UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the period ended September 30, 2003, or
|_| Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
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 (I.R.S. Employer Identification No.)
of Incorporation or Organization)
Wellesley House
90 Pitts Bay Road
Pembroke, Bermuda
(Address of Principal Executive HM 08
Offices) (Zip Code)
(441) 278-0400
Registrant's Telephone Number, Including Area Code
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter 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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Shares Outstanding
Description of Class as of November 13, 2003
- ---------------------------------- -----------------------
Ordinary Shares - $1.00 par value 63,912,000
INDEX
Page
----
Part I. FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets at September 30, 2003
and December 31, 2002 2
Unaudited Condensed Consolidated Statements of Income and
Comprehensive Income for the Three and Nine Months Ended
September 30, 2003 and 2002 3
Unaudited Condensed Consolidated Statements of Changes in
Shareholders' Equity for the Nine Months Ended
September 30, 2003 and 2002 4
Unaudited Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2003 and 2002 5
Notes to the Unaudited Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 21
Item 4. Controls and Procedures 48
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 49
Item 2. Changes in Securities and Use of Proceeds 49
Item 3. Defaults Upon Senior Securities 49
Item 4. Submission of Matters to a Vote of Security Holders 49
Item 5. Other Information 50
Item 6. Exhibits and Reports on Form 8-K 50
SIGNATURES 51
1
ENDURANCE SPECIALTY HOLDINGS LTD.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands of United States dollars except share amounts)
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
ASSETS (UNAUDITED)
Cash and cash equivalents $ 169,685 $ 256,840
Fixed maturity investments available for sale, at fair value
(amortized cost: $2,264,825 and $1,358,027 at September 30,
2003 and December 31, 2002, respectively) 2,306,164 1,406,409
Premiums receivable, net (includes $nil and $45,368 from
related parties at September 30, 2003 and December 31, 2002,
respectively) 603,634 264,355
Deferred acquisition costs 200,792 81,676
Prepaid reinsurance premiums 2,137 7,501
Accrued investment income 22,004 11,209
Intangible assets 33,334 14,344
Other assets 25,398 12,260
------------ ------------
Total assets $ 3,363,148 $ 2,054,594
============ ============
LIABILITIES
Reserve for losses and loss expenses $ 673,850 $ 200,840
Reserve for unearned premiums 917,797 403,305
Reinsurance balances payable 24,447 16,443
Bank debt 103,029 192,000
Net payable for investments purchased 50,253 6,470
Other liabilities 29,126 18,036
------------ ------------
Total liabilities 1,798,502 837,094
------------ ------------
SHAREHOLDERS' EQUITY
Common shares
Ordinary - 62,973,185 issued and outstanding (2002 - 54,061,185) 62,973 54,061
Class A - 938,815 issued and outstanding (2002 - 938,815) 939 939
Additional paid-in capital 1,188,793 1,009,415
Accumulated other comprehensive income 47,892 50,707
Retained earnings 264,049 102,378
------------ ------------
Total shareholders' equity 1,564,646 1,217,500
------------ ------------
Total liabilities and shareholders' equity $ 3,363,148 $ 2,054,594
============ ============
See accompanying notes to unaudited condensed consolidated financial statements.
2
ENDURANCE SPECIALTY HOLDINGS LTD.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(In thousands of United States dollars, except share and per share amounts)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenues
Gross premiums written and acquired $ 325,070 $ 228,285 $ 1,339,841 $ 623,472
============ ============ ============ ============
Net premiums written and acquired 324,405 216,819 1,336,808 590,513
Change in unearned premiums 11,425 (105,299) (518,859) (386,231)
------------ ------------ ------------ ------------
Net premiums earned (includes $258 and $23,772 from related
parties for the nine months ended September 30, 2003 and
2002, respectively) 335,830 111,520 817,949 204,282
Net investment income 18,736 13,488 49,758 29,355
Net foreign exchange gains (losses) 2,123 (11) 6,717 1,107
Net realized (losses) gains on sales of investments (932) 2,796 6,985 3,688
------------ ------------ ------------ ------------
Total revenues 355,757 127,793 881,409 238,432
------------ ------------ ------------ ------------
Expenses
Losses and loss expenses (includes $79 and $9,548 from
related parties for the nine months ended September 30,
2003 and 2002, respectively) 198,665 69,282 468,341 115,146
Acquisition expenses (includes $28 and $3,179 payable to
related parties for the nine months ended September 30,
2003 and 2002, respectively) 69,382 18,527 161,423 33,304
General and administrative expenses 28,905 10,774 71,448 26,195
Amortization of intangibles 944 325 2,294 325
Interest expense 1,013 30 3,393 30
------------ ------------ ------------ ------------
Total expenses 298,909 98,938 706,899 175,000
------------ ------------ ------------ ------------
Income before income taxes 56,848 28,855 174,510 63,432
Income tax (expense) benefit (305) 56 25 56
------------ ------------ ------------ ------------
Net income 56,543 28,911 174,535 63,488
------------ ------------ ------------ ------------
Other comprehensive (loss) income
Holding (losses) gains on investments arising during the
period (2003: net of applicable deferred income tax
credits of $82 and nil for the nine months ended
September 30, 2003 and 2002, and respectively) (17,603) 37,296 (444) 52,296
Foreign currency translation adjustments 1,977 -- 5,899 --
Net gain (loss) on derivatives designated as cash flow hedge 450 -- (1,285) --
Reclassification adjustment for net realized losses (gains)
included in net income 932 (2,796) (6,985) (3,688)
------------ ------------ ------------ ------------
Other comprehensive (loss) income (14,244) 34,500 (2,815) 48,608
------------ ------------ ------------ ------------
Comprehensive income $ 42,299 $ 63,411 $ 171,720 $ 112,096
============ ============ ============ ============
Per share data
Weighted average number of common and common equivalent
shares outstanding:
Basic 64,414,293 59,836,957 62,557,398 59,945,055
============ ============ ============ ============
Diluted 67,795,320 60,154,600 65,166,361 59,945,055
============ ============ ============ ============
Basic earnings per share $ 0.88 $ 0.48 $ 2.79 $ 1.06
============ ============ ============ ============
Diluted earnings per share $ 0.83 $ 0.48 $ 2.68 $ 1.06
============ ============ ============ ============
See accompanying notes to unaudited condensed consolidated financial statements.
3
ENDURANCE SPECIALTY HOLDINGS LTD.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN
SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(In thousands of United States dollars)
2003 2002
----------- -----------
Common shares
Balance, beginning of period $ 55,000 $ 60,000
Repurchase of common shares (750) (5,000)
Issuance of common shares 9,662 --
----------- -----------
Balance, end of period 63,912 55,000
----------- -----------
Additional paid-in capital
Balance, beginning of period 1,009,415 1,102,000
Repurchase of common shares (19,545) (95,000)
Issuance of common shares 197,110 --
Issuance of restricted share units 3,092 --
Public offering costs (3,820) --
Stock-based compensation expense 2,541 --
----------- -----------
Balance, end of period 1,188,793 1,007,000
----------- -----------
Accumulated other comprehensive income
Cumulative foreign currency translation adjustments:
Balance, beginning of period 3,662 --
Foreign currency translation adjustments 5,899 --
----------- -----------
Balance, end of period 9,561 --
----------- -----------
Unrealized holding gains (losses) on investments:
Balance, beginning of period 47,045 --
Net unrealized holding (losses) gains arising during the period, net of
reclassification adjustment (7,429) 48,608
----------- -----------
Balance, end of period 39,616 48,608
----------- -----------
Accumulated derivative gain (loss) on cash flow hedging instruments:
Balance, beginning of period -- --
Net change from current period hedging transactions (2,051) --
Net derivative loss reclassified to earnings 766 --
----------- -----------
Balance, end of period (1,285) --
----------- -----------
Total accumulated other comprehensive income 47,892 48,608
----------- -----------
Retained earnings
Balance, beginning of period 102,378 312
Net income 174,535 63,488
Issuance of restricted share units in lieu of dividends (28) --
Dividends on common shares (12,836) --
----------- -----------
Balance, end of period 264,049 63,800
----------- -----------
Total shareholders' equity $ 1,564,646 $ 1,174,408
=========== ===========
See accompanying notes to unaudited condensed consolidated financial statements.
