reinsurance
business segment reinsures catastrophic perils for ceding companies on a treaty
basis. Our property catastrophe reinsurance contracts provide protection for
most catastrophic losses that are covered in the underlying insurance policies
written by our ceding company clients. The principal perils in our portfolio
include hurricane, typhoon, earthquake, flood, tornado, hail and fire. This
segment is comprised of reinsurance contracts which incur losses only when
events occur that impact more than one risk or insured. Coverage for other
perils may be negotiated on a case-by-case basis. Protection under property
catastrophe treaties is provided on an occurrence basis, allowing our ceding
company clients to combine losses that have been incurred in any single event
from multiple underlying policies. The multiple claimant nature of property
catastrophe reinsurance requires careful monitoring and control of cumulative
aggregate exposure. This business is only underwritten by Endurance Bermuda. We
have 19 underwriters dedicated to this segment.
We have licensed catastrophe modeling software from all of the principal
firms, including EQE, RMS and AIR. These software tools use exposure data
provided by our ceding company clients to simulate catastrophic losses. We have
high standards for the quality and level of detail of such exposure data and
have an expressed preference for data at the zip code or postal code level. Data
provided at more summary levels, such as counties or CRESTA zones, is
conservatively modeled and effectively surcharged for increased uncertainty. Our
commitment to detailed exposure data precludes significant involvement as a
retrocessionaire in the current market. To date, less than 5% of the gross
written premiums in this segment have been derived from other reinsurers, with
over 95% coming from the catastrophe programs of insurance companies.
Data output from the software described above is incorporated in a
proprietary model for multiple purposes. First, the data output is used to
estimate the amount of reinsurance premium that is required to pay the long-term
expected losses under the proposed contracts. Second, the data output is used to
estimate correlation among the contracts we have written. The degree of
correlation is used to estimate the incremental capital required to support our
participation on each proposed contract, allowing us to calculate a return on
consumed capital. Finally, the data output is used to monitor and control the
Company's cumulative exposure to individual perils across all of our businesses.
Our pricing of property catastrophe reinsurance contracts is based on a
combination of modeled loss estimates, actual ceding company loss history,
surcharges for potential unmodeled exposures, fixed and variable expense
estimates and profit requirements. The profit requirements are based on
incremental capital usage estimates described above and the Company's required
return on consumed capital.
Similar to the Property Per Risk Treaty Reinsurance segment, the Property
Catastrophe Reinsurance market operates on a subscription basis with all
subscribing reinsurers participating at substantially the same pricing, terms
and conditions. Our average attachment point is approximately $215 million.
Generally, our maximum capacity on any one program is $30 million per event.
Our property catastrophe business is diversified geographically. As of
December 31, 2003, approximately 54% of our property catastrophe premium was
associated with exposures in the United States and the remainder from over 20
other countries around the world. Our principal exposures outside the United
States are in the United Kingdom, Europe, Australia, Canada and Japan. Our
estimates of exposures to the major perils in each of these territories are
provided in the "Risk Management" section below.
8
Our Property Catastrophe Reinsurance business is produced primarily by
Aon, Marsh, Willis and Benfield. Our principal competitors in this segment
include ACE Limited ("ACE"), Arch, AXIS Specialty Limited ("AXIS"), IPC Holdings
Ltd. ("IPC"), Montpelier Re, PartnerRe, Renaissance Re Holdings Ltd.
("Renaissance Re") and XL.
Casualty Treaty Reinsurance. Our Casualty Treaty Reinsurance business
segment reinsures third party liability exposures from ceding companies on a
treaty basis. Approximately 80% of the exposures are in the United States, with
the remainder representing worldwide risks, including the United States. The
exposures that we reinsure include automobile liability, professional liability,
directors' and officers' liability, umbrella liability and workers'
compensation. We write severity oriented casualty treaty business such as clash
and high excess workers' compensation in Endurance Bermuda. Most other casualty
treaty business is underwritten by Endurance U.S. We do not currently write
casualty treaty business in Endurance U.K. We have 19 underwriters dedicated to
this segment.
Our customer base includes national, regional and specialty insurance
companies. Due to the potential for long claims payment patterns in the
underlying business, we target ceding companies with strong financial positions.
We look for sophisticated actuarial capabilities, the demonstrated ability to
monitor and react to shifts in pricing levels and coverage changes, experienced
claims management capabilities and substantial net retentions from our clients.
We also favor companies and management teams that have worked through prior
property and casualty insurance market cycles.
The maximum capacity available for casualty treaty programs that are
exposed to loss by individual policy limits is $30 million, but we rarely
allocate capacity over $15 million. Our average capacity commitment in this
segment as of December 31, 2003 was approximately $3 million per program.
Our Casualty Treaty Reinsurance business is produced primarily by Aon,
Marsh, Willis and A.J. Gallagher. Our principal competitors in this segment are
American Re, Converium, General Re, Munich Re, Swiss Reinsurance Company ("Swiss
Re"), Transatlantic Re and XL.
Property Individual Risk. Our Property Individual Risk business segment
is comprised of the insurance and facultative reinsurance of commercial
properties. The policies written in this segment provide coverage for one
insured for each policy. The types of risks insured are generally properties
with sufficiently large values to require multiple insurers and reinsurers to
accommodate their insurance capacity needs. We underwrite property individual
risk business at Endurance Bermuda and Endurance U.K. We have 22 underwriters
specializing in property individual risk.
Our risks in this business segment are all well diversified across a
range of industries. These industries include real estate, retail,
manufacturing, chemicals, financial, utilities, telecommunications, construction
and civil engineering, municipalities/institutional properties and other
industries.
As of December 31, 2003, approximately 64% of the insured risks were
located in the United States and the remainder in the rest of the world,
including worldwide exposures which include U.S. based risks. We expect the
proportion of business written outside of the United States to increase as we
expand our capabilities in Endurance U.K. Approximately 91% of the business in
this segment is written on an excess of loss basis and 9% is written on a
proportional basis. The proportional policies are typically written with large
deductibles or self-insured retentions.
Our average attachment point overall is approximately $100 million. We
offer gross limits capacity of up to $50 million on any one risk. We limit these
lines to no more than $15 million on any one risk on risks located in active
catastrophe zones. To date, our average participation has been approximately $17
million on any one risk.
Our Property Individual Risk business is produced primarily by Marsh, Aon
and Jardine Lloyd Thompson. Our competitors in this segment include a large
number of insurance and reinsurance companies. Among our most frequent
competitors are ACE, Allianz AG ("Allianz"), Allied World Assurance Company Ltd.
("AWAC"), Arch, FM Global, Montpelier Re, Munich Re, Swiss Re, XL and Zurich.
Casualty Individual Risk. Our Casualty Individual Risk business segment
is comprised of the insurance and facultative reinsurance of third party
liability exposures. This segment is comprised of three lines of business:
Excess Casualty Insurance, Professional Lines Insurance and Healthcare. For the
year ended December 31, 2003, these lines of business represented approximately
33%, 19% and 48% of the gross written premiums for this segment, respectively.
This segment is only underwritten by Endurance Bermuda. We have 28 dedicated
underwriters who specialize in Excess Casualty, Professional Lines or
HealthCare.
The Excess Casualty Insurance line of business provides third party
liability insurance for a wide range of industry groups. Our clients are
typically Fortune 1000 companies with sophisticated risk management practices
who generally retain large portions of their own risk and purchase large
insurance limits. Our target clients within this group are in strong financial
positions, have formal, well-developed risk management programs and proactive
claims detection and management procedures. As of December 31, 2003,
approximately 20% of our insured risks in this line of business were solely
located in the United States and the remainder represented worldwide exposures,
including the United States.
9
Our minimum attachment point for the Excess Casualty Insurance line of
business is $25 million and our average attachment point is approximately $115
million. In all cases, we carefully review and approve our policy forms and
endorsements to ensure we are fully comfortable with the scope of coverage we
provide. Our maximum line in this category is $50 million, although we only
occasionally exceed $25 million, and only do so with explicit approval of
executive management. Our average line is approximately $28 million.
