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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to ___________
Commission file number: 0-14950
Argonaut Group, Inc.
(Exact name of Registrant as specified in its charter)
Delaware 95-4057601
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10101 Reunion Place, Suite 500, San Antonio, Texas 78216 (Address of
principal executive offices) (Zip code)
(210) 321-8400
(Registrant's telephone number including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ____
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of November 12, 2002.
Title Outstanding
Common Stock, par value $0.10 per share 21,580,688
ARGONAUT GROUP, INC.
TABLE OF CONTENTS
Page No.
Part I. FINANCIAL INFORMATION:
Item 1. Condensed Consolidated Financial Statements:
Consolidated Balance Sheets
September 30, 2002 and December 31, 2001.......................... 3
Consolidated Statements of Operations
Three and nine months ended September 30, 2002 and 2001........... 4
Consolidated Statements of Comprehensive Income (Loss)
Three and nine months ended September 30, 2002 and 2001........... 5
Consolidated Statements of Cash Flow
Nine months ended September 30, 2002 and 2001..................... 6
Notes to Condensed Consolidated Financial Statements................ 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............. 14
Item 3. Market Risks................................................. 23
Item 4. Controls and Procedures...................................... 24
Part II. OTHER INFORMATION:
Item 1. Legal Proceedings............................................ 24
Item 2. Changes in Securities and Use of Proceeds.................... 26
Item 3. Default Upon Senior Securities............................... 26
Item 4. Submission of Matters to a Vote of Security Holders.......... 26
Item 5. Other Information............................................ 26
Item 6. Exhibits and Reports on Form 8K ............................ 27
Signatures........................................................... 28
2
Part I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
ARGONAUT GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in millions, except per share amounts)
September 30, December 31,
2002 2001
--------------- ---------------
(Unaudited)
Assets
Investments:
Fixed maturities, available for sale, at fair value $ 847.4 $ 779.4
(cost: 2002 - $804.2; 2001 - $767.1)
Equity securities, available for sale, at fair value 259.0 326.3
(cost: 2002 - $174.2; 2001 - $175.6)
Other long term, at fair value 4.6 4.8
(cost: 2002 - $5.4; 2001 - $5.2)
Short-term investments, at fair value 54.0 42.7
--------------- ---------------
Total investments 1,165.0 1,153.2
--------------- ---------------
Cash and cash equivalents 29.3 14.0
Accrued investment income 11.0 12.5
Receivables:
Due from insureds 235.1 187.9
Due from reinsurance 263.4 256.5
Goodwill 102.7 102.4
Deferred federal income tax asset, net 82.5 78.1
Deferred acquisition costs 48.0 22.3
Prepaid assets 3.8 3.7
Other assets 55.4 32.6
--------------- ---------------
Total assets $ 1,996.2 $ 1,863.2
=============== ===============
Liabilities and Shareholders' Equity
Reserves for losses and loss adjustment expenses $ 1,159.5 $ 1,147.8
Unearned premiums 260.5 163.7
Accrued underwriting expenses and funds held 77.5 65.0
Income taxes payable, net 5.7 5.0
Other liabilities 59.1 34.2
--------------- ---------------
Total liabilities 1,562.3 1,415.7
--------------- ---------------
Shareholders' equity:
Common stock - $0.10 par, 35,000,000 shares authorized 21,580,688 and
21,557,238 shares issued and outstanding
at September 30, 2002 and December 31, 2001, respectively 2.2 2.2
Additional paid-in capital 96.6 93.6
Retained earnings 254.5 246.0
Deferred stock compensation (2.1) -
Accumulated other comprehensive income 82.7 105.7
--------------- ---------------
Total shareholders' equity 433.9 447.5
--------------- ---------------
Total liabilities and shareholders' equity $ 1,996.2 $ 1,863.2
=============== ===============
See accompanying notes.
3
ARGONAUT GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in millions, except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
----------------------------- ----------------------------
September 30, September 30,
2002 2001 2002 2001
-------------- ------------- ------------- -------------
Premiums and other revenue:
Earned premiums $ 96.3 $ 52.9 $ 264.9 $ 120.4
Net investment income 12.9 13.1 40.0 39.6
Realized investment gains, net 1.2 6.4 15.2 13.5
-------------- ------------- ------------- -------------
Total revenue 110.4 72.4 320.1 173.5
-------------- ------------- ------------- -------------
Expenses:
Losses and loss adjustment expenses 70.9 47.1 195.1 107.9
Underwriting, acquisition, and
insurance expenses 33.4 23.4 98.8 61.4
-------------- ------------- ------------- -------------
Total expenses 104.3 70.5 293.9 169.3
-------------- ------------- ------------- -------------
Income before income taxes 6.1 1.9 26.2 4.2
Provision for income taxes 1.4 0.6 7.9 0.7
-------------- ------------- ------------- -------------
Net income $ 4.7 $ 1.3 $ 18.3 $ 3.5
============== ============= ============= =============
Net income per common share:
Basic $ 0.22 $ 0.06 $ 0.85 $ 0.16
============== ============= ============= =============
Diluted $ 0.22 $ 0.06 $ 0.84 $ 0.16
============== ============= ============= =============
Dividends declared per common share: $ 0.15 $ 0.41 $ 0.45 $ 1.23
============== ============= ============= =============
Weighted average common shares:
Basic 21,575,262 21,572,543 21,565,687 21,628,945
============== ============= ============= =============
Diluted 21,646,263 21,579,430 21,667,228 21,635,859
============== ============= ============= =============
See accompanying notes.
4
ARGONAUT GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Dollars in millions)
(Unaudited)
Three Months Ended Nine Months Ended
-------------------------- --------------------------
September 30, September 30,
2002 2001 2002 2001
------------ ------------ ------------ ------------
Net income $ 4.7 $ 1.3 $ 18.3 $ 3.5
------------ ------------ ------------ ------------
Other comprehensive loss:
Unrealized gains (losses) on securities:
Losses arising during the period (40.5) (12.4) (20.2) (28.2)
Reclassification adjustment for gains included
in net income (1.2) (6.4) (15.2) (13.5)
------------ ------------ ------------ ------------
Other comprehensive loss before tax (41.7) (18.8) (35.4) (41.7)
Income tax benefit related to other
comprehensive loss (14.6) (6.6) (12.4) (14.6)
------------ ------------ ------------ ------------
Other comprehensive loss, net of tax (27.1) (12.2) (23.0) (27.1)
------------ ------------ ------------ ------------
Comprehensive loss $ (22.4) $ (10.9) $ (4.7) $ (23.6)
============ ============ ============ ============
See accompanying notes.
5
ARGONAUT GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(Dollars in millions)
(Unaudited)
Nine Months Ended
--------------------------
September 30,
2002 2001
------------ ------------
Cash flows from operating activities:
Net income $ 18.3 $ 3.5
Adjustments to reconcile net income to
net cash provided (used) by operations:
Amortization and depreciation 8.9 4.7
Deferred federal income tax expense 8.3 0.6
Realized investment gains, net (15.2) (13.5)
Change in:
Accrued investment income 1.5 8.6
Receivables (54.1) (36.0)
Unearned premiums on ceded reinsurance (13.5) (4.5)
Reserves for losses and loss adjustment expenses 11.8 (30.3)
Unearned premiums 96.8 24.4
Other assets and liabilities, net (11.0) 4.4
------------ ------------
Cash provided (used) by operating activities 51.8 (38.1)
------------ ------------
Cash flows from investing activities:
Sales of fixed maturity investments 53.8 153.2
Maturities and mandatory calls of fixed maturity investments 92.9 277.9
Sales of equity securities 30.9 49.1
Purchases of fixed maturity investments (188.5) (173.5)
Purchases of equity securities (13.4) (15.8)
Change in short-term investments (11.3) (43.0)
Acquisition, net of cash received - (162.9)
Other, net 8.4 9.1
------------ ------------
Cash (used) provided by investing activities (27.2) 94.1
------------ ------------
Cash flows from financing activities:
Retirement of common stock - (3.3)
Stock options exercised 0.4 -
Payment of cash dividend (9.7) (26.6)
Repayment of debt - (26.3)
------------ ------------
Cash used by financing activities: (9.3) (56.2)
------------ ------------
Change in cash and cash equivalents 15.3 (0.2)
Cash and cash equivalents, beginning of period 14.0 7.2
------------ ------------
Cash and cash equivalents, end of period $ 29.3 $ 7.0
============ ============
Additional disclosure:
Income taxes paid $ 0.8 $ 0.6
============ ============
See accompanying notes.
