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EVEREST GROUP, LTD. - Quarter Report: 2008 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED:

JUNE 30, 2008

 

Commission file number:

1-15731

 

EVEREST RE GROUP, LTD.

(Exact name of registrant as specified in its charter)

Bermuda

 

98-0365432

(State or other jurisdiction of

incorporation or organization)

 

 

(I.R.S. Employer

Identification No.)

Wessex House – 2nd Floor

45 Reid Street

PO Box HM 845

Hamilton HM DX, Bermuda

441-295-0006

 

(Address, including zip code, and telephone number, including area code,

of registrant’s principal executive office)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

                                                      YES

 X  

 

                            NO

    

 

Indicate by check mark whether the registrant is a large accelerated filer, and accelerated filer, or a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer

X

 

Accelerated filer

 

 

Non-accelerated filer

 

 

 

Smaller reporting company

 

(Do not check if smaller reporting company

 

 

 

Indicate by check mark whether the registrant is a shell company (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:

 

 

 

Number of Shares Outstanding

Class

 

At August 1, 2008

Common Shares, $0.1 par value

 

61,688,469

 

 


 

       EVEREST RE GROUP, LTD

               Index To Form 10-Q

 

                                                                                                         Page

             PART I

     FINANCIAL INFORMATION

 

 

   

Item 1.

Financial Statements

 

 

 

 

 

Consolidated Balance Sheets at June 30, 2008 (unaudited) and

 

 

December 31, 2007

1

 

 

 

 

Consolidated Statements of Operations and Comprehensive (Loss) Income for

 

 

the three and six months ended June 30, 2008 and 2007 (unaudited)

2

 

 

 

 

Consolidated Statements of Changes in Shareholders’ Equity for the three

 

 

and six months ended June 30, 2008 and 2007 (unaudited)

3

 

 

 

 

Consolidated Statements of Cash Flows for the three and six months                                                         

 

 

ended June 30, 2008 and 2007 (unaudited)

4

 

 

 

 

Notes to Consolidated Interim Financial Statements (unaudited)

5

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and

 

 

Results of Operation

19

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

48

 

 

 

Item 4.

Controls and Procedures

48

 

 

 


                                                                                         PART II

              OTHER INFORMATION

 

Item 1.

Legal Proceedings

     48

 

 

 

Item 1A.

Risk Factors

49

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds                                                         

49

 

 

 

Item 3.

Defaults Upon Senior Securities

49

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

50

 

 

 

Item 5.

Other Information

50

 

 

 

Item 6.

Exhibits

50

 

 

 


 

 


 

PART I

ITEM 1.  FINANCIAL STATEMENTS

EVEREST RE GROUP, LTD.

 

 

 

CONSOLIDATED BALANCE SHEETS

 

 

 

 

 

 

 

 

June 30,

 

December 31,

(Dollars in thousands, except par value per share)

2008

 

2007

 

(unaudited)

 

 

ASSETS:

 

 

 

Fixed maturities - available for sale, at market value

$     11,168,508

 

$      10,245,585

    (amortized cost: 2008, $11,253,928; 2007, $10,116,353)

 

 

 

Equity securities - available for sale, at market value (cost: 2008, $25,482; 2007, $24,378)

25,678

 

24,694

Equity securities - available for sale, at fair value

1,194,459

 

1,535,263

Short-term investments

1,260,980

 

2,225,708

Other invested assets (cost: 2008, $703,865; 2007, $651,898)

705,432

 

654,355

Cash

225,878

 

250,567

        Total investments and cash

14,580,935

 

14,936,172

Accrued investment income

154,158

 

145,056

Premiums receivable

972,874

 

989,921

Reinsurance receivables

649,789

 

666,164

Funds held by reinsureds

370,125

 

342,615

Deferred acquisition costs

365,779

 

399,563

Prepaid reinsurance premiums

84,253

 

88,239

Deferred tax asset

369,222

 

227,825

Federal income taxes recoverable

25,769

 

47,368

Other assets

220,024

 

156,559

TOTAL ASSETS

$     17,792,928

 

$      17,999,482

 

 

 

 

LIABILITIES:

 

 

 

Reserve for losses and loss adjustment expenses

$       9,078,381

 

$        9,040,606

Future policy benefit reserve

70,865

 

78,417

Unearned premium reserve

1,409,803

 

1,567,098

Funds held under reinsurance treaties

78,945

 

75,601

Losses in the course of payment

79,724

 

63,366

Commission reserves

45,551

 

48,753

Other net payable to reinsurers

48,617

 

68,494

8.75% Senior notes due 3/15/2010

199,751

 

199,685

5.4% Senior notes due 10/15/2014

249,708

 

249,689

6.6% Long term notes due 5/1/2067

399,641

 

399,639

Junior subordinated debt securities payable

329,897

 

329,897

Accrued interest on debt and borrowings

11,217

 

11,217

Other liabilities

223,225

 

182,250

        Total liabilities

12,225,325

 

12,314,712

 

 

 

 

Commitments and contingencies (Note 6)

 

 

 

 

 

 

 

SHAREHOLDERS' EQUITY:

 

 

 

Preferred shares, par value: $0.01; 50 million shares authorized;

 

 

 

    no shares issued and outstanding

-

 

-

Common shares, par value: $0.01; 200 million shares authorized; (2008) 65.5 million and

 

 

 

    (2007) 65.4 million issued and outstanding

655

 

654

Additional paid-in capital

1,816,174

 

1,805,844

Accumulated other comprehensive (loss) income, net of deferred income taxes of

 

 

 

    $36.6 million at 2008 and $87.2 million at 2007

(9,895)

 

163,155

Treasury shares, at cost; (2008) 3.9 million shares and (2007) 2.5 million shares

(367,322)

 

(241,584)

Retained earnings

4,127,991

 

3,956,701

        Total shareholders' equity

5,567,603

 

5,684,770

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY

$     17,792,928

 

$      17,999,482

The accompanying notes are an integral part of the consolidated financial statements.

 

 

 

 

 

1

 


 

 

EVEREST RE GROUP, LTD.

 

 

 

 

 

 

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

 

 

 

 

 

AND COMPREHENSIVE (LOSS) INCOME

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

(Dollars in thousands, except per share amounts)

2008

 

2007

 

2008

 

2007

 

(unaudited)

 

(unaudited)

REVENUES:

 

 

 

 

 

 

 

Premiums earned

$        942,095

 

$        999,320

 

$     1,854,068

 

$    2,004,049

Net investment income

175,917

 

179,693

 

326,049

 

335,489

Net realized capital (losses) gains

(31,566)

 

91,774

 

(167,949)

 

132,666

Net derivative income (expense)

2,080

 

5,995

 

(1,715)

 

3,227

Other expense

(10,166)

 

(8,044)

 

(15,327)

 

(4,379)

Total revenues

1,078,360

 

1,268,738

 

1,995,126

 

2,471,052

 

 

 

 

 

 

 

 

CLAIMS AND EXPENSES:

 

 

 

 

 

 

 

Incurred losses and loss adjustment expenses

604,742

 

619,114

 

1,150,092

 

1,184,882

Commission, brokerage, taxes and fees

244,713

 

234,423

 