The business in the Excess Casualty Insurance line of business is
produced primarily by Marsh, Aon and Jardine Lloyd Thompson. Our principal
competitors in this line of business include ACE, Arch, AWAC, Lloyd's of London
("Lloyd's"), Starr Excess Liability Insurance Company, Ltd ("Starr Excess"), XL
and Zurich.
Our Professional Lines Insurance line of business includes a limited
range of products: directors' and officers' liability insurance, errors and
omissions insurance and employment practices liability insurance. Our clients
include both for-profit and non-profit entities. We target clients with strong,
stable financial positions, paying particular attention to liquidity, solvency
margins and profitability. As of December 31, 2003, approximately 9% of our
insured risks in this line of business were located within the United States,
with the remainder representing worldwide risks, including the United States.
We require a minimum attachment point of $25 million and our average
attachment point has been approximately $155 million. We have maximum limits
capacity of up to $25 million and an average limit of $15 million on any one
risk. Business in this segment is written almost exclusively on a claims-made
basis and all of the business is written on an excess of loss basis.
Our Professional Lines Insurance business is produced primarily by Aon,
Jardine Lloyd Thompson and Marsh. Our principal competitors in this line of
business include ACE, Arch, AWAC, The Chubb Corporation, Lloyd's, Starr Excess,
XL and Zurich.
Our Healthcare business is focused on one narrow niche within the medical
professional liability market: hospital malpractice insurance. Within this
market, we target large institutional healthcare providers such as hospital
groups, university teaching hospitals and integrated healthcare delivery
systems. We do not work with smaller entities having 250 beds or less, nor do we
seek risks that are principally from long-term-care facilities. We do not insure
stand-alone individual physicians, physician groups, or other healthcare
professionals. We estimate that the large institutional healthcare niche
currently represents approximately $800 million in annual premiums for the
industry. As of December 31, 2003, all of our healthcare insureds were based in
the United States.
All of the business in our Healthcare line of business is written on an
excess of loss basis. Our average attachment point is approximately $25 million.
All of this business is written on a claims-made basis. We do not write any
multi-year policies, or programs with profit sharing or swing-rating plans. Our
average program participation is approximately $25 million.
Our principal underwriting considerations from this line of business are
based on evaluations of risk management policies and procedures, historical
claims activity, current exposures and operating jurisdictions. Pricing is
determined based on account-specific experience and exposure ratings. We
incorporate the insight that we have gained from a proprietary database of over
400,000 hospital claims.
Our Healthcare business is produced primarily by Marsh, Aon, Jardine
Lloyd Thompson and A.J. Gallagher.
Our principal competitors in this line of business are American
International Group, Inc., CNA Financial Corporation, Employers Reinsurance
Corporation and Zurich.
Aerospace and Other Specialty Lines. Our Aerospace and Other Specialty
Lines business segment is comprised primarily of the insurance and reinsurance
Aerospace lines, and to a lesser extent, of unique opportunities, including a
limited number of other reinsurance programs such as surety, marine, energy,
personal accident, terrorism and others.
Our Aerospace line is comprised of aviation and space business. The
aviation business includes hull, aircraft liability and aircraft products
coverages. Currently, approximately 30% of the exposures insured in this line of
business are in the United States with the remainder being distributed
throughout the world, including the United States. We write these exposures both
as insurance and reinsurance, with the reinsurance written both in the form of
facultative reinsurance and treaty reinsurance. In all cases, we track our
exposures by original insured in order to monitor our maximum exposures by major
airline and by major manufacturer. We currently do not write hull war risk,
primary general aviation business or workers' compensation for this category.
10
Our average attachment point is $6 million. Our average commitment has been
approximately $4 million per program.
Our expertise in the aviation category stems from an extensive database
of historical aviation claims and program structures. Individual account
decisions are based on a combination of qualitative evaluations of the risk
management programs of the original insureds and quantitative examinations of
our clients' track records and the records of peer and comparable operations.
The space business includes satellite launch and in-orbit coverage. We
have chosen to write space business through industry recognized leaders, and
currently support three organizations on a treaty reinsurance basis only.
Our Aerospace business is produced primarily by Aon, Marsh and Willis.
Our principal competitors in this line of business are Converium, Hannover
Ruckversicherungs-Aktiengesellschaft and Lloyd's.
Our remaining business in this segment represents a variety of contracts
which were underwritten utilizing the expertise of our senior underwriting
staff. These contracts are those that do not fit with our other segments. The
largest of these programs was a $51.9 million treaty for workers' compensation
coverages which was acquired as part of the Hart Re transaction and was not
intended to be renewed.
Our Special Accounts business is produced primarily by Aon, Marsh, Willis
and Benfield.
In December 2003, we announced that we are expanding our lines of
business to include accident reinsurance and marine and energy.
Distribution
We are a broker-market participant and conduct business almost
exclusively through insurance and reinsurance brokers around the world. The
brokerage distribution channel provides us with access to an efficient, variable
cost, and global distribution system without the significant time and expense
which would be incurred in creating wholly owned distribution networks.
Aon is our largest distributor of our reinsurance lines while Marsh is
our largest distributor of our insurance lines. A breakdown of our distribution
by broker is provided in the table below.
Percentage of Gross
Premiums Written for
the Year Ended
Broker December 31, 2003 (1)
-------- ----------------------
Aon.................................... 29.4 %
Marsh.................................. 26.7
Willis................................. 21.1
Benfield............................... 6.1
Towers Perrin.......................... 2.9
All Other.............................. 13.8
-------
Total............................... 100.0 %
=======
- ----------
(1) Excludes gross premiums acquired from HartRe.
Claims Management
We have received a moderate number of reported claims resulting in a
total of $162.5 million in case specific reserves on our balance sheet at
December 31, 2003. Notwithstanding the moderate claims activity to date, we have
a process in place for identifying, tracking and settling potential claims. The
responsibilities of the claims department include reviewing loss reports,
monitoring claims handling activities of ceding companies, requesting additional
information where appropriate, establishing initial case reserves including
determining whether the client's reported losses are sufficient and approving
payment of individual claims. We have established authority levels for all
individuals involved in the reserving and settlement of claims. We have a total
claims staff of 11.
When we receive notification of a potential claim, a member of our staff
logs the potential claim into our systems. An initial review is conducted by the
underwriter and underwriting manager responsible for the program in coordination
with our claims department. Once the validity of the given claim is established,
responsibility for management of the claim is transferred to our claims
department. As the claim develops, the claims department is empowered to draw on
those resources, both internal and external, it deems appropriate to settle the
claim appropriately. To date, the Company has worked to establish a network of
external legal and claims experts to augment our own in-house team.
11
In addition to managing reported claims and conferring with ceding
companies on claims matters, the claims department conducts periodic audits of
specific claims and the overall claims procedures of our reinsurance clients at
the offices of ceding companies. Through these audits, we are able to evaluate
ceding companies' claims-handling practices, including the organization of their
claims departments, their fact-finding and investigation techniques, their loss
notifications, the adequacy of their reserves, their negotiation and settlement
practices and their adherence to claims-handling guidelines.
Reserve for Losses and Loss Expenses
We are required by applicable insurance laws and regulations and U.S.
GAAP to establish reserves for losses and loss expenses that arise from our
products. These reserves are balance sheet liabilities representing estimates of
future amounts required to pay losses and loss expenses for insured or reinsured
claims which have occurred at or before the balance sheet date, whether already
known to us or not yet reported. It is our policy to establish these losses and
loss reserves prudently after reflecting all information known to us as of the
date they are recorded.
The Company uses statistical and actuarial methods to reasonably estimate
ultimate expected losses and loss expenses. The period of time from the
reporting of a loss to the Company and the settlement of the Company's liability
may be several years. During this period additional facts and trends will be
revealed. As these factors become apparent, reserves will be adjusted, sometimes
requiring an increase in the overall reserves of the Company, and at other times
requiring a reallocation of incurred but not reported reserves to specific case
reserves.