6
ARGONAUT GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - Basis of Presentation
The accompanying Condensed Consolidated Financial Statements of Argonaut
Group Inc. and subsidiaries (collectively "Argonaut Group" or "the Company")
have been prepared in conformity with accounting principles generally accepted
in the United States of America (GAAP) for interim financial information and
with the instructions for Form 10-Q and Article 10 of Regulation S-X. Certain
financial information that is normally included in annual financial statements,
including certain financial statement footnotes, prepared in accordance with
GAAP, is not required for interim reporting purposes and has been condensed or
omitted. These statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's Annual Report
to Shareholders for the year ended December 31, 2001, as amended (incorporated
by reference in Form 10-K filed with the Securities and Exchange Commission for
the year ended December 31, 2001).
The interim financial data as of September 30, 2002 and 2001 and for the
three and nine months ended September 30, 2002 and 2001 is unaudited. However,
in the opinion of management, the interim data includes all adjustments,
consisting of normal recurring accruals, necessary for a fair statement of the
Company's results for the interim periods. The operating results for the interim
periods are not necessarily indicative of the results to be expected for the
full year. All significant intercompany amounts have been eliminated. Certain
amounts applicable to prior periods have been reclassified to conform to the
presentation followed in 2002.
The balance sheet at December 31, 2001 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by GAAP for complete financial statements.
Note 2 - Recently Issued Accounting Pronouncements
In August 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 establishes a
single accounting model for the impairment or disposal of long-lived assets and
new standards for reporting discontinued operations. SFAS No. 144 superseded
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of" and APB Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." The provisions of SFAS No. 144 are effective in fiscal years
beginning after December 15, 2001 and, in general, are to be applied
prospectively. The Company adopted the provisions of SFAS No. 144 effective
January 1, 2002. The adoption of this standard did not have a material impact on
the consolidated results of operations and financial position.
7
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 supersedes Emerging
Issues Task Force Issue No. 94-3. SFAS No. 146 requires that the liability for a
cost associated with an exit or disposal activity be recognized when the
liability is incurred, not at the date of an entity's commitment to an exit or
disposal plan. The provisions of SFAS No. 146 are effective for exit or disposal
activities initiated after December 31, 2002. The Company does not anticipate
that the adoption of SFAS No. 146 will have a material impact on its
consolidated financial position, results of operations or cash flows.
Note 3 - Earnings Per Share
The following table presents the calculation of basic and diluted net
income per common share for the three and nine months ended September 30, 2002
and 2001.
Three Months Ended Nine Months Ended
------------------------------ ------------------------------
September 30, September 30,
(Dollars in millions except per share data) 2002 2001 2002 2001
-------------- -------------- -------------- --------------
Net income $ 4.7 $ 1.3 $ 18.3 $ 3.5
============== ============== ============== ==============
Weighted average shares-basic 21,575,262 21,572,543 21,565,687 21,628,945
Effect of dilutive securities:
Stock options 71,001 6,887 101,541 6,914
-------------- -------------- -------------- --------------
Weighted average shares-diluted 21,646,263 21,579,430 21,667,228 21,635,859
============== ============== ============== ==============
Net income per common share-basic $ 0.22 $ 0.06 $ 0.85 $ 0.16
Net income per common share-diluted $ 0.22 $ 0.06 $ 0.84 $ 0.16
Note 4 - Reserves for Losses and Loss Adjustment Expense
The following table provides a reconciliation of the beginning and ending
reserve balances for losses and loss adjustment expenses ("LAE"), net of
reinsurance, to the gross amounts reported in the balance sheet. Reinsurance
recoverables in this note exclude paid loss recoverables of $37.6 million and
$56.5 million as of September 30, 2002 and 2001, respectively.
Nine Months Ended
September 30,
------------------------
2002 2001
(Dollars in millions) ----------- ------------
Net reserves - beginning of the year $ 929.6 $ 757.6
Add:
Loss and LAE incurred during current calendar period, net of reinsurance:
Net reserves from acquired companies - 197.2
Current accident year 189.3 108.1
Prior accident years 5.8 (0.2)
----------- ------------
Loss and LAE acquired and incurred during current calendar period, net of reinsurance 195.1 305.1
Deduct:
Loss and LAE payments made during current calendar period, net of reinsurance:
Current accident year 36.0 27.6
Prior accident years 155.0 121.6
----------- ------------
Loss and LAE payments made during current calendar period, net of reinsurance 191.0 149.2
----------- ------------
Net reserves, end of period 933.7 913.5
Add:
Reinsurance recoverable on unpaid losses & LAE, end of period 225.8 220.8
----------- ------------
Gross reserves - end of period $ 1,159.5 $ 1,134.3
=========== ============
8
Prior year loss development of $5.8 million for the nine months ended
September 30, 2002 was primarily the result of the Company strengthening
reserves for asbestos claims by $7.0 million. The strengthening of reserves for
asbestos relates to claims associated with certain general liability policies
issued through one office from 1985 to the early 1990's which did not include an
asbestos exclusion. In addition to revisions to loss reserves to reflect any
material case-specific development in asbestos claims, the Company periodically
reviews all environmental and asbestos related reserves to evaluate the impact,
if any, of new developments in litigation trends, changes in actuarial
assumptions, and other industry-wide information then available. The Company
expects to complete its periodic review now in progress during the fourth
quarter of 2002. The results of this study may indicate further development on
these reserves, which would have a negative impact on the financial condition of
the Company and its Risk Based Capital ratio.
Note 5 - Other Assets
Other assets were comprised of the following:
September 30, December 31,
(Dollars in millions) 2002 2001
--------------- ---------------
Ceded unearned premiums $ 31.3 $ 17.8
Furniture, fixtures and equipment, net 16.0 10.7
Capital lease 1.4 1.4
Other 6.7 2.7
--------------- ---------------
Total other assets $ 55.4 $ 32.6
=============== ===============
Note 6 - Goodwill
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets". SFAS No. 142 required that goodwill and intangible assets with
indefinite useful lives no longer be amortized but instead tested for impairment
at least annually. SFAS No. 142 also requires that intangible assets with finite
useful lives be amortized over their respective useful lives to their estimated
residual values. The Company fully adopted the provisions of SFAS No. 142
effective January 1, 2002.
SFAS No. 142 requires that goodwill be assigned to the appropriate
reporting units and be tested for impairment by June 30, 2002. Any impairment
loss recognized as a result of a transitional impairment test of goodwill should
be reported as the cumulative effect of a change in accounting principle. The
Company completed the transitional goodwill impairment test required by SFAS No.
142 in the second quarter of 2002 and determined that there was no indication of
goodwill impairment. The Company will review goodwill for impairment during the
fourth quarter of 2002.
Had SFAS No.142 been adopted on the first day of 2001, amortization expense
would have been lowered by approximately $0.7 million and $2.1 million for the
three and nine month periods ended September 30, 2001, respectively. In
addition, net income would have increased $0.7 million (or $0.03 per diluted
share) to $2.0 million (or $0.09 per diluted share) for the three month period
ended September 30, 2001, and $2.1 million (or $0.10 per diluted share) to $5.6
million (or $0.26 per diluted share) for the nine month period then ended.