4
ENDURANCE SPECIALTY HOLDINGS LTD.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(In thousands of United States dollars)
2003 2002
----------- -----------
Cash flows provided by (used in) operating activities:
Net income $ 174,535 $ 63,488
Adjustments to reconcile net income to net cash provided by operating
activities
Depreciation and amortization 26,303 5,960
Net realized gains on sales of investments (6,985) (3,688)
Deferred taxes 324 --
Stock-based compensation expense 2,541 --
Premiums receivable, net (19,377) (176,631)
Deferred acquisition costs (32,963) (64,485)
Prepaid reinsurance premiums 5,364 5,292
Accrued investment income (10,795) (12,296)
Other assets (1,810) (9,243)
Reserve for losses and loss expenses 421,365 114,779
Reserve for unearned premiums 99,975 313,870
Reinsurance balances payable 8,004 (21,557)
Other liabilities 7,629 8,567
----------- -----------
Net cash provided by operating activities 674,110 224,056
----------- -----------
Cash flows provided by (used in) investing activities:
Proceeds from sales of fixed maturity investments 1,078,389 218,981
Purchases of fixed maturity investments (1,949,177) (1,455,780)
Purchases of fixed assets (15,099) (4,256)
Net cash acquired in HartRe acquisition 45,656 --
Purchase of net assets - LaSalle (1,532) (11,060)
----------- -----------
Net cash used in investing activities (841,763) (1,252,115)
----------- -----------
Cash flows provided by (used in) financing activities:
Issuance of common shares 206,384 --
Repurchase of common shares (20,295) (100,000)
Offering costs paid (3,820) (1,864)
Proceeds from bank debt -- 100,000
Bank debt repaid (88,971) --
Dividends paid (12,836) --
----------- -----------
Net cash provided by (used in) financing activities 80,462 (1,864)
----------- -----------
Effect of exchange rate changes on cash and cash equivalents 36 --
----------- -----------
Net decrease in cash and cash equivalents (87,155) (1,029,923)
Cash and cash equivalents, beginning of period 256,840 1,162,498
----------- -----------
Cash and cash equivalents, end of period $ 169,685 $ 132,575
=========== ===========
See accompanying notes to unaudited condensed consolidated financial statements.
5
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in tables expressed in thousands of United States dollars, except share
and per share amounts)
1. General
Endurance Specialty Holdings Ltd. ("Endurance Holdings") was organized as
a Bermuda holding company on June 27, 2002. Endurance Holdings writes
specialty lines of insurance and reinsurance on a global basis through its
three wholly-owned operating subsidiaries: Endurance Specialty Insurance
Ltd. ("Endurance Bermuda"), based in Bermuda; Endurance Worldwide
Insurance Limited ("Endurance U.K."), based in London, England; and
Endurance Reinsurance Corporation of America ("Endurance U.S."), based in
White Plains, New York.
The accompanying unaudited condensed consolidated financial statements
have been prepared on the basis of accounting principles generally
accepted in the United States for interim financial information and with
the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes
required by accounting principles generally accepted in the United States
for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary
for a fair presentation have been included. Results for the three and nine
month periods ended September 30, 2003 are not necessarily indicative of
the results that may be expected for the year ended December 31, 2003. The
unaudited condensed consolidated financial statements include the accounts
of Endurance Holdings and its wholly-owned subsidiaries, which are
collectively referred to herein as the "Company". All intercompany
transactions and balances have been eliminated on consolidation.
Management is required to make estimates and assumptions that affect the
amounts reported in the unaudited condensed consolidated financial
statements and accompanying disclosures. Actual results could differ from
those estimates. Among other matters, significant estimates and
assumptions are used to record premiums written and ceded, and to record
reserves for losses and loss expenses and contingencies. Estimates and
assumptions are periodically reviewed and the effects of revisions are
recorded in the consolidated financial statements in the period that they
are determined to be necessary.
The balance sheet at December 31, 2002 has been derived from the audited
financial statements at that date but does not include all of the
information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. These
unaudited condensed consolidated financial statements and notes thereto
should be read in conjunction with the consolidated financial statements
and notes thereto for the year ended December 31, 2002 contained in
Endurance Holdings' final prospectus filed with the United States
Securities and Exchange Commission on February 28, 2003 (Registration No.
333-102026) in connection with the initial public offering of Endurance
Holdings' ordinary shares.
Certain reclassifications have been made for 2002 to conform to the 2003
presentation.
2. Significant events
On August 27, 2003, the "lock-up" agreements entered into by the Company,
its directors and executive officers, all of its warrant holders and
certain of its current shareholders expired. The lock-up agreements were
entered into with the lead underwriters of the Company's initial public
offering and required bound parties to refrain from selling the Company's
ordinary shares.
On August 22, 2003, Kenneth J. LeStrange, Chairman of the Board of
Directors, President and Chief Executive Officer, purchased 50,000
ordinary shares of the Company for an aggregate purchase price of
$1,000,000, pursuant to the terms of the employment agreement between the
Company and Mr. LeStrange. On the same date, Mr. LeStrange purchased an
additional 4,400 ordinary shares in the open market at prevailing market
prices.
6
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except share
and per share amounts)
2. Significant events, cont'd.
On August 20, 2003, the Company repurchased 750,000 of its ordinary shares
at $27.06 per share. The closing market price per share on August 19, 2003
was $27.90.
On March 5, 2003, Endurance Holdings completed an initial public offering
which resulted in the issuance of 9,600,000 of its ordinary shares. The
ordinary shares are listed for trading on the New York Stock Exchange
under the symbol "ENH". Total proceeds received net of underwriting
discounts and other offering expenses were $201.5 million. Net proceeds
have been credited to shareholders' equity. Pursuant to the terms of its
term loan facility, upon consummation of the public offering, the Company
repaid $50.6 million of its outstanding principal under the term loan. The
Company invested the remaining net proceeds of the offering in
investment-grade, fixed maturity investments.
3. Debt and financing arrangements
On August 13, 2002, the Company entered into a $192 million three-year
term loan facility and a one year $108 million letter of credit and
revolving credit facility with a syndicate of commercial banks.
On August 8, 2003, the Company and its lenders amended the three-year term
loan facility and amended the letter of credit and revolving credit
facility. The amendments extended the letter of credit and revolving
credit facility for an additional year, increased the size of the letter
of credit and revolving credit facility to $500 million and revised
certain representations and covenants in the three-year term loan facility
and the letter of credit and revolving credit facility.
Interest rates on the term loan are LIBOR plus a spread that is based on
the Company's debt to capital ratio. The interest rate applied to the
outstanding balance averaged 2.92% during the nine month period ended
September 30, 2003. The amended letter of credit and revolving credit
facility expires on August 11, 2004, at which point any revolving credit
balance will be converted into a six-month term loan. The amended
agreements contain certain covenants including requirements that debt, as
defined in the agreements, to shareholders' equity does not exceed a ratio
of 0.35:1; consolidated tangible net worth must exceed $1.0 billion; and
the Company's unencumbered cash and investment grade assets must exceed
the greater of $400 million or outstanding debt and letters of credit. In
addition, the Company must apply 25% of the cash proceeds received from
any sale of equity securities and 100% of the cash proceeds from any debt
offerings to the repayment of outstanding principal of term loans
outstanding under the term loan facility. The Company was in compliance
with all covenants of these agreements at September 30, 2003.