471,860

 

460,078

Other underwriting expenses

39,728

 

37,541

 

79,972

 

73,601

Interest, fees and bond issue cost amortization expense         

19,794

 

24,243

 

39,581

 

41,706

Total claims and expenses

908,977

 

915,321

 

1,741,505

 

1,760,267

 

 

 

 

 

 

 

 

INCOME BEFORE TAXES

169,383

 

353,417

 

253,621

 

710,785

Income tax expense

16,356

 

70,549

 

22,661

 

130,335

 

 

 

 

 

 

 

 

NET INCOME

$         153,027

 

$        282,868

 

$        230,960

 

$       580,450

Other comprehensive loss, net of tax

(169,059)

 

(106,716)

 

(173,050)

 

(109,898)

 

 

 

 

 

 

 

 

COMPREHENSIVE (LOSS) INCOME

$         (16,032)

 

$        176,152

 

$          57,910

 

$       470,552

 

 

 

 

 

 

 

 

PER SHARE DATA:

 

 

 

 

 

 

 

Average shares outstanding (000's)

61,658

 

62,901

 

62,018

 

63,533

Net income per common share - basic

$               2.48

 

$              4.50

 

$              3.72

 

$             9.14

 

 

 

 

 

 

 

 

Average diluted shares outstanding (000's)

62,002

 

63,518

 

62,431

 

64,137

Net income per common share - diluted

$               2.47

 

$              4.45

 

$              3.70

 

$             9.05

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of the consolidated financial statements

 

 

 

 

 

 

 

2

 


 

EVEREST RE GROUP, LTD.

 

 

 

 

 

 

 

CONSOLIDATED STATEMENTS OF

 

 

 

 

 

 

 

CHANGES IN SHAREHOLDERS' EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

(Dollars in thousands, except share amounts)

2008

 

2007

 

2008

 

2007

 

(unaudited)

 

(unaudited)

COMMON SHARES (shares outstanding):

 

 

 

 

 

 

 

Balance, beginning of period

61,895,588

 

63,240,705

 

62,863,845

 

65,043,976

Issued during the period, net

26,515

 

156,935

 

110,258

 

253,664

Treasury shares aquired

(278,300)

 

(199,000)

 

(1,330,300)

 

(2,099,000)

Balance, end of period

61,643,803

 

63,198,640

 

61,643,803

 

63,198,640

 

 

 

 

 

 

 

 

COMMON SHARES (par value):

 

 

 

 

 

 

 

Balance, beginning of period

$                655

 

$                651

 

$                654

 

$                650

Issued during the period, net

-

 

2

 

1

 

3

Balance, end of period

655

 

653

 

655

 

653

 

 

 

 

 

 

 

 

ADDITIONAL PAID-IN CAPITAL:

 

 

 

 

 

 

 

Balance, beginning of period

1,810,946

 

1,777,070

 

1,805,844

 

1,770,496

Share-based compensation plans

5,190

 

14,094

 

10,236

 

20,631

Other

38

 

56

 

94

 

93

Balance, end of period

1,816,174

 

1,791,220

 

1,816,174

 

1,791,220

 

 

 

 

 

 

 

 

ACCUMULATED OTHER COMPREHENSIVE INCOME,

 

 

 

 

 

 

 

NET OF DEFERRED INCOME TAXES:

 

 

 

 

 

 

 

Balance, beginning of period

159,164

 

94,546

 

163,155

 

348,543

Cumulative effect to adopt FAS No. 159, net of tax

-

 

-

 

-

 

(250,815)

Net decrease during the period

(169,059)

 

(106,716)

 

(173,050)

 

(109,898)

Balance, end of period

(9,895)

 

(12,170)

 

(9,895)

 

(12,170)

 

 

 

 

 

 

 

 

RETAINED EARNINGS:

 

 

 

 

 

 

 

Balance, beginning of period

4,004,640

 

3,505,657

 

3,956,701

 

2,987,998

Cumulative effect to adopt FAS No. 159, net of tax

-

 

-

 

-

 

250,815

Net income

153,027

 

282,868

 

230,960

 

580,450

Dividends declared ($0.48 per quarter and $0.96 year-to-date per share in 2008 and 2007)

(29,676)

 

(30,223)

 

(59,670)

 

(60,961)

Balance, end of period

4,127,991

 

3,758,302

 

4,127,991

 

3,758,302

 

 

 

 

 

 

 

 

TREASURY SHARES AT COST:

 

 

 

 

 

 

 

Balance, beginning of period

(342,421)

 

(181,041)

 

(241,584)

 

-

Purchase of treasury shares

(24,901)

 

(19,039)

 

(125,738)

 

(200,080)

Balance, end of period

(367,322)

 

(200,080)

 

(367,322)

 

(200,080)

 

 

 

 

 

 

 

 

TOTAL SHAREHOLDERS' EQUITY, END OF PERIOD

$      5,567,603

 

$      5,337,925

 

$      5,567,603

 

$      5,337,925

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of the consolidated financial statements

 

 

 

 

 

 

 

 

3

 


 

EVEREST RE GROUP, LTD.

 

 

 

 

 

 

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

(Dollars in thousands)

2008

 

2007

 

2008

 

2007

 

(unaudited)

 

(unaudited)

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

Net income

$     153,027

 

$  282,868

 

$     230,960

 

$     580,450

Adjustments to reconcile net income to net cash provided by

 

 

 

 

 

 

 

    operating activities:

 

 

 

 

 

 

 

      (Increase) decrease in premiums receivable

(18,227)

 

45,724

 

13,510

 

48,290

      (Increase) decrease in funds held by reinsureds, net

(17,630)

 

(94)

 

(26,367)

 

981

      (Increase) decrease in reinsurance receivables

(24,715)

 

67,870

 

13,061

 

54,498

      (Increase) decrease in deferred tax asset

(34,672)

 

7,337

 

(90,802)

 

26,405

      Increase (decrease) in reserve for losses and loss adjustment expenses

16,026

 

(33,499)

 

66,076

 

(134,010)

      Decrease in future policy benefit reserve

(4,540)

 

(4,065)

 

(7,552)

 

(7,425)

      Decrease in unearned premiums

(81,454)

 

(91,315)

 

(154,415)

 

(111,347)

      Change in other assets and liabilities, net

(44,704)

 

(84,979)

 

4,734

 

(70,989)

      Non-cash compensation expense

2,891

 

4,437

 

10,570

 

9,287

      Amortization of bond premium/(accrual of bond discount)

4,023

 

(2,124)

 

4,476

 

(826)

      Amortization of underwriting discount on senior notes

45

 

41

 

88

 

80

      Net realized capital losses (gains)

31,566

 

(91,774)

 

167,949

 

(132,666)

Net cash (used in) provided by operating activities

(18,364)

 

100,427

 

232,288

 

262,728

 

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

Proceeds from fixed maturities matured/called - available for sale, at market value

257,634

 

305,278

 

546,561

 

617,195

Proceeds from fixed maturities sold - available for sale, at market value

82,737

 

169,549

 

129,947

 

204,035

Proceeds from equity securities sold - available for sale, at fair value

66,936

 

1,027,955

 

329,234

 

1,318,561

Distributions from other invested assets

2,696

 