9
Note 7 - Business Segments
As of September 30, 2002, the Company's operations include four continuing
business segments: excess and surplus lines, specialty commercial, specialty
workers' compensation and public entity. The results of operations for the three
and nine months ended September 30, 2002 include the activities of Colony
Insurance Group, included in the excess and surplus lines segment, and Rockwood
Casualty Insurance Group, included in the specialty commercial segment, both
acquired by the Company effective September 1, 2001. Prior periods have been
restated to reflect the current segments.
In May 2002, the Company acquired the renewal rights and certain assets of
Fulcrum, a subsidiary of the SCOR Group. The Company analyzed this acquisition
under the requirements of SFAS No. 141, "Business Combinations", and determined
the acquisition did not meet the requirements of a business combination. The
transaction has been accounted for as a purchase of assets. Fulcrum's results of
operations are included in the excess and surplus lines segment from the date of
acquisition.
The Company evaluates performance of the business segments based on
underwriting results plus investment income. Realized investment gains (losses)
and income taxes are considered part of corporate and other.
The following is a summary of the operating results by business segment for
the three months ended September 30, 2002 and 2001:
Excess & Specialty
Surplus Specialty Workers' Public Run-off Corporate
(in millions) Lines Commercial Compensation Entity Lines & Other Total
---------- ------------ --------------- --------- --------- ----------- -----------
2002
Premiums earned $ 39.9 $ 27.1 $ 26.3 $ 3.0 $ - $ - $ 96.3
Total expenses 36.9 26.6 29.9 3.0 7.2 0.7 104.3
---------- ------------ --------------- --------- --------- ----------- -----------
Net underwriting
income (loss) 3.0 0.5 (3.6) - (7.2) (0.7) (8.0)
Net investment income 2.8 2.5 7.5 0.1 - 12.9
---------- ------------ --------------- --------- --------- ----------- -----------
Segment profit
(loss) $ 5.8 $ 3.0 $ 3.9 $ 0.1 $(7.2) $ (0.7) $ 4.9
---------- ------------ --------------- --------- --------- ----------- -----------
Realized investment
gains ................................................................. 1.2 1.2
Provision for
income tax ................................................................. 1.4 1.4
-----------
Net income ................................................................. $ 4.7
===========
Excess & Specialty
Surplus Specialty Workers' Public Run-off Corporate
(in millions) Lines Commercial Compensation Entity Lines & Other Total
---------- ------------ --------------- --------- --------- ----------- -----------
2001
Premiums earned $ 8.6 $ 13.1 $ 30.0 $ 1.2 $ - $ - $ 52.9
Total expenses 8.2 12.8 47.0 1.6 (0.4) 1.3 70.5
---------- ------------ --------------- --------- --------- ----------- -----------
Net underwriting
income (loss) 0.4 0.3 (17.0) (0.4) 0.4 (1.3) (17.6)
Net investment income 0.8 1.6 10.2 0.1 - 0.4 13.1
---------- ------------ --------------- --------- --------- ----------- -----------
Segment profit
(loss) $ 1.2 $ 1.9 $ (6.8) $ (0.3) $ 0.4 $ (0.9) $ (4.5)
---------- ------------ --------------- --------- --------- ----------- -----------
Realized investment
gains ................................................................. 6.4 6.4
Provision for
income tax ................................................................. 0.6 0.6
-----------
Net income ................................................................. $ 1.3
===========
10
The following is a summary of the operating results by business segment for
the nine months ended September 30, 2002 and 2001:
Excess & Specialty
Surplus Specialty Workers' Public Run-off Corporate
(in millions) Lines Commercial Compensation Entity Lines & Other Total
----------- ------------ --------------- -------- --------- ----------- -----------
2002
Premiums earned $ 99.5 $ 77.8 $ 80.9 $ 6.7 $ - $ - $ 264.9
Total expenses 95.1 77.8 103.2 7.1 7.8 2.9 293.9
----------- ------------ --------------- -------- --------- ----------- -----------
Net underwriting
income (loss) 4.4 - (22.3) (0.4) (7.8) (2.9) (29.0)
Net investment income 7.6 7.5 24.1 0.4 - 0.4 40.0
----------- ------------ --------------- -------- --------- ----------- -----------
Segment profit
(loss) $ 12.0 $ 7.5 $ 1.8 $ - $ (7.8) $ (2.5) $ 11.0
----------- ------------ --------------- -------- --------- ----------- -----------
Realized investment
gains ............................................................... 15.2 15.2
Provision for
income tax ............................................................... 7.9 7.9
-----------
Net income ............................................................... $ 18.3
===========
Excess & Specialty
Surplus Specialty Workers' Public Run-off Corporate
(in millions) Lines Commercial Compensation Entity Lines & Other Total
----------- ------------ --------------- -------- --------- ----------- -----------
2001
Premiums earned $ 8.6 $ 29.7 $ 79.6 $ 2.5 $ - $ - $ 120.4
Total expenses 8.2 34.2 121.4 3.4 (0.4) 2.5 169.3
----------- ------------ --------------- -------- --------- ----------- -----------
Net underwriting
income (loss) 0.4 (4.5) (41.8) (0.9) 0.4 (2.5) (48.9)
Net investment income 0.8 4.1 34.2 0.1 - 0.4 39.6
----------- ------------ --------------- -------- --------- ----------- -----------
Segment profit
(loss) $ 1.2 $ (0.4) $ (7.6) $ (0.8) $ 0.4 $ (2.1) $ (9.3)
----------- ------------ --------------- -------- --------- ----------- -----------
Realized investment
gains ............................................................... 13.5 13.5
Provision for
income tax ............................................................... 0.7 0.7
-----------
Net income ............................................................... $ 3.5
===========
11
The following is a summary of identifiable assets by business segment as of
September 30, 2002 and December 31, 2001:
September 30, December 31,
(Dollars in millions) 2002 2001
--------------- ---------------
Excess & Surplus Lines $ 441.0 $ 350.9
Specialty Commercial 347.1 307.2
Specialty Workers' Compensation 1,169.3 1,165.9
Public Entity 22.9 15.9
Run-off Lines - -
Corporate & Other 15.9 23.3
--------------- ---------------
Total Assets $ 1,996.2 $ 1,863.2
=============== ===============
Note 8 - Underwriting, Acquisition and Insurance Expenses
Underwriting, acquisition and insurance expenses for the three and nine
months ended September 30, 2002 and 2001 were as follows:
Three Months Ended Nine Months Ended
----------------------------- ------------------------------
September 30, September 30,
(Dollars in millions) 2002 2001 2002 2001
------------- ------------- -------------- --------------
Commissions $ 20.3 $ 6.5 $ 49.4 $ 13.8
General Expenses 22.2 13.3 57.7 37.7
State assessments 2.7 1.1 6.7 4.2
Taxes, licenses and bureau fees 4.3 2.8 10.7 6.1
------------- ------------- -------------- --------------
49.5 23.7 124.5 61.8
Deferral of policy acquisition costs (16.1) (0.3) (25.7) (0.4)
------------- ------------- -------------- --------------
Total underwriting, acquisition and
insurance expense $ 33.4 $ 23.4 $ 98.8 $ 61.4
============= ============= ============== ==============
12
Note 9 - Deferred Stock Compensation
The Shareholders approved the 2002 Amended and Restated Stock Incentive
Plan ("the Plan") on April 30, 2002, which resulted in grants of 89,600 shares
of restricted stock to become effective. On May 1, 2002, an additional 12,000
shares of restricted stock were granted. The shares vest in equal annual
installments over a period of two to three years, subject to continued
employment. The stock is not issued until the vesting requirements are met, thus
the stock does not carry any voting or dividend rights.
