Quarterly Report for Period ending June 30, 2004

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, 2004

 

Commission file number 0-2253

 


 

PartnerRe Ltd.

(Exact name of Registrant as specified in its charter)

 


 

Bermuda   Not Applicable

(State or other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

96 Pitts Bay Road

Pembroke, Bermuda

  HM 08
(Address of principal executive offices)   (Zip Code)

 

(441) 292-0888

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 (the Exchange Act) during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

Yes  x    No  ¨

 

The number of the Registrant’s common shares (par value $1.00 per share) outstanding as of August 2, 2004 was 53,711,667.

 



PartnerRe Ltd.

INDEX TO FORM 10-Q

 

     Page

PART I—FINANCIAL INFORMATION     

ITEM 1.

   Financial Statements.     
     Report of Independent Registered Public Accounting Firm    2
     Unaudited Condensed Consolidated Balance Sheets June 30, 2004 and December 31, 2003    3
     Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income Six Months and Three Months Ended June 30, 2004 and 2003    4
     Unaudited Condensed Consolidated Statements of Shareholders’ Equity Six Months Ended June 30, 2004 and 2003    5
     Unaudited Condensed Consolidated Statements of Cash Flows Six Months Ended June 30, 2004 and 2003    6
     Notes to Unaudited Condensed Consolidated Financial Statements    7

ITEM 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    15

ITEM 3.

   Quantitative and Qualitative Disclosures about Market Risk    50

ITEM 4.

   Controls and Procedures    53
PART II—OTHER INFORMATION     

ITEM 1.

   Legal Proceedings    54

ITEM 2.

   Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities    54

ITEM 3.

   Defaults upon Senior Securities    54

ITEM 4.

   Submission of Matters to a Vote of Security Holders    54

ITEM 5.

   Other Information    55

ITEM 6.

   Exhibits and Reports on Form 8-K    55
     Signatures    56
     Exhibit Index    57

 


Part I — Financial Information

 

Item 1. Financial Statements

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Shareholders of PartnerRe Ltd.

 

We have reviewed the accompanying condensed consolidated balance sheet of PartnerRe Ltd. and subsidiaries as of June 30, 2004, and the related condensed consolidated statements of operations and comprehensive income for the three-month and six-month periods ended June 30, 2004 and 2003 and of shareholders’ equity and of cash flows for the six-month periods ended June 30, 2004 and 2003. These interim condensed consolidated financial statements are the responsibility of the Company’s management.

 

We conducted our reviews in accordance with standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

 

Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

 

We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of PartnerRe Ltd. and subsidiaries as of December 31, 2003 and the related consolidated statements of operations and comprehensive income, shareholders’ equity and cash flows for the year then ended (not presented herein); and in our report dated February 9, 2004, we expressed an unqualified opinion on those consolidated financial statements, which included an explanatory paragraph relating to the Company’s change in the method of accounting for goodwill, derivative instruments and hedging activities, Mandatorily Redeemable Preferred Securities and Trust Preferred Securities. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2003 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

 

Deloitte & Touche

Hamilton, Bermuda

July 26, 2004

 

2


PartnerRe Ltd.

Condensed Consolidated Balance Sheets

(Expressed in thousands of U.S. dollars, except parenthetical share data)

(Unaudited)

 

    

June 30,

2004


    December 31,
2003


 

Assets

                

Investments and cash

                

Fixed maturities, available for sale, at fair value (amortized cost: 2004, $4,833,567; 2003, $5,241,494)

   $ 4,859,290     $ 5,343,651  

Short-term investments, available for sale, at fair value (amortized cost: 2004, $14,459; 2003, $46,271)

     14,456       46,307  

Equities, available for sale, at fair value (cost: 2004, $671,524; 2003, $614,697)

     748,201       713,950  

Trading securities, at fair value (cost: 2004, $98,692; 2003, $113,385)

     102,148       122,544  

Cash and cash equivalents, at fair value, which approximates amortized cost

     1,523,567       558,692  

Other invested assets

     95,532       11,590  
    


 


Total investments and cash

     7,343,194       6,796,734  

Accrued investment income

     115,540       132,291  

Reinsurance balances receivable

     1,637,117       1,214,269  

Reinsurance recoverable on paid and unpaid losses

     191,556       188,706  

Funds held by reinsured companies

     1,075,870       1,068,432  

Deferred acquisition costs

     428,535       354,854  

Deposit assets

     321,294       508,037  

Taxes recoverable

     94,070       80,835  

Goodwill

     429,519       429,519  

Net receivable for securities sold

     10,305       —    

Other

     124,333       129,337  
    


 


Total Assets

   $ 11,771,333     $ 10,903,014  
    


 


Liabilities

                

Unpaid losses and loss expenses

   $ 5,056,732     $ 4,755,059  

Policy benefits for life and annuity contracts

     1,145,621       1,162,016  

Unearned premiums

     1,541,994       1,035,450  

Funds held under reinsurance treaties

     27,744       27,399  

Deposit liabilities

     534,668       570,634  

Long-term debt

     220,000       220,000  

Net payable for securities purchased

     —         5,389  

Accounts payable, accrued expenses and other

     124,458       126,675  

Debt related to trust preferred securities

     206,186       206,000  

Mandatorily redeemable preferred securities

     200,000       200,000  
    


 


Total Liabilities

     9,057,403       8,308,622  
    


 


Shareholders’ Equity

                

Common shares (par value $1.00, issued and outstanding: 2004, 53,692,627; 2003, 53,741,553)

     53,693       53,742  

Preferred shares (aggregate liquidation preference: $290,000,000; par value $1.00, issued and outstanding: 2004, 11,600,000; 2003, 11,600,000)

     11,600       11,600  

Additional paid-in capital

     1,016,847       1,023,167  

Deferred compensation

     (302 )     (125 )

Accumulated other comprehensive income:

                

Net unrealized gains on investments, net of tax

     86,030       166,492  

Currency translation adjustment

     4,090       16,657  

Retained earnings

     1,541,972       1,322,859  
    


 


Total Shareholders’ Equity

     2,713,930       2,594,392  
    


 


Total Liabilities and Shareholders’ Equity

   $ 11,771,333     $ 10,903,014  
    


 


 

See Accompanying Notes to Condensed Consolidated Financial Statements

 

3


PartnerRe Ltd.

Condensed Consolidated Statements of Operations and Comprehensive Income

(Expressed in thousands of U.S. dollars, except per share data)

(Unaudited)

 

    

For the three
months ended

June 30, 2004


   

For the three

months ended

June 30, 2003


   

For the six
months ended

June 30, 2004


   

For the six

months ended

June 30, 2003


 

Revenues

                                

Gross premiums written

   $ 841,934     $ 837,302     $ 2,395,556     $ 2,098,892  
    


 


 


 


Net premiums written

   $ 840,721     $ 838,860     $ 2,364,422     $ 2,073,607  

Decrease (increase) in unearned premiums

     114,114       23,988       (516,800 )     (404,523 )
    


 


 


 


Net premiums earned

     954,835       862,848       1,847,622       1,669,084  

Net investment income

     74,926       63,048       148,388       124,178  

Net realized investment gains

     8,042       15,566       45,856       55,636  

Other income

     4,122       2,873       7,036       5,150  
    


 


 


 


Total Revenues

     1,041,925       944,335       2,048,902       1,854,048  

Expenses

                                

Losses and loss expenses and life policy benefits

     619,669       554,273       1,189,527       1,110,270  

Acquisition costs

     226,817       201,599       431,148       371,321  

Other operating expenses

     67,884       58,078       135,446       109,349  

Interest expense

     10,168       3,231       20,336       6,426  

Net foreign exchange losses (gains)

     58       (5,198 )     (1,139 )     (8,932 )
    


 


 


 


Total Expenses

     924,596       811,983       1,775,318       1,588,434  
    


 


 


 


Income before distributions related to trust preferred and mandatorily redeemable preferred securities and taxes

     117,329       132,352       273,584       265,614  

Distributions related to trust preferred and mandatorily redeemable preferred securities

     —         6,815       —         13,630  

Income tax (benefit) expense

     (2,506 )     3,622       8,105       5,700  
    


 


 


 


Net income

     119,835       121,915       265,479       246,284  

Preferred dividends

     4,894       14,567       9,788       19,567  
    


 


 


 


Net income available to common shareholders

   $ 114,941     $ 107,348     $ 255,691     $ 226,717  
    


 


 


 


Calculation of comprehensive income, net of tax:

                                

Net income as reported

   $ 119,835     $ 121,915     $ 265,479     $ 246,284  

Change in unrealized gains or losses on investments

     (138,405 )     84,324       (80,462 )     52,160  

Change in currency translation adjustment

     (6,376 )     17,815       (12,567 )     28,047  
    


 


 


 


Comprehensive (loss) income

   $ (24,946 )   $ 224,054     $ 172,450     $ 326,491  
    


 


 


 


Per share data:

                                

Earnings per common share:

                                

Basic net income

   $ 2.14     $ 2.02     $ 4.76     $ 4.29  

Weighted average number of common shares outstanding

     53,791.5       53,221.8       53,737.5       52,810.3  

Diluted net income

   $ 2.12     $ 2.00     $ 4.71     $ 4.22  

Weighted average number of common and common equivalent shares outstanding

     54,339.3       53,698.7       54,305.9       53,716.4  

 

See Accompanying Notes to Condensed Consolidated Financial Statements

 

4


PartnerRe Ltd.

Condensed Consolidated Statements of Shareholders’ Equity

(Expressed in thousands of U.S. dollars)

(Unaudited)

 

     Common
shares


    Preferred
shares


   

Additional

paid-in
capital


   

Deferred
compen-

sation


   

Net

unrealized
gains on
investments,

net of tax


    Currency
translation
adjustment


    Retained
earnings


    

Total share-
holders’

equity


 

Balance at December 31, 2003

   $ 53,742     $ 11,600     $ 1,023,167     $ (125 )   $ 166,492     $ 16,657     $ 1,322,859      $ 2,594,392  

Issue of common shares

     109       —         4,753       —         —         —         —          4,862  

Repurchase of common shares

     (163 )     —         (8,954 )     —         —         —         —          (9,117 )

Adjustment on purchase contracts for common shares

     —         —         (2,390 )     —         —         —         —          (2,390 )

Issue of restricted common shares

     5       —         271       (276 )     —         —         —          —    

Amortization of deferred compensation

     —         —         —         99       —         —         —          99  

Net unrealized losses for period

     —         —         —         —         (80,462 )     —         —          (80,462 )

Currency translation adjustment

     —         —         —         —         —         (12,567 )     —          (12,567 )

Net income

     —         —         —         —         —         —         265,479        265,479  

Dividends on common shares

     —         —         —         —         —         —         (36,578 )      (36,578 )

Dividends on preferred shares

     —         —         —         —         —         —         (9,788 )      (9,788 )
    


 


 


 


 


 


 


  


Balance at June 30, 2004

   $ 53,693     $ 11,600     $ 1,016,847     $ (302 )   $ 86,030     $ 4,090     $ 1,541,972      $ 2,713,930  
    


 


 


 


 


 


 


  


Balance at December 31, 2002

   $ 52,376     $ 10,000     $ 977,714     $ (261 )   $ 119,605     $ (30,820 )   $ 948,568      $ 2,077,182  

Issue of common shares

     1,237       —         7,409       —         —         —         —          8,646  

Issue of preferred shares

     —         11,600       269,265       —         —         —         —          280,865  

Redemption of preferred shares

     —         (10,000 )     (232,163 )     —         —         —         —          (242,163 )

Adjustment on purchase contracts for common shares

     —         —         (2,390 )     —         —         —         —          (2,390 )

Amortization of deferred compensation

     —         —         —         68       —         —         —          68  

Net unrealized gains for period

     —         —         —         —         52,160       —         —          52,160  

Currency translation adjustment

     —         —         —         —         —         28,047       —          28,047  

Net income

     —         —         —         —         —         —         246,284        246,284  

Dividends on common shares

     —         —         —         —         —         —         (30,737 )      (30,737 )

Dividends on preferred shares

     —         —         —         —         —         —         (19,567 )      (19,567 )
    


 


 


 


 


 


 


  


Balance at June 30, 2003

   $ 53,613     $ 11,600     $ 1,019,835     $ (193 )   $ 171,765     $ (2,773 )   $ 1,144,548      $ 2,398,395  
    


 


 


 


 


 


 


  


 

See Accompanying Notes to Condensed Consolidated Financial Statements

 

5


PartnerRe Ltd.

Condensed Consolidated Statements of Cash Flows

(Expressed in thousands of U.S. dollars)

(Unaudited)

 

    

For the six
months ended

June 30, 2004


   

For the six
months ended

June 30, 2003


 

Cash Flows From Operating Activities:

                

Net income

   $ 265,479     $ 246,284  

Adjustments to reconcile net income to net cash provided by operating activities:

                

Accrual of discount on investments, net of amortization of premium

     24,139       5,772  

Net realized investment gains

     (45,856 )     (55,636 )

Changes in:

                

Unearned premiums

     516,800       404,523  

Reinsurance balances receivable

     (451,883 )     (359,016 )

Unpaid losses and loss expenses including life policy benefits

     372,148       372,015  

Net taxes recoverable

     2,866       4,859  

Other changes in assets and liabilities

     (82,965 )     (109,924 )

Net sales (purchases) of trading securities

     23,762       (4,618 )

Other items, net

     (2,956 )     (8,327 )
    


 


Net cash provided by operating activities

     621,534       495,932  
    


 


Cash Flows From Investing Activities:

                

Sales of fixed maturities

     5,360,231       4,368,536  

Redemptions of fixed maturities

     302,765       168,473  

Purchases of fixed maturities

     (5,204,777 )     (4,690,324 )

Net sales (purchases) of short-term investments

     30,925       (20,424 )

Net purchases of equities

     (17,412 )     (63,180 )

Other

     (71,612 )     (9,656 )
    


 


Net cash provided by (used in) investing activities

     400,120       (246,575 )
    


 


Cash Flows From Financing Activities:

                

Cash dividends paid to shareholders

     (46,366 )     (49,076 )

Net (Repurchase) issue of common shares

     (3,979 )     8,646  

Issue of preferred shares

     —         280,865  

Redemption of preferred shares

     —         (242,163 )

Adjustment on purchase contract for common shares

     (2,390 )     (2,390 )
    


 


Net cash used in financing activities

     (52,735 )     (4,118 )
    


 


Effect of exchange rate changes on cash

     (4,044 )     1,770  

Increase in cash and cash equivalents

     964,875       247,009  

Cash and cash equivalents—beginning of period

     558,692       710,640  
    


 


Cash and cash equivalents—end of period

   $ 1,523,567     $ 957,649  
    


 


 

See Accompanying Notes to Condensed Consolidated Financial Statements

 

6


PartnerRe Ltd.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1. General

 

PartnerRe Ltd. (the “Company”) provides reinsurance on a worldwide basis through its wholly owned subsidiaries, Partner Reinsurance Company Ltd. (“Partner Reinsurance Company”), PartnerRe SA, and Partner Reinsurance Company of the U.S. (“PartnerRe U.S.”). Risks reinsured include, but are not limited to, property, casualty, motor, agriculture, aviation/space, catastrophe, credit/surety, engineering/energy, marine, special risk, other lines and life/annuity and health. The Company also offers financial products that provide weather and credit protection to industrial and service companies on a worldwide basis.