5,572

 

13,881

 

27,383

Cost of fixed maturities acquired - available for sale, at market value

(1,166,727)

 

(155,618)

 

(1,853,304)

 

(255,487)

Cost of equity securities acquired - available for sale, at market value

-

 

-

 

(440)

 

-

Cost of equity securities acquired - available for sale, at fair value

(70,856)

 

(816,891)

 

(149,381)

 

(1,138,408)

Cost of other invested assets acquired

(24,048)

 

(78,004)

 

(48,099)

 

(119,765)

Net change in short-term securities

1,006,187

 

(873,100)

 

964,051

 

(1,103,090)

Net change in unsettled securities transactions

(74,233)

 

(3,992)

 

(5,742)

 

(4,412)

Net cash provided by (used in) investing activities

80,326

 

(419,251)

 

(73,292)

 

(453,988)

 

 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

Common shares issued during the period, net

2,337

 

9,715

 

(239)

 

11,440

Purchase of treasury shares

(24,901)

 

(19,039)

 

(125,738)

 

(200,080)

Net proceeds from issuance of long term notes

-

 

395,637

 

-

 

395,637

Dividends paid to shareholders

(29,676)

 

(30,223)

 

(59,670)

 

(60,961)

Net cash (used in) provided by financing activities

(52,240)

 

356,090

 

(185,647)

 

146,036

 

 

 

 

 

 

 

 

EFFECT OF EXCHANGE RATE CHANGES ON CASH

(1,815)

 

(9,685)

 

1,962

 

(16,854)

 

 

 

 

 

 

 

 

Net increase (decrease) in cash

7,907

 

27,581

 

(24,689)

 

(62,078)

Cash, beginning of period

217,971

 

160,209

 

250,567

 

249,868

Cash, end of period

$     225,878

 

$  187,790

 

$     225,878

 

$     187,790

 

 

 

 

 

 

 

 

SUPPLEMENTAL CASH FLOW INFORMATION

 

 

 

 

 

 

 

Cash transactions:

 

 

 

 

 

 

 

    Income taxes paid

$       67,486

 

$   135,022

 

$     100,704

 

$     160,306

    Interest paid

$       25,136

 

$     16,189

 

$       39,067

 

$       34,378

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

 

 

 

 

 

 

4

 


NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS (UNAUDITED)

 

For the Three and Six Months Ended June 30, 2008 and 2007

 

1. General

 

As used in this document, “Group” means Everest Re Group, Ltd.; “Holdings” means Everest Reinsurance Holdings, Inc.; “Everest Re” means Everest Reinsurance Company and its subsidiaries (unless the context otherwise requires); and the “Company” means Everest Re Group, Ltd. and its subsidiaries.

 

The unaudited consolidated financial statements of the Company for the three and six months ended June 30, 2008 and 2007 include all adjustments, consisting of normal recurring accruals, which, in the opinion of management, are necessary for a fair statement of the results on an interim basis. Certain financial information, which is normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), has been omitted since it is not required for interim reporting purposes. The year end consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. The results for the three and six months ended June 30, 2008 and 2007 are not necessarily indicative of the results for a full year. These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the years ended December 31, 2007, 2006 and 2005 included in the Company’s most recent Form 10-K filing.

 

2. New Accounting Pronouncements

 

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Financial Accounting Standards (“FAS”) No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities - including an amendment to FASB Statement No. 115” (“FAS 159”). FAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The Company adopted FAS 159 as of January 1, 2007.

 

In March 2008, the FASB issued FAS No. 161 “Disclosures about Derivative Instruments and Hedging Activities - an amendment of FASB Statement No. 133 (“FAS 161”). FAS 161 requires entities to provide additional disclosures on derivative and hedging activities regarding their affect on financial position, financial performance and cash flows. This statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The impact of a January 1, 2009 adoption should be immaterial.

 

3. Fair Value

 

Effective January 1, 2007, the Company adopted and implemented FAS 159 for its actively managed equity securities. In conjunction with the Company implementing a more active management strategy for these securities, FAS 159 provided guidance on accounting and presentation of these investments in the Company’s consolidated financial statements. Upon adoption of FAS 159, the Company recognized a $250.8 million cumulative-effect adjustment to retained earnings, net of $110.3 million of tax. The Company records fair value re-measurements as net realized capital gains or losses in the consolidated statements of operations and comprehensive income. The Company recorded $28.5 million and $150.0 million in net realized capital losses due to fair value re-measurement for the three and six months ended

 

5

 


 

June 30, 2008, respectively. The Company recorded $69.3 million and $109.8 million in net realized capital gains due to fair value re-measurements for the three and six months ended June 30, 2007, respectively.

 

The following table presents the fair value measurement levels for all assets and liabilities, which the Company has recorded at fair value as of the periods indicated:

 

 

 

 

Fair Value Measurement Using:

 

 

 

Quoted Prices

 

 

 

 

 

 

 

in Active

 

Significant

 

 

 

 

 

Markets for

 

Other

 

Significant

 

 

 

Identical

 

Observable

 

Unobservable

 

 

 

Assets

 

Inputs

 

Inputs

(Dollars in thousands)

June 30, 2008

 

(Level 1)

 

(Level 2)

 

(Level 3)

Assets:

 

 

 

 

 

 

 

   Fixed maturities

$            11,168,508

 

$                     -

 

$       11,142,860

 

$               25,648

   Equity securities, fair value

1,194,459

 

1,041,415

 

153,044

 

-

   Equity securities, market value    

25,678

 

15,781

 

9,897

 

-

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

   Equity put options

$                    41,368

 

$                      -

 

$                        -

 

$               41,368

 

 

 

 

Fair Value Measurement Using:

 

 

 

Quoted Prices

 

 

 

 

 

 

 

in Active

 

Significant

 

 

 

 

 

Markets for

 

Other

 

Significant

 

 

 

Identical

 

Observable

 

Unobservable

 

 

 

Assets

 

Inputs

 

Inputs

(Dollars in thousands)

December 31, 2007

 

(Level 1)

 

(Level 2)

 

(Level 3)

Assets:

 

 

 

 

 

 

 

   Fixed maturities

$              10,245,585

 

$                     -

 

$        9,977,607

 

$             267,978

   Equity securities, fair value

1,535,263

 

1,361,789

 

173,474

 

-

   Equity securities, market value    

24,694

 

14,797

 

9,897

 

-

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

   Equity put options

$                     39,653

 

$                     -

 

$                      -

 

$                39,653

 

 

6

 


 

The following table presents the fixed maturity investments for which fair value was measured under level 3 for the periods indicated:

 

 

Fair Value

 

Measurements Using:

 

2008

 

2007

 

Significant

 

Significant

 

Unobservable

 

Unobservable

 

Inputs

 

Inputs

(Dollars in thousands)

(Level 3)

 

(Level 3)

Assets:

 

 

 

Beginning balance at January 1

$          267,978

 

$           166,753

   Total gains or (losses) (realized/unrealized)

 

 

 

      Included in earnings (or changes in net assets)

(2,314)

 

55

      Included in other comprehensive income

(587)

 

(379)

   Purchases, issuances and settlements

325

 

(342)

   Transfers in and/or (out) of Level 3

(239,754)

 

(144,381)

Ending balance at June 30

$             25,648

 

$             21,706

 

 

 

 

The amount of total losses for the period included in earnings

 

 

 

   (or changes in net assets) attributable to the change in unrealized         

 

 

 

      gains (losses) relating to assets still held at the reporting date

$            (6,500)

 

$                       -

 

The fixed maturities valued under level 3 were valued by investment brokers for which the Company believes reflects fair value, but was unable to verify that inputs to the valuation model were observable.