Under the provisions of SFAS No. 123, "Accounting for Stock Based
Compensation", the Company has elected to account for its stock-based
compensation under ABP Opinion 25, "Accounting for Stock Issued to Employees."
Under APB Opinion 25, the accrual for the shares granted under the plan was
recorded at fair market value on the measurement date with a corresponding
charge to shareholders' equity representing the unearned portion of the grant.
The unearned portion of the grant is amortized as compensation expense on a
straight-line basis over the related vesting period. Compensation for the three
and nine month period ended September 30, 2002 totaled $0.3 million and $0.4
million, respectively.
13
Item 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition
The following is a discussion and analysis of the consolidated results of
operations and financial condition of Argonaut Group, Inc. and its subsidiaries
(collectively, "Argonaut Group" or the "Company") for the three and nine months
ended September 30, 2002 and 2001. It should be read in conjunction with the
consolidated financial statements and other data presented herein as well as
with the Management's Discussion and Analysis of Results of Operation and
Financial Condition contained in the Company's 2001 Annual Report on Form 10-K,
as amended.
Overview
As of September 30, 2002, the Company's operations include four continuing
business segments: excess and surplus lines, specialty commercial, specialty
workers' compensation and public entity. The results of operations for the three
and nine months ended September 30, 2002 include Colony Insurance Group
("Colony"), included in the excess and surplus lines segment, and Rockwood
Casualty Insurance Group ("Rockwood"), included in the specialty commercial
segment, both acquired by the Company effective September 1, 2001, as well as
business resulting from the renewal rights acquired in May 2002 from Fulcrum
Insurance Company ("Fulcrum") - see segment results.
The property-casualty insurance industry is characterized by a large number
of competing companies and modest market shares by industry participants.
According to A.M. Best Company, a leading insurance industry rating and analysis
firm, as of December 31, 2001, there were approximately 2,500 property-casualty
insurance companies operating in the United States. Argonaut Group's principal
insurance subsidiaries ranked among the 250 largest property and casualty
insurance company organizations in the United States, measured by net premiums
written (113th), and policyholder' surplus (123rd). With respect to admitted
assets, Argonaut Group's insurance subsidiaries ranked 88th relative to industry
peers.
The Company's principal competitors cannot be easily classified. The
Company's principal lines of business are written by numerous other insurance
companies. Competition for any one account may come from very large national
firms or smaller regional companies. For the workers' compensation lines,
additional competition comes from state workers' compensation funds.
Property and casualty insurance is a highly competitive business,
particularly with respect to excess and surplus lines, commercial lines and
workers' compensation insurance. Over the past several years, competition has
become more intense due to the efforts of many insurance companies to obtain,
maintain and expand market shares by offering relatively low premium rates.
Competition has grown from established companies and the entry of new
competitors into the industry. These factors have resulted in low revenue
growth, deterioration in operating profits and, until recently, falling prices.
The results of companies in the property and casualty industry historically
have been subject to significant fluctuations and uncertainties including
cyclical changes in the insurance and reinsurance industry. Rising levels of
actual costs that are not known by companies at the time they price their
product, volatile and unpredictable developments, including man-made, weather
related and other natural catastrophes, and increased competition from an influx
of new capital and financial services firms, state sponsored entities, and
internet based companies all affect the industry's and individual companies'
profitability. However, the industry has begun to show renewed focus on premium
rate adequacy and, as a result, the downward pressure on premium rates is
abating as many competitors implement rate increases.
14
The Company's insurance subsidiaries are subject to the Risk Based Capital
("RBC") provisions as promulgated by the National Association of Insurance
Commissioners. RBC is designed to measure the capital adequacy of an insurer
based on the inherent specific risks of each insurer. The RBC calculation yields
a ratio of the total adjusted statutory capital of an insurance company to the
minimum level of statutory capital as calculated under the provisions of the RBC
model. The RBC calculation takes into account: (1) asset risk, (2) credit risk,
(3) underwriting risk, and (4) all other relevant risks. Both increased growth
in premiums written and reduction in the amount of an insurance company's
statutory surplus can negatively affect RBC ratios. During the quarter ended
September 30, 2002 the Company experienced continued premium growth.
Additionally, the current trends in the equity markets have resulted in a
decline in the unrealized gains in the equity portfolios of the insurance
subsidiaries, thereby reducing statutory surplus.
The RBC for The Insurers Model Act provides four levels of regulatory
authority if the ratio yielded by the calculation falls below specified
minimums: (1) Company Action Level Event, (2) Regulatory Action Level Event, (3)
Authorized Control Level Event, and (4) Mandatory Control Level Event. These
four levels of authority provide for increasing regulatory remedies for
companies that fail to meet the appropriate levels under the statutes.
The Company's insurance subsidiaries are members of the statutorily created
insolvency guarantee associations in all states where they are authorized to
transact business. These associations were formed for the purpose of paying
claims of insolvent companies. The Company is assessed its pro rata share of
such claims based upon its premium writings, subject to a maximum annual
assessment per line of insurance. Such costs can generally be recovered through
surcharges on future premiums. Management does not believe that assessments on
current insolvencies will have a material effect on the Company's financial
condition or results of operations.
Consolidated results of operations
The following table summarizes the results from operations for the three
and nine month periods ended September 30, 2002 and 2001, respectively.
Three months ended Nine months ended
September 30, September 30,
(Dollars in millions) 2002 2001 2002 2001
---------------------- --------------------------
---------------------- --------------------------
Premiums earned $ 96.3 $ 52.9 $ 264.9 $ 120.4
Net investment income $ 12.9 $ 13.1 $ 40.0 $ 39.6
Losses and loss adjustment expenses $ 70.9 $ 47.1 $ 195.1 $ 107.9
Underwriting, acquisition and
insurance expenses $ 33.4 $ 23.4 $ 98.8 $ 61.4
Operating income (loss), net of tax $ 3.9 $ (2.9) $ 8.4 $ (5.3)
Net income $ 4.7 $ 1.3 $ 18.3 $ 3.5
15
Premiums earned increased for the three and nine month periods ended
September 30, 2002 due to: (1) rate increases across all product lines, and (2)
the inclusion of operating results of Colony and Rockwood for the full three and
nine month periods ended September 30, 2002 as compared to one month for the
same periods ended 2001.
Net investment income for the three and nine periods ended September 30,
2002 was comparable to the same periods in 2001. Higher invested balances offset
lower investment yields encountered during 2002.
The increase in losses and loss adjustment expenses was primarily
attributable to the increase in premiums written combined with the inclusion of
Colony and Rockwood for the full periods during 2002 as compared to one month
during 2001. The Company's loss ratio improved to 73.6% in the current quarter
compared to 89.1% for the same period in 2001. For the nine months ended
September 30, 2002, the Company's loss ratio was 73.7% compared to 89.7% for the
same period in 2001. The improvement in the loss ratio was primarily
attributable to the results of Colony and Rockwood coupled with favorable loss
development in the specialty workers' compensation segment - see segment
discussion.
The Company's underwriting, acquisition and insurance expenses increased to
$33.4 million for the three months ended September 30, 2002 from $23.4 million
for the same quarter of 2001 due primarily to premium volume produced by Colony
and Rockwood. The expense ratio for the three months ended September 30, 2002
improved to 34.7% versus 44.1% in the comparable quarter of 2001. This was
primarily due to the addition of Colony and Rockwood in 2002, the effect of
which was to lower the weighted average Company expense ratio, as Colony and
Rockwood incurred a lower expense ratio than the specialty workers' compensation
segment. The expense ratio for the nine months ended September 30, 2002 also
improved to 37.3% from 51.0% in the nine months ended 2001 for the same factors
previously noted.