 

The accompanying condensed consolidated financial statements are unaudited and have been prepared by the Company pursuant to the rules and regulations of the United States Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. The preparation of financial statements in conformity with U.S. GAAP requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. While Management believes that the amounts included in the condensed consolidated financial statements reflect the best estimates and assumptions, actual results could differ from those estimates. The Company’s principal estimates include:

 

  Unpaid losses and loss expenses, including policy benefits for life and annuity contracts;

 

  Gross and net premiums written and net premiums earned;

 

  Recoverability of deferred acquisition costs;

 

  Determination of other-than-temporary impairment of investments;

 

  Recoverability of tax loss carry-forwards;

 

  Valuation of goodwill; and

 

  Valuation of certain derivative financial instruments.

 

In the opinion of Management, all adjustments (which include normal recurring adjustments) necessary for a fair presentation of results for the interim periods have been made. The results for the six-month and three-month periods ended June 30, 2004 are not necessarily indicative of results to be expected for the full fiscal year. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. To facilitate comparison of information across periods, certain reclassifications have been made to prior year amounts to conform to the current year’s presentation.

 

2. Recent Development

 

In February 2004, the Company invested $73.2 million in Channel Re, a new financial guarantee reinsurer based in Bermuda, which will assume a portfolio of approximately $27 billion of in-force business from MBIA, participate in new MBIA reinsurance treaties and provide facultative reinsurance support to MBIA. Other shareholders in Channel Re are Renaissance Re, Koch Financial Re and MBIA. The Company’s investment represents 20% of the common stock of Channel Re and this investment is recorded, using the equity method, in the other invested assets line on the Company’s condensed consolidated balance sheet.

 

7


PartnerRe Ltd.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

3. Stock Options

 

The following table illustrates the net effect on net income available to common shareholders and net income per share as if the fair value provisions of SFAS 123 had been applied retroactively to all outstanding equity-based compensation for the three-month and six-month periods ended June 30, 2004 and 2003 (in thousands of U.S. dollars, except per share data):

 

    

For the three

months ended

June 30, 2004


   

For the three

months ended

June 30, 2003


    For the six
months ended
June 30, 2004


    For the six
months ended
June 30, 2003


 

Net income available to common shareholders:

                                

As reported

   $ 114,941     $ 107,348     $ 255,691     $ 226,717  

Add: Stock-related compensation expense included in net income as reported

   $ 2,264     $ 1,062     $ 3,495     $ 1,325  

Less: Total stock-related compensation expense determined under fair-value method for all grants

   $ 3,632     $ 3,150     $ 6,660     $ 5,689  
    


 


 


 


Pro forma

   $ 113,573     $ 105,260     $ 252,526     $ 222,353  

Net income per common share:

                                

Basic

                                

As reported

   $ 2.14     $ 2.02     $ 4.76     $ 4.29  

Pro forma

   $ 2.11     $ 1.98     $ 4.70     $ 4.21  

Diluted

                                

As reported

   $ 2.12     $ 2.00     $ 4.71     $ 4.22  

Pro forma

   $ 2.09     $ 1.96     $ 4.65     $ 4.14  

Weighted average assumptions used:

                                

Risk-free interest rate

     4.5 %     3.7 %     3.7 %     3.7 %

Expected life

     7 years       7 years       7 years       7 years  

Expected volatility

     25 %     25 %     25 %     25 %

Dividend yield

     2 %     2 %     2 %     2 %

 

8


PartnerRe Ltd.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

4. New Accounting Policy

 

The Company’s investment in Channel Re qualifies as an investment in a corporate joint venture and is accounted for using the equity method. The Company’s share of Channel Re’s net income and other comprehensive income is reported in the Company’s net income and other comprehensive income, respectively. The Company calculates its share of Channel Re’s net income and other comprehensive income on the basis of the Company’s share of Channel Re’s common shares currently outstanding.

 

5. Recent Accounting Pronouncements

 

In July 2003, the Accounting Standards Executive Committee (AcSEC) of the American Institute of Certified Public Accountants (AICPA) issued Statement of Position 03-01, “Accounting and Reporting by Insurance Enterprises for Certain Non-traditional Long-Duration Contracts and for Separate Accounts” (SOP 03-01). SOP 03-01 complements the guidance available in SFAS No. 60 “Accounting and Reporting by Insurance Enterprises,” and SFAS No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments” for insurance products introduced since the issuance of these two SFAS. SOP 03-01 is effective for financial statements for fiscal years beginning after December 15, 2003. The Company has adopted SOP 03-01 as of January 1, 2004 and the adoption did not have a significant impact on the Company’s condensed consolidated financial statements.

 

In March of 2004, the Emerging Issues Task Force (“EITF”) reached consensus on the guidance provided in EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments (“EITF 03-1”) as applicable to debt and equity securities that are within the scope of SFAS 115 Accounting for Certain Investments in Debt and Equity Securities and equity securities that are accounted for using the cost method specified in Accounting Policy Board Opinion No. 18 The Equity Method of Accounting for Investments in Common Stock. Under this guidance, an investment is considered impaired if the fair value of the investment is less than its cost including adjustments for amortization, accretion, foreign exchange, and hedging. EITF 03-1 outlines that an impairment would be considered other-than-temporary unless a) the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for the recovery of the fair value up to (or beyond) the cost of the investment and b) evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. The investor should consider its cash or working capital needs to assess its intent and ability to hold an investment for a reasonable period of time for the recovery of fair value up to or beyond the cost of the investment. In addition, the severity and duration of the impairment should also be considered in determining whether the impairment is other-than-temporary. Adoption of this standard may accelerate the timing of losses from declines in value due to interest rates even if there is no deterioration of the credit of the issuer; however, it is not anticipated to have a significant impact on shareholders’ equity as fluctuations in market value of available for sale securities are already reflected in Accumulated Other Comprehensive Income. This new guidance for determining whether impairment is other-than-temporary is effective for reporting periods beginning after June 15, 2004. The Company is currently evaluating the impact of the new accounting guidance on its process for determining whether other-than-temporary declines exist within its debt and equity investment portfolio as well as the impact on its condensed consolidated financial statements.

 

6. Financing Arrangement

 

In June 2004, the Company renewed its syndicated unsecured credit facility on substantially the same terms and conditions except for an increase in the term of the facility, which was extended from 364 days to three years, and an increase in the minimum consolidated tangible net worth (defined as total shareholders’ equity plus mandatorily redeemable preferred shares and trust preferred shares minus goodwill) that the Company is required to maintain from $1,250 million plus 50% of cumulative net income for the period from January 1, 2002 through the end of the most recently ended fiscal year to $1,825 million plus 50% of cumulative net income for the period from January 1, 2004 through the end of the most recently ended fiscal year.

 

9


PartnerRe Ltd.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

7. Segment Information

 

The Company monitors the performance of its underwriting operations in three segments, Non-life, Alternative Risk Transfer (ART) and Life. The Non-life segment is further divided into three sub-segments, U.S. Property and Casualty, Global (Non-U.S.) Property and Casualty and Worldwide Specialty. Segments and sub-segments represent markets that are reasonably homogeneous in terms of geography, client types, buying patterns, underlying risk patterns and approach to risk management.

 

The U.S. Property and Casualty sub-segment includes property, casualty and motor risks generally originating in the United States and written by PartnerRe U.S. The Global (Non-U.S.) Property and Casualty sub-segment includes property, casualty and motor risks generally originating outside of the United States, written by Partner Reinsurance Company and PartnerRe SA. The Worldwide Specialty sub-segment is comprised of business that is generally considered to be specialized due to the sophisticated technical underwriting required to analyze risks, and is global in nature, inasmuch as appropriate risk management for these lines requires a globally diversified portfolio of risks. This sub-segment consists of several lines of business for which the Company believes it has developed specialized knowledge and underwriting capabilities. These lines of business include agriculture, aviation/space, catastrophe, credit/surety, engineering/energy, marine, special risk and other lines. The ART segment includes finite reinsurance, structured finance and weather-related products, and starting in the second quarter of 2004, includes the results of the Company’s investment in Channel Re. The Life segment includes life, health and annuity lines of business.

 

Because the Company does not manage its assets by segment, investment income is not allocated to the Non-life segment of the reinsurance operations. However, because of the interest-sensitive nature of some of the Company’s Life and ART products, investment income is considered in Management’s assessment of the profitability of the Life and ART segments. The following items are not considered in evaluating the results of each segment: net realized investment gains and losses, interest expense, distributions related to trust preferred and mandatorily redeemable preferred securities, net foreign exchange gains and losses, income tax expense or benefit and preferred share dividends. Segment results are shown net of intercompany transactions. The Company has treated its ART operations as a reportable segment for the first time in the first quarter of 2004. Segment information for prior periods has been reclassified to conform to this new presentation.

 

Management measures results for the Non-life segment on the basis of the “loss ratio”, “acquisition ratio”, “technical ratio”, “other overhead expense ratio” and “combined ratio.” The “loss ratio” is obtained by dividing losses and loss expenses by net premiums earned, the “acquisition ratio” is obtained similarly by dividing acquisition costs by net premiums earned and the “other overhead expense ratio” is obtained by dividing other operating expenses by net premiums earned. The “technical ratio” is the sum of the loss and acquisition ratios. The “combined ratio” is the sum of the technical and other overhead expense ratios. Management measures results for the Non-life sub-segments on the basis of the loss ratio, acquisition ratio and technical ratio. Management measures segment results for the Life and ART segments on the basis of the “allocated underwriting result”, which includes revenues from net premiums earned, other income, net investment income for ART and allocated net investment income for Life, and expenses from losses and loss expenses, acquisition costs and other operating expenses.

 

For each of the segments and sub-segments presented, premiums are earned on a basis that is consistent with the risks covered under the terms of the reinsurance contracts, which generally is one to two years. The difference between the gross and net premiums written is attributable to the cost of retrocession protection, as the Company selectively purchases retrocession protection as part of its overall risk management process.

 

10


PartnerRe Ltd.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The following table provides a summary of the segment revenues and results for the six-month and three-month periods ended June 30, 2004 and 2003 (in millions of U.S dollars except ratios):

 

For the six months ended June 30, 2004

 

     US
P&C


    Global
(Non -
US
P&C)


    Worldwide
Specialty


   

Total
Non-

Life
Segment


    ART
Segment
(A)


    Life
Segment


    Corporate

     Total

 

Gross premiums written

   $ 577     $ 666     $ 956     $ 2,199     $ 3     $ 194     $  —        $ 2,396  

Net premiums written

   $ 577     $ 666     $ 932     $ 2,175     $ 2     $ 187     $  —        $ 2,364  

(Increase) decrease in unearned premiums

     (120 )     (181 )     (206 )     (507 )     —         (9 )     —          (516 )
    


 


 


 


 


 


 


  


Net premiums earned

   $ 457     $ 485     $ 726     $ 1,668     $ 2     $ 178     $  —        $ 1,848  

Losses and loss expenses including life policy benefits

     (334 )     (370 )     (346 )     (1,050 )     —         (140 )     —          (1,190 )

Acquisition costs

     (95 )     (124 )     (161 )     (380 )     —         (51 )     —          (431 )
    


 


 


 


 


 


 


  


Technical Result

   $ 28     $ (9 )   $ 219     $ 238     $ 2     $ (13 )   $  —        $ 227  

Other income

     n/a       n/a       n/a       —         7       —         —          7  

Other operating expenses

     n/a       n/a       n/a       (96 )     (8 )     (12 )     (20 )      (136 )
    


 


 


 


 


 


 


  


Underwriting Result

     n/a       n/a       n/a     $ 142     $ 1     $ (25 )     n/a      $ 98  

Net investment income

     n/a       n/a       n/a       n/a       —         21       127        148  
    


 


 


 


 


 


 


  


Allocated Underwriting Result (6)

     n/a       n/a       n/a       n/a       n/a     $ (4 )     n/a        n/a  

Net realized investment gains

     n/a       n/a       n/a       n/a       n/a       n/a       46        46  

Interest expense

     n/a       n/a       n/a       n/a       n/a       n/a       (20 )      (20 )

Net foreign exchange gains

     n/a       n/a       n/a       n/a       n/a       n/a       1        1  

Income tax expense

     n/a       n/a       n/a       n/a       n/a       n/a       (8 )      (8 )
    


 


 


 


 


 


 


  


Net Income

     n/a       n/a       n/a       n/a       n/a       n/a       n/a      $ 265  

Loss ratio (1)

     73.1 %     76.2 %     47.7 %     63.0 %                                 

Acquisition ratio (2)

     20.9       25.6       22.1       22.7                                   
    


 


 


 


                                

Technical ratio (3)

     94.0 %     101.8 %     69.8 %     85.7 %                                 

Other overhead expense ratio (4)

                             5.8                                   
                            


                                

Combined Ratio (5)

                             91.5 %                                 

 