 

The following table presents the equity index put options for which fair value was measured under level 3 for the periods indicated:

 

 

Fair Value

 

Measurements Using:

 

2008

 

2007

 

Significant

 

Significant

 

Unobservable

 

Unobservable

 

Inputs

 

Inputs

(Dollars in thousands)

(Level 3)

 

(Level 3)

Liabilities:

 

 

 

Beginning balance at January 1

$            39,653

 

$            37,529

   Total (gains) or losses (realized/unrealized)

 

 

 

      Included in earnings (or changes in net assets)

1,715

 

(3,152)

      Included in other comprehensive income

-

 

-

   Purchases, issuances and settlements

-

 

-

   Transfers in and/or (out) of Level 3

-

 

-

Ending balance at June 30

$            41,368

 

$            34,377

 

 

 

 

The amount of total gains or losses for the period included in earnings     

 

 

 

   (or changes in net assets) attributable to the change in unrealized

 

 

 

      gains or losses relating to liabilities still held at the reporting date

$                      -

 

$                      -

 

 

7

 


 

Since there is no active market for these long dated equity index put options, their valuation was considered as level 3.

 

The Company sold seven equity put options, which are outstanding. These products meet the definition of a derivative under FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS 133”). The Company’s position in these contracts is unhedged and is accounted for as a derivative in accordance with FAS 133. Accordingly, these contracts are carried at fair value and are recorded in “Other liabilities” in the consolidated balance sheets and changes in fair value are recorded in the consolidated statements of operations and comprehensive income. The Company recorded net derivative income of $2.1 million and $6.0 million for the three months ended June 30, 2008 and 2007, respectively, The Company recorded net derivative expense of $1.7 million and net derivative income of $3.2 million for the six months ended June 30, 2008 and 2007, respectively.

 

The fair value was calculated using an industry accepted option pricing model, Black-Scholes, which used the following assumptions:

 

 

At June 30, 2008

 

 

 

Contract

 

Contracts

 

based on

 

based on

 

FTSE 100

 

S & P 500 Index

 

Index

Equity index

1,280.0

 

5,625.9

Interest rate

5.67% to 6.29%

   

5.81%

Time to maturity                                                                                    

8.9 to 22.8 yrs

 

12.1 yrs

Volatility

24.9% to 26.0%

 

32.0%

 

4. Capital Transactions

 

On December 1, 2005, the Company filed a shelf registration statement on Form S-3ASR with the Securities and Exchange Commission (“SEC”), as a Well Known Seasoned Issuer. This shelf registration statement was used by Group to register common shares, preferred shares, debt securities, warrants, share purchase contracts and share purchase units; by Holdings to register debt securities and by Everest Re Capital Trust III (“Capital Trust III”) to register trust preferred securities.

 

 

On April 26, 2007, Holdings completed a public offering of $400.0 million principal amount of 6.6% fixed to floating rate long term subordinated notes with a scheduled maturity date of May 15, 2037 and a final maturity date of May 1, 2067. The net proceeds from the offering were used to redeem all of the outstanding 7.85% junior subordinated debt securities on November 15, 2007 and for general corporate purposes.

 

8

 


 

5. Earnings Per Common Share

 

Net income per common share has been computed below, based upon weighted average common and diluted shares outstanding.

 

 

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

(Dollars in thousands, except per share amounts)

2008

 

2007

 

2008

 

2007

Net income (numerator)

$     153,027

 

$     282,868

 

$     230,960

 

$     580,450

Weighted average common and effect of dilutive shares

 

 

 

 

 

 

 

   used in the computation of net income per share:

 

 

 

 

 

 

 

      Weighted average shares outstanding - basic (denominator)

61,658

 

62,901

 

62,018

 

63,533

      Effect of dilutive shares

344

 

617

 

413

 

604

      Weighted average shares outstanding - diluted (denominator)

62,002

 

63,518

 

62,431

 

64,137

Net income per common share:

 

 

 

 

 

 

 

   Basic

$           2.48

 

$           4.50

 

$           3.72

 

$           9.14

   Diluted

$           2.47

 

$           4.45

 

$           3.70

 

$           9.05

 

Options to purchase 922,950 and 917,950 common shares for the three and six months ended June 30, 2008, respectively, at prices ranging from $91.41 to $99.98 were outstanding but were not included in the computation of earnings per diluted share as the options’ exercise price was greater than the average market price of the common shares for the relevant periods. Options to purchase 4,000 and 10,000 common shares for the three and six months ended June 30, 2007, respectively, at prices ranging from $99.98 to $106.275 were outstanding but were not included in the computation of earnings per diluted share as the options’ exercise price was greater than the average market price of the common shares for the relevant periods. All outstanding options expire on or between September 25, 2008 and February 20, 2018.

 

6. Contingencies

 

In the ordinary course of business, the Company is involved in lawsuits, arbitrations and other formal and informal dispute resolution procedures, the outcomes of which will determine the Company’s rights and obligations under insurance, reinsurance and other contractual agreements. In some disputes, the Company seeks to enforce its rights under an agreement or to collect funds owing to it. In other matters, the Company is resisting attempts by others to collect funds or enforce alleged rights. These disputes arise from time to time and are ultimately resolved through both informal and formal means, including negotiated resolution, arbitration and litigation. In all such matters, the Company believes that its positions are legally and commercially reasonable. While the final outcome of these matters cannot be predicted with certainty, the Company does not believe that any of these matters, when finally resolved, will have a material adverse effect on the Company’s financial position or liquidity. However, an adverse resolution of one or more of these items in any one quarter or fiscal year could have a material adverse effect on the Company’s results of operations in that period.

 

In 1993 and prior, the Company had a business arrangement with The Prudential Insurance Company of America ("The Prudential") wherein, for a fee, the Company accepted settled claim payment obligations of certain property and casualty insurers, and, concurrently, became the owner of the annuity or assignee of the annuity proceeds funded by the property and casualty insurers specifically to fulfill these fully settled obligations. In these circumstances, the Company would be liable if The Prudential, which has an A+ (Superior) financial strength rating from A.M. Best Company (“A.M. Best”), was unable to make the annuity

 

9

 


 

payments. At June 30, 2008, the estimated cost to replace all such annuities for which the Company was contingently liable was $151.8 million. 

 

Prior to its 1995 initial public offering, the Company had purchased annuities from an unaffiliated life insurance company with an A+ (Superior) financial strength rating from A.M. Best to settle certain claim liabilities of the company. Should the life insurance company become unable to make the annuity payments, the Company would be liable for those claim liabilities. At June 30, 2008, the estimated cost to replace such annuities was $22.2 million.