Reserves for losses and loss expenses are based in part upon the
estimation of losses resulting from catastrophic events. Estimation by the
Company of losses resulting from catastrophic events based upon its own
historical claim experience is inherently difficult because of the Company's
short operating history and the potential severity of property catastrophe
claims. Therefore, the Company utilizes commercially available models, as well
as historical reinsurance industry property catastrophe claims experience, for
purposes of evaluating future trends and providing an estimate of ultimate
claims costs.
To assist us in establishing appropriate reserves for losses and loss
expenses, we analyze a significant amount of insurance industry information with
respect to the pricing environment and loss settlement patterns. In combination
with our individual pricing analyses, this industry information is used to guide
our loss and loss expense estimates. These estimates are reviewed regularly, and
such adjustments, if any, are recorded in earnings in the periods in which they
are determined. Our losses and loss expense reserves are reviewed annually by
our outside actuarial specialists.
While management believes that it has made a reasonable estimate of
ultimate losses, the ultimate claims experience may not be as reliably predicted
as may be the case with other insurance and reinsurance operations, and there
can be no assurance that losses and loss expenses will not exceed the total
reserves.
Underwriting and Risk Management
Internal underwriting controls are exercised through Kenneth J.
LeStrange, our Chief Executive Officer. Underwriting authority is delegated to
the managers of our lines of business and to underwriters in accordance with
prudent practice and an understanding of each individual's capabilities.
Detailed letters of underwriting authority are issued to each of our
underwriters. These letters contain our operating guidelines, a description of
the analytic process to be followed, referral requirements broken down by
sources of business, terms and conditions, situations and the limits capacity
and annual premium for any one contract. Our profitability guidelines are
attached to each such letter as an exhibit and are stated in terms of maximum
combined ratio targets, excluding our general and administrative expenses, by
line of business. Our profitability guidelines are regularly reviewed to reflect
changes in market conditions, interest rates, capital structure and
market-expected returns.
We have a disciplined approach to underwriting and risk management that
relies heavily upon the collective underwriting expertise of our management and
staff. This expertise is in turn guided by the following underwriting
principles:
o We will underwrite and accept only those risks we know and
understand;
o We will perform our own independent pricing or risk review on all
risks we accept; and
o We will accept only those risks that are expected to earn a level
of profit commensurate with the risk they present.
12
Before we review any program proposal, we consider the appropriateness of
the client, including the quality of its management and its risk management
strategy. In addition, we require each program to include significant
information on the nature of the perils to be included and detailed aggregate
information as to the location or locations of the risks covered. We further
request information on the client's loss history for the perils being reinsured,
together with relevant underwriting considerations. If a program meets the
preceding underwriting criteria, we then evaluate the proposal in terms of its
risk/reward profile to assess the adequacy of the proposed pricing and its
potential impact on our overall return on capital as well as our corporate risk
objectives.
It is our corporate objective to limit the risk of a significant loss on
an economic basis, which includes limiting premiums and reinstatement premiums
from a one in one hundred year series of catastrophic events to no more than 25%
of our total capital.
To achieve the above objectives, we utilize a variety of proprietary and
commercially available tools to quantify and monitor the various risks we accept
as a company.
Our proprietary systems include those for modeling risks associated with
property catastrophe, hospital professional liability, aviation, property
individual risk and workers' compensation business, various casualty and
specialty pricing models as well as our proprietary portfolio risk management
and capital allocation models. These systems allow us to monitor our pricing and
risk on a contract by contract basis across the Company's lines of business.
We have fully integrated our internal actuarial staff into the
underwriting and decision making process. We use in-depth actuarial and risk
analysis to evaluate and approve all contracts prior to any authorization. In
addition to internal actuaries and risk professionals, we make use of outside
consultants as necessary to develop the appropriate analysis for pricing. We
require significant amounts of data from our clients and turn down business in
which we feel the data provided to us is insufficient for us to make an
appropriate analysis.
To monitor the catastrophe and correlation risk of our direct property
and treaty property business, we have subscribed to and utilize natural
catastrophe modeling tools from EQE, RMS and AIR. We take an active role in the
evaluation of these commercial catastrophe pricing models, providing feedback to
the modeling companies to improve the efficiencies of these models. We also
supplement the model output in certain territories with the results of our
proprietary models. We use modeling not just for the underwriting of individual
transactions but also to optimize the total return and risk of our underwriting
portfolio.
Separate from our natural catastrophe exposed businesses, we underwrite
and accept casualty and specialty insurance and reinsurance business. We apply
the same standards with respect to actuarial and risk analysis to these
businesses using commercial data and models licensed from the Insurance Services
Office, Inc. ("ISO"), the National Council on Compensation Insurance, Inc.
("NCCI"), the Reinsurance Association of America ("RAA"), A.M. Best, Airclaims
Ltd., Bloomberg, and various professional service firms. As with our natural
catastrophe exposed businesses, we seek to identify those casualty and specialty
exposures that are most likely to be simultaneously influenced by significant
events. These exposures are then jointly tracked to ensure that we do not
develop an excessive accumulation of exposure to that particular type of event.
In addition to the above technical and analytical practices, our
underwriters use a variety of means, including specific contract terms, to
manage the Company's exposure to loss. These include occurrence limits,
aggregate limits, reinstatement provisions and loss ratio caps. Additionally,
underwriters use appropriate exclusions, terms and conditions to further
eliminate particular risks or exposures that our underwriting team deems to be
significant. Accordingly, our Bermuda underwriting location provides us with a
particular advantage in this regard because there are no limitations upon our
use of coverage restrictions in insurance policies.
Investments
We follow an investment strategy designed to emphasize the preservation
of our invested assets and provide sufficient liquidity for the prompt payment
of claims. In determining our investment decisions, we consider the impact of
various catastrophic events, particularly those to which our insurance and
reinsurance portfolio may be exposed, on our invested assets to protect our
financial position. As of December 31, 2003, our portfolio consisted of high
investment grade rated, liquid, fixed maturity securities of short to medium
term duration. We currently have no investments in equity securities, less than
investment grade securities, real estate, or other classes of alternative
investments.
As of December 31, 2003, our aggregate invested assets totaled
approximately $2.7 billion. Invested assets have grown significantly as a result
of strong operating cash flow. Invested assets include cash and cash equivalents
and fixed maturity securities managed by our investment managers. The portfolio
is managed by two professional management firms in accordance with investment
guidelines set by the investment committee of our Board of Directors. The
average credit quality of our investments is AAA/Aaa, with no investments in
securities rated below A-/A3 as determined by S&P and Moody's Investor Services
("Moody's") respectively. Short-term instruments must be rated a minimum of
A-1/P-1. The target duration is 3.0 years and the portfolio has an income versus
total return orientation. At December 31, 2003, the average duration of our
invested assets was 3.08 years. There have been no credit losses to date. At
December 31, 2003, there were $26.2 million of net unrealized gains in the
portfolio.
13
The following table sets forth the types of securities in our fixed
maturity portfolio, excluding cash equivalents and short term securities, and
their fair values and amortized costs as of December 31, 2003:
Amortized Unrealized Unrealized Fair
Type of Investment Cost Gains Losses Value
- ------------------- ------------ ----------- ----------- ------------
(in thousands)
U.S. government and agencies..................... $ 862,945 $ 8,969 $(2,029) $ 869,885
Non U.S. government securities................... 216,469 2,231 (2,477) 216,223
Corporate securities............................. 344,575 12,304 (1,732) 355,147
Mortgage-backed securities....................... 764,457 8,497 (2,687) 770,267
Asset-backed securities.......................... 308,706 3,875 (794) 311,787
---------- ------- ------- ----------
Total............................................ $2,497,152 $35,876 $(9,719) $2,523,309
========== ======= ======= ==========
U.S. Government and Agencies. U.S. government and agency securities are
comprised of bonds issued by the U.S. Treasury, the Federal Home Loan Bank, the
Federal Home Loan Mortgage Corporation, and the Federal National Mortgage
Association ("Fannie Mae").
Non U.S. government securities. Non U.S. government securities represent
the fixed income obligations of non U.S. governmental entities.