11


PartnerRe Ltd.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

For the six months ended June 30, 2003

 

    

US

P&C


   

Global

(Non -US

P&C)


   

Worldwide

Specialty


   

Total

Non-

Life

Segment


   

ART

Segment

(A)


   

Life

Segment


    Corporate

     Total

 

Gross premiums written

   $ 539     $ 487     $ 918     $ 1,944     $ —       $ 155     $ —        $ 2,099  

Net premiums written

   $ 539     $ 491     $ 896     $ 1,926     $ —       $ 148     $ —        $ 2,074  

Increase in unearned premiums

     (128 )     (74 )     (197 )     (399 )     —         (6 )     —          (405 )
    


 


 


 


 


 


 


  


Net premiums earned

   $ 411     $ 417     $ 699     $ 1,527     $ —       $ 142     $ —        $ 1,669  

Losses and loss expenses including life policy benefits

     (286 )     (283 )     (409 )     (978 )     —         (132 )     —          (1,110 )

Acquisition costs

     (107 )     (106 )     (135 )     (348 )     —         (23 )     —          (371 )
    


 


 


 


 


 


 


  


Technical Result

   $ 18     $ 28     $ 155     $ 201     $ —       $ (13 )   $ —        $ 188  

Other income

     n/a       n/a       n/a       —         5       —         —          5  

Other operating expenses

     n/a       n/a       n/a       (83 )     (5 )     (8 )     (13 )      (109 )
    


 


 


 


 


 


 


  


Underwriting Result

     n/a       n/a       n/a     $ 118     $ —       $ (21 )     n/a      $ 84  

Net investment income

     n/a       n/a       n/a       n/a       —         24       100        124  
    


 


 


 


 


 


 


  


Allocated Underwriting Result (6)

     n/a       n/a       n/a       n/a       n/a     $ 3       n/a        n/a  

Net realized investment gains

     n/a       n/a       n/a       n/a       n/a       n/a       56        56  

Interest expense

     n/a       n/a       n/a       n/a       n/a       n/a       (6 )      (6 )

Net foreign exchange gains

     n/a       n/a       n/a       n/a       n/a       n/a       8        8  

Income tax expense

     n/a       n/a       n/a       n/a       n/a       n/a       (6 )      (6 )

Distributions related to trust preferred and mandatorily redeemable preferred securities

     n/a       n/a       n/a       n/a       n/a       n/a       (14 )      (14 )
    


 


 


 


 


 


 


  


Net Income

     n/a       n/a       n/a       n/a       n/a       n/a       n/a      $ 246  
    


 


 


 


 


 


 


  


Loss ratio (1)

     69.5 %     68.0 %     58.6 %     64.1 %                                 

Acquisition ratio (2)

     26.1       25.2       19.3       22.8                                   
    


 


 


 


                                

Technical ratio (3)

     95.6 %     93.2 %     77.9 %     86.9 %                                 

Other overhead expense ratio (4)

                             5.4                                   
                            


                                

Combined Ratio (5)

                             92.3 %                                 

(A) This segment includes the Company’s share of Channel Re’s net income in the amount of $0.7 million in the 2004 period. The 2003 period includes no income from Channel Re as the Company acquired its equity ownership in the first quarter of 2004.
(1) Loss ratio is obtained by dividing losses and loss expenses by net premiums earned.
(2) Acquisition ratio is obtained by dividing acquisition costs by net premiums earned.
(3) Technical ratio is defined as the sum of the loss ratio and the acquisition ratio.
(4) Other overhead expense ratio is obtained by dividing other operating expenses by net premiums earned.
(5) Combined ratio is the sum of the technical ratio and the other overhead expense ratio.
(6) Allocated Underwriting Result is defined as net premiums earned, other income and net investment income less losses and loss expenses, acquisition costs and other overhead expenses.

 

12


PartnerRe Ltd.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

For the three months ended June 30, 2004

 

    

US

P&C


   

Global

(Non -US

P&C)


    Worldwide
Specialty


   

Total

Non-

Life

Segment


   

ART

Segment

(A)


   

Life

Segment


    Corporate

     Total

 

Gross premiums written

   $ 201     $ 197     $ 337     $ 735     $ 2     $ 105     $ —        $ 842  

Net premiums written

   $ 201     $ 197     $ 337     $ 735     $ 2     $ 104     $ —        $ 841  

(Increase) decrease in unearned premiums

     33       33       45       111       (1 )     4       —          114  
    


 


 


 


 


 


 


  


Net premiums earned

   $ 234     $ 230     $ 382     $ 846     $ 1     $ 108     $ —        $ 955  

Losses and loss expenses including life policy benefits

     (168 )     (183 )     (183 )     (534 )     —         (86 )     —          (620 )

Acquisition costs

     (53 )     (60 )     (87 )     (200 )     —         (27 )     —          (227 )
    


 


 


 


 


 


 


  


Technical Result

   $ 13     $ (13 )   $ 112     $ 112     $ 1     $ (5 )   $ —        $ 108  

Other income

     n/a       n/a       n/a       —         4       —         —          4  

Other operating expenses

     n/a       n/a       n/a       (48 )     (4 )     (6 )     (10 )      (68 )
    


 


 


 


 


 


 


  


Underwriting Result

     n/a       n/a       n/a     $ 64     $ 1     $ (11 )     n/a      $ 44  

Net investment income

     n/a       n/a       n/a       n/a       —         11       64        75  
    


 


 


 


 


 


 


  


Allocated Underwriting Result (6)

     n/a       n/a       n/a       n/a       n/a     $ —         n/a        n/a  

Net realized investment gains

     n/a       n/a       n/a       n/a       n/a       n/a       8        8  

Interest expense

     n/a       n/a       n/a       n/a       n/a       n/a       (10 )      (10 )

Net foreign exchange losses

     n/a       n/a       n/a       n/a       n/a       n/a       —          —    

Income tax benefit

     n/a       n/a       n/a       n/a       n/a       n/a       (3 )      3  
    


 


 


 


 


 


 


  


Net Income

     n/a       n/a       n/a       n/a       n/a       n/a       n/a      $ 120  
    


 


 


 


 


 


 


  


Loss ratio (1)

     71.9 %     79.2 %     47.8 %     63.0 %                                 

Acquisition ratio (2)

     22.6       26.0       22.8       23.6                                   
    


 


 


 


                                

Technical ratio (3)

     94.5 %     105.2 %     70.6 %     86.6 %                                 

Other overhead expense ratio (4)

                             5.6                                   
                            


                                

Combined Ratio (5)

                             92.2 %                                 

 

13


PartnerRe Ltd.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

For the three months ended June 30, 2003

 

    

US

P&C


   

Global

(Non -US

P&C)


   

Worldwide

Specialty


   

Total

Non-

Life

Segment


   

ART

Segment

(A)


   

Life

Segment


    Corporate

     Total

 

Gross premiums written

   $ 221     $ 182     $ 366     $ 769     $ —       $ 68     $ —        $ 837  

Net premiums written

   $ 221     $ 186     $ 366     $ 773     $ —       $ 66     $ —        $ 839  

Increase in unearned premiums

     (6 )     29       —         23       —         1       —          24  
    


 


 


 


 


 


 


  


Net premiums earned

   $ 215     $ 215     $ 366     $ 796     $ —       $ 67     $ —        $ 863  

Losses and loss expenses including life policy benefits

     (148 )     (145 )     (202 )     (495 )     —         (59 )     —          (554 )

Acquisition costs

     (57 )     (57 )     (74 )     (188 )     —         (14 )     —          (202 )
    


 


 


 


 


 


 


  


Technical Result

   $ 10     $ 13     $ 90     $ 113     $ —       $ (6 )   $ —        $ 107  

Other income

     n/a       n/a       n/a       —         3       —         —          3  

Other operating expenses

     n/a       n/a       n/a       (44 )     (3 )     (4 )     (7 )      (58 )
    


 


 


 


 


 


 


  


Underwriting Result

     n/a       n/a       n/a     $ 69     $ —       $ (10 )     n/a      $ 52  

Net investment income

     n/a       n/a       n/a       n/a       —         12       51        63  
    


 


 


 


 


 


 


  


Allocated Underwriting Result (6)

     n/a       n/a       n/a       n/a       n/a     $ 2       n/a        n/a  

Net realized investment gains

     n/a       n/a       n/a       n/a       n/a       n/a       16        16  

Interest expense

     n/a       n/a       n/a       n/a       n/a       n/a       (3 )      (3 )

Net foreign exchange gains

     n/a       n/a       n/a       n/a       n/a       n/a       5        5  

Income tax expense

     n/a       n/a       n/a       n/a       n/a       n/a       (4 )      (4 )

Distributions related to trust preferred and mandatorily redeemable preferred securities

     n/a       n/a       n/a       n/a       n/a       n/a       (7 )      (7 )
    


 


 


 


 


 


 


  


Net Income

     n/a       n/a       n/a       n/a       n/a       n/a       n/a      $ 122  
    


 


 


 


 


 


 


  


Loss ratio (1)

     68.7 %     67.8 %     55.2 %     62.2 %                                 

Acquisition ratio (2)

     26.6       26.4       20.0       23.6                                   
    


 


 


 


                                

Technical ratio (3)

     95.3 %     94.2 %     75.2 %     85.8 %                                 

Other overhead expense ratio (4)

                             5.5                                   
                            


                                

Combined Ratio (5)

                             91.3 %                                 

(A) This segment includes the Company’s share of Channel Re’s net income in the amount of $0.7 million in the 2004 period. The 2003 period includes no income from Channel Re as the Company acquired its equity ownership in the first quarter of 2004.

 

(1) Loss ratio is obtained by dividing losses and loss expenses by net premiums earned.

 

(2) Acquisition ratio is obtained by dividing acquisition costs by net premiums earned.

 

(3) Technical ratio is defined as the sum of the loss ratio and the acquisition ratio.

 

(4) Other overhead expense ratio is obtained by dividing other operating expenses by net premiums earned.

 

(5) Combined ratio is the sum of the technical ratio and the other overhead expense ratio.

 

(6) Allocated Underwriting Result is defined as net premiums earned, other income and net investment income less losses and loss expenses, acquisition costs and other overhead expenses.

 

14


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

 

The following is a discussion and analysis of the unaudited consolidated financial condition at June 30, 2004 and results of operations of PartnerRe Ltd. (the “Company”) for the six-month and three-month periods ended June 30, 2004 and 2003. This discussion and analysis should be read in conjunction with the attached unaudited condensed consolidated financial statements and notes thereto and the audited consolidated financial statements of the Company at and for the year ended December 31, 2003 and notes thereto included in the Company’s 2003 Annual Report to Shareholders. The unaudited condensed consolidated financial statements at and for the three and six-month periods ended June 30, 2004 and notes thereto have been reviewed by independent accountants in accordance with standards of the Public Company Accounting Oversight Board (United States). This Management’s Discussion and Analysis of Financial Condition and Results of Operations includes references to financial figures prepared in accordance with accounting principles generally accepted in the United States and ratios that are calculated using these figures.

 

Forward Looking Statements

 

Certain statements contained in this document, including Management’s Discussion and Analysis, may be considered forward-looking statements as defined in section 27A of the United States Securities Act of 1933 and section 21E of the United States Securities Exchange Act of 1934. Forward-looking statements are made based upon management’s assumptions and expectations concerning the potential effect on the Company of future events and financial performance and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are subject to significant business, economic and competitive risks and uncertainties that could cause actual results to differ materially from those reflected in such forward-looking statements. PartnerRe’s forward-looking statements could be affected by numerous foreseeable and unforeseeable events and developments such as:

 

(1) the occurrence of catastrophic events or other reinsured events with a frequency or severity exceeding our expectations;

 

(2) a decrease in the level of demand for reinsurance and/or an increase in the supply of reinsurance capacity;

 

(3) increased competitive pressures, including the consolidation and increased globalization of reinsurance providers;

 

(4) actual losses and loss expenses exceeding our loss reserves, which are necessarily based on actuarial and statistical projections of ultimate losses;

 

(5) acts of terrorism;

 

(6) changes in the cost, availability and performance of retrocessional reinsurance, including the ability to collect reinsurance recoverables;

 

(7) concentration risk in dealing with a limited number of brokers;

 

(8) developments in and risks associated with global financial markets which could affect our investment portfolio;

 

(9) changing rates of inflation and other economic conditions;

 

(10) availability of borrowings and letters of credit under the Company’s credit facilities;

 

(11) losses due to foreign currency exchange rate fluctuations;

 

(12) restrictions in the issue of work permits which could result in loss of the services of any one of our executives;

 

(13) changes in the legal or regulatory environments in which we operate, including the passage of federal or state legislation subjecting Partner Reinsurance Company Ltd. or PartnerRe SA to supervision or regulation, including additional tax regulation, in the United States or other jurisdictions in which we operate;

 

(14) actions by rating agencies that might impact the Company’s ability to continue to write existing business or write new business;

 

(15) changes in accounting policies, their application or interpretation; and

 

(16) the other factors set forth in the Company’s other documentation on file with the SEC.

 

15


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

The foregoing discussion of important factors should not be construed as exhaustive and should be read in conjunction with other cautionary statements that are included herein or elsewhere. The words “believe,” “anticipate,” “estimate,” “project,” “plan,” “expect,” “intend,” “hope,” “forecast,” “evaluate,” “will likely result” or “will continue” or words of similar impact generally involve forward-looking statements. We caution readers not to place undue reliance on these forward-looking statements, which speak only as of their dates. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

General

 

The Company provides reinsurance on a worldwide basis through its wholly owned subsidiaries, Partner Reinsurance Company Ltd. (“Partner Reinsurance Company”), PartnerRe SA, and Partner Reinsurance Company of the U.S. (“PartnerRe US”). Risks reinsured include, but are not limited to, property, casualty, motor, agriculture, aviation/space, catastrophe, credit/surety, engineering/energy, marine, special risk, other lines and life/annuity and health. The Company also offers financial products that provide weather and credit protection to industrial and service companies on a worldwide basis.