In accordance with the terms of the Company's term loan facility, the
Company prepaid $50.6 million of the outstanding principal on the term
loan facility on March 5, 2003 with a portion of the proceeds from the
Company's initial public offering of its ordinary shares. In addition, the
Company made a further scheduled principal payment of $38.4 million on its
term loan facility on September 26, 2003.
At September 30, 2003, the Company had $103.0 million of the term loan
outstanding. In addition, letters of credit totaling $68.5 million were
outstanding at September 30, 2003. Under the terms of the term loan
facility, the Company is required to making further repayments of $76.8
million by September 30, 2004 and $26.2 million by September 30, 2005. The
Company recorded interest expense of $3.4 million for the nine month
period ended September 30, 2003 and at September 30, 2003, the fair value
of the borrowings approximates the carrying value.
7
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except share
and per share amounts)
3. Debt and financing arrangements, cont'd.
As part of its overall strategy to manage interest rate exposure, the
Company has entered into an interest rate swap contract to hedge the
variable cash outflows related to the term loan facility. The contract
became effective on March 27, 2003 and provides for the exchange of
floating rate payments for fixed rate payments (2.62% per annum) on a
declining notional amount corresponding to the outstanding principal
amount of the $100 million drawn down on the term loan facility on
September 27, 2002. The agreement has been designated as a "cash flow
hedge" under Statement of Financial Accounting Standard ("SFAS") No. 133,
and accordingly, the changes in fair value of the derivative are recorded
in other comprehensive income and recognized as a component of interest
expense in the statement of income when the variable interest expense
affects earnings. At September 30, 2003 the fair value of the interest
rate swap amounted to a liability of $1.3 million and is included on the
balance sheet as a component of other liabilities; the estimated net
amount of the existing loss that is expected to be reclassified into
earnings in the next twelve months is $1.1 million. The fair value of the
interest rate swap was estimated by calculating the net present value of
expected future cash flows based on market rates at September 30, 2003.
4. Business combination
On May 15, 2003, the Company completed a transaction with The Hartford
Fire Insurance Company and HartRe Company, L.L.C. (collectively, "HartRe")
to assume the majority of the in-force reinsurance business of HartRe, to
acquire exclusive renewal rights to that business and to hire certain
employees of HartRe necessary for the operation of the assumed business.
The transaction was structured as a bordereaux quota share retrocession of
the majority of HartRe's reinsurance business, a purchase of HartRe's
renewal rights with respect to such business and an agreement with respect
to the claims handling for the business. The effective date of the
arrangement was April 1, 2003. Some of the contracts included in HartRe's
in-force reinsurance business were proportionally assumed by the Company
from the original inception dates of the underlying contracts. The Company
did not assume any of HartRe's historical reinsurance liabilities from
expired policies.
The primary reasons for the transaction were to acquire potentially
profitable business, to increase the Company's presence in the U.S.
domestic reinsurance marketplace and to increase the U.S. based staff of
the Company. The transaction was accounted for as a purchase method
business combination in accordance with SFAS No. 141, "Business
Combinations".
The initial purchase price payable by the Company was $30.5 million and
the fair value of the net assets acquired was $30.3 million, resulting in
$0.2 million of goodwill.
8
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except share
and per share amounts)
4. Business combination, cont'd.
The fair value of net assets acquired is summarized as follows:
Assets
Cash $ 70,876
Premiums receivable, net 319,902
Acquisition cost of in-force contracts 86,153
Other identifiable intangible assets 19,563
--------
Assets acquired 496,494
--------
Liabilities
Unearned premiums 414,517
Reserve for losses and loss expenses 51,645
--------
Liabilities acquired 466,162
--------
Net assets acquired $ 30,332
========
Other identifiable intangible assets include the fair value of the
customer lists, including the underwriter relationships, and the
non-solicit and non-compete rights purchased. These other identifiable
assets are estimated to have finite lives of up to ten years and they are
being amortized over such periods.
Estimated amortization expense for the next five years as of September 30,
2003 is as follows:
Year Ended
September 30, Amount
------------- ------
2004 $ 2,156
2005 2,031
2006 1,906
2007 1,906
2008 1,906
-------
$ 9,905
=======
The acquisition cost of in-force contracts are included in deferred
acquisition costs in the consolidated balance sheet and are amortized
pro-rata over the remaining terms of the related in-force contracts. The
related amortization expense in the three and nine month periods ended
September 30, 2003 of $24.8 million and $45.3 million, respectively, is
included in acquisition expenses in the condensed consolidated statement
of income.
9
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except share
and per share amounts)
4. Business combination, cont'd.
In addition to the initial purchase price, Endurance U.S. may be required
to pay further amounts to HartRe. Such contingent amounts are based on the
renewal and profitability of the in-force business acquired. Upon renewal
of the business acquired over the two years following April 1, 2003,
commissions are due at a range of 1-5% of premiums depending on the line
of business. Contingent renewal commissions are only payable to the extent
they exceed $10 million for the first year following closing and $5
million for the second year following closing. These amounts are
guaranteed and constitute part of the initial purchase price. In addition,
a profit sharing commission will be paid if the net loss ratio of the
business associated with the property treaty, property catastrophe, and
aviation lines is less than a blended target loss ratio for the 2003
accident year. The contingent profit commission will be equal to 50% of
underwriting profits generated by the difference between the ultimate loss
ratio and target loss ratio multiplied by the earned premiums for the 2003
accident year. At September 30, 2003, the majority of the in-force
contracts acquired had not yet come up for renewal, and as such, amounts
potentially payable to HartRe based on renewals were not yet determinable.
The profitability component of the contingent payments will not be
determinable until further maturation of the 2003 accident year results on
the business acquired from HartRe. Any such contingent amounts will be
recorded as an increase in goodwill in the period in which they are
determined to be payable.
Operating results of the HartRe business acquired have been included in
the consolidated financial statements from April 1, 2003, which is the
effective date of the retrocession agreement. As required by SFAS No. 141,
the following selected unaudited pro forma information is being provided
to present a summary of the combined results of the Company and the HartRe
business acquired assuming the transaction had been effected on January 1,
2002. The unaudited pro forma data is for informational purposes only and
does not necessarily represent results that would have occurred if the
transaction had taken place on the basis assumed above.