 

7. Other Comprehensive Loss

 

The following table presents the components of other comprehensive loss for the periods indicated:

 

 

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

(Dollars in thousands)

2008

 

2007

 

2008

 

2007

Net unrealized depreciation of investments,

 

 

 

 

 

 

 

   net of deferred income taxes

$   (144,465)

 

$   (121,232)

 

$   (164,986)

 

$   (119,488)

Currency translation adjustments, net of deferred income taxes    

(25,228)

 

14,516

 

(8,698)

 

9,590

Pension adjustment

634

 

-

 

634

 

-

 

 

 

 

 

 

 

 

Other comprehensive loss, net of deferred income taxes

$   (169,059)

 

$   (106,716)

 

$   (173,050)

 

$   (109,898)

 

 

10

 


 

8. Letters of Credit

 

The Company has arrangements available for the issuance of letters of credit, which letters are generally collateralized by the Company’s cash and investments. The Company’s agreement with Citibank is a bilateral letter of credit agreement only. On November 6, 2007 the Citibank bilateral letter of credit agreement was decreased by $50.0 million to $300.0 million. All other terms of this agreement remain the same. The Company’s other facility, the Wachovia Group Credit Facility, involves a syndicate of lenders (see Note 13 of the Group Credit Facility), with Wachovia acting as administrative agent. The Citibank Holdings Credit Facility involves a syndicate of lenders (see Note 13 of the Holdings Credit Facility), with Citibank acting as administrative agent. At June 30, 2008 and December 31, 2007, letters of credit for $486.6 million and $491.1 million, respectively, were issued and outstanding. The letters of credit collateralize reinsurance obligations of the Company’s non-U.S. operations. The following table summarizes the Company’s letters of credit as of June 30, 2008.

 

(Dollars in thousands)

 

 

 

 

 

 

Bank

 

Commitment

 

In Use

 

Date of Expiry

Citibank-Bilateral Letter of Credit Agreement

 

$          300,000

 

$      26,001

 

12/31/2008

 

 

 

 

45,896

 

03/08/2009

 

 

 

 

30,000

 

12/31/2011

 

 

 

 

55,654

 

12/31/2012

       Total Citibank Bilateral Agreement

$          300,000

 

$    157,551

 

 

 

 

 

 

 

 

 

Citibank Holdings Credit Facility

 

$          150,000

 

$      17,204

 

12/31/2008

       Total Citibank Holdings Credit Facility

$          150,000

 

$      17,204

 

 

 

 

 

 

 

 

 

Wachovia Group Credit Facility

Tranche One

$          350,000

 

$      22,038

 

12/31/2008

 

Tranche Two

500,000

 

289,764

 

12/31/2008

       Total Wachovia Group Credit Facility

$          850,000

 

$    311,802

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     Total Letters of Credit

 

$       1,300,000

 

$    486,557

 

 

 

9. Trust Agreements

 

Certain subsidiaries of Group, principally Everest Reinsurance (Bermuda), Ltd. (“Bermuda Re”), a Bermuda insurance company and direct subsidiary of Group, have established trust agreements, which effectively use the Company's investments as collateral, as security for assumed losses payable to certain non-affiliated ceding companies. At June 30, 2008, the total amount on deposit in trust accounts was $104.5 million.

 

10. Senior Notes

 

On October 12, 2004, Holdings completed a public offering of $250.0 million principal amount of 5.40% senior notes due October 15, 2014. On March 14, 2000, Holdings completed a public offering of $200.0 million principal amount of 8.75% senior notes due March 15, 2010.

 

Interest expense incurred in connection with these senior notes was $7.8 million for the three months ended June 30, 2008 and 2007 and $15.6 million for the six months ended June 30, 2008 and 2007. Market value, which is based on quoted market price at June 30, 2008 and December 31, 2007, was $220.8

 

11

 


 

million and $235.3 million, respectively, for the 5.40% senior notes and $208.0 million and $215.9 million, respectively, for the 8.75% senior notes.

 

11. Long Term Subordinated Notes

 

On April 26, 2007, Holdings completed a public offering of $400.0 million principal amount of 6.6% fixed to floating rate long term subordinated notes with a scheduled maturity date of May 15, 2037 and a final maturity date of May 1, 2067. During the fixed rate interest period from May 3, 2007 through May 14, 2017, interest will be at the annual rate of 6.6%, payable semi-annually in arrears on November 15 and May 15 of each year, commencing on November 15, 2007, subject to Holdings’ right to defer interest on one or more occasions for up to ten consecutive years. During the floating rate interest period from May 15, 2017 through maturity, interest will be based on the 3 month London Interbank Offered Rate (“LIBOR”) plus 238.5 basis points, reset quarterly, payable quarterly in arrears on February 15, May 15, August 15 and November 15 of each year, subject to Holdings’ right to defer interest on one or more occasions for up to ten consecutive years. Deferred interest will accumulate interest at the applicable rate compounded semi-annually for periods prior to May 15, 2017, and compounded quarterly for periods from and including May 15, 2017.

 

Holdings can redeem the long term subordinated notes prior to May 15, 2017, in whole but not in part at the applicable redemption price, which will equal the greater of (a) 100% of the principal amount being redeemed and (b) the present value of the principal payment on May 15, 2017 and scheduled payments of interest that would have accrued from the redemption date to May 15, 2017 on the long term subordinated notes being redeemed, discounted to the redemption date on a semi-annual basis at a discount rate equal to the treasury rate plus an applicable spread of either 0.25% or 0.50%, in each case plus accrued and unpaid interest. Holdings may redeem the long term subordinated notes on or after May 15, 2017, in whole or in part at 100% of the principal amount plus accrued and unpaid interest; however, redemption on or after the scheduled maturity date and prior to May 1, 2047 is subject to a replacement capital covenant. This covenant is for the benefit of certain senior note holders and it mandates that Holdings receive proceeds from the sale of another subordinated debt issue, of at least similar size, before it may redeem the subordinated notes.

 

Interest expense incurred in connection with these long term notes was $6.6 million and $13.2 million for the three and six months ended June 30, 2008, respectively, and $4.3 million for the three and six months ended June 30, 2007. Market value, which is based on quoted market price at June 30, 2008 and December 31, 2007, was $288.0 million and $349.8 million for the 6.6% long term subordinated notes.

 

12. Junior Subordinated Debt Securities Payable

 

On March 29, 2004, Holdings issued $329.9 million of 6.20% junior subordinated debt securities due March 29, 2034 to Everest Re Capital Trust II (“Capital Trust II”). Holdings may redeem the junior subordinated debt securities before their maturity at 100% of their principal amount plus accrued interest as of the date of redemption. The securities may be redeemed, in whole or in part, on one or more occasions at any time on or after March 30, 2009; or at any time, in whole, but not in part, within 90 days of the occurrence and continuation of a determination that the Trust may become subject to tax or the Investment Company Act.

 

On November 14, 2002, Holdings issued $216.5 million of 7.85% junior subordinated debt securities due November 15, 2032 to Everest Re Capital Trust (“Capital Trust”). Holdings redeemed all of the junior subordinated debt securities at 100% of their principal amount plus accrued interest on November 15, 2007.