 

Because of the inherent volatility of some of the lines of business the Company underwrites, the operating results and financial condition of the Company can be adversely impacted by catastrophes and other large losses that may give rise to claims under reinsurance coverages provided by the Company. Catastrophe reinsurance comprises a material portion of the Company’s exposure. Catastrophe losses result from events such as windstorms, earthquakes, floods, hail, tornadoes, severe winter weather, fires, explosions and other man-made or natural disasters, the incidence and severity of which are inherently unpredictable. Because catastrophe reinsurance accumulates large aggregate exposures to man-made and natural disasters, the Company’s loss experience in this line of business could be characterized by low frequency and high severity, particularly since it usually provides reinsurance that pays only after the primary insurer has experienced a specified level of loss, which tends to reduce the Company’s exposure to higher-frequency low-severity losses. This is likely to result in substantial volatility in the Company’s financial results for any fiscal quarter or year and could have a material adverse effect on the Company’s financial condition or results of operations.

 

The Company writes other lines of business and products that can be affected by large losses, including property, casualty, motor, agriculture, aviation/space, credit/surety, engineering/energy, marine, special risk, other lines, life/annuity and health, finite reinsurance, structured finance and weather-related products. The Company endeavors to manage its exposure to catastrophe and other large losses by (i) attempting to limit its aggregate exposure on catastrophe reinsurance in any particular geographic zone defined by the Company and attempting to limit its exposure to per risk reinsurance, (ii) selective underwriting practices, (iii) diversification of risks by geographic area and by lines and classes of business, and (iv) to a certain extent by purchasing retrocessional reinsurance and credit default swaps. Despite the Company’s efforts to manage its exposure to catastrophe and other large losses, the effect of a single catastrophic event or series of events affecting one or more geographic zones or changes in the relative frequency or severity of catastrophic or other large loss events could have a material adverse effect on the Company’s financial condition or results of operations. Should the Company incur a substantial catastrophe loss, its ability to write future business may be impacted.

 

Business Environment

 

The reinsurance industry is both highly competitive and cyclical. Competition in the industry is influenced by several factors including variations in interest rates and financial markets, changes in legal, regulatory and judicial environments, inflation and general economic conditions. Reinsurance cycles vary in length and the up cycle, the profitable years leading to increases in reinsurers’ capital, can result from either strong reinsurance pricing and terms and conditions or strong investment income resulting from high interest rates or the combination of both circumstances. The occurrence of a catastrophic loss or one or a series of large losses would typically influence reinsurance pricing and terms and conditions. Growth in capital is a prime determinant of capacity and competition in the reinsurance industry and ultimately leads to a softening of pricing and terms and conditions. Management believes that reinsurance pricing generally follows loss cost trends, but that the lag between the loss trend cycle and the pricing cycle is ultimately affected by the availability of capital in the industry.

 

16


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Following the last downturn in the cycle, the reinsurance industry’s expected profitability experienced consistent improvements during years 2001 through 2003 and this trend was further amplified following the event of September 11, 2001. Beginning in 2004 the Company saw a change in this trend and believes that for most lines of business that the industry has seen the peak in the current profitability cycle. Currently we are experiencing a market that is gradually weakening, in terms of price and terms and conditions; however, this is occurring in an orderly and understandable fashion. The short-tailed lines, e.g., property energy, aviation and catastrophe, are currently experiencing the most significant pricing deterioration as the loss experience over the past several years has been excellent and provided the industry with more capital. Pricing in longer tailed lines of business e.g., casualty, continues to improve; however, improvements are at a much slower pace than has been experienced in the last few years. In spite of these changes in the business environment the Company continues to find business opportunities that have adequate pricing and which the Company believes are consistent with its long term goals and objectives.

 

Looking forward, the Company expects to see a continuation of a slowly weakening market through 2005, assuming the absence of a major industry event, which could lead to a change in the current trends in pricing.

 

As interest rates continue to rise we expect to see a contraction in the amount of capital available to the industry; however, we also expect to see improved investment income into 2005 as operating cash flows and maturing investments are invested at increasing rates of return.

 

Critical Accounting Policies

 

See the discussion of the Company’s Critical Accounting Policies in the Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s 2003 Annual Report to Shareholders. The following discussion updates specific information related to the Company’s estimates for unpaid loss and loss expense reserves since December 31, 2003 and March 31, 2004.

 

The Company performs quarterly reviews of the adequacy of unpaid losses and loss expense reserves, taking into account current and historical reported claims information, industry information and trends, and other factors that could have an impact on the ultimate settlement value of claims incurred by the Company. The claims information reported to the Company in any one period can pertain to the current as well as prior years and can indicate an increase or a decrease in the losses anticipated by the cedant. This new information can influence the Company’s assessment of its ultimate loss ratios as well as the level of required losses and loss expense reserves currently held. Although the dollar value of emerging reported losses may not be significant on an individual basis, the Company monitors the accumulation of such individual losses (referred to as “attritional losses”) to identify trends that may be meaningful from a reserving standpoint. In any given quarter, the Company may increase its reserve estimates relating to claims of prior periods (referred to as “adverse loss development”), or it may reduce its reserves related to prior periods (referred to as “positive loss development”), depending on what information becomes available for consideration during the quarterly evaluation of reserves.

 

The allocation of losses to accident years attempts to match losses with the period in which the related premiums were earned and facilitates the review of calendar year results, which typically include results from the current accident year and development on prior accident years. The following table shows the net positive (adverse) loss development for prior accident years in the Non-life segment (in millions of U.S. dollars):

 

    

Three months
ended June 30,

2004


   

Three months
ended June 30,

2003


   

Six months
ended June 30,

2004


   

Six months
ended June 30,

2003


 

Prior year positive (adverse) loss development:

                                

Non-life segment:

                                

U.S. Property and Casualty

   $ (6 )   $ (9 )   $ (9 )   $ (16 )

Global (Non-U.S.) Property and Casualty

     (13 )     —         (17 )     27  

Worldwide Specialty

     49       (5 )     115       (22 )
    


 


 


 


Total prior-year loss development

   $ 30     $ (14 )   $ 89     $ (11 )

 

17


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

The components making up the net positive loss development for the three-month and six-month periods ended June 30, 2004 and 2003 are described in more detail in the discussion of the individual sub-segments that make up the Non-life segment, below.

 

At June 30, 2004, the Company had gross Non-life reserves for unpaid losses and loss expenses of $5.1 billion, comprised of outstanding loss reserves (case reserves) of $2.2 billion, incurred but not reported (IBNR) reserves of $2.7 billion and additional case reserves (ACR) of $0.2 billion. The Company had Non-life ceded reserves of $0.2 billion recoverable under retrocessional agreements, resulting in net Non-life reserves of $4.9 billion. At December 31, 2003, the Company had gross Non-life reserves for unpaid losses and loss expenses of $4.8 billion, comprised of case reserves of $2.2 billion, IBNR reserves of $2.5 billion and ACR of $0.1 billion. At March 31, 2004, the Company had gross Non-life reserves for unpaid losses and loss expenses of $4.9 billion, comprised of case reserves of $2.2 billion, IBNR reserves of $2.6 billion and ACR of $0.1 billion.

 

The Company estimates its unpaid losses and loss expense reserves using single point estimates for each sub-segment. These reserves represent the Company’s best estimate of future losses and loss expense amounts. Ranges around these point estimates are developed using stochastic simulations and techniques and provide an indication as to the degree of variability of the unpaid losses and loss expense reserves. The Company interprets the ranges produced by these techniques as confidence intervals around the best estimates for each sub-segment. However, due to the inherent volatility in the business written by the Company there can be no guarantee that the final settlement of the unpaid losses and loss expense reserves will fall within these ranges. The point estimates recorded by the Company and the range of estimates around these point estimates for net reserves at June 30, 2004, were as follows (in millions of U.S. dollars):

 

     Recorded
Point Estimate


   High

   Low

U.S. Property and Casualty

   $ 1,383    $ 1,666    $ 1,045

Global (Non-U.S.) Property and Casualty

     1,851      2,087      1,528

Worldwide Specialty

     1,653      1,717      1,299

 

It is not appropriate to add together the ranges of each sub-segment in an effort to determine a high and low range around the Company’s total carried unpaid losses and loss expense reserves.

 

Estimates of ultimate liabilities are contingent on many future events. The eventual outcome of these events may be different from the assumptions underlying the reserve estimates. In the event the business environment and social trends diverge from historical trends, the Company may have to adjust its reserves to amounts falling significantly outside its current estimate range. Management believes that the recorded reserves represent the best estimate of future liabilities based on information available as at June 30, 2004. The estimates are continually reviewed and the ultimate liability may be in excess of, or less than, the amounts provided, for which any adjustments will be reflected in the periods in which they become known.

 

Reserves for policy benefits for ordinary life, accident and health policies have been established based upon information reported by ceding companies supplemented by the Company’s best actuarial estimates of mortality, morbidity, persistency and investment income, with appropriate provision for adverse deviation. Future policy benefit reserves for annuity and universal life products are carried at their accumulated values. Reserves for policy claims and benefits include both mortality and morbidity claims in the process of settlement and claims that are assumed to have been incurred but not yet reported. Interest rate assumptions used to estimate liabilities for policy benefits for life and annuity contracts ranged from 1.5% to 6.7%. Actual experience in a particular period may vary from assumed experience and, consequently, may affect the Company’s results in future periods.

 

Included in the business that is considered to have a long reporting tail is the Company’s exposure to asbestos and environmental claims. The Company’s reserve for unpaid losses and loss expenses for asbestosis and environmental exposures have not changed significantly since December 31, 2003. (See Note 5 to the consolidated financial statements in the Company’s 2003 Annual Report to Shareholders.)

 

18


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Results of Operations—for the Six Months Ended June 30, 2004 and 2003

 

Results Summary

 

The Company measures its performance in several ways. Among the performance measures accepted under U.S. GAAP are diluted net income per share and return on beginning common shareholders’ equity (ROE), two measures that focus on the return provided to the Company’s common shareholders. Diluted net income per share is obtained by dividing net income available to common shareholders by the weighted average number of common and common share equivalents outstanding. Net income available to common shareholders is defined as net income less preferred share dividends. Net income available to common shareholders is also used in the calculation of the Company’s ROE, which is calculated by dividing net income available to common shareholders by the net book value of the common shareholders’ equity at the beginning of the year. ROE figures are presented on an annualized basis. The net book value of the common shareholders’ equity is obtained by subtracting the aggregate liquidation value of the preferred shares from total shareholders’ equity.

 

The Company analyses its net income in four parts: underwriting result, investment income, income and expenses from other operations and fixed charges. Underwriting result is defined as net premiums earned and other income less losses and loss expenses, acquisition costs and other overhead expenses. Investment income includes interest and dividends, net of investment expenses, generated by the Company’s investment portfolio, as well as interest income generated on funds held and certain ART transactions. Income and expenses from other operations include net realized investment gains and losses, net foreign exchange gains and losses, and income tax expense or benefit. Fixed charges are comprised of interest expense and distributions related to Trust Preferred and Mandatorily Redeemable Preferred Securities.

 

Underwriting result, investment income, income and expenses from other operations, fixed charges, net income available to common shareholders, diluted net income per common share and ROE for the six months ended June 30, 2004 and 2003 were as follows (in millions of U.S. dollars, except per share data and ROE):

 

    

For the six

months ended

June 30, 2004


   

% Change
2004

over 2003


   

For the six

months ended

June 30, 2003


 

Underwriting result

   $ 98     18 %   $ 84  

Investment income

     148     19       124  

Income and expenses from other operations

     39     (34 )     58  

Fixed charges

     (20 )   (1 )     (20 )
    


       


Net income

   $ 265     8     $ 246  

Less: Preferred dividends

     9     (50 )     19  
    


       


Net income available to common shareholders

   $ 256     13     $ 227  

Diluted net income per share

   $ 4.71     12     $ 4.22  

Annualized return on beginning common shareholders’ equity (ROE)

     22.2 %           24.8 %

 

Net income available to common shareholders and diluted net income per share for the 2004 period improved compared to the equivalent period of 2003 principally as a result of higher underwriting result and increased net investment income. Other operations have partially offset the increase.

 

Underwriting result increased significantly from $84 million for the six-month period ended June 30, 2003 to $98 million for the same period of 2004. Contributing to the improvement of underwriting result were the strong market conditions as well as favorable development on prior accident year losses as the Company reduced its estimate of losses for certain lines as the “at risk” period for older years expired and updated information was received from cedants.

 

In addition to higher income generated by the underwriting operations, the Company reported net investment income of $148 million for the six months ended June 30, 2004 compared to $124 million during the equivalent period in 2003. The increase in investment income is attributable to the investment of the Company’s significant cash flow from operations, which amounted to $622 million for the six months ended June 30, 2004 and $1.3 billion since June 30, 2003.

 

19


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Income and expense from other operations has decreased from $58 million for the six months ended June 30, 2003 to $39 million for the equivalent period in 2004 primarily as a result of lower net realized investment gains. Realized investment gains and losses, which account for most of the decrease, are generally a function of multiple factors with the most significant being the prevailing interest rates and the timing of disposition of available for sale fixed maturities and equity securities, and charges for the recognition of other-than-temporary impairments in the Company’s investment portfolio. As the Company repositions its investment portfolio to take advantage of market conditions, it generates sales of securities that result in the realization of the unrealized market value appreciation or depreciation on the securities. The realization of the unrealized market value appreciation or depreciation does not change the Company’s comprehensive income and shareholders’ equity, as it merely transfers the gain or loss from the accumulated other comprehensive income section of the condensed consolidated balance sheets to the net income on the condensed consolidated statements of operations and the retained earnings section of the condensed consolidated balance sheets.

 

Preferred dividends for the six months ended June 30, 2003 included a non-recurring charge of $10 million related to the redemption of the Company’s Series A preferred shares and the overlap of preferred dividend on Series A and Series C preferred shares prior to the redemption of the Series A preferred shares in the second quarter of 2003.

 

Notwithstanding the increase in the net income in the first half of 2004 compared to the same period in 2003, the Company’s annualized ROE declined as the opening equity available to common shareholders increased at a faster rate than net income available to common shareholders.