Operating income is defined as net income excluding after-tax realized
gains or losses on sales of securities. Since operating income excludes the
effects of realized gains and losses attributable to the Company's investment
portfolio, management believes it presents the underlying results of operations
of the Company's primary businesses. Operating income should not be viewed as a
substitute for net income determined in accordance with GAAP. Consolidated
operating income for the three months ended September 30, 2002 was $3.9 million
compared to an operating loss of $2.9 million for the comparable quarter in
2001. Operating income for the nine months ended September 30, 2002 was $8.4
million compared to an operating loss of $5.3 million for the nine months then
ended in 2001. Improvement in operating income was primarily attributable to the
addition of Colony and Rockwood, which reported combined operating income of
$5.4 million and $11.4 million for the three and nine month periods ended
September 30, 2002, respectively. Additionally, improved operating results were
reported along all business segments for the periods in 2002 - see segment
discussion below.
Net income increased to $4.7 million and $18.3 million for the three and
nine months ended September 30, 2002, respectively, compared to $1.3 million and
$3.5 million for the same periods in 2001. The increase in net income was
attributable to the inclusion of the results of operation of Colony and Rockwood
for the full three and nine month periods in 2002, compared to a one month
period in 2001. Additionally, improved operating results along all business
segments were reported for 2002. The specialty workers' compensation segment
benefited from improved loss results and the deferral of acquisition costs. The
deferral of acquisition costs was partially offset by legal costs and an
increase to the allowance for doubtful accounts on premium balances receivable
(see segment discussion.) Net income for 2002 also reflects the positive impact
of the elimination of goodwill amortization (see note 6), which became effective
on January 1, 2002.
16
Segment Results.
Excess and Surplus Lines. The following table summarizes the excess and
surplus lines results of operations for the three and nine months ended
September 30, 2002 and 2001, respectively. Colony was acquired by the Company
effective September 1, 2001, and its results of operations are included from
this date. On May 6, 2002, the Company announced it had completed the
acquisition for the renewal rights and certain other assets of Fulcrum, a
subsidiary of the SCOR Group.
Three months ended Nine months ended
September 30, September 30,
(Dollars in millions) 2002 2001 2002 2001
---------------------- --------------------------
Net written premiums $ 70.3 $ 9.6 $ 145.5 $ 9.6
========== ========== ============ ============
Premiums earned 39.9 8.6 99.5 8.6
Losses and loss adjustment expenses 24.7 5.4 62.4 5.4
Underwriting expense 12.2 2.8 32.7 2.8
---------- ---------- ------------ ------------
Underwriting income 3.0 0.4 4.4 0.4
Net investment income 2.8 0.8 7.6 0.8
---------- ---------- ------------ ------------
Operating income $ 5.8 $ 1.2 $ 12.0 $ 1.2
========== ========== ============ ============
Combined ratio 92.6% 95.0% 95.6% 95.0%
========== ========== ============ ============
For the three months ended September 30, 2002, the excess and surplus lines
segment, written through Colony and Fulcrum, reported an underwriting profit of
$3.0 million and a combined ratio of 92.6%. For the nine months ended September
30, 2002, the excess and surplus lines segment reported an underwriting profit
of $4.4 million and a combined ratio of 95.6%.
For the three and nine months ended September 30, 2002 the business
underwritten by Colony, exclusive of Fulcrum, produced a combined ratio of 88.7%
and 93.2% on premiums earned of $34.0 million and $93.4 million, respectively.
For the same three and nine month periods of 2001 premiums earned were $8.6
million and produced a combined ratio of 95.0%.
For the three and nine month periods ended September 30, 2002, Colony has
experienced rate increases across virtually all lines of business compared to
the same periods in 2001. Though excess and surplus lines historically have a
lower renewal rate, Colony is able to write new business at higher rates than
the expiring policies due to favorable market conditions. These rate increases
combined with initiatives to reduce underwriting expenses have reduced the
expense ratio in 2002 versus 2001.
Premiums earned on the Fulcrum business for the three month period ended
September 30, 2002 were approximately $5.8 million which produced a $0.9 million
underwriting loss. From the date of acquisition through September 30, 2002,
Fulcrum generated premiums earned of approximately $6.1 million, which produced
a $2.0 million underwriting loss. Earned premium lags written premiums as
policies are renewed. However, underwriting expenses reflect the full staffing
that accompanied the renewal rights purchase, and this is responsible for the
Fulcrum underwriting loss.
17
Net investment income for the three and nine month periods ended September
30, 2002 was $2.8 million and $7.6 million, respectively. Net investment income
of $0.8 million for the three and nine month periods ended September 30, 2001
represented income on investments for the one month period since acquisition.
Specialty Commercial. The following table summarizes the specialty
commercial results of operations for the three and nine months ended September
30, 2002 and 2001. Rockwood was acquired by the Company effective September 1,
2001, and its results from operations are included from this date.
Three months ended Nine months ended
September 30, September 30,
(Dollars in millions) 2002 2001 2002 2001
---------------------- --------------------------
Net written premiums $ 30.5 $ 13.4 $ 83.2 $ 31.4
========== ========== ============ ============
Premiums earned 27.1 13.1 77.8 29.7
Losses and loss adjustment expenses 18.5 8.8 54.0 24.0
Underwriting expenses 8.1 4.0 23.8 10.2
---------- ---------- ------------ ------------
Underwriting income (loss) 0.5 0.3 - (4.5)
Net investment income 2.5 1.6 7.5 4.1
---------- ---------- ------------ ------------
Operating income $ 3.0 $ 1.9 $ 7.5 $ (0.4)
========== ========== ============ ============
Combined ratio 98.0% 97.5% 100.0% 115.2%
========== ========== ============ ============
For the three months ended September 30, 2002, the specialty commercial
segment, written through Rockwood and Argonaut Great Central, reported
underwriting income of $0.5 million and a combined ratio of 98.0%, compared to
underwriting income of $0.3 million and a combined ratio of 97.5% for the same
period ended 2001. For the nine months ended September 30, 2002, this segment
broke even on an underwriting basis and reported a combined ratio of 100.0%
compared to an underwriting loss of $4.5 million and a combined ratio of 115.2%
for the same period ended 2001.
For the three and nine month periods ended September 30, 2002, Rockwood
reported net written premiums of $19.1 million and $53.7 million, respectively.
For the three and nine month periods ended September 30, 2002, Rockwood
contributed net earned premiums of $18.4 million and $51.7 million,
respectively. Rockwood has experienced growth in its commercial workers'
compensation line, combined with price increases of approximately 10%. Argonaut
Great Central's written and earned premiums were comparable to the same periods
for the prior year.
The specialty commercial segment's loss ratio for the three months ended
September 30, 2002 was 68.0% compared to 66.9% in the comparable period of 2001.
The slight increase in the loss ratio was primarily attributable to the
commercial business written by Rockwood. This business typically incurs a higher
loss ratio compared to Rockwood's mining business, and a slight shift in the mix
of Rockwood's business to more commercial accounts has increased the loss ratio
minimally. Losses and loss adjustment expenses increased $9.7 million for the
three months ended September 30, 2002 compared to the same period of 2001,
primarily due to Rockwood's inclusion for the entire third quarter of 2002 as
compared to its 2001 third quarter results which included one month of
operations. Similarly, in the third quarter of 2002, Rockwood incurred $13.1
million of losses compared to $3.3 million in the third quarter of 2001.
Rockwood's loss ratio for the three months ended September 30, 2002 was 71.3%.
The implementation of more stringent underwriting standards at Argonaut Great
Central, combined with pricing actions and geographical and product
diversification, resulted in an improved loss ratio of 61.1% for the three
months ended September 30, 2002, as compared to 64.1% for the same period in
2001.
18
For the nine months ended September 30, 2002, Rockwood incurred losses and
loss adjustment expenses of $36.7 million, resulting in a loss ratio of 71.1%.
Argonaut Great Central's loss ratio improved to 66.1% for the nine months ended
September 30, 2002 from 82.5% for the same period of 2001 due to the factors
noted above.