THREE MONTHS ENDED
September 30, 2003 September 30, 2002
Net premiums written and acquired $ 324,405 $ 331,213
Total revenues $ 355,757 $ 158,552
Total expenses $ (299,214) $ (125,640)
Net income $ 56,543 $ 32,912
Basic earnings per share $ 0.88 $ 0.55
Diluted earnings per share $ 0.83 $ 0.55
NINE MONTHS ENDED
September 30, 2003 September 30, 2002
Net premiums written and acquired $ 1,613,338 $ 838,477
Total revenues $ 966,850 $ 293,220
Total expenses $ (784,663) $ (220,078)
Net income $ 182,187 $ 73,142
Basic earnings per share $ 2.91 $ 1.22
Diluted earnings per share $ 2.80 $ 1.22
10
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except share
and per share amounts)
5. Earnings per share
Basic earnings per common share are calculated by dividing net income
available to holders of Endurance Holdings' ordinary shares and class A
shares (collectively referred to as "common shares") by the weighted
average number of common shares outstanding. In addition to the actual
common shares outstanding, the weighted average number of common shares
included in the basic earnings per common share calculation also includes
the fully vested restricted share units discussed in note 6. Diluted
earnings per common share are based on the weighted average number of
common shares and dilutive potential common shares outstanding during the
period of calculation using the treasury stock method. The following
tables set forth the computation of basic and diluted earnings per share:
THREE MONTHS ENDED
SEPTEMBER 30,
2003 2002
----------- -----------
Numerator:
Net income available to common shareholders $ 56,543 $ 28,911
----------- -----------
Denominator:
Weighted average shares - basic
Ordinary shares outstanding 64,280,696 59,836,957
Vested restricted share units outstanding 133,597 --
----------- -----------
64,414,293 59,836,957
Share equivalents
Unvested restricted share units 548 --
Warrants 2,407,784 317,643
Options 972,695 --
----------- -----------
Weighted average shares - diluted 67,795,320 60,154,600
----------- -----------
Basic earnings per common share $ 0.88 $ 0.48
----------- -----------
Diluted earnings per common share $ 0.83 $ 0.48
----------- -----------
NINE MONTHS ENDED
SEPTEMBER 30,
2003 2002
----------- -----------
Numerator:
Net income available to common shareholders $ 174,535 $ 63,488
----------- -----------
Denominator:
Weighted average shares - basic
Ordinary shares outstanding 62,452,835 59,945,055
Vested restricted share units outstanding 104,563 --
----------- -----------
62,557,398 59,945,055
Share equivalents
Unvested restricted share units 185 --
Warrants 1,892,888 --
Options 715,890 --
----------- -----------
Weighted average shares - diluted 65,166,361 59,945,055
----------- -----------
Basic earnings per common share $ 2.79 $ 1.06
----------- -----------
Diluted earnings per common share $ 2.68 $ 1.06
----------- -----------
11
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except share
and per share amounts)
5. Earnings per share, cont'd.
The Company declared dividends of $0.12 per common share on August 8, 2003
and $0.08 per common share on May 15, 2003.
6. Stock-based employee compensation plans
The Company has a stock-based employee compensation plan (the "Option
Plan") which provides for the grant of options to purchase the Company's
common shares, share appreciation rights, restricted shares, share bonuses
and other equity incentive awards to key employees. On March 1, 2003, the
Company settled $3.1 million of its 2002 annual bonus obligations to
certain employees with grants of 133,234 fully vested restricted share
units. The restricted share units will be automatically settled over a
three year period. At the Company's exclusive option, the restricted share
units may be settled in cash, ordinary shares or in a combination thereof.
The fair value of the restricted share units at the date of grant was
equal to the 2002 bonus obligation recognized during the year ended
December 31, 2002, and as such, no additional compensation expense has
been recognized in 2003. Holders of restricted share units receive
additional incremental restricted share units when the Company pays
dividends on its common shares.
Effective January 1, 2002, the Company adopted the fair value recognition
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation",
prospectively to all employee awards granted, modified, or settled after
January 1, 2002. Awards under the Option Plan vest over periods of up to
five years. Therefore, the cost related to stock-based employee
compensation included in the determination of net income for 2003 and 2002
is less than that which would have been recognized if the fair value based
method had been applied to all awards granted.
The following tables illustrate the effect on net income and earnings per
share if the fair value based method had been applied to all outstanding
and unvested awards:
THREE MONTHS ENDED
SEPTEMBER 30,
2003 2002
------------- ------------
Net income, as reported $ 56,543 $ 28,911
Add: Stock-based employee compensation expense
included in reported net income, net of related tax
effects 1,127 --
Deduct: Total stock-based employee compensation
expense determined under fair value based method for
all awards, net of related tax effects (1,127) (965)
------------- ------------
Pro forma net income $ 56,543 $ 27,946
============= ============
Earnings per share:
Basic - as reported $ 0.88 $ 0.48
============= ============
Basic - pro forma $ 0.88 $ 0.47
============= ============
Diluted - as reported $ 0.83 $ 0.48
============= ============
Diluted - pro forma $ 0.83 $ 0.47
============= ============
12
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except share
and per share amounts)
6. Stock-based employee compensation plans, cont'd.
NINE MONTHS ENDED
SEPTEMBER 30,
2003 2002
--------- ---------
Net income, as reported $ 174,535 $ 63,488
Add: Stock-based employee compensation expense included in
reported net income, net of related tax effects 2,542 --
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards, net
of related tax effects (5,259) (3,201)
--------- ---------
Pro forma net income $ 171,818 $ 60,287
========= =========
Earnings per share:
Basic - as reported $ 2.79 $ 1.06
========= =========
Basic - pro forma $ 2.75 $ 1.01
========= =========
Diluted - as reported $ 2.68 $ 1.06
========= =========
Diluted - pro forma $ 2.64 $ 1.01
========= =========
7. Segment reporting
The determination of the Company's business segments is based on how the
Company monitors the performance of its underwriting operations. The
Company has six reportable business segments: property per risk treaty
reinsurance, property catastrophe reinsurance, casualty treaty
reinsurance, property individual risk, casualty individual risk and
aerospace and other specialty lines.
o Property Per Risk Treaty Reinsurance - reinsures individual
property risks of ceding companies on a treaty basis.
o Property Catastrophe Reinsurance - reinsures catastrophic
perils for ceding companies on a treaty basis.
o Casualty Treaty Reinsurance - reinsures third party liability
exposures from ceding companies on a treaty basis.
o Property Individual Risk - insurance and facultative
reinsurance of commercial properties.
o Casualty Individual Risk - insurance and facultative
reinsurance of third party liability exposures.
o Aerospace and Other Specialty Lines - insurance and
reinsurance of 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.
Because the Company does not manage its assets by segment, investment
income and total assets are not allocated to the individual segments.
Management measures segment results on the basis of the combined ratio
that is obtained by dividing the sum of the losses and loss expenses,
acquisition expenses and general and administrative expenses by net
premiums earned.
13
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except share
and per share amounts)
7. Segment reporting, cont'd.
General and administrative expenses incurred by segments are allocated
directly. Remaining corporate overhead is allocated based on each
segment's proportional share of gross premiums written and acquired. The
following table provides a summary of the segment revenues and results for
the three months ended September 30, 2003:
Property Per Property Casualty
Risk Treaty Catastrophe Treaty
Reinsurance Reinsurance Reinsurance
----------- ----------- -----------
Revenues
Gross premiums written and acquired $ 46,026 $ 43,938 $ 130,229
---------- ---------- ----------
Net premiums written and acquired 46,026 43,938 130,197
---------- ---------- ----------
Net premiums earned 86,577 48,453 80,988
---------- ---------- ----------
Expenses
Losses and loss expenses 54,590 18,488 48,009
Acquisition expenses 22,643 4,887 22,754
General and administrative expenses 4,450 5,362 8,030
---------- ---------- ----------
81,683 28,737 78,793
---------- ---------- ----------
Underwriting income $ 4,894 $ 19,716 $ 2,195
========== ========== ==========
Loss ratio 63.1% 38.2% 59.3%
Acquisition expense ratio 26.2% 10.1% 28.1%
General and administrative expense ratio 5.1% 11.1% 9.9%
---------- ---------- ----------
Combined ratio 94.4% 59.4% 97.3%
---------- ---------- ----------
Aerospace and
Other
Property Casualty Specialty
Individual Risk Individual Risk Lines
--------------- --------------- -------------
Revenues
Gross premiums written and acquired $ 20,734 $ 51,543 $ 32,600
---------- ---------- ----------
Net premiums written and acquired 20,101 51,543 32,600
---------- ---------- ----------
Net premiums earned 15,730 48,108 55,974
---------- ---------- ----------
Expenses
Losses and loss expenses 6,711 33,331 37,536
Acquisition expenses 1,673 5,628 11,797
General and administrative expenses 2,985 5,054 3,024
---------- ---------- ----------
11,369 44,013 52,357
---------- ---------- ----------
Underwriting income $ 4,361 $ 4,095 $ 3,617
========== ========== ==========
Loss ratio 42.7% 69.3% 67.1%
Acquisition expense ratio 10.6% 11.7% 21.1%
General and administrative expense ratio 19.0% 10.5% 5.4%
---------- ---------- ----------
Combined ratio 72.3% 91.5% 93.6%
---------- ---------- ----------
14
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except share
and per share amounts)