 

The next section provides a detailed analysis of the Company’s underwriting result by segment and sub-segment, investment income, income and expenses from other operations and fixed charges for the six-month periods ended June 30, 2004 and 2003.

 

Results by Segment

 

See the description of the Company’s segments and sub-segments included in Note 7 to the Condensed Consolidated Financial Statements in Item 1, above.

 

20


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Non-life Segment

 

U.S. Property and Casualty

 

The following table provides the components of the technical result and their corresponding ratios for this sub-segment for the six months ended June 30, 2004 and 2003 (in millions of U.S. dollars):

 

     For the six
months ended
June 30, 2004


   

% Change
2004

over 2003


    For the six
months ended
June 30, 2003


 

Gross premiums written

   $ 577     7 %   $ 539  

Net premiums written

     577     7       539  

Net premiums earned

   $ 457     11     $ 411  

Losses and loss expenses

     334     17       286  

Acquisition costs

     95     (11 )     107  
    


       


Technical result

   $ 28     54     $ 18  

Loss ratio

     73.1 %           69.5 %

Acquisition ratio

     20.9 %           26.1 %

Technical ratio

     94.0 %           95.6 %

 

Premiums

 

The U.S. Property and Casualty sub-segment represented 24% of net premiums written in the first six months of 2004. The growth in net premiums written over the equivalent period of 2003 was most pronounced in the casualty and motor lines, where terms and conditions remained strong, while premiums in the property line decreased principally due to the softening of terms and conditions and increased cedant retention. Notwithstanding the strong terms and conditions prevailing in this sub-segment, the Company has remained selective in pursuing business that meets its profitability objectives. The Company continued its controlled expansion in the specialty casualty line as it believes that this line will continue to provide very good terms and conditions. Based on the July 1, 2004 pricing indications and renewal information received from cedants and brokers, gross and net premiums written are expected to grow during the remainder of 2004 in this sub-segment, driven by the casualty line (including specialty casualty business). Net premiums earned are expected to increase modestly for all lines during the remainder of 2004.

 

Losses and loss expenses

 

The growth in the losses and loss expense volume in the six months ended June 30, 2004 compared to the equivalent period in 2003, is due to the growth in the Company’s book of business and exposure as evidenced by the increase in net premiums earned for this sub-segment. The technical ratio for the six months ended June 30, 2004 and 2003 included no catastrophe or other significant losses. The increase in loss ratio for the six months ended June 30, 2004 compared to the corresponding 2003 period occurred primarily as a result of the continued expansion of the specialty casualty line that typically tends to have a higher loss ratio due to the long-tail nature of the risk involved. Accordingly, these treaties also typically provide for investment income on invested premiums during a longer period as losses are typically paid later than for other lines. The technical result and ratio for the six months ended June 30, 2004 and 2003 included $9 million and $16 million, respectively, of adverse prior year loss development. The adverse loss development of $9 million recorded in the 2004 period included adverse loss development on the motor and casualty lines, which was partially offset by positive loss development on the shorter-tailed property line. Included in the positive loss development on the property line was a $12 million reduction in the Company’s loss estimate related to the event of September 11, as the Company received information from cedants indicating that certain outstanding loss reserves were no longer necessary. The adverse loss development recorded in the 2003 period pertained principally to the casualty line.

 

Acquisition costs

 

The decrease in the acquisition costs and acquisition ratio during the first six months of 2004 is due to the reduction of the acquisition ratio on treaties with experience credits under the form of sliding scale and profit commission adjustments. A shift from proportional to non-proportional business within this sub-segment also reduced the acquisition ratio as non-proportional business typically carries lower acquisition costs.

 

21


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Global (Non-U.S.) Property and Casualty

 

The following table provides the components of the technical result and their corresponding ratios for this sub-segment for the six months ended June 30, 2004 and 2003 (in millions of U.S. dollars):

 

     For the six
months ended
June 30, 2004


   

% Change
2004

over 2003


    For the six
months ended
June 30, 2003


 

Gross premiums written

   $ 666     37 %   $ 487  

Net premiums written

     666     36       491  

Net premiums earned

   $ 485     17     $ 417  

Losses and loss expenses

     370     31       283  

Acquisition costs

     124     18       106  
    


       


Technical result

   $ (9 )   NM     $ 28  

Loss ratio

     76.2 %           68.0 %

Acquisition ratio

     25.6 %           25.2 %

Technical ratio

     101.8 %           93.2 %

NM: not meaningful

 

Premiums

 

The Global (Non-U.S.) Property and Casualty sub-segment represented 28% of net premiums written in the six months ended June 30, 2004. The growth in gross and net premiums written over the equivalent period of 2003 was the result of two factors. A substantial portion of the growth related to refinements in the process used for estimating premiums written on certain portfolio treaties that renewed during the first quarter of 2004. As discussed in the Company’s Form 10-Q for the first quarter of 2004, the impact of the refinement was to recognize upfront, gross and net premiums written of approximately $146 million that would have been recognized ratably over the year had this refinement not been made. This increase in premiums written was largely offset by a corresponding increase in unearned premiums. The change will not affect the annual gross and net premiums written volume but will affect comparisons of quarterly and half-year figures over the previous year. As the year progresses, the year to date comparison will be less impacted by the timing issue. The second factor impacting the growth rate was the weaker U.S. dollar during the first six months of 2004 compared to the equivalent period of 2003. As a result, foreign exchange contributed approximately 13 points to the growth in net premiums written. Through the six months ended June 30, 2004, the Company continued to observe strong prices and terms and conditions in the casualty and motor lines and observed that even though pricing in the property line remains at a profitable level, terms and conditions are softening for this line. Notwithstanding the generally strong terms and conditions prevailing in this sub-segment, the Company has seen increased competition but has remained selective in pursuing business that meets its profitability objectives and has declined treaties where terms and conditions did not meet the Company’s objectives. Based on the July 1, 2004 pricing indications and renewal information received from cedants and brokers, and assuming constant foreign exchange rates, gross and net premiums written are expected to have moderate growth in the remainder of 2004 in this sub-segment. Net premiums earned are expected to grow moderately during the remainder of 2004.

 

Losses and loss expenses

 

The technical ratio for the six months ended June 30, 2004 and 2003 included no catastrophe or other individually significant losses. The increase in the loss ratio for the six months ended June 30, 2004 compared to the corresponding 2003 period occurred primarily because of weak technical result in the casualty and motor lines which were partially offset by good results in the property line during the first six months of 2004. The technical result and ratio for the six-month periods ended June 30, 2004 and 2003 included $17 million of adverse prior year loss development, or 3.4 points on the loss ratio, and $27 million, or 6.5 points on the loss ratio, of positive loss development, respectively. The adverse loss development recorded in the first six months of 2004 included adverse loss development on the casualty and motor lines, which was partially offset by positive loss development on the property line. The positive loss development recorded in the first six-months of 2003 pertained principally to the property line.

 

Acquisition costs

 

The acquisition ratio for the first six months of 2004 and 2003 was comparable.

 

22


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Worldwide Specialty

 

The following table provides the components of the technical result and their corresponding ratios for this sub-segment for the six months ended June 30, 2004 and 2003 (in millions of U.S. dollars):

 

     For the six
months ended
June 30, 2004


   

% Change
2004

over 2003


    For the six
months ended
June 30, 2003


 

Gross premiums written

   $ 956     4 %   $ 918  

Net premiums written

     932     4       896  

Net premiums earned

   $ 726     4     $ 699  

Losses and loss expenses

     346     (15 )     409  

Acquisition costs

     161     19       135  
    


       


Technical result

   $ 219     42     $ 155  

Loss ratio

     47.7 %           58.6 %

Acquisition ratio

     22.1 %           19.3 %

Technical ratio

     69.8 %           77.9 %

 

Premiums

 

The Worldwide Specialty sub-segment represented 40% of net premiums written in the first six months of 2004. The growth in net premiums written over the equivalent period of 2003 was principally due to the weakening of the U.S. dollar in the first six months of 2004 compared to the first six months of 2003. During the first six months of 2004, the Company has seen no real change in market trends since the second half of 2003 where the pricing for the most profitable lines of business had started to decline and the other lines exhibited a slow but orderly reduction in the rate of price increases as a result of increasing competition. The Company has remained selective in pursuing business that meets its profitability objectives. Based on the July 1, 2004 pricing indications and renewal information received from cedants and brokers, and assuming constant foreign exchange rates, gross and net premiums written for the remainder of the year are expected to be flat or decrease during 2004 for this sub-segment. Net premiums earned are expected to increase modestly during the remainder of 2004.

 

Losses and loss expenses

 

While the technical ratio for the six months ended June 30, 2004 included large losses in the marine and energy lines, including the $30 million loss on the Algerian gas plant explosion, the first six months of 2003 included no catastrophe or other significant losses. The decrease in the losses and loss expenses and loss ratio in the six months ended June 30, 2004 compared to June 30, 2003, is principally due to the positive loss development recorded during the first six months of 2004. The technical result and ratio for the periods ended June 30, 2004 and 2003 included $115 million of positive loss development and $22 million of adverse loss development, respectively. The positive loss development of $115 million recorded in the first six months of 2004 included positive loss development on the special risk, catastrophe, aviation, agriculture and engineering/energy lines, which was partially offset by adverse loss development on the marine line. Included in the positive loss development of 2004 was a $21 million reduction in the Company’s loss estimate related to the event of September 11, as the Company received information from cedants indicating that certain outstanding loss reserves were no longer necessary. The adverse loss development recorded in the first six months of 2003 pertained principally to the specialty property line.

 

Acquisition costs

 

The increase in the acquisition costs and acquisition ratio compared to the six months ended June 30, 2003 resulted primarily from a shift from treaties previously written on a net basis, where premiums are ceded to the Company net of acquisition costs, to treaties written on a gross basis, where acquisitions costs are reported separately from premiums. This change in the form of the treaty does not affect the net result under the treaty but distorts the quarter over quarter comparison for acquisition costs. Other factors contributing to the increase included intensifying competition in this sub-segment, which tends to increase acquisition costs, and a shift between lines of business where certain lines carry higher acquisition ratios.

 

23


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

ART Segment

 

The following table provides the components of the underwriting result for this segment for the six months ended June 30, 2004 and 2003 (in millions of U.S. dollars):

 

     For the six
months ended
June 30, 2004


    For the six
months ended
June 30, 2003


 

Gross premiums written

   $ 3     $  —    

Net premiums written

     2       —    

Net premiums earned

   $ 2     $  —    

Losses and loss expenses

     —         —    

Acquisition costs

     —         —    
    


 


Technical result

   $ 2     $  —    

Other Income

     7       5  

Other operating expenses

     (8 )     (5 )
    


 


Underwriting result

   $ 1     $  —    

 

As reinsurance accounting does not apply for much of the business in this segment, premiums alone are not a representative measure of activity in ART. This segment is very transaction driven, and revenues and profit trends will be uneven, especially given the still small size of this segment. The ART segment had good growth in revenues during the first six months of 2004 despite low interest rates, which reduce the attractiveness of finite business for clients, and low credit spreads, which reduce the opportunities in the structured finance business. Finite business had strong accounting results due to the commutation of two large treaties, which accelerated the recognition of the margin on the treaties. Results in the structured finance line included losses arising due to the marking down of derivative positions related to certain securities whose market value had declined due to wider spreads on underlying securities while results in the weather line included losses resulting from higher than normal spring temperature in Japan. The Company’s share of the results of Channel Re for the first six months of 2004, amount to $0.7 million and is included in the ART segment results. The Company expects the ART segment and results to grow during the remainder of the year as this segment continues to expand.

 

24


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Life Segment

 

The following table provides the components of the allocated underwriting result for this segment for the six months ended June 30, 2004 and 2003 (in millions of U.S. dollars):

 

     For the six
months ended
June 30, 2004


   

% Change
2004

over 2003


    For the six
months ended
June 30, 2003


 

Gross premiums written

   $ 194     25 %   $ 155  

Net premiums written

     187     26       148  

Net premiums earned

   $ 178     25     $ 142  

Life policy benefits

     140     (5 )     132  

Acquisition costs

     51     117       23  
    


       


Technical result

   $ (13 )   (3 )   $ (13 )

Other operating expenses

     (12 )   (44 )     (8 )

Allocated investment income

     21     (11 )     24  
    


       


Allocated underwriting result

   $ (4 )   NM     $ 3  

NM: not meaningful.

 

Premiums

 

The Life segment represented 8% of net premiums written in the first six months of 2004. Gross and net premiums written for the first six months of 2004 have grown over the equivalent period of 2003 principally as a result of renewing large treaties in the second quarter of 2004, which the Company wrote for the first time in the fourth quarter of 2003, and the impact of the weaker U.S. dollar in the first six months of 2004. This segment is small and accordingly growth trends may be uneven depending on the timing of individual contracts. The Company continues to expect growth for the year in the mortality and annuity business. Based on the July 1, 2004 pricing indications and renewal information received from cedants and brokers, and assuming constant foreign exchange rates, annual gross and net premiums written for 2004 are expected to increase between 15% to 35% for this segment. Net premiums earned are expected to increase more modestly during the remainder of 2004.

 

Life policy benefits and acquisition costs

 

The increase in life policy benefits in the first six months of 2004 over the first six months of 2003, relates principally to the growth in the Company’s book of business and exposure as evidenced by the increase in net premiums earned for this segment. The increase in the acquisition costs during the first six months of 2004 is principally due to a change in the mix of business where certain lines typically carry higher acquisition costs. The Company also recognized a $5.0 million charge in the first six months of 2004 to reduce deferred acquisition costs on annuity treaties retained in the sale of PartnerRe Life Insurance Company of the U.S. during 2000. The prolonged period of low interest rates has had a negative effect on these treaties resulting in a charge reflecting the actual experience to date as well as a revised projection of future results given updated assumptions.