Corporate Securities. Corporate securities are comprised of bonds issued
by corporations rated A-/A3 or higher and are diversified across a wide range of
issuers and industries. The principal risk of corporate securities is the
potential loss of income and potential realized and unrealized principal losses
due to insolvencies or deteriorating credit. The largest corporate credit in the
Company's portfolio represented 0.5% of total invested assets at December 31,
2003. We actively monitor our corporate credit exposures and have had no
realized credit related losses to date. Our investment guidelines call for the
sale of any bond which becomes rated less than the lower of A- or A3 from S&P or
Moody's.
Mortgage-Backed Securities. Mortgage-backed securities are purchased to
diversify our portfolio risk characteristics from primarily corporate credit
risk to a mix of credit risk and cash flow risk. The majority of the mortgage-
backed securities in our investment portfolio have relatively low cash flow
variability.
The principal risks inherent in holding mortgage-backed securities are
prepayment and extension risks, which will affect the timing of when cash flow
will be received. Our active monitoring of our mortgage-backed securities
mitigates exposure to losses from cash flow risk associated with interest rate
fluctuations. Our mortgage-backed securities are principally comprised of AAA-
rated pools of residential mortgages originated by Fannie Mae and the Government
National Mortgage Association.
Asset-Backed Securities. Asset-backed securities are purchased both to
diversify the overall risks of our fixed maturity portfolio and to provide
attractive returns. Our asset-backed securities are diversified both by type of
asset and by issuer and are comprised of AAA-rated bonds backed by pools of
automobile loan receivables and credit card receivables originated by a variety
of financial institutions.
The principal risks in holding asset-backed securities are structural,
credit and capital market risks. Structural risks include the security's
priority in the issuer's capital structure, the adequacy of and ability to
realize proceeds from the collateral and the potential for prepayments. Credit
risks include consumer or corporate credits such as credit card holders and
corporate obligors. Capital market risks include the general level of interest
rates and the liquidity for these securities in the market place.
The investment ratings (provided by major rating agencies) for fixed
maturity securities held as of December 31, 2003 and the percentage of our total
fixed maturity securities they represented at such date were as follows:
Ratings Fair Value Percentage
-------- ------------ -----------
(in thousands)
U.S. government and government
agencies.............................. $ 869,885 34.5%
AAA/Aaa................................. 1,303,447 51.7%
AA/Aa................................... 89,668 3.5%
A/A..................................... 260,309 10.3%
---------- ------
Total................................... $2,523,309 100.0%
========== =======
14
The maturity distribution for fixed maturity securities held as of
December 31, 2003 was as follows:
Maturity Amortized Cost Fair Value
---------- ------------------ ------------
(in thousands)
Due within one year.................................................... $ 65,187 $ 65,768
Due after one year through five years.................................. 891,142 902,815
Due after five years through ten years................................. 387,089 392,931
Due after ten years.................................................... 80,571 79,741
Mortgage-backed securities............................................. 764,457 770,267
Asset-backed securities................................................ 308,706 311,787
------------ ------------
Total.................................................................. $ 2,497,152 $ 2,523,309
============ ------------
Our investment returns for the year ended December 31, 2003 were as
follows (in thousands):
Net investment income............................ $ 71,010
Net realized gains on sales of investments....... 5,718
Net decrease in unrealized gains................. (22,225)
----------
Total net investment return...................... $ 54,503
----------
Our investment committee establishes investment guidelines and supervises
our investment activity. The investment committee regularly monitors our overall
investment results, reviews compliance with our investment objectives and
guidelines, and ultimately reports our overall investment results to the board
of directors. Our investment guidelines specify minimum criteria on the overall
credit quality and liquidity characteristics of the portfolio. They include
limitations on the size of certain holdings as well as restrictions on
purchasing certain types of securities or investing in certain industries.
Currently our investment guidelines restrict the purchase of financial futures,
options, swaps, and other derivatives for investment purposes, subject to
approval of our investment committee and our board of directors. Our investment
managers may be instructed to invest some of the investment portfolio in
currencies other than U.S. dollars based upon the business we have written, the
currency in which our loss reserves are denominated on our books or regulatory
requirements.
We have engaged our investment managers to provide investment advisory
and management services. We have agreed to pay investment management fees based
on the month-end market values held under their respective custody. The fees,
which vary depending on the amount of assets under management, are included in
net investment income. These agreements may be terminated by either party upon
30 days written notice. In the year ended December 31, 2003, we incurred
investment management fees of $2.3 million.
Ratings
Ratings have become an increasingly important factor in establishing the
competitive position of insurance and reinsurance companies. A.M. Best assigned
to Endurance Bermuda, Endurance U.K. and Endurance U.S. a financial strength
rating of "A" (Excellent) and Standard & Poor's assigned a financial strength
rating to Endurance Bermuda, Endurance U.K. and Endurance U.S. of "A-" (Strong).
A.M. Best upgraded our rating from "A-" to "A" in May 2003, making us one of a
small number of companies to receive an upgrade during the year. Of 124 ratings
actions by A.M. Best in the period from September 11, 2001 to December 29, 2003,
Endurance was one of only six companies worldwide to receive a ratings upgrade
by A.M. Best. The objective of A.M. Best's and Standard & Poor's rating systems
is to provide an opinion of an insurer's or reinsurer's financial strength and
ability to meet ongoing obligations to its policyholders. These ratings reflect
A.M. Best's and Standard & Poor's opinions of Endurance Bermuda's, Endurance
U.K.'s and Endurance U.S.'s initial capitalization, performance, management and
sponsorship, and are not applicable to the Company's ordinary shares and are not
a recommendation to buy, sell or hold such shares. A.M. Best maintains a letter
scale rating system ranging from "A++" (Superior) to "F" (In Liquidation), and
includes 16 separate ratings categories. Within these categories, "A++"
(Superior) and "A+" (Superior) are the highest, followed by "A" (Excellent) and
"A-" (Excellent). Publications of A.M. Best indicate that the "A" and "A-"
ratings are assigned to those companies that, in A.M. Best's opinion, have
demonstrated an excellent ability to meet their obligations to policyholders.
These ratings are subject to periodic review by, and may be revised downward or
revoked at the sole discretion of, A.M. Best. The rating "A" (Excellent) by A.M.
Best is the third highest of 15 rating levels (the rating of "S" (Suspended) is
considered a rating category but not a rating level). Standard & Poor's
maintains a letter rating system ranging from "AAA" (Extremely Strong) to "R"
(Under Regulatory Supervision). Within these categories, "AAA" (Extremely
Strong) is the highest, followed by "AA+", "AA" and "AA-" (Very Strong) and
"A+", "A" and "A-" (Strong). Publications of Standard & Poor's indicate that the
"A+", "A" and "A-" ratings are assigned to those companies that, in Standard &
Poor's opinion, have demonstrated strong financial security characteristics, but
are somewhat more likely to be affected by adverse business conditions than are
insurers with higher ratings. These ratings may be changed, suspended, or
withdrawn at the discretion of Standard & Poor's. The rating "A-" (Strong) by
Standard & Poor's is the seventh highest of twenty-one rating levels.
15
Competition
The insurance and reinsurance industries are mature and highly
competitive. Insurance and reinsurance companies compete on the basis of many
factors, including premium charges, general reputation and perceived financial
strength, the terms and conditions of the products offered, ratings assigned by
independent rating agencies, speed of claims payments and reputation and
experience in the particular risk to be underwritten.
We expect to compete directly with numerous other parties, including
established global insurance and reinsurance companies, other start-up insurance
and reinsurance entities, as well as potential capital markets and
securitization structures aimed at managing catastrophe and other risks.
Many of these entities have significantly larger amounts of capital and
more employees than the Company.
Employees
As of March 5, 2004, we had 252 full-time employees. We believe that our
employee relations are satisfactory. None of our employees are subject to
collective bargaining agreements.
16
RISK FACTORS
Before investing in our ordinary shares you should carefully consider the
following risk factors and all other information set forth in this Annual Report
on Form 10-K. These risks could materially affect our business, results of
operations or financial condition and cause the trading price of our ordinary
shares to decline. You could lose all or part of your investment.
Risks Relating to Our Business
Since we have a limited operating history, it is difficult to predict our future
performance.