 

12

 


 

Fair value, which is primarily based on quoted market price of the related trust preferred securities, at June 30, 2008 and December 31, 2007 was $248.2 million and $250.8 million, respectively, for the 6.20% junior subordinated debt securities.

 

Interest expense incurred in connection with these junior subordinated notes was $5.1 million and $9.4 million for the three months ended June 30, 2008 and 2007, respectively, and $10.2 million and $18.7 million for the six months ended June 30, 2008 and 2007, respectively.

 

Capital Trust II is a wholly owned finance subsidiary of Holdings. Capital Trust was dissolved upon the completion of the redemption of the trust preferred securities on November 15, 2007.

 

Holdings considers that the mechanisms and obligations relating to the trust preferred securities, taken together, constitute a full and unconditional guarantee by Holdings of Capital Trust II’s payment obligations with respect to the trust preferred securities.

 

Capital Trust II will redeem all of the outstanding trust preferred securities when the junior subordinated debt securities are paid at maturity on March 29, 2034. The Company may elect to redeem the junior subordinated debt securities, in whole or in part, at any time on or after March 30, 2009. If such an early redemption occurs, the outstanding trust preferred securities would also be proportionately redeemed.

 

There are certain regulatory and contractual restrictions on the ability of Holdings’ operating subsidiaries to transfer funds to Holdings in the form of cash dividends, loans or advances. The insurance laws of the State of Delaware, where Holdings’ direct insurance subsidiaries are domiciled, require regulatory approval before those subsidiaries can pay dividends or make loans or advances to Holdings that exceed certain statutory thresholds. In addition, the terms of Holdings’ Credit Facility (discussed in Note 13) require Everest Re, Holdings’ principal insurance subsidiary, to maintain a certain statutory surplus level as measured at the end of each fiscal year. At December 31, 2007, $2,595.1 million of the $3,248.5 million in net assets of Holdings’ consolidated subsidiaries were subject to the foregoing regulatory restrictions.

 

13. Credit Line

 

Effective July 27, 2007, Group, Bermuda Re and Everest International Reinsurance, Ltd. (“Everest International”) entered into a new five year, $850.0 million senior credit facility with a syndicate of lenders, replacing the December 8, 2004, senior credit facilities, which would have expired on December 8, 2007. Both the July 27, 2007 and December 8, 2004 senior credit facilities are referred to as the “Group Credit Facility”. Wachovia Bank is the administrative agent for the Group Credit Facility, which consists of two tranches. Tranche one provides up to $350.0 million of revolving credit for liquidity and general corporate purposes, and for the issuance of unsecured standby letters of credit. The interest on the revolving loans shall, at the Company’s option, be either (1) the Base Rate (as defined below) or (2) an adjusted LIBOR plus a margin. The Base Rate is the higher of (a) the prime commercial lending rate established by Wachovia Bank or (b) the Federal Funds Rate plus 0.5% per annum. The amount of margin and the fees payable for the Group Credit Facility depends on Group’s senior unsecured debt rating. Tranche two exclusively provides up to $500.0 million for the issuance of standby letters of credit on a collateralized basis.

 

The Group Credit Facility requires Group to maintain a debt to capital ratio of not greater than 0.35 to 1 and to maintain a minimum net worth. Minimum net worth is an amount equal to the sum of $3,575.4 million plus 25% of consolidated net income for each of Group’s fiscal quarters, for which statements are available ending on or after January 1, 2007 and for which consolidated net income is positive, plus 25% of any increase in consolidated net worth during such period attributable to the issuance of ordinary and preferred shares. As of June 30, 2008, the Company was in compliance with all Group Credit Facility covenants.

 

13

 


 

At June 30, 2008 and December 31, 2007, there were outstanding letters of credit of $22.0 million under tranche one of the Group Credit Facility. At June 30, 2008 and December 31, 2007, there were outstanding standby letters of credit of $289.8 million and $288.0 million, respectively, under tranche two of the Group Credit Facility.

 

Effective August 23, 2006, Holdings entered into a new five year, $150.0 million senior revolving credit facility with a syndicate of lenders, referred to as the “Holdings Credit Facility”. Citibank N.A. is the administrative agent for the Holdings Credit Facility. The Holdings Credit Facility is used for liquidity and general corporate purposes. The Holdings Credit Facility provides for the borrowing of up to $150.0 million with interest at a rate selected by Holdings equal to either, (1) the Base Rate (as defined below) or (2) a periodic fixed rate equal to the Eurodollar Rate plus an applicable margin. The Base Rate means a fluctuating interest rate per annum in effect from time to time to be equal to the higher of (a) the rate of interest publicly announced by Citibank as its prime rate or (b) 0.5% per annum above the Federal Funds Rate, in each case plus the applicable margin. The amount of margin and the fees payable for the Holdings Credit Facility depends upon Holdings’ senior unsecured debt rating.

 

The Holdings Credit Facility requires Holdings to maintain a debt to capital ratio of not greater than 0.35 to 1 and Everest Re to maintain its statutory surplus at $1.5 billion plus 25% of future aggregate net income and 25% of future aggregate capital contributions after December 31, 2005. As of June 30, 2008, Holdings was in compliance with all Holdings Credit Facility covenants.

 

At June 30, 2008 and December 31, 2007, there were outstanding letters of credit of $17.2 million under the Holdings Credit Facility.

 

Costs incurred in connection with the Group Credit Facility and the Holdings Credit Facility were $0.3 million for the three months ended June 30, 2008 and 2007 and $0.7 million and $0.6 million for the six months ended June 30, 2008 and 2007, respectively.

 

14. Segment Results

 

The Company, through its subsidiaries, operates in five segments: U.S. Reinsurance, U.S. Insurance, Specialty Underwriting, International and Bermuda. The U.S. Reinsurance operation writes property and casualty reinsurance, on both a treaty and facultative basis, through reinsurance brokers, as well as directly with ceding companies within the U.S. The U.S. Insurance operation writes property and casualty insurance primarily through general agents and surplus lines brokers within the U.S. The Specialty Underwriting operation writes accident and health (“A&H”), marine, aviation and surety business within the U.S. and worldwide through brokers and directly with ceding companies. The International operation writes non-U.S. property and casualty reinsurance through Everest Re’s branches in Canada and Singapore and offices in Miami and New Jersey. The Bermuda operation provides reinsurance and insurance to worldwide property and casualty markets and reinsurance to life insurers through brokers and directly with ceding companies from its Bermuda office and reinsurance to the United Kingdom and European markets through its UK branch.

 

These segments are managed in a coordinated fashion with respect to pricing, risk management, control of aggregate catastrophe exposures, capital, investments and support operations. Management generally monitors and evaluates the financial performance of these operating segments based upon their underwriting results.

 

Underwriting results include earned premium less losses and loss adjustment expenses ("LAE") incurred, commission and brokerage expenses and other underwriting expenses. Underwriting results are measured

14

 


 

using ratios, in particular loss, commission and brokerage and other underwriting expense ratios, which, respectively, divide incurred losses, commissions and brokerage and other underwriting expenses by premiums earned. The Company utilizes inter-affiliate reinsurance, although such reinsurance does not materially impact segment results, as business is generally reported within the segment in which the business was first produced.