 

25


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Premium distribution by Line of Business

 

The distribution of net premiums written by line of business for the six months ended June 30, 2004 and 2003 was as follows (in millions of U.S. dollars):

 

     For the six
months ended
June 30, 2004


  

% Change
2004

over 2003


    For the six
months ended
June 30, 2003


Non-life

                   

Property and Casualty

                   

Property

   $ 469    12 %   $ 418

Casualty

     495    23       402

Motor

     279    33       210

Worldwide Specialty

                   

Agriculture

     72    1       71

Aviation/Space

     108    (17 )     131

Catastrophe

     283    (1 )     286

Credit/Surety

     124    32       94

Engineering/Energy

     123    (15 )     145

Marine

     51    1       50

Special Risk

     165    47       112

Other

     6    (17 )     7

ART

     2    NM       —  

Life

     187    26       148
    

        

Total

   $ 2,364    14     $ 2,074

NM: not meaningful.

 

The distribution of premiums is affected by renewal patterns for non-proportional treaties as premiums for those treaties are written at the inception of the treaty rather than over the treaty period. A number of factors affected the amount and distribution of net premiums written during the first six months of 2004 as follows: i) as prices are declining in a number of short-tail lines, the Company has determined to non-renew certain treaties; ii) a number of treaties were non-renewed as a result of the cedant retaining the risk as opposed to ceding it to a reinsurer; iii) an increase in net premiums written related to refinements in the Company’s process used for estimating premiums written on certain portfolio treaties, which affected the half-year over half-year comparison for the property and motor lines; and iv) while the U.S. dollar strengthened during the first six months of 2004, it nonetheless was weaker than it was in the first six months of 2003. As a result, changes in foreign exchange contributed approximately 7 points to the growth in net premiums written and affect the half-year over half-year comparison for all lines.

 

26


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Premium distribution by Treaty Type

 

The Company typically writes business on either a proportional or non-proportional basis. On a proportional treaty, the Company shares proportionally in both the premiums and losses of the cedant. In non-proportional business, the Company is typically exposed to loss events in excess of a predetermined dollar amount or loss ratio. In both proportional and non-proportional business, the Company typically reinsures a large group of primary insurance contracts written by the ceding company. In addition, the Company writes business on a facultative basis. Facultative arrangements are generally specific to an individual risk and can be written on either a proportional or non-proportional basis. Generally, the Company has more influence over pricing, as well as terms and conditions, in non-proportional and facultative arrangements.

 

The distribution of gross premiums written by type of business for the six months ended June 30, 2004 and 2003 was as follows (in millions of U.S. dollars):

 

     For the six
months ended
June 30, 2004


  

% Change
2004

over 2003


    For the six
months ended
June 30, 2003


Non-Life Segment

                   

Proportional

   $ 1,126    23 %   $ 916

Non-Proportional

     916    3       885

Facultative

     157    10       143

Life Segment

                   

Proportional

     166    24       134

Non-Proportional

     28    34       21

ART Segment

                   

Proportional

     —      NM       —  

Non-Proportional

     3    NM       —  
    

        

Total

   $ 2,396    14     $ 2,099

NM: not meaningful.

 

The distribution of gross premiums written by type of business for the first six months of 2004 is influenced by the previously discussed impact of the refinements in the Company’s process used for estimating premiums written on certain portfolio treaties.

 

Premium distribution by Geographic Region

 

The geographic distribution of gross premiums written for the six months ended June 30, 2004 and 2003 was as follows (in millions of U.S. dollars):

 

     For the six
months ended
June 30, 2004


  

% Change
2004

over 2003


    For the six
months ended
June 30, 2003


North America

   $ 901    (1 )%   $ 906

Europe

     1,142    34       855

Asia, Australia and New Zealand

     237    1       235

Latin America and the Caribbean

     93    7       87

Africa

     23    44       16
    

        

Total

   $ 2,396    14     $ 2,099

 

Growth in the European market is influenced by the refinements in the process used for estimating premiums written on certain portfolio treaties. In addition, the weakening of the U.S. dollar against the euro and other currencies in the first six months of 2004 compared to the same period in 2003 contributed to the increase in the European market for the 2004 period. These two factors distort the half-year over half-year comparison.

 

27


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Premium Distribution by Production Source

 

The Company produces its business, or gross premiums written, both through brokers and through direct relationships with cedants. The distribution of gross premiums written by production source for the six months ended June 30, 2004 and 2003 was as follows:

 

     For the six
months ended
June 30, 2004


    For the six
months ended
June 30, 2003


 

Broker

   65 %   67 %

Direct

   35 %   33 %

 

The Company’s U.S. Property and Casualty sub-segment generates business predominantly through brokers, and other Non-life sub-segments generate business predominantly through direct relationships with cedants. The distribution of gross premiums by production source was comparable for both periods presented. Based on July 1, 2004 pricing indications and renewal information from cedants and brokers, and assuming constant foreign exchange rates, the Company expects only modest changes in the production source of gross premiums written during the remainder of 2004.

 

Investment Income

 

Net investment income for the six-month periods ended June 30, 2004 and 2003 were as follows (in millions of U.S. dollars):

 

     For the six
months ended
June 30, 2004


  

% Change
2004

over 2003


    For the six
months ended
June 30, 2003


Net investment income

   $ 148    19 %   $ 124

 

The increase in net investment income is primarily due to the investment of cash flows from operations that has outpaced the reduction in yields since the first quarter of 2003, and the effect of the decline of the U.S. dollar against the euro and other currencies, which contributed approximately 5% to the growth in the first six months of 2004. In the first six months of 2004, the Company had a larger volume of invested assets resulting from the investment of $1.3 billion of operating cash flow since June 30, 2003. The average yield to maturity on the Company’s fixed income investment portfolio was 4.0% at June 30, 2004 compared to 3.5% at June 30, 2003 and 3.8% at December 31, 2003. The increase in interest rates during the second quarter of 2004 has not affected the Company’s investment income yet. The Company expects that higher interest rates will contribute to growth in its investment income as operating cash flows are invested at increasingly higher interest rates.

 

The table below provides the components of net investment income for the six-month periods ended June 30, 2004 and 2003 (in millions of U.S. dollars):

 

     For the six
months ended
June 30, 2004


   

% Change
2004

over 2003


    For the six
months ended
June 30, 2003


 

Fixed maturities, short-term investments, cash and cash equivalents

   $ 127     27 %   $ 100  

Equities

     10     22       8  

Funds held and other

     20     (8 )     22  

Investment expense

     (9 )   39       (6 )
    


       


Net investment income

   $ 148     19     $ 124  

 

Net investment income from fixed maturities, short-term investments, cash and cash equivalents, and equities has increased compared to the first six months of 2003 primarily due to the increase in the asset base resulting from the reinvestment of significant positive cash flow from operations during the last twelve months. Net investment income from fixed maturities has also increased due to the lower rate of prepayments on mortgage-backed securities.

 

28


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

The decrease in investment income on funds held and other is primarily attributable to one life annuity treaty, which reported lower investment income and lower losses during the first half-year of 2004 compared to the same period of 2003.

 

The increase in investment expense in 2004 over 2003 is primarily a result of the Company’s larger asset base upon which expenses are incurred.

 

Current economic indicators continue to suggest moderate global economic growth led by the U.S. economy. Based on the prevailing economic indicators, and assuming constant foreign exchange rates, the Company expects market interest rates to continue to rise in the United States and to rise more modestly in Europe during the remainder of 2004, and this combined with the larger asset base as at June 30, 2004, as well as expected positive cash flow from operations, should contribute to higher investment income for the Company during 2004 compared to 2003.

 

Income and Expenses from Other Operations

 

Income and expenses from other operations for the six-month periods ended June 30, 2004 and 2003 were as follows (in millions of U.S. dollars):

 

     For the six
months ended
June 30, 2004


   

% Change
2004

over 2003


    For the six
months ended
June 30, 2003


 

Net realized investment gains

   $ 46     (18 )%   $ 56  

Net foreign exchange gains

     1     (87 )     8  

Income tax expense

     (8 )   42       (6 )
    


       


Income from other operations

   $ 39     (34 )   $ 58  

 

The net realized gains of $46 million recorded during the first six months of 2004 included gross realized losses in the amount of $35 million as portfolio managers performed some repositioning in the portfolio in anticipation of further rises in interest rates. Of these total amounts, losses realized on sales of fixed maturities and equity securities were approximately $31 million and $4 million, respectively. The aggregate fair value of fixed maturities and equity securities sold at a loss were approximately $2.3 billion and $26 million, respectively.

 

The components of net realized investment gains or losses for the six-month periods ended June 30, 2004 and 2003 were as follows (in millions of U.S. dollars):

 

     2004

    2003

 

Net realized gains on available-for-sale securities, excluding other-than-temporary impairments

   $ 42     $ 71  

Other-than-temporary impairments

     (1 )     (30 )

Net realized gains on trading securities

     8       3  

Change in net unrealized holding (losses) gains on trading securities

     (6 )     5  

Net realized losses on designated hedging activity

     (3 )     (6 )

Net gains on other invested assets

     7       14  

Other realized and unrealized investment losses

     (1 )     (1 )
    


 


Net realized investment gains

   $ 46     $ 56  

 

Net realized investment gains and losses are a function of the timing of disposition of available for sale fixed maturities and equity securities as the Company repositions its investment portfolio to take advantage of market conditions, charges for the recognition of other-than-temporary impairments in the Company’s investment portfolio, changes in the market value of trading securities and the net ineffectiveness of the Company’s designated hedges.

 

29


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

The general decline in interest rates in the prior two years has resulted in a significant increase in the fair value of the Company’s fixed income portfolio, as the prevailing market interest rates were lower than the average coupon rate of the Company’s fixed income portfolio. During the normal course of its operations, the Company bought and sold securities to take advantage of market conditions. Since most of the securities in the fixed income portfolio carried unrealized gains until interest rates began to increase in the second quarter of 2004, the sale of securities generated realized investment gains and reduced the unrealized investment gains recorded in the shareholders’ equity section of the condensed consolidated balance sheets. The increase in interest rates during 2004 has resulted in a reduction of the Company’s unrealized gains on its investment portfolio. If interest rates continue to rise, the Company will see a reduction of the value of its fixed income portfolio. Refer to Quantitative and Qualitative Disclosures about Market Risk in Item 3 below for a further discussion of the Company’s exposure to interest rate risk.

 

During the six-month periods ended June 30, 2004 and 2003, the Company recorded other-than-temporary impairments of $0.5 million and $29.9 million, respectively.

 

The Company hedges a significant portion of its currency risk exposure as discussed in the Quantitative and Qualitative Disclosures about Market Risk in Item 3 below. The decrease in net foreign exchange gains over the six months ended June 30, 2003 results from a smaller ineffectiveness of the Company’s undesignated hedges during the first half of 2004.

 

The Company’s income tax expense or benefit is contingent on the distribution of the Company’s results in each tax jurisdiction. Although the income tax expense is comparable for the six months ended June 30, 2004 and 2003, the 2004 period includes a tax recovery in the amount of $6 million related to the settlement of a tax arbitration in France.

 

30


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Results of Operations – for the Three Months Ended June 30, 2004 and 2003

 

Underwriting result, investment income, income and expenses from other operations, fixed charges, net income available to common shareholders, diluted net income per common share and ROE for the three months ended June 30, 2004 and 2003 were as follows (in millions of U.S. dollars, except per share data and ROE):

 

     For the three
months ended
June 30, 2004


   

% Change
2004

over 2003


    For the three
months ended
June 30, 2003


 

Underwriting result

   $ 44     (14 )%   $ 52  

Investment income

     75     19       63  

Income and expenses from other operations

     11     (38 )     17  

Fixed charges

     (10 )   (1 )     (10 )
    


       


Net income

   $ 120     (2 )   $ 122  

Less: Preferred dividends

     5     (66 )     15  
    


       


Net income available to common shareholders

   $ 115     7     $ 107  

Diluted net income per share

   $ 2.12     6     $ 2.00  

Annualized return on beginning common shareholders’ equity (ROE)

     20.0  %           23.5  %

 

Net income available to common shareholders and diluted net income per share for the 2004 period improved compared to the equivalent period of 2003 principally as a result of increased net investment income, lower net realized investment gains and lower preferred dividends. The underwriting result and income and expenses from other operations have partially offset the increase.

 

The underwriting result decreased from $52 million for the three-month period ended June 30, 2003 to $44 million for the same period of 2004. Contributing to the decrease in underwriting result were the underwriting loss in the Global (Non-U.S.) Property & Casualty sub-segment following modest increases to reserves for prior years in the motor and casualty lines and an increase in operating expenses since the second quarter of 2003, resulting from the Company’s continued investment in its infrastructure. The strong market conditions as well as other favorable development on prior accident year losses partially offset the decrease in underwriting result during the second quarter of 2004.

 

In addition to higher income generated by the underwriting operations, the Company reported net investment income of $75 million for the three months ended June 30, 2004 compared to $63 million during the equivalent period in 2003. The increase in investment income is attributable to the investment of the Company’s significant cash flow from operations, which amounted to $287 million for the three months ended June 30, 2004 and $1.3 billion for the 12 months ended June 30, 2004.

 

31


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Income and expense from other operations has decreased from $17 million for the three months ended June 30, 2003 to $11 million for the equivalent period in 2004 primarily as a result of lower realized investment gains. Realized investment gains and losses, which account for most of the decrease, are generally a function of multiple factors with the most significant being the combination of prevailing interest rates and the timing of disposition of available for sale fixed maturities and equity securities, and charges for the recognition of other-than-temporary impairments in the Company’s investment portfolio. As the Company repositions its investment portfolio to take advantage of market conditions, it generates sales of securities that result in the realization of the unrealized market value appreciation or depreciation on the securities. The realization of the unrealized market value appreciation or depreciation does not change the Company’s comprehensive income and shareholders’ equity, as it merely transfers the gain or loss from the accumulated other comprehensive income section of the condensed consolidated balance sheets to the net income on the condensed consolidated statements of operations and the retained earnings section of the condensed consolidated balance sheets.

 

Preferred dividends for the three months ended June 30, 2003 included a non-recurring charge of $10 million related to the redemption of the Company’s Series A preferred shares and the overlap of preferred dividend on Series A and Series C preferred shares prior to the redemption of the Series A preferred shares in the second quarter of 2003.