Our Bermuda insurance subsidiary, Endurance Bermuda, was formed on
November 30, 2001 and began operations on December 17, 2001. Endurance Holdings
was formed on June 27, 2002. Endurance U.S. was formed on September 5, 2002 and
received a license to write certain lines of reinsurance business in the State
of New York from the New York State Department of Insurance (the "New York
Department") on December 18, 2002. Endurance U.K. was formed on April 10, 2002
and on December 4, 2002 was authorized by the United Kingdom's Financial
Services Authority ("FSA") to begin writing certain lines of insurance and
reinsurance in the United Kingdom and European Union. As a result, there is
limited historical financial and operating information available to help you
evaluate our past performance or to make a decision about an investment in our
ordinary shares. Companies in their initial stages of development present
substantial business and financial risks and may suffer significant losses.
These new companies must successfully develop business relationships, establish
operating procedures, hire staff, install management information and other
systems, establish facilities and obtain licenses, as well as take other steps
necessary to conduct their intended business activities. As a result of these
risks, it is possible that we may not be successful in implementing our business
strategy or in completing the development of the infrastructure necessary to run
our business. In addition, because of our limited operating history, our
historical financial results may not accurately predict our future performance.
As a result of industry factors or factors specific to us, we may have to alter
our anticipated methods of conducting our business, such as the nature, amount
and types of risks we assume.
If actual claims exceed our reserve for losses and loss expenses, our financial
condition and results of operations could be adversely affected.
Our success depends upon our ability to accurately assess the risks
associated with the businesses that we insure or reinsure. We establish loss
reserves to cover our estimated liability for the payment of all losses and loss
expenses incurred with respect to premiums earned on the policies that we write.
Loss reserves do not represent an exact calculation of liability. Rather, loss
reserves are estimates of what we expect the ultimate settlement and
administration of claims will cost. These estimates are based upon actuarial and
statistical projections and on our assessment of currently available data, as
well as estimates of future trends in claims severity and frequency, judicial
theories of liability and other factors. Loss reserve estimates are refined
continually in an ongoing process as experience develops and claims are reported
and settled. Establishing an appropriate level of loss reserves is an inherently
uncertain process. Moreover, these uncertainties are greater for insurers like
us than for insurers with a longer operating history because we do not yet have
an established loss history. Because of this uncertainty, it is possible that
our reserves at any given time will prove inadequate.
To the extent we determine that actual losses and loss expenses exceed
our expectations and reserves recorded in our financial statements, we will be
required to immediately increase reserves. This could cause a material reduction
in our profitability and capital. The number and size of reported claims that we
have received to date have been moderate, resulting in $162.5 million in case
reserves on our balance sheet at December 31, 2003. In the future, the number of
claims could increase, and their cumulative size could exceed our loss reserves.
As a property and property catastrophe insurer and reinsurer, we are
particularly vulnerable to losses from catastrophes.
Our property and property catastrophe insurance and reinsurance
operations expose us to claims arising out of catastrophes. Catastrophes can be
caused by various unpredictable events, including earthquakes, hurricanes,
hailstorms, severe winter weather, floods, fires, tornadoes, explosions and
other natural or man-made disasters. We also face substantial exposure to losses
resulting from acts of war, acts of terrorism and political instability. The
global geographic distribution of our business subjects us to catastrophe
exposure for natural events occurring in a number of areas throughout the world,
including, but not limited to, windstorms in Europe, hurricanes in Florida, the
Gulf Coast and the Atlantic coast regions of the United States, typhoons and
earthquakes in Japan and earthquakes in California and the New Madrid region of
the United States. The loss experience of property catastrophe insurers and
reinsurers has generally been characterized as low frequency but high severity
in nature. We expect that increases in the values and concentrations of insured
property will increase the severity of such occurrences in the future. In the
event that we experience catastrophe losses, there is a possibility that our
unearned premium and loss reserves will be inadequate to cover these risks. In
addition, because accounting regulations do not permit insurers and reinsurers
to reserve for such catastrophic events until they occur, claims from
catastrophic events could cause substantial volatility in our financial results
for any fiscal quarter or year and could have a material adverse effect on our
financial condition and results of operations. Our ability to write new business
also could be adversely impacted. See "Business -- Underwriting and Risk
Management."
17
As a property and casualty insurer and reinsurer, we could face losses from war,
terrorism and political unrest.
We may have substantial exposure to losses resulting from acts of war,
acts of terrorism and political instability. These risks are inherently
unpredictable, although recent events may lead to increased frequency and
severity. It is difficult to predict their occurrence with statistical certainty
or to estimate the amount of loss an occurrence will generate. Accordingly, it
is possible that our loss reserves will be inadequate to cover these risks.
Although we generally exclude acts of terrorism from insurance policies and
reinsurance treaties where practicable, we also provide coverage in
circumstances where we believe we are adequately compensated for assuming such
risk. Even in cases where we have deliberately sought to exclude coverage, we
may not be able to eliminate completely our exposure to terrorist acts and thus
it is possible that these acts will have a material adverse effect on us.
The risks associated with property and casualty reinsurance underwriting could
adversely affect us.
Because we participate in property and casualty reinsurance markets, the
success of our underwriting efforts depends, in part, upon the policies,
procedures and expertise of the ceding companies making the original
underwriting decisions. We face the risk that these ceding companies may fail to
accurately assess the risks that they assume initially, which, in turn, may lead
us to inaccurately assess the risks we assume. If we fail to establish and
receive appropriate premium rates, we could face significant losses on these
contracts.
If actual renewals of our existing contracts do not meet expectations, our
premiums written in future years and our future results of operations could be
materially adversely affected.
Our contracts are generally for a one-year term. In our financial
forecasting process, we make assumptions about the renewal of our prior year's
contracts. If actual renewals do not meet expectations, our premiums written in
future years and our future results of operations could be materially adversely
affected. This risk is especially prevalent in the first quarter of each year
when a large number of reinsurance contracts are subject to renewal.
The failure of any of the loss limitation methods we employ could have a
material adverse effect on our financial condition or on our results of
operations.
We seek to limit our loss exposure by writing many of our insurance and
reinsurance contracts on an excess of loss basis, adhering to maximum
limitations on policies written in defined geographical zones, limiting program
size for each client, establishing per risk and per occurrence limitations for
each event and prudent underwriting guidelines for each program written. In the
case of proportional treaties, we seek per occurrence limitations or loss ratio
caps to limit the impact of losses from any one event. Most of our direct
liability insurance policies include maximum aggregate limitations. We also seek
to limit our loss exposure through geographic diversification. Geographic zone
limitations involve significant underwriting judgments, including the
determination of the area of the zones and whether a policy falls within
particular zone limits. Disputes relating to coverage and choice of legal forum
may also arise. As a result, various provisions of our policies, such as
limitations or exclusions from coverage or choice of forum, may not be
enforceable in the manner we intend and some or all of our other loss limitation
methods may prove to be ineffective. Underwriting is a matter of judgment,
involving important assumptions about matters that are inherently unpredictable
and beyond our control, and for which historical experience and probability
analysis may not provide sufficient guidance. One or more catastrophic or other
events could result in claims that substantially exceed our expectations, which
could have a material adverse effect on our financial condition and our results
of operations, possibly to the extent of eliminating our shareholders' equity.
Since we are dependent on key executives, the loss of any of these executives or
our inability to retain other key personnel could adversely affect our business.
Our success substantially depends upon our ability to attract and retain
qualified employees and upon the ability of our senior management and other key
employees to implement our business strategy. We believe there are only a
limited number of available qualified executives in the business lines in which
we compete. Although we are not aware of any planned departures, we rely
substantially upon the services of Kenneth J. LeStrange, our Chief Executive
Officer, President and Chairman of the board of directors, Steven W. Carlsen,
Chairman of Endurance U.S. and President of Endurance Services, and James R.
Kroner, our Chief Financial Officer. Each of Messrs. LeStrange, Carlsen and
Kroner have employment agreements with the Company. We believe we have been
successful in attracting and retaining key personnel since our inception. The
loss of any of their services or the services of other members of our management
team or the inability to attract and retain other talented personnel could
impede the further implementation of our business strategy, which could have a
material adverse effect on our business. We do not currently maintain key man
life insurance policies with respect to any of our employees.