7. Segment reporting, cont'd.
The following table provides a summary of the segment revenues and results
for the three months ended September 30, 2002:
Property Per Property Casualty
Risk Treaty Catastrophe Treaty
Reinsurance Reinsurance Reinsurance
------------ ----------- -----------
Revenues
Gross premiums written and acquired $ 59,963 $ 22,689 $ 67,041
----------- ----------- -----------
Net premiums written and acquired 59,963 12,095 67,041
----------- ----------- -----------
Net premiums earned 19,884 34,045 15,651
----------- ----------- -----------
Expenses
Losses and loss expenses 10,790 28,651 8,758
Acquisition expenses 4,279 4,659 4,703
General and administrative expenses 3,409 721 3,029
----------- ----------- -----------
18,478 34,031 16,490
----------- ----------- -----------
Underwriting income (loss) $ 1,406 $ 14 $ (839)
=========== =========== ===========
Loss ratio 54.3% 84.2% 56.0%
Acquisition expense ratio 21.5% 13.7% 30.0%
General and administrative expense ratio 17.1% 2.1% 19.4%
----------- ----------- -----------
Combined ratio 92.9% 100.0% 105.4%
----------- ----------- -----------
Aerospace and
Property Casualty Other Specialty
Individual Risk Individual Risk Lines
--------------- --------------- ---------------
Revenues
Gross premiums written and acquired $ 19,407 $ 37,352 $ 21,833
----------- ----------- -----------
Net premiums written and acquired 18,534 37,352 21,833
----------- ----------- -----------
Net premiums earned 11,960 14,984 14,996
----------- ----------- -----------
Expenses
Losses and loss expenses 1,983 11,321 7,779
Acquisition expenses 1,232 1,352 2,302
General and administrative expenses 910 1,643 1,062
----------- ----------- -----------
4,125 14,316 11,143
----------- ----------- -----------
Underwriting income $ 7,835 $ 668 $ 3,853
=========== =========== ===========
Loss ratio 16.6% 75.6% 51.9%
Acquisition expense ratio 10.3% 9.0% 15.4%
General and administrative expense ratio 7.6% 11.0% 7.1%
----------- ----------- -----------
Combined ratio 34.5% 95.6% 74.4%
----------- ----------- -----------
15
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except share
and per share amounts)
7. Segment reporting, cont'd.
The following table reconciles total segment results to consolidated
income before income taxes for the three months ended September 30, 2003
and 2002, respectively:
2003 2002
-------- --------
Total underwriting income $ 38,878 $ 12,937
Net investment income 18,736 13,488
Net foreign exchange gains (losses) 2,123 (11)
Net realized (losses) gains on sales of investments (932) 2,796
Amortization of intangibles (944) (325)
Interest expense (1,013) (30)
-------- --------
Consolidated income before income taxes $ 56,848 $ 28,855
======== ========
16
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except share
and per share amounts)
7. Segment reporting, cont'd.
The following table provides a summary of the segment revenues and results
for the nine months ended September 30, 2003:
Property Per Property Casualty
Risk Treaty Catastrophe Treaty
Reinsurance Reinsurance Reinsurance
------------ ----------- -----------
Revenues
Gross premiums written and acquired $ 360,417 $ 170,410 $ 332,585
----------- ----------- -----------
Net premiums written and acquired 360,417 171,120 330,254
----------- ----------- -----------
Net premiums earned 205,868 127,953 194,689
----------- ----------- -----------
Expenses
Losses and loss expenses 124,431 29,931 124,070
Acquisition expenses 53,905 14,347 53,541
General and administrative expenses 16,219 10,592 15,995
----------- ----------- -----------
194,555 54,870 193,606
----------- ----------- -----------
Underwriting income $ 11,313 $ 73,083 $ 1,083
=========== =========== ===========
Loss ratio 60.4% 23.4% 63.7%
Acquisition expense ratio 26.2% 11.2% 27.5%
General and administrative expense ratio 7.9% 8.3% 8.2%
----------- ----------- -----------
Combined ratio 94.5% 42.9% 99.4%
----------- ----------- -----------
Aerospace and
Property Casualty Other Specialty
Individual Risk Individual Risk Lines
--------------- --------------- ---------------
Revenues
Gross premiums written and acquired $ 58,486 $ 154,495 $ 263,448
----------- ----------- -----------
Net premiums written and acquired 57,074 154,495 263,448
----------- ----------- -----------
Net premiums earned 47,558 118,474 123,407
----------- ----------- -----------
Expenses
Losses and loss expenses 16,823 84,044 89,042
Acquisition expenses 4,928 13,505 21,197
General and administrative expenses 5,189 11,226 12,227
----------- ----------- -----------
26,940 108,775 122,466
----------- ----------- -----------
Underwriting income $ 20,618 $ 9,699 $ 941
=========== =========== ===========
Loss ratio 35.4% 70.9% 72.2%
Acquisition expense ratio 10.4% 11.4% 17.2%
General and administrative expense ratio 10.9% 9.5% 9.9%
----------- ----------- -----------
Combined ratio 56.7% 91.8% 99.3%
----------- ----------- -----------
17
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except share
and per share amounts)
7. Segment reporting, cont'd.
The following table provides a summary of the segment revenues and results
for the nine months ended September 30, 2002:
Property Per Property Casualty
Risk Treaty Catastrophe Treaty
Reinsurance Reinsurance Reinsurance
------------ ----------- -----------
Revenues
Gross premiums written and acquired $ 123,584 $ 170,186 $ 143,481
----------- ----------- -----------
Net premiums written and acquired 123,584 138,100 143,481
----------- ----------- -----------
Net premiums earned 28,448 77,257 35,405
----------- ----------- -----------
Expenses
Losses and loss expenses 14,657 45,937 20,820
Acquisition expenses 6,019 11,419 8,452
General and administrative expenses 5,156 7,212 6,012
----------- ----------- -----------
25,832 64,568 35,284
----------- ----------- -----------
Underwriting income $ 2,616 $ 12,689 $ 121
=========== =========== ===========
Loss ratio 51.5% 59.5% 58.8%
Acquisition expense ratio 21.2% 14.8% 23.9%
General and administrative expense ratio 18.1% 9.3% 17.0%
----------- ----------- -----------
Combined ratio 90.8% 83.6% 99.7%
----------- ----------- -----------
Aerospace and
Property Casualty Other Specialty
Individual Risk Individual Risk Lines
--------------- --------------- ---------------
Revenues
Gross premiums written and acquired $ 50,989 $ 66,289 $ 68,943
----------- ----------- -----------
Net premiums written and acquired 50,116 66,289 68,943
----------- ----------- -----------
Net premiums earned 19,263 21,525 22,384
----------- ----------- -----------
Expenses
Losses and loss expenses 4,661 16,425 12,646
Acquisition expenses 1,909 1,894 3,611
General and administrative expenses 2,142 2,772 2,901
----------- ----------- -----------
8,712 21,091 19,158
----------- ----------- -----------
Underwriting income $ 10,551 $ 434 $ 3,226
=========== =========== ===========
Loss ratio 24.2% 76.3% 56.5%
Acquisition expense ratio 9.9% 8.8% 16.1%
General and administrative expense ratio 11.1% 12.9% 13.0%
----------- ----------- -----------
Combined ratio 45.2% 98.0% 85.6%
----------- ----------- -----------
18
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except share
and per share amounts)