The expense ratio for the specialty commercial segment of 30.0% in the
third quarter of 2002 is comparable to the expense ratio of 30.6% in the third
quarter of 2001. Underwriting expenses for the three months ended September 30,
2002 included $5.2 million attributable to Rockwood, compared to $1.2 million
for the same period ended 2001. Rockwood's expense ratio was 28.2% for the three
months ended September 30, 2002. Argonaut Great Central's expense ratio of 33.7%
for the three months ended September 30, 2002 was comparable to its expense
ratio for the same period of 2001.
For the nine months ended September 30, 2002, underwriting expenses for the
specialty commercial segment included $14.8 million attributable to Rockwood.
Rockwood incurred an expense ratio of 28.6% for this nine month period. Argonaut
Great Central's expense ratio improved to 34.5% for the nine months ended
September 30, 2002, compared to an expense ratio of 35.5% for the same period of
2001.
Net investment income for the three and nine months ended September 30,
2002 was $2.5 million and $7.5 million, respectively compared to $1.6 million
and $4.1 million for the same periods ended in 2001. Rockwood contributed $1.8
million and $5.1 million for the three and nine month periods ended September
30, 2002, compared to $0.5 million since acquisition in 2001. Argonaut Great
Central earned net investment income of $0.7 million and $2.4 million for the
three and nine months ended September 30, 2002, respectively, compared to $1.0
million and $3.5 million for the same periods in 2001. Argonaut Great Central's
net investment income was impacted by lower investment yields partially offset
by higher invested balances.
Specialty Workers' Compensation. The following table summarizes the
specialty workers' compensation results of operations for the three and nine
months ended September 30, 2002 and 2001.
19
Three months ended Nine months ended
September 30, September 30,
(Dollars in millions) 2002 2001 2002 2001
---------------------- --------------------------
Net written premiums $ 40.2 $ 36.7 $ 110.3 $ 96.2
========== ========== ============ ============
Premiums earned 26.3 30.0 80.9 79.6
Losses and loss adjustment expenses 18.5 32.5 66.9 76.9
Underwriting expense 11.4 14.5 36.3 44.5
---------- ---------- ------------ ------------
Underwriting loss (3.6) (17.0) (22.3) (41.8)
Net investment income 7.5 10.2 24.1 34.2
---------- ---------- ------------ ------------
Operating income (loss) $ 3.9 $ (6.8) $ 1.8 $ (7.6)
========== ========== ============ ============
Combined ratio 112.9% 156.7% 127.6% 152.5%
========== ========== ============ ============
For the quarter ended September 30, 2002 the specialty workers'
compensation segment, written through Argonaut Insurance Company, reported an
underwriting loss of $3.6 million and a combined ratio of 112.9%, compared to an
underwriting loss of $17.0 million and a combined ratio of 156.7% for the same
period ended 2001. For the nine months ended September 30, 2002, the specialty
workers' compensation segment reported a net underwriting loss of $22.3 million
and a combined ratio of 127.6%, compared to a net underwriting loss of $41.8
million and a combined ratio of 152.5% for the nine months ended September 30,
2001.
Increases in net written premiums for the three and nine months ended
September 30, 2002 as compared to the same periods ended 2001 were primarily due
to rate increases. Higher ceded premium rates during 2002 held down the level of
net written premium and net earned premium increases for both the quarter and
year to date as compared to 2001. Net written premium for the three months ended
September 30, 2002 includes a reduction of $0.3 million for the return of
premium on loss sensitive retrospectively rated policies. This compares to a
$3.8 million net written premium increase for the billing of additional premium
for retrospectively rated policies for the three months ended September 30,
2001. Earned premium for both periods was unaffected as the billings were offset
against previously established retrospective premium reserves.
Losses and loss adjustment expenses for the three and nine month periods
ended September 30, 2002 resulted in loss ratios of 70.0% and 82.7%,
respectively, compared to 108.2% and 96.7% for the three and nine month periods
ended September 30, 2001. The improvement in the loss ratio was due to rate
increases implemented in 2001 and 2002 and favorable loss development on
policies written in prior years.
The expense ratio for the three and nine months ended September 30, 2002
improved to 43.0% and 44.9%, respectively, from 48.5% and 55.8% for the like
periods in the prior year. During the three months ended September 30, 2002, the
Company deferred $7.4 million of acquisition costs related to policies written
in 2002. During the three months ended September 30, 2002, the Company incurred
legal expenses of approximately $2.0 million for litigation and increased its
allowance for doubtful accounts on premiums receivable by approximately $0.9
million. For the nine months ended September 30, 2002, acquisition costs of
$13.1 million have been deferred. Acquisition costs were not deferred during
2001.
20
Net investment income for the three and nine months ended September 30,
2002 was $7.5 million and $24.1 million, respectively, compared to $10.2 million
and $34.2 million for the same periods of 2001. The decline in net investment
income was the result of lower investment yields combined with a reduction in
the invested balances.
Public Entity. The following table summarizes the results of operations for
the public entity segment for the three and nine months ended September 30, 2002
and 2001.
Three months ended Nine months ended
September 30, September 30,
(Dollars in millions) 2002 2001 2002 2001
---------------------- --------------------------
Net written premiums $ 5.5 $ 2.0 $ 9.9 $ 4.6
========== ========== ============ ============
Premiums earned 3.0 1.2 6.7 2.5
Losses and loss adjustment expenses 1.9 0.9 4.6 1.9
Underwriting expense 1.1 0.7 2.5 1.5
---------- ---------- ------------ ------------
Underwriting loss - (0.4) (0.4) (0.9)
Net investment income 0.1 0.1 0.4 0.1
---------- ---------- ------------ ------------
Operating income (loss) $ 0.1 $ (0.3) $ - $ (0.8)
========== ========== ============ ============
Combined ratio 101.5% 131.3% 106.8% 135.6%
========== ========== ============ ============
For the three months ended September 30, 2002 the public entity segment,
written through Trident Insurance Services, Inc., broke even on an underwriting
basis, compared to an underwriting loss of $0.4 million for the same period
ended 2001. For the nine months ended September 30, 2002, the public entity
segment reported a net underwriting loss of $0.4 million and a combined ratio of
106.8%, compared to a net underwriting loss of $0.9 million and a combined ratio
of 135.6% for the same period ended 2001. This segment began writing business in
the fourth quarter of 2000, and continues to experience growth as it penetrates
its target market.
Run-off Lines. Corporate policy beginning in 1985 was to exclude asbestos
coverage on all general liability policies. During the three months ended
September 30, 2002, management identified claims associated with a certain
general liability policies issued through one office from 1985 to the early
1990's which did not exclude absolute asbestos coverage. In response, the
Company increased loss reserves by $7.0 million during the three months ended
September 30, 2002 resulting in an underwriting loss for the run-off lines of
$7.2 million. Although the Company continues to review policy files issued
during this period for additional exposure, management believes the policies
written were limited to the specific time frame and location first identified.
In addition to revisions to loss reserves to reflect any material
case-specific development in asbestos claims, the Company periodically reviews
all environmental and asbestos related reserves to evaluate the impact, if any,
of new developments in litigation trends, changes in actuarial assumptions, and
other industry-wide information then available. The Company expects to complete
its periodic review now in progress during the fourth quarter of 2002. The
results of this study may indicate further development on these reserves, which
would have a negative impact on the financial condition of the Company and its
RBC ratio, and may subject the Company to the levels of regulatory authority
noted previously.