18
Our business could be adversely affected by Bermuda employment restrictions.
We will need to continue to hire employees to work in Bermuda. Under
Bermuda law, non-Bermudians (other than spouses of Bermudians) may not engage in
any gainful occupation in Bermuda without an appropriate governmental work
permit. Work permits may be granted or extended by the Bermuda government upon
showing that, after proper public advertisement in most cases, no Bermudian (or
spouse of a Bermudian) is available who meets the minimum standard requirements
for the advertised position. The Bermuda government recently announced a new
policy limiting the duration of work permits to six years, with certain
exemptions for key employees. All of our 48 Bermuda-based professional employees
who require work permits, including Messrs. LeStrange and Kroner, have been
granted permits by the Bermuda government. The terms of these permits range from
three to five years depending on the individual. None of our current Bermuda
employees for whom we have applied for a work permit have been denied. It is
possible that we could lose the services of one or more of our key employees if
we are unable to obtain or renew their work permits, which could have a material
adverse effect on our business.
A decline in the financial strength ratings of Endurance Bermuda, Endurance U.K.
or Endurance U.S. could affect our standing among brokers and customers and
cause our premiums and earnings to decrease.
Ratings have become an increasingly important factor in establishing the
competitive position of insurance and reinsurance companies. A.M. Best assigned
to Endurance Bermuda, Endurance U.K. and Endurance U.S. a financial strength
rating of "A" (Excellent) and Standard & Poor's assigned a financial strength
rating to Endurance Bermuda, Endurance U.K. and Endurance U.S. of "A-" (Strong).
The objective of A.M. Best's and Standard & Poor's rating systems is to provide
an opinion of an insurer's or reinsurer's financial strength and ability to meet
ongoing obligations to its policyholders. These ratings reflect A.M. Best's and
Standard & Poor's opinions of Endurance Bermuda's, Endurance U.K.'s and
Endurance U.S.'s initial capitalization, performance, management and
sponsorship, and are not applicable to the Company's ordinary shares and are not
a recommendation to buy, sell or hold such shares. A.M. Best maintains a letter
scale rating system ranging from "A++" (Superior) to "F" (In Liquidation), and
includes 16 separate ratings categories. Within these categories, "A++"
(Superior) and "A+" (Superior) are the highest, followed by "A" (Excellent) and
"A-" (Excellent). Publications of A.M. Best indicate that the "A" and "A-"
ratings are assigned to those companies that, in A.M. Best's opinion, have
demonstrated an excellent ability to meet their ongoing obligations to
policyholders. These ratings are subject to periodic review by, and may be
revised downward or revoked at the sole discretion of, A.M. Best. The rating "A"
(Excellent) by A.M. Best is the third highest of 15 rating levels (the rating of
"S" (Suspended) is considered a rating category but not a rating level).
Standard & Poor's maintains a letter rating system ranging from "AAA" (Extremely
Strong) to "R" (Under Regulatory Supervision). Within these categories, "AAA"
(Extremely Strong) is the highest, followed by "AA+", "AA" and "AA-" (Very
Strong) and "A+", "A" and "A-" (Strong). Publications of Standard & Poor's
indicate that the "A+", "A" and "A-" ratings are assigned to those companies
that, in Standard & Poor's opinion, have demonstrated strong financial security
characteristics, but are somewhat more likely to be affected by adverse business
conditions than are insurers with higher ratings. These ratings may be changed,
suspended, or withdrawn at the discretion of Standard & Poor's. The rating "A-"
(Strong) by Standard & Poor's is the seventh highest of twenty-one rating
levels.
If Endurance Bermuda's, Endurance U.K.'s or Endurance U.S.'s rating is
reduced from its current level by A.M. Best or Standard & Poor's, our
competitive position in the insurance and reinsurance industry would suffer, and
it would be more difficult for us to market our products. A downgrade could
result in a significant reduction in the number of insurance and reinsurance
contracts we write and in a substantial loss of business as client companies,
and brokers that place such business, move to other competitors with higher
ratings.
Our holding company structure and certain regulatory and other constraints
affect our ability to pay dividends and make other payments.
Endurance Holdings is a holding company and, as such, has no substantial
operations of its own. Dividends and other permitted distributions from
insurance subsidiaries are expected to be Endurance Holdings' primary source of
funds to meet ongoing cash requirements, including debt service payments and
other expenses, and to pay dividends, if any, to shareholders. Bermuda law and
regulations, including, but not limited to, Bermuda insurance regulations,
restrict the declaration and payment of dividends and the making of
distributions by Endurance Bermuda unless certain regulatory requirements are
met. The inability of Endurance Bermuda to pay dividends in an amount sufficient
to enable Endurance Holdings to meet its cash requirements at the holding
company level could have a material adverse effect on its operations. In
addition, Endurance U.K. and Endurance U.S. are subject to significant
regulatory restrictions limiting their ability to declare and pay dividends. We
therefore do not expect to receive dividends from either of those subsidiaries
for the foreseeable future.
19
Endurance Holdings is subject to Bermuda regulatory constraints that will
affect its ability to pay dividends on its ordinary shares and make other
payments. Under the Bermuda Companies Act 1981, as amended (the "Companies
Act"), Endurance Holdings may declare or pay a dividend or make a distribution
out of retained earnings or contributed surplus only if it has reasonable
grounds for believing that it is, or would after the payment be, able to pay its
liabilities as they become due and if the realizable value of its assets would
thereby not be less than the aggregate of its liabilities and issued share
capital and share premium accounts. In addition, our credit facilities prohibit
Endurance Holdings from declaring or paying any dividends if a default or event
of default has occurred and is continuing at the time of such declaration or
payment or would result from such declaration or payment. For a discussion of
the legal limitations on our subsidiaries' ability to pay dividends to Endurance
Holdings and of Endurance Holdings to pay dividends to its shareholders, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources.".
The cost of reinsurance security arrangements may materially impact our margins.
As a Bermuda reinsurer, Endurance Bermuda is required to post collateral
security with respect to reinsurance liabilities it assumes from ceding insurers
domiciled in the U.S. The posting of collateral security is generally required
in order for U.S. ceding companies to obtain credit on their U.S. statutory
financial statements with respect to reinsurance liabilities ceded to unlicensed
or unaccredited reinsurers. Under applicable statutory provisions, the security
arrangements may be in the form of letters of credit, reinsurance trusts
maintained by third-party trustees or funds-withheld arrangements whereby the
trusted assets are held by the ceding company. Endurance Bermuda has the ability
to issue up to $470 million in letters of credit under the Company's letter of
credit and revolving credit facility that expires on August 6, 2004. If this
facility is not sufficient or if the Company is unable to renew this facility or
is unable to arrange for other types of security on commercially acceptable
terms, the ability of Endurance Bermuda to provide reinsurance to U.S.-based
clients may be severely limited.
Security arrangements may subject our assets to security interests and/or
require that a portion of our assets be pledged to, or otherwise held by, third
parties. Although the investment income derived from our assets while held in
trust typically accrues to our benefit, the investment of these assets is
governed by the investment regulations of the state of domicile of the ceding
insurer, which may be more restrictive than the investment regulations
applicable to us under Bermuda law. The restrictions may result in lower
investment yields on these assets, which could have a material adverse effect on
our profitability.
The right of certain significant investors to designate a majority of our
directors may prevent or frustrate attempts by shareholders to replace or remove
the current management of the Company.
As of March 5, 2004, our founding shareholders beneficially own ordinary
shares aggregating approximately 68% of the equity interest in our ordinary
shares on a fully diluted basis assuming the full exercise of all vested share
options, restricted share units and warrants exercisable for ordinary shares or
class A shares. Certain of our significant investors have contractual rights to
nominate designees as candidates for election to our board of directors and
select from our directors members of committees of our board of directors, and
have so designated seven of our existing eleven directors.