7. Segment reporting, cont'd.
The following table reconciles total segment results to consolidated
income before income taxes for the nine months ended September 30, 2003
and 2002, respectively:
2003 2002
----------- -----------
Total underwriting income $ 116,737 $ 29,637
Net investment income 49,758 29,355
Net foreign exchange gains 6,717 1,107
Net realized gains on sales of investments 6,985 3,688
Amortization of intangibles (2,294) (325)
Interest expense (3,393) (30)
----------- -----------
Consolidated income before income taxes $ 174,510 $ 63,432
=========== ===========
The following table provides the reserves for losses and loss expenses by
segment as of September 30, 2003 and 2002, respectively:
2003 2002
----------- -----------
Property per Risk Treaty Reinsurance $ 149,100 $ 14,158
Property Catastrophe Reinsurance 62,636 45,801
Casualty Treaty Reinsurance 189,485 21,287
Property Individual Risk 29,903 4,661
Casualty Individual Risk 118,001 16,425
Aerospace and Other Specialty Lines 124,725 12,447
----------- -----------
Total $ 673,850 $ 114,779
=========== ===========
8. Commitments and contingencies
Concentrations of credit risk. As of September 30, 2003, substantially all
the Company's cash and investments were held by two custodians. The
Company's investment guidelines limit the amount of credit exposure to any
one issuer other than the U.S. Treasury.
Major production sources. During the nine month period ended September 30,
2003, the Company obtained 76% of its gross premiums written through three
brokers: Aon Corporation - 34.2%, Marsh & McLennan Companies, Inc. -
27.3%, and Willis Companies - 14.2%. Gross premiums written excludes
$405.0 million of gross premiums acquired from HartRe.
Letters of credit. As of September 30, 2003, the Company's bankers have
issued letters of credit of approximately $68.5 million in favor of
certain ceding companies.
Investment commitments. As of September 30, 2003, the Company had
committed cash and cash equivalents and fixed maturity investments of
$170.2 million in favor of certain ceding companies to collateralize
obligations.
19
ENDURANCE SPECIALTY HOLDINGS LTD.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS - CONTINUED
(Amounts in tables expressed in thousands of United States dollars, except share
and per share amounts)
8. Commitments and contingencies, cont'd.
Employment agreements. The Company has entered into employment agreements
with certain officers that provide for option awards, executive benefits
and severance payments under certain circumstances.
Operating Leases. The Company leases office space and office equipment
under operating leases. Future minimum lease commitments at September 30,
2003 are as follows:
Year Ended
September 30, Amount
------------- ------
2004 $ 4,689
2005 5,293
2006 4,626
2007 4,678
2008 4,583
2009 and thereafter 24,445
---------
$ 48,314
=========
Total rent expense under operating leases for the nine month period ended
September 30, 2003 was $2,298,000 (2002 - $490,000).
20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a discussion and analysis of our financial condition and
results of operations for the three and nine month periods ended September 30,
2003 and 2002. This discussion and analysis should be read in conjunction with
the unaudited condensed consolidated financial statements and related notes
contained in this Form 10-Q and the audited consolidated financial statements
and related notes for the fiscal year ended December 31, 2002, as well as the
discussions of critical accounting policies and qualitative and quantitative
disclosure about market risk, contained in our final prospectus filed with the
Securities and Exchange Commission on February 28, 2003 (Registration No.
333-102026) in connection with the initial public offering of our ordinary
shares.
Some of the information contained in this discussion and analysis or set forth
elsewhere in this Form 10-Q, including information with respect to our plans and
strategy for our business, includes forward looking statements that involve risk
and uncertainties. Please see the section captioned "Cautionary Statement
Regarding Forward-Looking Statements" for more information on factors that could
cause actual results to differ materially from the results described in or
implied by any forward-looking statements contained in this discussion and
analysis.
Overview
Endurance Specialty Holdings Ltd. ("Endurance Holdings") was organized as a
Bermuda holding company on June 27, 2002. Endurance Holdings has three
wholly-owned operating subsidiaries: Endurance Specialty Insurance Ltd.
("Endurance Bermuda"), based in Bermuda; Endurance Worldwide Insurance Limited
("Endurance U.K."), based in London, England; and Endurance Reinsurance
Corporation of America " ("Endurance U.S."), based in New York. Endurance
Holdings and its wholly-owned subsidiaries are collectively referred to in this
discussion and analysis as the "Company".
The Company writes specialty lines of commercial property and casualty insurance
and reinsurance on a global basis, and seeks to create a portfolio of specialty
lines which are profitable and have limited correlation with one another. The
Company defines specialty lines as those lines of insurance and reinsurance that
require dedicated, specialized underwriting skills and resources in order to be
profitably underwritten. The Company believes that a well constructed portfolio
of diversified risks will produce less volatile results than each of the
individual lines of business independently and will provide a superior
risk-adjusted return on our capital. 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.
The insurance lines that the Company writes are included in the property
individual risk, casualty individual risk, and aerospace and other specialty
lines segments. The reinsurance lines that the Company writes are included in
the property per risk treaty reinsurance, property catastrophe reinsurance,
casualty treaty reinsurance, and aerospace and other specialty lines segments.
Property insurance and reinsurance provides coverage of an insurable interest in
tangible property for property loss, damage or loss of use. The Company writes
property lines through its property per risk treaty reinsurance, property
catastrophe reinsurance, property individual risk, and aerospace and other
specialty lines segments.
Casualty insurance and reinsurance is primarily concerned with the losses caused
by injuries to third parties, i.e., not the insured, or to property owned by
third parties and the legal liability imposed on the insured resulting
therefrom. It includes, but is not limited to, employers' liability, workers'
compensation, public liability, automobile liability, personal liability and
aviation liability insurance. The Company writes casualty lines through its
casualty treaty reinsurance, casualty individual risk, and aerospace and other
specialty lines segments.
21
Application of Critical Accounting Estimates
Our condensed consolidated financial statements are based on the selection of
accounting policies and application of significant accounting estimates, which
require management to make significant estimates and assumptions. We believe
that some of the more critical judgments in the areas of accounting estimates
and assumptions that affect our financial condition and results of operations
are related to the recognition of premiums written and ceded and reserves for
losses and loss expenses. For a detailed discussion of our critical accounting
estimates please refer to our final prospectus filed with the Securities and
Exchange Commission on February 28, 2003 (Registration No. 333-102026). There
were no material changes in the application of our critical accounting estimates
subsequent to that report. We have discussed the application of these critical
accounting estimates with our Board of Directors and Audit Committee.