 

The Company does not maintain separate balance sheet data for its operating segments. Accordingly, the Company does not review and evaluate the financial results of its operating segments based upon balance sheet data.

 

The following tables present the underwriting results for the operating segments for the periods indicated:

 

U.S. Reinsurance

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

(Dollars in thousands)

2008

 

2007

 

2008

 

2007

Gross written premiums

$        200,348

 

$       271,670

 

$       434,067

 

$       626,022

Net written premiums

198,079

 

271,566

 

427,952

 

620,475

 

 

 

 

 

 

 

 

Premiums earned

$        238,084

 

$       314,293

 

$       527,368

 

$       667,534

Incurred losses and LAE

116,736

 

110,169

 

293,598

 

232,544

Commission and brokerage

70,101

 

81,328

 

150,367

 

157,602

Other underwriting expenses                 

6,850

 

7,320

 

15,660

 

13,814

Underwriting gain

$          44,397

 

$       115,476

 

$         67,743

 

$       263,574

 

U.S. Insurance

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

(Dollars in thousands)

2008

 

2007

 

2008

 

2007

Gross written premiums

$        190,977

 

$      161,637

 

$       401,437

 

$       379,010

Net written premiums

153,892

 

145,392

 

330,488

 

342,777

 

 

 

 

 

 

 

 

Premiums earned

$        181,199

 

$      178,080

 

$       375,713

 

$       371,053

Incurred losses and LAE

193,505

 

125,251

 

327,444

 

304,719

Commission and brokerage

39,351

 

35,420

 

74,719

 

68,636

Other underwriting expenses                 

15,900

 

12,014

 

30,242

 

24,379

Underwriting (loss) gain

$        (67,557)

 

$          5,395

 

$      (56,692)

 

$      (26,681)

 

Specialty Underwriting

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

(Dollars in thousands)

2008

 

2007

 

2008

 

2007

Gross written premiums

$          84,202

 

$        76,377

 

$       139,113

 

$       131,058

Net written premiums

83,006

 

75,852

 

137,277

 

129,128

 

 

 

 

 

 

 

 

Premiums earned

$          78,855

 

$        77,111

 

$       131,140

 

$       132,842

Incurred losses and LAE

41,538

 

54,620

 

69,887

 

95,749

Commission and brokerage

19,646

 

15,432

 

36,040

 

31,272

Other underwriting expenses                 

1,834

 

1,775

 

4,245

 

3,364

Underwriting gain

$          15,837

 

$          5,284

 

$         20,968

 

$            2,457

 

 

15

 


 

International

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

(Dollars in thousands)

2008

 

2007

 

2008

 

2007

Gross written premiums

$        218,984

 

$        202,626

 

$       405,362

 

$       375,970

Net written premiums

218,901

 

202,621

 

405,187

 

376,498

 

 

 

 

 

 

 

 

Premiums earned

$        213,990

 

$        208,895

 

$       404,958

 

$       388,653

Incurred losses and LAE

133,261

 

162,432

 

243,007

 

258,143

Commission and brokerage

55,810

 

53,052

 

102,120

 

96,589

Other underwriting expenses                

4,747

 

4,332

 

9,801

 

8,050

Underwriting gain (loss)

$          20,172

 

$       (10,921)

 

$         50,030

 

$         25,871

 

Bermuda

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

(Dollars in thousands)

2008

 

2007

 

2008

 

2007

Gross written premiums

$        210,812

 

$       223,153

 

$       402,846

 

$       440,170

Net written premiums

210,878

 

223,105

 

402,515

 

439,535

 

 

 

 

 

 

 

 

Premiums earned

$        229,967

 

$       220,941

 

$       414,889

 

$       443,967

Incurred losses and LAE

119,702

 

166,642

 

216,156

 

293,727

Commission and brokerage

59,805

 

49,191

 

108,614

 

105,979

Other underwriting expenses                 

5,827

 

4,299

 

12,614

 

9,187

Underwriting gain

$          44,633

 

$              809

 

$         77,505

 

$         35,074

 

The following table reconciles the underwriting results for the operating segments to income before taxes as reported in the consolidated statements of operations and comprehensive income for the periods indicated:

 

 

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

(Dollars in thousands)

2008

 

2007

 

2008

 

2007

Underwriting results

$         57,482

 

$       116,043

 

$       159,554

 

$       300,295

Net investment income

175,917

 

179,693

 

326,049

 

335,489

Net realized capital (losses) gains     

(31,566)

 

91,774

 

(167,949)

 

132,666

Net derivative income (expense)            

2,080

 

5,995

 

(1,715)

 

3,227

Corporate expenses

(4,570)

 

(7,801)

 

(7,410)

 

(14,807)

Interest expense

(19,794)

 

(24,243)

 

(39,581)

 

(41,706)

Other expense

(10,166)

 

(8,044)

 

(15,327)

 

(4,379)

Income before taxes

$       169,383

 

$       353,417

 

$       253,621

 

$       710,785



 

The Company produces business in the U.S., Bermuda and internationally. The net income deriving from and assets residing in the individual foreign countries in which the Company writes business are not identifiable in the Company’s financial records. Based on written premium, the largest country, other than the U.S., in which the Company writes business, is the United Kingdom, with $90.6 million and $200.1 million of written premium for the three and six months ended June 30, 2008, respectively. No other country represented more than 5% of the Company’s revenues.

 

16

 


 

15. Share-Based Compensation Plans

 

There were no share-based compensation awards granted for the three months ended June 30, 2008.

 

For the six months ended June 30, 2008, share-based compensation awards granted were 95,000 restricted shares and 378,500 options. The grant exercise price was $99.70 per share. The fair value of $25.43 per option was calculated on the date of the grant using the Black-Scholes option valuation model. The following assumptions were used in calculating the fair value of the options granted for the six months ended June 30, 2008:

 

Weighted-average volatility

25.90%

Weighted-average dividend yield

2.00%

Weighted-average expected term

6.4 years

Weighted-average risk-free rate

3.33%

Weighted-average forfeiture

11.71%

 

16. Retirement Benefits

 

The Company maintains both qualified and non-qualified defined benefit pension plans for its U.S. employees. In addition, the Company has a retiree health plan for eligible retired employees.

 

Net periodic benefit cost for U.S. employees included the following components for the periods indicated:

 

Pension Benefits

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

(Dollars in thousands)

2008

 

2007

 

2008

 

2007

Service cost

$          1,438

 

$         1,225

 

$         2,875

 

$         2,450

Interest cost

1,394

 

1,352

 

2,788

 

2,704

Expected return on plan assets

(1,757)

 

(1,386)

 

(3,513)

 

(2,772)

Amortization of prior service cost              

12

 

32

 

25

 

64

Amortization of net loss

100

 

467

 

200

 

934

FAS 88 settlement charge

544

 

-

 

725

 

-

Net periodic benefit cost

$          1,731

 

$         1,690

 

$         3,100

 

$         3,380

 

 

 

 

 

 

 

 

Other Benefits

Three Months Ended

 

Six Months Ended

 

June 30,

 

June 30,

(Dollars in thousands)

2008

 

2007

 

2008

 

2007

Service cost

$             207

 

$             158

 

$             413

 

$             316

Interest cost

162

 

129

 

325

 

258

Amortization of net loss

13

 

-

 

25

 

-

Net periodic benefit cost

$             382

 

$             287

 

$             763

 

$             574

 

The Company contributed $1.2 million to the pension benefit plan for the three and six months ended June 30, 2008. The Company contributed $1.6 million to the pension benefit plan for the three and six months ended June 30, 2007.