As a result of their ownership position and contractual rights, our
significant investors and their board representatives, independently and voting
together with our other existing shareholders, will have the ability to
significantly influence matters requiring shareholder approval, including,
without limitation, the election of directors and amalgamations, consolidations
and sales of all or substantially all of our assets.
The commercial and investment activities of our significant investors may lead
to conflicts of interest.
Certain of our significant investors engage in commercial activities and
enter into transactions or agreements with us or in competition with us, which
may give rise to conflicts of interest. We derive a significant portion of our
business through reinsurance relationships and other arrangements in which Aon,
one of the selling shareholders, has acted as a broker or insurance or
reinsurance intermediary. Due to Aon's investment in us and their involvement in
our formation, it is possible that certain brokers and intermediaries that
compete with Aon will perceive a conflict of interest in our relationships with
Aon and may, therefore, be hesitant to present insurance and reinsurance
proposals and opportunities to us. As of March 5, 2004, Aon held approximately
19.4% of our outstanding ordinary shares on a fully diluted basis.
20
Some of our significant investors or their affiliates have sponsored, and
may in the future sponsor, other entities engaged in or intending to engage in
insurance and reinsurance underwriting, some of which, together with our
significant investors, may compete with us. Certain of our significant investors
and their affiliates have also entered into agreements with and made investments
in numerous companies that may compete with us.
Profitability may be adversely impacted by inflation.
The effects of inflation could cause the cost of claims from catastrophes
or other events to rise in the future. Our reserve for losses and loss expenses
includes assumptions about future payments for settlement of claims and claims
handling expenses, such as medical treatments and litigation costs. To the
extent inflation causes these costs to increase above reserves established for
these claims, we will be required to increase our loss reserves with a
corresponding reduction in our net income in the period in which the deficiency
is identified.
Our investment performance may affect our financial assets and ability to
conduct business.
We derive a significant portion of our income from our invested assets.
As a result, our operating results depend in part on the performance of our
investment portfolio, which currently consists of fixed maturity securities. Our
income derived from our invested assets was $76.7 million or 29.1% of our net
income for the year ended December 31, 2003. Our operating results are subject
to a variety of investment risks, including risks relating to general economic
conditions, market volatility, interest rate fluctuations, liquidity risk and
credit and default risk. Additionally, with respect to certain investments, we
are subject to pre-payment or reinvestment risk.
With respect to our longer-term liabilities, we strive to structure our
investments in a manner that recognizes our liquidity needs for our future
liabilities. In that regard, we attempt to correlate the maturity and duration
of our investment portfolio to our general and specific liability profile.
However, if our liquidity needs or general and specific liability profile
unexpectedly change, we may not be successful in continuing to structure our
investment portfolio in that manner. The market value of our fixed maturity
investments will be subject to fluctuation depending on changes in various
factors, including prevailing interest rates. To the extent that we are
unsuccessful in correlating our investment portfolio with our liabilities, we
may be forced to liquidate our investments at times and prices that are not
optimal, which could have a material adverse effect on the performance of our
investment portfolio.
Interest rates are highly sensitive to many factors, including
governmental monetary policies, domestic and international economic and
political conditions and other factors beyond our control. Although we attempt
to take measures to manage the risks of investing in a changing interest rate
environment, we may not be able to mitigate interest rate sensitivity
effectively. Our mitigation efforts include maintaining a high quality portfolio
with a relatively short duration to reduce the effect of interest rate changes
on book value. A significant portion of the investment portfolio matures each
year, allowing for reinvestment at current market rates. The portfolio is
actively managed and trades are made to balance our exposure to interest rates.
However, a significant increase in interest rates could have a material adverse
effect on our book value.
We may be adversely affected by foreign currency fluctuations.
We have made a significant investment in the capitalization of Endurance
U.K., which is denominated in British Sterling. In addition, we enter into
reinsurance and insurance contracts where we are obligated to pay losses in
currencies other than U.S. dollars. For the year ended December 31, 2003,
approximately 9% of our gross premiums were written in currencies other than the
U.S. dollar. A portion of our cash and cash equivalents, investments and loss
reserves are also denominated in non-U.S. currencies. The majority of our
operating foreign currency assets and liabilities are denominated in Euros,
British Sterling, Canadian Dollars, Japanese Yen and Australian Dollars ("Major
Currencies"). We may, from time to time, experience losses from fluctuations in
the values of these and other non-U.S. currencies, which could have a material
adverse affect on our results of operations.
We periodically buy and sell Major Currencies or investment securities
denominated in Major Currencies in an attempt to match our non-U.S. dollar
assets to our related non-U.S. dollar liabilities. We have no currency hedges in
place; however, as part of our matching strategy, we consider the use of hedges
when we become aware of probable significant losses that will be paid in
non-U.S. currencies. However, it is possible that we will not successfully match
our exposures or structure the hedges so as to effectively manage these risks.
We may require additional capital in the future which may not be available or
only available on unfavorable terms.
Our future capital requirements depend on many factors, including our
ability to write new business successfully and to establish premium rates and
reserves at levels sufficient to cover losses. We may need to raise additional
funds through financings or curtail our growth and reduce our assets. Any equity
or debt financing, if available at all, may be on terms that are not favorable
to us. In the case of equity financings, dilution to our shareholders could
result, and in any case such securities may have rights, preferences and
privileges that are senior to those of the ordinary shares offered hereby. If we
cannot obtain adequate capital, our business, results of operations and
financial condition could be adversely affected.
21
Since we depend on a few brokers for a large portion of our revenues, loss of
business provided by any one of them could adversely affect us.
We market our insurance and reinsurance worldwide primarily through
insurance and reinsurance brokers. In the year ended December 31, 2003, our top
five brokers represented approximately 86% of our gross premiums written,
excluding gross premiums acquired in the HartRe transaction. See "Business --
Distribution". One of those brokers, Aon, is currently one of our investors.
Affiliates of two of these brokers, Marsh and Benfield, have also co-sponsored
the formation of other Bermuda reinsurers that may compete with us, and these
brokers may decide to favor the reinsurers they sponsored over other companies.
Loss of all or a substantial portion of the business provided by one or more of
these brokers could have a material adverse effect on our business.
Our reliance on brokers subjects us to their credit risk.
In accordance with industry practice, we frequently pay amounts owed on
claims under our insurance or reinsurance contracts to brokers, and these
brokers, in turn, pay these amounts over to the clients that have purchased
insurance or reinsurance from us. If a broker fails to make such a payment, in a
significant majority of business that the Company writes, it is highly likely
that the Company will be liable to the client for the deficiency because of
local laws or contractual obligations. Likewise, when the client pays premiums
for these policies to brokers for payment over to us, these premiums are
considered to have been paid and, in most cases, the client will no longer be
liable to us for those amounts, whether or not we have actually received the
premiums. Consequently, we assume a degree of credit risk associated with
brokers around the world with respect to most of our insurance and reinsurance
business. To date we have not experienced any losses related to such credit
risks.
The effects of emerging claim and coverage issues on our business are uncertain.
As industry practices and legal, judicial, social and other environmental
conditions change, unexpected and unintended issues related to claims and
coverage may emerge. These issues may adversely affect our business by either
extending coverage beyond our underwriting intent or by increasing the number or
size of claims. In some instances, these changes may not become apparent until
some time after we have issued insurance or reinsurance contracts that are
affected by the changes. As a result, the full extent of liability under our
insurance or reinsurance contracts may not be known for many years after a
contract is issued.
Recent examples of emerging claims and coverage issues include:
o larger settlements and jury awards for professionals and corporate
directors and officers covered by professional liability and
directors' and officers' liability insurance; and
o a growing trend of plaintiffs targeting property and casualty
insurers in purported class action litigations relating to
claims-handling, insurance sales practices and other practices
related to the conduct of our business.
The effects of these and other unforeseen emerging claim and coverage
issues are extremely hard to predict and could harm our business.
We operate in a highly competitive environment which could adversely impact our
operating margins.