Results of operations - for the three month periods ended September 30, 2003 and
September 30, 2002
Results of operations for the three months ended September 30, 2003 and 2002
were as follows:
September 30, September 30,
2003 2002 Change
------------- ------------- -----------
Underwriting income
Revenues
Gross premiums written and acquired $ 325,070 $ 228,285 $ 96,785
----------- ----------- -----------
Net premiums written and acquired 324,405 216,819 107,586
----------- ----------- -----------
Net premiums earned 335,830 111,520 224,310
----------- ----------- -----------
Expenses
Losses and loss expenses 198,665 69,282 129,383
Acquisition expenses 69,382 18,527 50,855
General and administrative expenses 28,905 10,774 18,131
----------- ----------- -----------
296,952 98,583 198,369
----------- ----------- -----------
Underwriting income 38,878 12,937 25,941
Net investment income 18,736 13,488 5,248
Net foreign exchange gains (losses) 2,123 (11) 2,134
Net realized (losses) gains on sales of investments (932) 2,796 (3,728)
Amortization of intangibles (944) (325) (619)
Interest expense (1,013) (30) (983)
Income tax (expense) benefit (305) 56 (361)
----------- ----------- -----------
Net income $ 56,543 $ 28,911 $ 27,632
=========== =========== ===========
Loss ratio 59.2% 62.1% (2.9%)
Acquisition expense ratio 20.7% 16.6% 4.1%
General and administrative expense ratio 8.6% 9.7% (1.1%)
----------- ----------- -----------
Combined ratio 88.5% 88.4% 0.1%
----------- ----------- -----------
Reserve for losses and loss expenses $ 673,850 $ 114,779 $ 559,071
=========== =========== ===========
Premiums. In the three months ended September 30, 2003, gross premiums written
and acquired were $325.1 million compared to gross premiums written and acquired
of $228.3 million for the period ended September 30, 2002. Gross premiums
written and acquired increased during the three months to September 30, 2003
principally as a result of the establishment of Endurance U.S. which has
observed
22
favorable underwriting opportunities in the casualty treaty reinsurance segment.
Endurance U.S. has added $63.2 million in casualty treaty reinsurance premiums
compared to the same period in 2002. In addition, significant premium growth has
been recorded in Endurance Bermuda within the casualty individual risk segment
which has experienced favorable underwriting conditions in the excess general
liability and professional lines.
There were negligible premiums ceded in the three months ended September 30,
2003 compared to $11.5 million for the three months ended September 30, 2002.
The premiums ceded in 2002 resulted from retrocessional contracts acquired from
LaSalle in May of 2002. The Company currently does not purchase significant
levels of reinsurance protection as part of its overall underwriting strategy.
Net premiums earned for the three months ended September 30, 2003 were $335.8
million compared to net premiums earned for the three months ended September 30,
2002 of $111.5 million. Net premiums earned increased in 2003 as a result of the
higher level of premiums written in the three months ended September 30, 2003
compared to 2002, in addition to the earning of net premiums that were written
in the period since the inception of the Company.
Net Investment Income. Net investment income for the three months ended
September 30, 2003 was $18.7 million, compared to net investment income of $13.5
million for the three months ended September 30, 2002. Investment income was
derived primarily from interest earned on fixed maturity investments partially
offset by investment management fees. The increase in net investment income was
principally due to a 71% increase in invested assets, invested in a decreasing
interest rate environment. The increase in invested assets resulted from
positive net operating cash flows when compared to September 30, 2002.
Investment management fees for both the three months ended September 30, 2003
and 2002 were $0.4 million.
The annualized period book yield (which is the average yield of the invested
portfolio after adjusting for accretion and amortization from the purchase
price) and total return of the investment portfolio (which includes realized and
unrealized gains and losses) for the three months ended September 30, 2003 were
3.83% and 0.30%, respectively. For the three months ended September 30, 2002,
the annualized period book yield and total return were 4.49% and 3.89%,
respectively. The interest rate environment in the third quarter of 2003 has
been extremely volatile. The yield on the benchmark five year US Treasury bond
has moved 120 basis points from a high of 3.61% to a low of 2.41% during the
quarter. The Company has taken these opportunities to redeploy cash into higher
yielding securities thus reducing the overall portfolio cash position to 3.4%
and extending the duration to 3.06 years. Overall, the decrease in book yield
from September 30, 2002 is a direct result of investing our operating cash flows
in an interest rate environment that is dramatically lower than 2002.
Net Realized Investment Gains. Net realized investment losses for the three
months ended September 30, 2003 were $0.9 million, compared to net realized
investment gains in the three months ended September 30, 2002 of $2.8 million.
Net investment losses in the three months ended September 30, 2003 were realized
from the sale of fixed maturity securities.
Losses and Loss Expenses. Losses and loss expenses for the three months ended
September 30, 2003 and 2002 were $198.7 million and $69.3 million, respectively.
The loss ratios for the three months ended September 30, 2003 and 2002 were
59.2% and 62.1%, respectively. The decrease in loss ratio in the year is the
result of a varying pattern of losses incurred across different lines of
business. The property catastrophe reinsurance segment has experienced a
relatively light period of losses compared to 2002 when significant losses
relating to the central European floods were incurred. Additionally, lower than
anticipated levels of reported losses relating to prior periods has resulted in
favorable adjustments to prior period reserves across the property catastrophe
reinsurance, property individual risk and casualty individual risk segments.
These positive influences on losses and loss expenses were partially offset by
specific loss events occurring in the period, including the loss of the Loral
Galaxy IV satellite, expected claims from Hurricane Fabian in Bermuda and from
Hurricane Isabel in the United States.
23
The Company participates in lines of business where claims may not be reported
for many years. Accordingly, management does not believe that reported claims
are the only valid means for estimating ultimate obligations. The overall loss
reserves were established by the Company's actuaries and reflect management's
best estimate of ultimate losses.
Acquisition Expenses. Acquisition expenses for the three months ended September
30, 2003 were $69.4 million compared to acquisition expenses of $18.5 million
for the three months ended September 30, 2002. The acquisition expense ratio for
the three months ended September 30, 2003 was 20.7% compared to an acquisition
expense ratio of 16.6% for the three months ended September 30, 2002. The
increase in acquisition expense ratio is due to an increase in the proportion of
treaty reinsurance premiums earned, which tend to have higher acquisition costs.
In particular, the HartRe transaction of May 15, 2003 resulted in the
acquisition of treaty business with an average acquisition expense of 24.2% for
the three months ended September 30, 2003.
General and Administrative Expenses. General and administrative expenses for the
three months ended September 30, 2003 were $28.9 million, compared to general
and administrative expenses of $10.8 million for the three months ended
September 30, 2002. Expenditure has increased in the year in line with the
growth in underwriting activity and ultimately, staffing levels. At September
30, 2003 the Company had 214 employees compared to 73 employees at September 30,
2002.
The general and administrative expense ratio for the three months ended
September 30, 2003 was 8.6% compared to a general and administrative expense
ratio of 9.7% for the three months ended September 30, 2002. The ratio has
declined as a result of growth in premiums earned.
Net Income. Net income for the three months ended September 30, 2003 was $56.5
million compared to $28.9 million for the three months ended September 30, 2002.
Net income in the 2003 period was comprised of net underwriting income of $38.8
million, net investment income of $18.7 million, net realized investment losses
of $0.9 million, net foreign exchange gains of $2.1 million, interest expense of
$1.0 million, amortization of intangible assets of $0.9 million and tax expense
of $0.3 million. Net income in the 2002 period was comprised of net underwriting
income of $12.9 million, net investment income of $13.5 million, net realized
investment gains of $2.8 million and amortization of intangible assets of $0.3
million. The increase in net income for the three months ended September 30,
2003 compared to the same period in 2002 is due to the growth of the Company's
underwriting activities, favorable loss experience and an increase in invested
assets.
Comprehensive Income. Comprehensive income for the three months ended September
30, 2003 was $42.3 million compared to comprehensive income for the three months
ended September 30, 2002 of $63.4 million. Comprehensive income for the 2003
period was comprised of the net income of $56.5 million described above, a
decrease in net unrealized investment gains of $16.7 million, gains on foreign
currency translation adjustments of $2.0 million and a net gain on derivatives
designated as a cash flow hedge of $0.5 million. Comprehensive income for the
2002 period was comprised of the net income of $28.9 million described above and
a net increase in unrealized investment gains of $34.5 million.