 

17

 


17. Related-Party Transactions

 

During the normal course of business, the Company, through its affiliates, engages in reinsurance and brokerage and commission business transactions with companies controlled by or affiliated with its outside directors. Such transactions, individually and in the aggregate, are not material to the Company’s financial condition, results of operations and cash flows.

 

18. Income Taxes

 

The Company uses a projected annual effective tax rate in accordance with FASB Statement No. 109, "Accounting for Income Taxes" ("FAS 109"), to calculate its quarterly tax expense. Under this methodology, when an interim quarter’s pre-tax income (loss) varies significantly from a full year’s income (loss) projection, the tax impact resulting from the income (loss) variance is effectively spread between the impacted quarter and the remaining quarters of the year, except for discreet items impacting an individual quarter.

 

The Company recognizes accrued interest related to unrecognized tax benefits and penalties in income taxes. For the three and six months ended June 30, 2008, the Company accrued and recognized approximately $0.4 million and $0.8 million, respectively, in interest and penalties.

 

18

 


 

 

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

 

Industry Conditions.

The worldwide reinsurance and insurance businesses are highly competitive, as well as cyclical by product and market. As a result, financial results tend to fluctuate with periods of constrained availability, high rates and strong profits followed by periods of abundant capacity, low rates and constrained profitability. Competition in the types of reinsurance and insurance business that we underwrite is based on many factors, including the perceived overall financial strength of the reinsurer or insurer, ratings of the reinsurer or insurer by A.M. Best Company and/or Standard & Poor’s Rating Services, underwriting expertise, the jurisdictions where the reinsurer or insurer is licensed or otherwise authorized, capacity and coverages offered, premiums charged, other terms and conditions of the reinsurance and insurance business offered, services offered, speed of claims payment and reputation and experience in lines written. Furthermore, the market impact from these competitive factors related to reinsurance and insurance is generally not consistent across lines of business, domestic and international geographical areas and distribution channels.

 

We compete in the U.S., Bermuda and international reinsurance and insurance markets with numerous global competitors. Our competitors include independent reinsurance and insurance companies, subsidiaries or affiliates of established worldwide insurance companies, reinsurance departments of certain insurance companies and domestic and international underwriting operations, including underwriting syndicates at Lloyd’s. Some of these competitors have greater financial resources than we do and have established long term and continuing business relationships, which can be a significant competitive advantage. In addition, the lack of strong barriers to entry into the reinsurance business and the potential for securitization of reinsurance and insurance risks through capital markets provide additional sources of potential reinsurance and insurance capacity and competition.

 

We continued to see increased competition during the second quarter of 2008 with generally lower rates, higher commissions and demands by cedants for improved terms and conditions. The extent of the increased competition and its effect on rates, terms and conditions varied widely by market and coverage but was most prevalent in the U.S. reinsurance markets. In addition to demanding lower rates and improved terms, ceding companies are retaining more of their business by reducing quota share percentages, purchasing excess of loss covers in lieu of quota shares, and increasing retentions on excess of loss business. We have also experienced reduced quota share premiums, particularly on catastrophe exposed business, due to increased purchases of common account covers by ceding companies, which reduces the premiums subject to the quota share contract. There was also increased competition in the U.S. insurance market, particularly in the workers’ compensation and contractor coverages; however, given the specialty nature of our business, we believe the impact on our business to be less pronounced than on the market generally.

 

Rate decreases in the international markets have generally been less pronounced than in the U.S. markets and we have grown our business in the Middle East, Latin America and Asia. We are expanding our international reach by opening a new office in Brazil to capitalize on the recently expanded opportunity for professional reinsurers in that market and on the economic growth expected for Brazil in the future. International results have also benefited from the weaker U.S. dollar since the foreign currencies convert to higher dollar amounts resulting in favorable year over year premium comparisons.

 

We are unable to predict the impact on future market conditions from increased competition and legislative initiatives. In addition to these market forces, reinsurers continue to reassess their risk appetites and rebalance their property portfolios to obtain a greater spread of risk against the backdrop of: (i) recent revisions to the industry’s catastrophe loss projection models, which are indicating significantly higher loss potentials and consequently higher pricing requirements and (ii) elevated rating agency scrutiny and capital requirements for many catastrophe exposed companies.

 

19

 


 

Overall, we believe that current marketplace conditions offer profit opportunities for us given our strong ratings, distribution system, reputation and expertise. We continue to employ our strategy of targeting business that offers the greatest profit potential, while maintaining balance and diversification in our overall portfolio.

 

20

 


 

Financial Summary.

We monitor and evaluate our overall performance based upon financial results. The following table displays a summary of the consolidated net income, ratios and shareholders’ equity for the periods indicated:

 

 

Three Months Ended

 

Percentage

 

Six Months Ended

 

Percentage

 

June 30,

 

Increase/

 

June 30,

 

Increase/

(Dollars in millions)

2008

 

2007

 

(Decrease)

 

2008

 

2007

 

(Decrease)

Gross written premiums

$      905.3

 

$      935.5

 

-3.2%

 

$   1,782.8

 

$      1,952.2

 

-8.7%

Net written premiums

864.8

 

918.5

 

-5.9%

 

1,703.4

 

1,908.4

 

-10.7%

 

 

 

 

 

 

 

 

 

 

 

 

REVENUES:

 

 

 

 

 

 

 

 

 

 

 

Premiums earned

$      942.1

 

$      999.3

 

-5.7%

 

$   1,854.1

 

$      2,004.0

 

-7.5%

Net investment income

175.9

 

179.7

 

-2.1%

 

326.0

 

335.5

 

-2.8%

Net realized capital (losses) gains

(31.6)

 

91.8

 

-134.4%

 

(167.9)

 

132.7

 

-226.6%

Net derivative income (expense)

2.1

 

6.0

 

-65.3%

 

(1.7)

 

3.2

 

-153.1%

Other expense

(10.2)

 

(8.0)

 

27.3%

 

(15.3)

 

(4.4)

 

NM

Total revenues

1,078.4

 

1,268.7

 

-15.0%

 

1,995.1

 

2,471.1

 

-19.3%

 

 

 

 

 

 

 

 

 

 

 

 

CLAIMS AND EXPENSES:

 

 

 

 

 

 

 

 

 

 

 

Incurred losses and loss adjustment expenses

604.7

 

619.1

 

-2.3%

 

1,150.1

 

1,184.9

 

-2.9%

Commission, brokerage, taxes and fees

244.7

 

234.4

 

4.4%

 

471.9

 

460.1

 

2.6%

Other underwriting expenses

39.7

 

37.5

 

5.8%

 

80.0

 

73.6

 

8.7%

Interest expense

19.8

 

24.2

 

-18.4%

 

39.6

 

41.7

 

-5.1%

Total claims and expenses

909.0

 

915.3

 

-0.7%

 

1,741.5

 

1,760.3

 

-1.1%