 

Notwithstanding the increase in the net income in the second quarter of 2004 compared to the same period in 2003, the Company’s annualized ROE declined as the opening equity available to common shareholders increased at a faster rate than net income available to common shareholders.

 

The next section provides a detailed analysis of the Company’s underwriting result by segment and sub-segment, investment income, income and expenses from other operations and fixed charges for the three-month periods ended June 30, 2004 and 2003.

 

Results by Segment

 

Non-life Segment

 

32


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

U.S. Property and Casualty

 

The following table provides the components of the technical result and their corresponding ratios for this sub-segment for the three months ended June 30, 2004 and 2003 (in millions of U.S. dollars):

 

     For the three
months ended
June 30, 2004


   

% Change
2004

over 2003


    For the three
months ended
June 30, 2003


 

Gross premiums written

   $ 201     (9 )%   $ 221  

Net premiums written

     201     (9 )     221  

Net premiums earned

   $ 234     9     $ 215  

Losses and loss expenses

     168     14       148  

Acquisition costs

     53     (7 )     57  
    


       


Technical result

   $ 13     27     $ 10  

Loss ratio

     71.9 %           68.7 %

Acquisition ratio

     22.6 %           26.6 %

Technical ratio

     94.5 %           95.3 %

 

Premiums

 

The U.S. Property and Casualty sub-segment represented 24% of net premiums written in the second quarter of 2004. The decrease in net premiums written over the second quarter of 2003 had two principal causes. First, the increase in the proportion of Minimum and Deposit premiums written during the first quarter of 2004 has resulted in the recording of the entire premium written at the inception of the treaty rather than ratably during the treaty period. Second, a number of large treaties that were renewed in the first quarter of 2004 were renewed in the second quarter of 2003, and that distorts quarter over quarter comparisons. Through the three months ended June 30, 2004, the Company continued to observe strong prices and terms and conditions in the casualty and motor lines and a softening of terms and conditions in the property line. Notwithstanding the strong terms and conditions prevailing in this sub-segment, the Company has remained selective in pursuing business that meets its profitability objectives. The Company continued its controlled expansion in the specialty casualty line as it believes that this line will continue to provide very good terms and conditions.

 

Losses and loss expenses

 

The growth in the losses and loss expense volume in the quarter ended June 30, 2004 compared to June 30, 2003, is due to the growth in the Company’s book of business and exposure as evidenced by the increase in net premiums earned for this sub-segment. The technical ratio for the quarters ended June 30, 2004 and 2003 included no catastrophe or other significant losses. The increase in loss ratio for the three months ended June 30, 2004 compared to the corresponding 2003 period occurred primarily as a result of the continued expansion of the specialty casualty line that typically tends to have a higher loss ratio due to the long-tail nature of the risk involved. Accordingly, these treaties also typically provide for investment income on invested premiums during a longer period as losses are typically paid later than for other lines. The technical result and ratio for the quarters ended June 30, 2004 and 2003 included $6 million and $9 million, respectively, of adverse prior year loss development. The adverse loss development of $6 million recorded in the second quarter of 2004 included adverse loss development on the motor and casualty lines, which was partially offset by positive loss development on the property line. Included in the positive loss development on the property line was a $6 million reduction in the Company’s loss estimate related to the event of September 11. The adverse loss development recorded in the second quarter of 2003 pertained principally to the casualty line.

 

Acquisition costs

 

The decrease in the acquisition costs and acquisition ratio during the second quarter of 2004 is due to the reduction of the acquisition ratio on treaties with experience credits under the form of sliding scale and profit commission adjustments.

 

33


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Global (Non-U.S.) Property and Casualty

 

The following table provides the components of the technical result and their corresponding ratios for this sub-segment for the three months ended June 30, 2004 and 2003 (in millions of U.S. dollars):

 

     For the three
months ended
June 30, 2004


   

% Change
2004

over 2003


    For the three
months ended
June 30, 2003


 

Gross premiums written

   $ 197     8 %   $ 182  

Net premiums written

     197     6       186  

Net premiums earned

   $ 230     7     $ 215  

Losses and loss expenses

     183     26       145  

Acquisition costs

     60     5       57  
    


       


Technical result

   $ (13 )   NM     $ 13  

Loss ratio

     79.2 %           67.8 %

Acquisition ratio

     26.0 %           26.4 %

Technical ratio

     105.2 %           94.2 %

NM: not meaningful

 

Premiums

 

The Global (Non-U.S.) Property and Casualty sub-segment represented 24% of net premiums written in the second quarter of 2004. The growth in gross and net premiums written over the second quarter of 2003 was the result of two opposing factors. As discussed in the Company’s six-month results for this sub-segment, comparison of net premiums written for the second quarter of 2004 and 2003 are distorted as a result of the refinements in the process used for estimating premiums written on certain portfolio treaties during 2004. The second factor impacting the growth rate was the weaker U.S. dollar during the second quarter of 2004 compared to the equivalent period of 2003. As a result, foreign exchange contributed approximately 8 points to the growth in net premiums written. Through the three months ended June 30, 2004, the Company continued to observe strong prices and terms and conditions in the casualty and motor lines and observed that even though pricing in the property line remains at a profitable level, terms and conditions are softening for this line. Notwithstanding the generally strong terms and conditions prevailing in this sub-segment, the Company has seen increased competition but has remained selective in pursuing business that meets its profitability objectives and has declined treaties where terms and conditions did not meet the Company’s objectives.

 

Losses and loss expenses

 

The technical ratio for the quarters ended June 30, 2004 and 2003 included no catastrophe or other individually significant losses. The increase in the loss ratio for the three months ended June 30, 2004 compared to the corresponding 2003 period occurred primarily because of weak technical result in the casualty and motor lines which were partially offset by good results in the property line during the second quarter of 2004. The technical result and ratio for the quarters ended June 30, 2004 and 2003 included $13 million and less than $1 million of adverse prior year loss development, respectively. The adverse loss development recorded in the second quarter of 2004 included adverse loss development in the casualty and motor lines, which was partially offset by positive loss development on the property line.

 

Acquisition costs

 

The acquisition costs and acquisition ratios for the second quarters of 2004 and 2003 were comparable.

 

34


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Worldwide Specialty

 

The following table provides the components of the technical result and their corresponding ratios for this sub-segment for the three months ended June 30, 2004 and 2003 (in millions of U.S. dollars):

 

     For the three
months ended
June 30, 2004


   

% Change
2004

over 2003


    For the three
months ended
June 30, 2003


 

Gross premiums written

   $ 337     (8 )%   $ 366  

Net premiums written

     337     (8 )     366  

Net premiums earned

   $ 382     4     $ 366  

Losses and loss expenses

     183     (10 )     202  

Acquisition costs

     87     18       74  
    


       


Technical result

   $ 112     24     $ 90  

Loss ratio

     47.8 %           55.2 %

Acquisition ratio

     22.8 %           20.0 %

Technical ratio

     70.6 %           75.2 %

 

Premiums

 

The Worldwide Specialty sub-segment represented 40% of net premiums written in the second quarter of 2004. The decrease in net premiums written over the second quarter of 2003 was most evident in the aviation, catastrophe and energy lines and was principally due to increased competition in these profitable short-tail lines. This decrease was partially offset by the weaker U.S. dollar in the second quarter of 2004 compared to the second quarter of 2003, which contributed approximately 5 points of growth during the second quarter of 2004. The Company has seen no real change in market trends in this sub-segment since the second half of 2003 where the pricing for the most profitable lines of business had started to decline and the other lines exhibited a slow but orderly reduction in the rate of price increases as a result of increasing competition. The Company has remained selective in pursuing business that meets its profitability objectives.

 

Losses and loss expenses

 

The technical ratio for the second quarter ended June 30, 2004 and 2003 included no catastrophe or other significant losses. The decrease in the losses and loss expenses and loss ratio in the quarter ended June 30, 2004 compared to June 30, 2003, is principally due to the positive loss development recorded during the second quarter of 2004 and a shift toward longer-tailed lines, which typically carry a higher loss ratio. The technical result and ratio for the quarters ended June 30, 2004 and 2003 included $49 million of positive loss development and $5 million of adverse loss development, respectively. The positive loss development of $49 million recorded in the second quarter of 2004 included positive loss development on the special risk, aviation, agriculture, catastrophe and engineering/energy lines. Included in the positive loss development of 2004 was a $21 million reduction in the Company’s loss estimate related to the event of September 11, as the Company received information from cedants indicating that certain outstanding loss reserves were no longer necessary.

 

Acquisition costs

 

The increase in the acquisition costs and acquisition ratio compared to the three months ended June 30, 2003 resulted primarily from a shift from treaties previously written on a net basis, whereby premiums are ceded to the Company net of acquisition costs, to treaties written on a gross basis, whereby acquisitions costs are reported separately from premiums. This change in the form of the treaty does not affect the net result under the treaty but distorts the quarter over quarter comparison for acquisition costs. Other factors contributing to the increase included intensifying competition in this sub-segment, which tends to increase acquisition costs, and a shift between lines of business where certain lines carry higher acquisition ratios.

 

35


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

ART Segment

 

The following table provides the components of the underwriting result for this segment for the three months ended June 30, 2004 and 2003 (in millions of U.S. dollars):

 

    

For the three
months ended
June 30,

2004


   

For the three
months ended
June 30,

2003


 

Gross premiums written

   $ 2     $  —    

Net premiums written

     2       —    

Net premiums earned

   $ 1     $  —    

Losses and loss expenses

     —         —    

Acquisition costs

     —         —    
    


 


Technical result

   $ 1     $  —    

Other Income

     4       3  

Other operating expenses

     (4 )     (3 )
    


 


Underwriting result

   $ 1     $  —    

 

As reinsurance accounting does not apply for much of the business in this segment, premiums alone are not a representative measure of activity in ART. This segment is very transaction driven, and revenues and profit trends will be uneven, especially given the still small size of this segment. The ART segment had good growth in revenues during the second quarter of 2004 despite low interest rates, which reduce the attractiveness of finite business for clients, and low credit spreads, which reduce the opportunities in the structured finance business. Finite business had strong accounting results due to the commutation of one large treaty, which accelerated the recognition of the margin on the treaty. Results in the structured finance line included losses due to the marking down of derivative positions related to certain securities whose market value had declined due to wider spreads on underlying securities while results in the weather line included losses resulting from higher than normal spring temperatures in Japan. The Company’s share in the results of Channel Re for the second quarter of 2004 amounts to $0.7 million and is included in this segment’s results.

 

Life Segment

 

The following table provides the components of the allocated underwriting result for this segment for the three months ended June 30, 2004 and 2003 (in millions of U.S. dollars):

 

     For the three
months ended
June 30, 2004


   

% Change
2004

over 2003


    For the three
months ended
June 30, 2003


 

Gross premiums written

   $ 105     54 %   $ 68  

Net premiums written

     104     57       66  

Net premiums earned

   $ 108     60     $ 67  

Life policy benefits

     86     46       59  

Acquisition costs

     27     86       14  
    


       


Technical result

   $ (5 )   17     $ (6 )

Other operating expenses

     (6 )   40       (4 )

Allocated investment income

     11     (7 )     12  
    


       


Allocated underwriting result

   $  —       NM     $ 2  

NM: not meaningful.

 

36


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Premiums

 

The Life segment represented 12% of net premiums written in the second quarter of 2004. Gross and net premiums written for the second quarter of 2004 have grown over the equivalent period of 2003 principally as a result of renewing large treaties in the second quarter of 2004, which the Company wrote for the first time in the fourth quarter of 2003, and the impact of the weaker U.S. dollar in the second quarter of 2004. This segment is small and accordingly growth trends may be uneven depending on the timing of individual contracts.

 

Life policy benefits and acquisition costs

 

The increase in life policy benefits and acquisition costs in the second quarter of 2004 over the same period in 2003, relates principally from the growth in the Company’s book of business and exposure as evidenced by the increase in net premiums earned for this segment.

 

Premium distribution by Line of Business

 

The distribution of net premiums written by line of business for the three months ended June 30, 2004 and 2003 was as follows (in millions of U.S. dollars):

 

     For the three
months ended
June 30, 2004


  

% Change
2004

over 2003


    For the three
months ended
June 30, 2003


Non-life

                   

Property and Casualty

                   

Property

   $ 157    (14 )%   $ 183

Casualty

     160    3       155

Motor

     81    18       69

Worldwide Specialty

                   

Agriculture

     42    (3 )     44

Aviation/Space

     61    (14 )     71

Catastrophe

     52    (14 )     60

Credit/Surety

     62    11       55

Engineering/Energy

     65    (12 )     74

Marine

     16    (18 )     19

Special Risk

     36    (6 )     39

Other

     3    (20 )     4

ART

     2    NM       —  

Life

     104    57       66
    

        

Total

   $ 841    —       $ 839

NM: not meaningful

 

The distribution of premiums is affected by renewal patterns for non-proportional treaties as premiums for those treaties are written at the inception of the treaty rather than over the treaty period. A number of factors affected the amount and distribution of net premiums written during the second quarter of 2004 as follows: i) as prices are declining in a number of short-tail lines, the Company has determined to non-renew certain treaties; ii) a number of treaties were non-renewed as a result of the cedant retaining the risk as opposed to ceding it to a reinsurer; iii) a decrease in net premiums written related to refinements in the Company’s process used for estimating premiums written on certain portfolio treaties, which affected the quarter over quarter comparison for the property and motor lines; and iv) the U.S. dollar was weaker than it was in the second quarter of 2003. As a result, changes in foreign exchange contributed approximately 5 points to the growth in net premiums written in the second quarter of 2004 and affect the quarter over quarter comparison for all lines.

 

37


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Premium distribution by Treaty Type

 

The Company typically writes business on either a proportional or non-proportional basis. On a proportional treaty, the Company shares proportionally in both the premiums and losses of the cedant. In non-proportional business, the Company is typically exposed to loss events in excess of a predetermined dollar amount or loss ratio. In both proportional and non-proportional business, the Company typically reinsures a large group of primary insurance contracts written by the ceding company. In addition, the Company writes business on a facultative basis. Facultative arrangements are generally specific to an individual risk and can be written on either a proportional or non-proportional basis. Generally, the Company has more influence over pricing, as well as terms and conditions, in non-proportional and facultative arrangements.