Underwriting results by operating segments
The determination of the Company's business segments is based on how the Company
monitors the performance of its underwriting operations. Management measures
segment results on the basis of the combined ratio, which is obtained by
dividing the sum of the losses and loss expenses, acquisition expenses and
general and administrative expenses by net premiums earned. As a newly formed
company, our historical combined ratio may not be indicative of future
underwriting performance. The Company does not manage its assets by segment;
accordingly, investment income and total assets are not allocated to the
individual segments. General and administrative expenses incurred by segments
are allocated directly. Remaining corporate overhead is allocated based on each
segment's proportional share of gross premiums written and acquired.
24
Property per risk treaty reinsurance
Our Property Per Risk Treaty Reinsurance business segment reinsures individual
property risks of ceding companies on a treaty basis. Our property per risk
reinsurance contracts cover claims from individual insurance policies written by
our ceding company clients and include both personal lines and commercial lines
exposures. The following table summarizes the underwriting results, associated
ratios and the reserve for losses and loss expenses for the Property Per Risk
Treaty Reinsurance business segment for the three months ended September 30,
2003 and 2002, respectively.
THREE MONTHS ENDED
September 30, September 30,
2003 2002 Change
------------- ------------- ---------
Revenues
Gross premiums written and acquired $ 46,026 $ 59,963 $ (13,937)
----------- ----------- ---------
Net premiums written and acquired 46,026 59,963 (13,937)
----------- ----------- ---------
Net premiums earned 86,577 19,884 66,693
----------- ----------- ---------
Expenses
Losses and loss expenses 54,590 10,790 43,800
Acquisition expenses 22,643 4,279 18,364
General and administrative expenses 4,450 3,409 1,041
----------- ----------- ---------
81,683 18,478 63,205
----------- ----------- ---------
Underwriting income $ 4,894 $ 1,406 $ 3,488
=========== =========== =========
Loss ratio 63.1% 54.3% 8.8%
Acquisition expense ratio 26.2% 21.5% 4.7%
General and administrative expense ratio 5.1% 17.1% (12.0%)
----------- ----------- ---------
Combined ratio 94.4% 92.9% 1.5%
----------- ----------- ---------
Reserve for losses and loss expenses $ 149,100 $ 14,158 $ 134,942
Premiums. For the three months ended September 30, 2003 gross premiums written
and acquired were $46.0 million and net premiums earned were $86.6 million
compared to gross premiums written and acquired of $60.0 million and net
premiums earned of $19.9 million for the same period in 2002. The growth in
premiums earned is primarily the result of the earning of premiums that have
been written since the inception of the Company given that 75.2% of premiums
were written on a policies attaching basis and are typically earned over a
24-month risk period.
Losses and Loss Expenses. Losses and loss expenses for the three months ended
September 30, 2003 and September 30, 2002 were $54.6 million and $10.8 million,
respectively. The loss ratio was 63.1% for the three months ended September 30,
2003 and 54.3% for the same period in 2002. The increase in loss ratio in 2003
is principally attributable to a higher level of losses reported in the three
months ended September, 2003 compared to the same period in 2002 causing an
increase in reserves.
Acquisition Expenses. Acquisition expenses for the three months ended September
30, 2003 were $22.6 million or 26.2% of net premiums earned. For the three
months ended September 30, 2002, acquisition expenses were $4.3 million or 21.5%
of net premiums earned. The higher expense ratio in the three months to
September 30, 2003 is due to an increased percentage of business in this segment
relating to quota share reinsurance contracts, which incur higher commissions
than treaty excess of loss contracts. The acquisition of the in-force HartRe
property per risk reinsurance business with an average acquisition expense ratio
of 24.7% contributed to this trend.
25
General and Administrative Expenses. General and administrative expenses for the
three months ended September 30, 2003 and September 30, 2002 were $4.5 million
and $3.4 million, respectively. Expenditure has increased in the year in line
with the growth in underwriting activity and ultimately, staffing levels.
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. 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
following table summarizes the underwriting results, associated ratios and the
reserve for losses and loss expenses for the Property Catastrophe Reinsurance
business segment for the three months ended September 30, 2003 and 2002,
respectively.
THREE MONTHS ENDED
September 30, September 30,
2003 2002 Change
------------ ------------- ----------
Revenues
Gross premiums written and acquired $ 43,938 $ 22,689 $ 21,249
---------- ---------- ----------
Net premiums written and acquired 43,938 12,095 31,843
---------- ---------- ----------
Net premiums earned 48,453 34,045 14,408
---------- ---------- ----------
Expenses
Losses and loss expenses 18,488 28,651 (10,163)
Acquisition expenses 4,887 4,659 228
General and administrative expenses 5,362 721 4,641
---------- ---------- ----------
28,737 34,031 (5,294)
---------- ---------- ----------
Underwriting income $ 19,716 $ 14 $ 19,702
========== ========== ==========
Loss ratio 38.2% 84.2% (46.0%)
Acquisition expense ratio 10.1% 13.7% (3.6%)
General and administrative expense ratio 11.1% 2.1% 9.0%
---------- ---------- ----------
Combined ratio 59.4% 100.0% (40.6%)
---------- ---------- ----------
Reserve for losses and loss expenses $ 62,636 $ 45,801 $ 16,835
Premiums. For the three months ended September 30, 2003, gross premiums written
and acquired were $43.9 million and net premiums earned were $48.5 million
compared to gross premiums written and acquired of $22.7 million and net
premiums earned of $34.1 million for the same period in 2002. The majority of
the contracts associated with this segment are written on a losses occurring
basis. Accordingly, the premium is earned evenly over the contract term, most
often a twelve month period. The increase in gross premiums written and acquired
is principally the result of Endurance Bermuda taking advantage of favorable
underwriting opportunities and recording $14.8 million of gross written premium
from new contracts. In 2003 the Company has not participated to the same degree
in retrocessional coverage as in 2002, resulting in an increase in net premiums
earned.
Losses and Loss Expenses. Losses and loss expenses for the three months ended
September 30, 2003 and September 30, 2002 were $18.5 million and $28.7 million,
respectively. The loss ratio was 38.2% for the three months ended September 30,
2003 and 84.2% for the same period in 2002. The lower loss ratio in 2003 in this
segment is attributable to the low level of catastrophe losses experienced. The
higher 2002 loss ratio is primarily due to the Company incurring losses related
to the Central European floods of
26
August 2002. The reduction in loss ratio in 2003 is further influenced by
favorable adjustments to 2002 reserves resulting from lower than expected
reported losses relating to the 2002 European floods.
Acquisition Expenses. Acquisition expenses for the three months ended September
30, 2003 were $4.9 million or 10.1% of net premiums earned. For the three months
ended September 30, 2002, acquisition expenses were $4.7 million or 13.7% of net
premiums earned. The impact of ceded reinsurance purchased in 2002, which
yielded very low ceding commissions overall, resulted in the expense ratio in
2002 being higher than in 2003 when a negligible amount of reinsurance was
purchased.
General and Administrative Expenses. General and administrative expenses for the
three months ended September 30, 2003 and September 30, 2002 were $5.4 million
and $0.7 million, respectively. The increase is due to the higher level of
premiums written in 2003 that increased the indirect overhead allocation to this
segment.
Casualty treaty reinsurance
Our Casualty Treaty Reinsurance business segment reinsures third party liability
exposures from ceding companies on a treaty basis. The exposures that we
reinsure include automobile liability, professional liability, directors' and
officers' liability, umbrella liability and workers' compensation. The follo