21
On October 7, 2002, an action was filed by Western MacArthur Company,
MacArthur Company, Western Asbestos Company and certain other individual
claimants in the Superior Court of Alameda County, California against Argonaut
Insurance Company ("Argonaut"), The Home Insurance Company and The Hartford
Accident & Indemnity Company entitled Lila Mitchell, et al. v. Argonaut
Insurance Company, et al., Alameda Superior Court Case No. 2002067900. This case
seeks coverage for claims already at issue in the previously filed action
entitled Western MacArthur Company and MacArthur Company v. United States
Fidelity & Guaranty Co., The Saint Paul Companies, Inc., St. Paul Fire & Marine
Ins. Co., and Argonaut Insurance Company, Alameda Superior Court Case No.
721595-7 seeking adjudication of the same issues as presented in that action.
Argonaut's sole nexus to these suits is nine construction wrap-up policies with
an occurrence limit of $200,000 per policy issued to Western MacArthur Company
and Western Asbestos Company, respectively, for liability arising out of work
performed on five construction sites in the 1960's and 70's. Management
estimates that approximately 1% of the claimants in the purported class action
suits against Western MacArthur were associated in any way with the job sites
covered by the Argonaut policies. Argonaut has in the ordinary course of
business set up reserves in connection with these claims in prior years. Based
on the above circumstances, management's evaluation of Argonaut's exposure to
the Western MacArthur litigation remains unchanged and no adjustments to the
existing reserves are planned based on any of the recent events in this series
of lawsuits.
Liquidity and Capital Resources
The Company's principal operating cash flow sources are premiums and
investment income. The primary operating cash outflows are for claim payments
and operating expenses.
For the nine months ended September 30, 2002, net cash provided by
operating activities was $51.8 million, compared to net cash used for operating
activities of $38.1 million for the same period ended 2001. The increase in cash
inflow was primarily attributable to the inclusion of Colony and Rockwood for
the full nine month period ended September 30, 2002, compared to one month since
acquisition in 2001, coupled with improved underwriting results from rate
increases implemented in 2001 and 2002.
For the nine months ended September 30, 2002, dividends of $11.5 million
were paid to Argonaut Group, Inc. by Argonaut Insurance Company. No dividends
were paid to Argonaut Group, Inc. during the three months ended September 30,
2002. Dividends from subsidiaries are the primary source of funds for liquidity,
shareholder dividends and stock repurchases.
As of September 30, 2002, the Company has repurchased approximately 7.9
million shares of common stock out of a total 10 million shares authorized for
repurchase. During the three and nine months ended September 30, 2002, the
Company did not repurchase additional shares of its common stock.
On October 4, 2002, the Company filed a shelf registration statement on
Form S-3 to sell up to $150 million of common stock. The Company intends to
amend this filing to include debt securities and/or preferred stock.
Refer to "Management's Discussion and Analysis on Operating Results and
Financial Condition - Liquidity" in the Company's 2001 Annual Report on Form
10-K, as amended, for further discussion on the Company's liquidity.
22
Critical Accounting Policies
Refer to "Critical Accounting Policies" in the Company's 2001 Annual Report
on Form 10-K, as amended, for information on accounting policies that the
Company considers critical in preparing its Consolidated Financial Statements.
These policies include significant estimates made by management using
information available at the time the estimates were made. However, these
estimates could change materially if different information or assumptions were
used.
Forward Looking Statements
Management's Discussion and Analysis of Results of Operations and Financial
Conditions, Quantitative and Qualitative information about Market Risk and the
accompanying Condensed Consolidated Financial Statements (including the notes
thereto) contains "forward-looking statements" which are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
The forward-looking statements are based on the Company's current expectations
and beliefs concerning future developments and their potential effects on the
Company. There can be no assurance that actual developments will be those
anticipated by the Company. Actual results may differ materially from those
projected as a result of significant risks and uncertainties, including
non-receipt of the expected payments, changes in interest rates, effect of the
performance of financial markets on investment income and fair values of
investments, development of claims and the effect on loss reserves, including
environmental and asbestos claims, accuracy in projecting loss reserves, the
impact of competition and pricing environments, changes in the demand for the
Company's products, the effect of general economic conditions, natural and
man-made catastrophes and terrorism activities, volatility of reinsurance
availability and collectability, adverse state and federal legislation and
regulations, developments relating to existing agreements, heightened
competition, changes in pricing environments including rising levels of actual
costs that are not known at the time products are priced, and changes in asset
valuations. The Company undertakes no obligation to publicly update any
forward-looking statements as a result of events or developments subsequent to
the date of this Quarterly Report.
Item 3. Market Risks
The Company's assets include financial instruments subject to the risk of
potential losses from adverse changes in market rates and prices. The primary
market risk exposures are interest rate risk and equity price risk. The Company
does not hold any foreign currency risk or derivative instruments.
Due to the trends in the bond and equity markets during the three months
ended September 30, 2002, the Company analyzed the investment portfolio for
securities which were deemed to have suffered an impairment identified as other
than temporary. If a decline in the fair value of an individual security is
identified as other than temporary, the difference between cost and estimated
fair value is charged to income as a realized investment loss. During the nine
months ended September 30, 2002, realized investment gains for the equity and
bond portfolios were reduced $3.3 million and $0.9 million, respectively, due to
the recognition of other than temporary impairment on certain securities.
23
The Company regularly monitors its investment portfolio for securities
which have suffered an impairment which is deemed to be other than temporary. Of
those securities whose carrying value exceeded fair market value at September
30, 2002, approximately $7.4 million are at risk of being written down in the
next twelve months.
The Company holds a well-diversified portfolio of investments in common
stocks representing U.S. firms in industries and market segments ranging from
small market capitalization stocks to the Standard & Poors 500 stocks. Equity
price risk is managed primarily through the daily monitoring of funds committed
to the various types of securities owned and by limiting the exposure in any one
investment or type of investment. At September 30, 2002, investments in equity
securities include an investment in the common stock of Curtiss-Wright
Corporation which represents approximately 10% (pre-tax) of the total
shareholders' equity.
The Company's primary exposure to interest rate risk relates to its fixed
maturity investments including redeemable preferred stock. Changes in market
interest rates directly impact the market value of the fixed maturity securities
and redeemable preferred stocks. Some fixed income securities have call or
prepayment options. This subjects the Company to reinvestment risk as issuers
may call their securities, causing the Company to reinvest the proceeds at lower
interest rates.
Exposure to credit rate risk is managed by adhering to specific guidelines
in connection with the investment portfolio. The Company primarily invests in
high investment grade bonds ("AAA" rated U.S. treasury notes and government
agencies and "A" or better for municipal bonds, corporate bonds and preferred
stocks.) Less than 1.0% of the fixed income portfolio is invested in bonds rated
lower than "BAA".
Item 4. Controls and Procedures
In connection with the filing of this Form 10-Q, management, including the
chief executive officer and the chief financial officer, has reviewed the
effectiveness of the Company's disclosure controls and procedures designed to
ensure that material information relating to the Company and its consolidated
subsidiaries is made known to management by others within such consolidated
subsidiaries. Based on the evaluation, management, including the chief executive
officer and chief financial officer, concluded that the Company's disclosure
controls and procedures were effective as of September 30, 2002.
During the three month period ended September 30, 2002 and through the date
of filing, there were, a) no significant changes in the Company's disclosure
controls and procedures designed to ensure that material information relating to
the Company and its consolidated subsidiaries is made known to management by
others within such consolidated subsidiaries, b) no significant changes in other
factors that could significantly affect internal controls, and c) no corrective
action required or taken with regard to significant deficiencies and material
weaknesses in such internal controls.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
Superior Construction, Inc. v. Argonaut Insurance Company. A putative class
action was filed in Los Angeles Superior Court alleging that Argonaut Insurance
Company in isolated instances inadvertently miscoded loss data regarding
workers' compensation claims reported to the California Workers' Compensation
Insurance Rating Bureau from 1989 through 1993. Superior's complaint sought
monetary damages, including punitive damages and costs, as well as injunctive
relief.