 

The distribution of gross premiums written by type of business for the three months ended June 30, 2004 and 2003 was as follows (in millions of U.S. dollars):

 

     For the three
months ended
June 30, 2004


  

% Change

2004

over 2003


    For the three
months ended
June 30, 2003


Non-Life Segment

                   

Proportional

   $ 520    13 %   $ 462

Non-Proportional

     158    (32 )     234

Facultative

     57    (19 )     73

Life Segment

                   

Proportional

     101    60       63

Non-Proportional

     4    (23 )     5

ART Segment

                   

Proportional

     —      —         —  

Non-Proportional

     2    NM       —  
    

        

Total

   $ 842    1     $ 837

 

NM:  not meaningful

 

The distribution of gross premiums written by type of business for the second quarter of 2004 is influenced by the refinements in the Company’s process used for estimating premiums written on certain portfolio treaties as discussed above. Additionally, the U.S. dollar was weaker than it was in the second quarter of 2003. As a result, changes in foreign exchange contributed approximately 5 points to the growth in net premiums written in the second quarter of 2004 and affect the quarter over quarter comparison for all treaty types.

 

38


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Premium distribution by Geographic Region

 

The geographic distribution of gross premiums written for the three months ended June 30, 2004 and 2003 was as follows (in millions of U.S. dollars):

 

     For the three
months ended
June 30, 2004


   % Change
2004 over
2003


    For the three
months ended
June 30, 2003


North America

   $ 330    (12 )%   $ 374

Europe

     392    30       301

Asia, Australia and New Zealand

     85    (27 )     117

Latin America and the Caribbean

     28    (28 )     38

Africa

     7    (2 )     7
    

        

Total

   $ 842    1     $ 837

 

A number of factors distorted the quarterly distribution of gross premiums written by geographic area as follows: i) the increase in the proportion of Minimum and Deposit premiums written during the first quarter of 2004 in North America has resulted in the recording of the entire premium written at the inception of the treaty rather than ratably during the treaty period; ii) a number of large treaties in North America were renewed in the first quarter of 2004 while they were renewed in the second quarter of 2003; iii) the comparison for Europe is affected by the refinements in the Company’s process used for estimating premiums written on certain portfolio treaties as discussed above; iv) the weakening of the U.S. dollar against the euro and other currencies contributed to increases in all markets for the 2004 period.

 

Premium Distribution by Production Source

 

The Company produces its business, or gross premiums written, both through brokers and through direct relationships with cedants. The distribution of gross premiums written by production source for the three months ended June 30, 2004 and 2003 was as follows:

 

     For the three
months ended
June 30, 2004


    For the three
months ended
June 30, 2003


 

Broker

   62 %   66 %

Direct

   38 %   34 %

 

The Company’s U.S. Property and Casualty sub-segment generates business predominantly through brokers, and other Non-life sub-segments generate business predominantly through direct relationships with cedants. The distribution of gross premiums by production source was comparable for both periods presented.

 

39


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

Investment Income

 

Net investment income for the three-month periods ended June 30, 2004 and 2003 were as follows (in millions of U.S. dollars):

 

     For the three
months ended
June 30, 2004


  

% Change
2004

over 2003


    For the three
months ended
June 30, 2003


Net investment income

   $ 75    19 %   $ 63

 

The increase in net investment income is primarily due to the investment of cash flows from operations that has outpaced the reduction in yields since the second quarter of 2003, and the effect of the decline of the U.S. dollar against the euro and other currencies, which contributed approximately 4% to the growth in the second quarter of 2004. In the second quarter of 2004, the Company had a larger volume of invested assets resulting from the investment of $1.3 billion of operating cash flow since June 30, 2003.

 

The table below provides the components of net investment income for the three-month periods ended June 30, 2004 and 2003 (in millions of U.S. dollars):

 

     For the three
months ended
June 30, 2004


    % Change
2004 over
2003


    For the three
months ended
June 30, 2003


 

Fixed maturities, short-term investments, cash and cash equivalents

   $ 63     24 %   $ 51  

Equities

     6     32       4  

Funds held and other

     10     (5 )     11  

Investment expense

     (4 )   38       (3 )
    


       


Net investment income

   $ 75     19     $ 63  

 

Net investment income from fixed maturities, short-term investments, cash and cash equivalents, and equities has increased compared to the second quarter of 2003 primarily due to the increase in the asset base resulting from the reinvestment of significant positive cash flow from operations during the last twelve months. Net investment income from fixed maturities has also increased due to the lower rate of prepayments on mortgage-backed securities.

 

The investment income on funds held is comparable for both periods.

 

The increase in investment expenses in 2004 over 2003 is a result of the Company’s larger asset base upon which expenses are incurred.

 

Income and Expenses from Other Operations

 

Income and expenses from other operations for the three-month periods ended June 30, 2004 and 2003 were as follows (in millions of U.S. dollars):

 

     For the three
months ended
June 30, 2004


  

% Change
2004

over 2003


    For the three
months ended
June 30, 2003


 

Net realized investment gains

   $ 8    (48 )%   $ 16  

Net foreign exchange gains

     —      NM       5  

Income tax benefit (expense)

     3    NM       (4 )
    

        


Income from other operations

   $ 11    (39 )   $ 17  

NM: not meaningful

 

The net realized gains of $8 million recorded during the second quarter of 2004 included gross realized losses in the amount of $29 million. Of these total amounts, losses realized on sales of fixed maturities and equity securities were approximately $25 million and $4 million, respectively. The aggregate fair value of fixed maturities and equity securities sold at a loss were approximately $1.7 billion and $24 million, respectively.

 

40


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

The components of net realized investment gains or losses for the three-month periods ended June 30, 2004 and 2003 were as follows (in millions of U.S. dollars):

 

     2004

    2003

 

Net realized gains on available-for-sale securities, excluding other-than-temporary impairments

   $ 7     $ 31  

Other-than-temporary impairments

     —         (24 )

Net realized gains on trading securities

     2       3  

Change in net unrealized holding (losses) gains on trading securities

     (5 )     4  

Net realized losses on designated hedging activity

     (1 )     (7 )

Net gains on other invested assets

     4       9  

Other realized and unrealized investment gains

     1       —    
    


 


Net realized investment gains

   $ 8     $ 16  

 

Net realized investment gains and losses are a function of the timing of disposition of available for sale fixed maturities and equity securities as the Company repositions its investment portfolio to take advantage of market conditions, charges for the recognition of other-than-temporary impairments in the Company’s investment portfolio, changes in the market value of trading securities and the net ineffectiveness of the Company’s designated hedges.

 

The general decline in interest rates in the prior two years has resulted in a significant increase in the fair value of the Company’s fixed income portfolio, as the prevailing market interest rates were lower than the average coupon rate of the Company’s fixed income portfolio. During the normal course of its operations, the Company bought and sold securities to take advantage of market conditions. Since most of the securities in the fixed income portfolio carried unrealized gains until interest rates began to increase in the second quarter of 2004, the sale of securities generated realized investment gains and reduced the unrealized investment gains recorded in the shareholders’ equity section of the condensed consolidated balance sheets. The increase in interest rates during 2004 has resulted in a reduction of the Company’s unrealized gains on its investment portfolio. If interest rates continue to rise, the Company will see a reduction of the value of its fixed income portfolio. Refer to Quantitative and Qualitative Disclosures about Market Risk in Item 3 below for a further discussion of the Company’s exposure to interest rate risk.

 

During the quarters ended June 30, 2004 and 2003, the Company recorded other-than-temporary impairments of $0.4 million and $23.9 million, respectively.

 

The Company hedges a significant portion of its currency risk exposure as discussed in the Quantitative and Qualitative Disclosures about market Risk in Item 3 below. The decrease in net foreign exchange gains over the three months ended June 30, 2003 results from a smaller ineffectiveness on the Company’s undesignated hedges during the second quarter of 2004.

 

The Company’s income tax expense or benefit is contingent on the distribution of the Company’s results in each tax jurisdiction. The second quarter of 2004 includes a tax recovery in the amount of $6 million related to the settlement of a tax arbitration in France.

 

Financial Condition and Liquidity and Capital Resources

 

Investments

 

Total invested assets, including cash and cash equivalents, were $7.3 billion as at June 30, 2004 compared to $6.8 billion at December 31, 2003. The major factors influencing the change in cash and invested assets in the six-month period ended June 30, 2004 were:

 

  net cash provided by operating activities of $622 million;

 

  the conversion of a finite reinsurance treaty within the ART segment from a deposit basis where the cedant retains the invested assets underlying the treaty to a funds transfer basis where the invested assets are held by the Company adding $164 million to invested assets;

 

  the issuance of the Company’s common shares under the Company’s equity plans for $5 million; offset by

 

  the repurchase of the Company’s common shares under the Company’s repurchase program for $9 million;

 

  the decrease in unsettled security trades payables of $16 million;

 

  the decrease in the net unrealized gains on investments of $52 million driven by an increase in interest rates;

 

  dividend payments on common and preferred shares and interest payments on debt related to trust preferred securities and mandatorily redeemable preferred securities totaling $62 million;

 

  net negative influence of the effect of a stronger U.S. dollar relative to the euro and other currencies as it relates to the conversion of invested assets and cash balances into U.S. dollars.

 

The Company employs a conservative investment philosophy. It maintains a high-quality, well-balanced and liquid portfolio having the dual objectives of optimizing current income and achieving capital appreciation. The Company’s investment strategy allows the use of derivative securities, subject to strict limitations. Derivatives instruments may be used to replicate investment positions or market exposures that would be allowed under the Company’s investment policy if implemented in other ways. The increase in cash and cash equivalents at June 30, 2004 compared to December 31, 2003 resulted from the use of TBA future deliveries (to be announced mortgage-backed securities) and cash rather than actual mortgage-backed securities to maintain the Company’s exposure to mortgage-backed securities.

 

41


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

From a risk management perspective, the Company divides its invested assets, which are comprised of total investments and cash, accrued investment income and net receivable (payable) for securities sold (purchased), into two categories, liability funds and capital funds. Liability funds represent invested assets supporting the net reinsurance assets and liabilities and are invested entirely in high-quality fixed income securities. The preservation of liquidity and protection of capital are the primary investment objectives for these assets. The portfolio managers are required to follow strict investment guidelines as to minimum ratings, and issuer and sector concentrations. Capital fund assets represent the capital of the Company and are invested to maximize total return, subject to strict risk assumption and portfolio diversification guidelines, including issuer and sector concentration limitations. Capital funds may be invested in investment-grade fixed income securities, less-than-investment-grade bonds, convertible securities, preferred stocks and common stocks. The Company believes that an allocation of a portion of its investments to equities is both prudent and desirable inasmuch as it helps to achieve broader asset diversification and maximization of the portfolio’s total return over time. Since the Company’s allocation to equities is predicated on a long-term strategic investment in this asset class, the Company has the ability to and fully expects to withstand the effects of cyclical market value swings of the broader equity markets on its portfolio.

 

At June 30, 2004, the liability funds totaled $4.7 billion and were comprised of cash and cash equivalents, short-term investments, AAA, AA and A rated securities. The capital funds, which totaled $2.8 billion, were comprised of investment-grade fixed maturities, below-investment-grade fixed maturities and equities.

 

Approximately 97% of the invested assets currently held by the Company are publicly traded and, accordingly, market valuations for such securities are readily available. For those securities not publicly traded (3% of the Company’s invested assets or approximately $241 million), consisting primarily of bank loan portfolios, non-publicly traded real estate funds, private placement equity investments and other specialty asset classes, valuation techniques depend on the nature of the individual asset. The valuation techniques used by the Company’s investment managers are reviewed by the Company and are generally commensurate with standard valuation techniques for each asset class.

 

As at June 30, 2004, fixed maturities, short-term investments and cash and cash equivalents had an average yield to maturity at market of 4.0% compared to 3.8% as at December 31, 2003. The increase in the average yield to maturity was the result of the increase in interest rates seen during the first six months of 2004. At the same time, the duration of the Company’s investment portfolio shifted from 3.6 years at December 31, 2003 to 3.5 years at June 30, 2004. As at June 30, 2004, approximately 94% of the fixed income securities were rated investment grade (BBB- or higher) by Standard & Poor’s (or estimated equivalent) compared to 93% as at December 31, 2003.

 

For accounting purposes, the Company’s investment portfolio is categorized according to two distinct classifications – “available for sale” and “trading” securities. For a description of the different accounting treatments afforded to these separate accounting classifications, refer to Note 3(f) to the consolidated financial statements in the Company’s 2003 Annual Report to Shareholders.

 

At June 30, 2004, investments classified as available for sale comprised 98% of the Company’s total portfolio (excluding cash and cash equivalents and other invested assets) with 2% being classified as trading securities. Included in the available for sale category is the Company’s portfolio of fixed maturity investments, which are comprised primarily of investment grade securities issued by the U.S. government or U.S. government sponsored agencies, state and foreign governments and corporations. In addition, as part of its investment strategy, the Company invests a small percentage of its portfolio in less-than-investment-grade bonds, which are also classified as available for sale. The Company also invests in equity securities of both U.S. and non-U.S. publicly traded corporations. Finally the Company has an allocation to convertible securities and equities in its investment portfolio and these are classified as trading securities.

 

42


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)

 

The cost, market value, gross unrealized gains and gross unrealized losses on investments classified as available for sale at June 30, 2004 were as follows (in millions of U.S. dollars):

 

     Cost (1)

  

Gross

Unrealized

Gains


  

Gross

Unrealized

Losses


   

Market

Value


June 30, 2004

                            

Fixed maturities

                            

- U.S. government

   $ 572    $ 7    $ (3 )   $ 576

- states or political subdivisions of states of the U.S.

     6      —        —         6

- other foreign governments

     1,191      9      (10 )     1,190

- corporate

     2,762      50      (26 )     2,786

- mortgage/asset-backed securities

     303      1      (3 )     301
    

  

  


 

Total fixed maturities

     4,834      67      (42 )     4,859

Short-term investments

     14      —        —         14

Equities

     672      87      (10 )     749