The insurance and reinsurance industries are highly competitive. We
compete with major U.S. and non-U.S. insurers and reinsurers, including other
Bermuda-based insurers and reinsurers. For information regarding competition in
each of our business segments, see "Business -- Business Segments." Many of our
competitors have greater financial, marketing and management resources. A number
of newly-organized, Bermuda-based insurance and reinsurance entities compete in
the same market segments in which we operate. In addition, we may not be aware
of other companies that may be planning to enter the segments of the insurance
and reinsurance market in which we operate or of existing companies that may be
planning to raise additional capital. Increasing competition could result in
fewer submissions, lower premium rates and less favorable policy terms and
conditions, which could have a material adverse impact on our growth and
profitability.
Further, insurance/risk-linked securities and derivative and other non-
traditional risk transfer mechanisms and vehicles are being developed and
offered by other parties, including non-insurance company entities, which could
impact the demand for traditional insurance or reinsurance. A number of new,
proposed or potential industry or legislative developments could further
increase competition in our industry. These developments include:
22
o several new insurance and reinsurance companies have been formed
and capitalized in excess of $500 million since September 2001 and
a number of these companies compete with us in the same markets;
o legislative mandates for insurers to provide certain types of
coverage in areas where we or our ceding clients do business, such
as the mandated terrorism coverage in the Terrorism Risk Insurance
Act of 2002, could eliminate the opportunities for us to write
those coverages; and
o programs in which state-sponsored entities provide property
insurance in catastrophe prone areas or other "alternative
markets" types of coverage could eliminate the opportunities for
us to write those coverages.
In addition, insurance companies that merge may be able to enhance their
negotiating position when buying reinsurance and may be able to spread their
risks across a consolidated, larger capital base so that they require less
reinsurance.
New competition from these developments could cause the demand for
insurance or reinsurance to fall or the expense of customer acquisition and
retention to increase, either of which could have a material adverse affect on
our growth and profitability.
Efforts to comply with the Sarbanes-Oxley Act will entail significant
expenditure; non-compliance with the Sarbanes-Oxley Act may adversely affect us.
The Sarbanes-Oxley Act of 2002 that became law in July 2002, as well as
new rules subsequently implemented by the Securities and Exchange Commission
("Commission") and the NYSE, have required, and will require, changes to some of
our accounting and corporate governance practices, including the requirement
that we issue a report on our internal controls as required by Section 404 of
the Sarbanes-Oxley Act. We expect these new rules and regulations to continue to
increase our accounting, legal and other costs, and to make some activities more
difficult, time consuming and/or costly. Compliance with Section 404 of the
Sarbanes-Oxley Act is required by December 31, 2004. In the event that we are
unable to achieve compliance with the Sarbanes-Oxley Act of 2002 and related
rules, it may have a material adverse effect on us.
The historical cyclicality of the property and casualty reinsurance industry may
cause fluctuations in our results.
Historically, property and casualty reinsurers have experienced
significant fluctuations in operating results due to competition, frequency of
occurrence or severity of catastrophic events, levels of capacity, general
economic conditions and other factors. Demand for reinsurance is influenced
significantly by underwriting results of primary property and casualty insurers
and prevailing general economic conditions. The supply of reinsurance is related
to prevailing prices, the levels of insured losses and the levels of industry
surplus which, in turn, may fluctuate in response to changes in rates of return
on investments being earned in the reinsurance industry. As a result, the
reinsurance business historically has been a cyclical industry characterized by
periods of intense price competition due to excessive underwriting capacity as
well as periods when shortages of capacity permitted favorable premium levels.
Although rates for many products have generally increased since our formation,
and remain above our benchmark rates, the supply of reinsurance may increase,
either by capital provided by new entrants or by the commitment of additional
capital by existing reinsurers, which may cause prices to decrease. We are
beginning to see more competition across many of the lines of business in which
we participate. Any of these factors could lead to a significant reduction in
premium rates, less favorable policy terms and conditions and fewer submissions
for our underwriting services. In addition to these considerations, changes in
the frequency and severity of losses suffered by insurers may affect the cycles
of the reinsurance business significantly, and we expect to experience the
effects of such cyclicality.
Acquisitions or strategic investments that we made or may make could turn out to
be unsuccessful.
As part of our strategy, we have pursued and may continue to pursue
growth through acquisitions and/or strategic investments in new businesses. The
negotiation of potential acquisitions or strategic investments as well as the
integration of an acquired business or new personnel could result in a
substantial diversion of management resources. Acquisitions could involve
numerous additional risks such as potential losses from unanticipated litigation
or levels of claims and inability to generate sufficient revenue to offset
acquisition costs.
23
Our ability to manage our growth through acquisitions or strategic
investments will depend, in part, on our success in addressing these risks. Any
failure by us to effectively implement our acquisitions or strategic investment
strategies could have a material adverse effect on our business, financial
condition or results of operations.
The regulatory system under which we operate, and potential changes thereto,
could have a material adverse effect on our business.
General. Our insurance subsidiaries may not be able to obtain or maintain
necessary licenses, permits, authorizations or accreditations, or may be able to
do so only at great cost. In addition, we may not be able to comply fully with,
or obtain appropriate exemptions from, the wide variety of laws and regulations
applicable to insurance or reinsurance companies or holding companies. Failure
to comply with or to obtain appropriate exemptions under any applicable laws
could result in restrictions on our ability to do business in one or more of the
jurisdictions in which we operate and fines and other sanctions, which could
have a material adverse effect on our business. See "Regulatory Matters."
Endurance Bermuda. Endurance Bermuda is a registered Class 4 Bermuda
insurance and reinsurance company. Among other matters, Bermuda statutes,
regulations and policies of the BMA require Endurance Bermuda to maintain
minimum levels of statutory capital, statutory capital and surplus, and
liquidity, to meet solvency standards, to obtain prior approval of ownership and
transfer of shares and to submit to certain periodic examinations of its
financial condition. These statutes and regulations may, in effect, restrict
Endurance Bermuda's ability to write insurance and reinsurance policies, to make
certain investments and to distribute funds.
Endurance Bermuda does not maintain a principal office, and its personnel
do not solicit, advertise, settle claims or conduct other activities that may
constitute the transaction of the business of insurance or reinsurance, in any
jurisdiction in which it is not licensed or otherwise not authorized to engage
in such activities. Although Endurance Bermuda does not believe it is or will be
in violation of insurance laws or regulations of any jurisdiction outside
Bermuda, inquiries or challenges to Endurance Bermuda's insurance or reinsurance
activities may still be raised in the future.
The offshore insurance and reinsurance regulatory environment has become
subject to increased scrutiny in many jurisdictions, including the United States
and various states within the United States. Compliance with any new laws
regulating offshore insurers or reinsurers could have a material adverse effect
on our business.
Endurance U.K. On December 4, 2002, Endurance U.K. received authorization
from the FSA to begin writing certain lines of insurance and reinsurance in the
United Kingdom. As an authorized insurer in the United Kingdom, Endurance U.K.
is able to operate throughout the European Union, subject to compliance with
certain notification requirements of the FSA and in some cases, certain local
regulatory requirements. As an FSA authorized insurer, the insurance and
reinsurance businesses of Endurance U.K. are subject to close supervision by the
FSA. During 2004, the FSA will strengthen its requirements for senior management
arrangements, systems and controls of insurance and reinsurance companies under
its jurisdiction and will place an increased emphasis on risk identification and
management in relation to the prudential regulation of insurance and reinsurance
business in the United Kingdom. Though, in many respects, the 2004 changes in
the FSA's requirements amplify existing FSA principles and rules and codify good
business practice, certain of these changes, and any new guidance given by the
FSA, may have an adverse impact on the business of Endurance U.K.
In addition, given that the framework for supervision of insurance and
reinsurance companies in the United Kingdom is largely formed by E.U. directives
(which are implemented by member states through national legislation), changes
at the E.U. level may affect the regulatory scheme under which Endurance U.K.
operates. A general review of E.U. insurance solvency directives is currently in
progress and may lead to changes such as increased minimum capital requirements.
Before this, however, the FSA has proposed to introduce new enhanced capital
requirements ("ECR") for insurers and reinsurers which will include capital
charges based on assets, claims and premiums. The level of ECR seems likely to
be at least twice the existing required minimum solvency margin for most
companies, although the FSA has already adopted an i