24
Following mediation, Argonaut Insurance Company agreed, without admitting
liability or any wrongdoing and subject to court approval, to enter into a class
action settlement resolving all claims. Although management is unable to
reasonably estimate at this time the actual amounts which may be paid to class
members under the settlement upon final approval by the court, the maximum
liability consists of $3 million, consisting of a) $1.0 million in attorney's
fees payable to the plaintiff's attorneys, b) cash payments to qualifying
applicants from a $1.0 million fund established for this purpose, and c) up to
$1.0 million in vouchers for discounts on future premiums distributed to
qualifying applicants. As of September 30, 2002 the Company has accrued $2.0
million representing the estimate of cash outlays the Company will pay under
this settlement. The Company has not accrued the remaining $1.0 million as it
relates to the vouchers that will be redeemed, if any, and plans to expense the
vouchers as they are received.
Argonaut Insurance Company v. Los Angeles Metropolitan Transit Authority.
On August 30, 1996, the Los Angeles County Metropolitan Transportation Authority
("MTA") filed a civil action against Argonaut Insurance Company alleging breach
of contract, breach of the covenant of good faith and fair dealing, and
requesting ancillary relief in the form of an accounting, an injunction and
restitution in connection with allegations regarding failures to perform under
certain contracts of insurance. The MTA contends that it has been damaged by an
unspecified amount.
Argonaut Insurance Company has responded to the complaint, and brought
certain counterclaims against the MTA in connection with the facts underlying
the lawsuit. The Company believes it has meritorious defenses, and intends to
vigorously contest these claims. The trial judge for the MTA litigation has
ordered that the first stage of this case to be tried before a three-judge panel
instead of jury by agreement of the parties, currently set for June 30, 2003.
That trial will consider a portion of Argonaut Insurance Company's counterclaim
for sums it contends are due to it from the MTA. To date the Court has ruled on
three motions for summary adjudication relating to the recoverability of the
receivable, one filed by Argonaut and two by the MTA. In each instance the Court
has adopted the position asserted by Argonaut Insurance Company. The Company
believes it has a reasonable basis for recovery for amounts paid on behalf of
the MTA.
Voluntary Market Premium Litigation. Argonaut Insurance Company was sued in
sixteen lawsuits brought on behalf of alleged classes of purchasers of
retrospectively rated workers' compensation insurance, alleging that the
defendants, including other compensation insurers, charged the purported class
unlawful premiums. Plaintiffs have threatened to bring similar claims against
Argonaut Insurance Company in several other states, but to date have not. Of the
original sixteen suits filed, all but four have either been dismissed or
judgment entered for defendant at the trial court level, although some rulings
are subject to appeal or further review. Two of the remaining five have been
determined no longer material, with all but one count having been dismissed and
class certification denied, and one case has been dormant for over two years.
The remaining case has been stayed by the Federal Fifth Circuit Court pending
interlocutory appeal from a ruling by the trial court in Texas approving class
certification. Argonaut Insurance Company intends to vigorously defend these
lawsuits and has been successful in having a number of them dismissed or stayed.
Management is unable to determine the potential financial impact of lawsuits
which remain active at this time.
25
Diamond Woodworks vs. Argonaut Insurance Company. Filed in the Superior
Court of Orange County, California, this case arose out of Argonaut Insurance
Company's alleged mishandling of a workers' compensation claim and alleged
fraudulent acts towards the plaintiff. On June 19, 2000 the jury awarded
approximately $700,000 in compensatory damages and $14.0 million in punitive
damages against the Argonaut Insurance Company, which verdict was subsequently
confirmed by the Court. Argonaut Insurance Company filed post judgment motions
and the judgment for punitive damages was reduced to $5.5 million. Argonaut
Insurance Company is pursuing an appeal of the adverse final judgment, and has
posted a surety bond for the judgment pending appeal. The Company has recorded
the $700,000 judgment for compensatory damages but has not recorded the $5.5
million judgment for punitive damages. Management is currently unable to
estimate the amount (if any) of punitive damages that will be paid, but believes
that current reserves are adequate.
Princeville Hotel v. Argonaut Insurance Company. The underlying case
alleges wrongful denial of a property damage claim originally made in 1991 by
the Princeville Hotel in Hawaii regarding installation of a new roof for that
facility. Additional claims have also been brought for failure to provide a
defense to two contractors listed as additional insureds on the policy. Although
all indemnity and defense obligations arising under the policy in connection
with the underlying claim have been resolved and accrued for by the Company in
prior periods, claims for extra-contractual damages, including punitive damages,
have been brought by the additional insureds or their assigns and are still
pending. Argonaut Insurance Company settled the most significant of these claims
during the third quarter for the sum of $1.8 million, and as to the remaining
non-material claims the Company believes it has meritorious defenses and intends
to vigorously contest such claims. As of September 30, 2002, the Company had
fully accrued the $1.8 million related to the settlement. Subsequent to this
date, the Company paid this settlement in full.
The insurance subsidiaries of the Company are parties to legal actions
incidental to their business. Based on the advice of counsel, management of the
Company believes that the resolution of these matters will not materially affect
the Company's financial condition or results of operations.
Item 2. Changes in Securities and Use of Proceeds
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None
26
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Item 99.1 Certification of Compliance with Section 906 Sarbanes-Oxley
Act of 2002
Item 99. 2 Certification of Compliance with Section 302 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8K
None
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Argonaut Group, Inc.
(Registrant)
/s/ Mark E. Watson III
- ---------------------------------------
Mark E. Watson III
Chief Executive Officer and President
(principal executive officer)
/s/ Mark W. Haushill
- ---------------------------------------
Mark W. Haushill
Chief Financial Officer, Vice President and Treasurer
(principal financial and accounting officer)
/s/ Byron L. LeFlore, Jr.
- ---------------------------------------
Byron L. LeFlore, Jr.
General Counsel, Vice President and Secretary
November 13, 2002
28
EXHIBIT 99.1
CERTIFICATION OF COMPLIANCE WITH SECTION 906
SARBANES-OXLEY ACT OF 2002
I, Mark E. Watson III, President and Chief Executive Officer of Argonaut Group,
Inc. (the "Company") hereby certify in connection with the Form 10-Q covering
the period July 1, 2002 through September 30, 2002 (the "Report") that:
1. The Report fully complies with the requirements of Section 13(a) of the
Securities Exchange Act of 1934; and
2. The information in the Report fairly presents, in all material respects,
the financial condition and results of operations of the Company.
CERTIFIED this 13th day of November, 2002.
/s/ Mark E. Watson III
------------------------
Mark E. Watson III
President and Chief Executive
Officer
29
CERTIFICATION OF COMPLIANCE WITH SECTION 906
SARBANES-OXLEY ACT OF 2002
I, Mark W. Haushill, Vice President, Chief Financial Officer and Treasurer of
Argonaut Group, Inc. (the "Company") hereby certify in connection with the Form
10-Q covering the period July 1, 2002 through September 30, 2002 (the "Report")
that:
1. The Report fully complies with the requirements of Section 13(a) of the
Securities Exchange Act of 1934; and
2. The information in the Report fairly presents, in all material respects,
the financial condition and results of operations of the Company.
CERTIFIED this 13th day of November, 2002.
/s/ Mark W. Haushill
-----------------------
Mark W. Haushill
Vice President, Chief Financial
Officer and Treasurer
30
EXHIBIT 99.2
CERTIFICATE OF COMPLIANCE
I, Mark E. Watson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Argonaut
Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors:
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
CERTIFIED this 13th day of November, 2002.
/s/ Mark E. Watson III
------------------------
Mark E. Watson III
President and Chief Executive
Officer
31
CERTIFICATE OF COMPLIANCE
I, Mark W. Haushill, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Argonaut
Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors:
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
CERTIFIED this 13th day of November, 2002.
/s/ Mark W. Haushill
Mark W. Haushill
Vice President, Chief Financial
Officer and Treasurer
32