Back to GetFilings.com
UNITED STATES
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 June 30, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from __________ to ___________
Commission file number: 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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act.) Yes X No ____
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of August 4, 2003.
Title Outstanding
Common Stock, par value $0.10 per share 21,608,351
ARGONAUT GROUP, INC.
TABLE OF CONTENTS
Page No.
Part I. FINANCIAL INFORMATION:
Item 1. Condensed Consolidated Financial Statements:
Consolidated Balance Sheets
June 30, 2003 and December 31, 2002............................ 3
Consolidated Statements of Operations
Three and six months ended June 30, 2003 and 2002.............. 4
Consolidated Statements of Comprehensive Income
Three and six months ended June 30, 2003 and 2002.............. 5
Consolidated Statements of Cash Flow
Six months ended June 30, 2003 and 2002........................ 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................................................ 22
Item 4. Controls and Procedures..................................... 23
Part II. OTHER INFORMATION:
Item 1. Legal Proceedings........................................... 24
Item 2. Changes in Securities and Use of Proceeds................... 24
Item 3. Default Upon Senior Securities.............................. 24
Item 4. Submission of Matters to a vote of Security Holders......... 24
Item 5. Other Information........................................... 24
Item 6. Exhibits and Reports on Form 8-K ........................... 25
Signatures ........................................................ 26
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)
June 30, December 31,
2003 2002
-------------- --------------
(Unaudited)
Assets:
Investments:
Fixed maturities, at fair value (cost: 2003 - $961.5; 2002 - $850.7) $ 1,017.3 $ 894.1
Equity securities, at fair value (cost: 2003 - $145.5; 2002 - $149.2) 241.2 237.1
Other long-term investments, at fair value (cost: 2003 - $12.1; 2002 - $10.8) 11.5 10.0
Short-term investments, at fair value which approximates cost 102.3 40.1
-------------- --------------
Total investments 1,372.3 1,181.3
-------------- --------------
Cash and cash equivalents 64.2 77.4
Accrued investment income 13.2 13.0
Premiums receivable 230.6 221.6
Reinsurance recoverable 470.5 470.1
Notes receivable 47.1 -
Goodwill 105.7 105.7
Deferred federal income tax asset, net 5.7 20.0
Deferred acquisition costs, net 57.7 54.7
Other assets 87.1 65.1
-------------- --------------
Total assets $ 2,454.1 $ 2,208.9
============== ==============
Liabilities:
Reserves for losses and loss adjustment expenses $ 1,348.2 $ 1,281.6
Unearned premiums 318.0 284.9
Funds held 171.6 163.6
Deferred gain, retroactive reinsurance 40.5 40.0
Junior subordinated debentures 15.5 -
Related party note payable 12.0 -
Income taxes payable, net 7.6 1.5
Accrued expenses and other liabilities 111.4 109.6
-------------- --------------
Total liabilities 2,024.8 1,881.2
-------------- --------------
Shareholders' equity:
Preferred stock -$0.10 par, 5,000,000 shares authorized
Series A mandatory convertible preferred stock - 2,953,310 and 0 shares
issued and outstanding at June 30, 2003 and December 31, 2002 0.3 -
Common stock - $0.10 par, 35,000,000 shares authorized; 21,608,351 and 21,602,082
shares issued and outstanding at June 30, 2003 and December 31, 2002, respectively 2.2 2.2
Additional paid-in capital 131.8 96.4
Retained earnings 198.6 145.9
Deferred stock compensation (1.7) (1.7)
Accumulated other comprehensive income, net 98.1 84.9
-------------- --------------
Total shareholders' equity 429.3 327.7
-------------- --------------
Total liabilities and shareholders' equity $ 2,454.1 $ 2,208.9
============== ==============
See accompanying notes.
ARGONAUT GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in millions, except per share amounts)
(Unaudited)
Three Months Ended Six Months Ended
----------------------------- ----------------------------
June 30, June 30,
2003 2002 2003 2002
-------------- ------------- ------------- -------------
Premiums and other revenue:
Earned premiums $ 144.9 $ 84.0 $ 269.0 $ 168.6
Net investment income 13.3 13.8 26.8 27.1
Realized investment gains, net 7.7 5.9 63.7 14.0
-------------- ------------- ------------- -------------
Total revenue 165.9 103.7 359.5 209.7
-------------- ------------- ------------- -------------
Expenses:
Losses and loss adjustment expenses 101.5 61.6 188.8 124.2
Underwriting, acquisition, and
insurance expenses 52.2 32.8 99.6 65.4
Interest expense 1.9 - 4.1 -
-------------- ------------- ------------- -------------
Total expenses 155.6 94.4 292.5 189.6
-------------- ------------- ------------- -------------
Income before income taxes 10.3 9.3 67.0 20.1
Provision (benefit) for income taxes (9.4) 3.2 13.7 6.5
-------------- ------------- ------------- -------------
Net income $ 19.7 $ 6.1 $ 53.3 $ 13.6
============== ============= ============= =============
Net income per common share:
Basic $ 0.89 $ 0.28 $ 2.44 $ 0.63
============== ============= ============= =============
Diluted $ 0.80 $ 0.28 $ 2.31 $ 0.63
============== ============= ============= =============
Dividends declared per common share: $ - $ 0.15 $ - $ 0.30
============== ============= ============= =============
Weighted average common shares:
Basic 21,607,032 21,563,823 21,605,268 21,560,847
============== ============= ============= =============
Diluted 24,579,549 21,698,566 23,116,001 21,677,658
============== ============= ============= =============
See accompanying notes.
ARGONAUT GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in millions)
(Unaudited)
Three Months Ended Six Months Ended
-------------------------- --------------------------
June 30, June 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
Net income $ 19.7 $ 6.1 $ 53.3 $ 13.6
------------ ------------ ------------ ------------
Other comprehensive income:
Unrealized gains on securities:
Gains arising during the period 35.4 5.3 26.4 20.2
Reclassification adjustment for gains included
in net income or loss (7.7) (5.9) (6.1) (14.0)
------------ ------------ ------------ ------------
Other comprehensive income (loss) before tax 27.7 (0.6) 20.3 6.2
Income tax expense (benefit) related to other
comprehensive income (loss) 9.7 (0.2) 7.1 2.2
------------ ------------ ------------ ------------
Other comprehensive income (loss), net of tax 18.0 (0.4) 13.2 4.0
------------ ------------ ------------ ------------
Comprehensive income $ 37.7 $ 5.7 $ 66.5 $ 17.6
============ ============ ============ ============
See accompanying notes
ARGONAUT GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
(Dollars in millions)
(Unaudited)
Six Months Ended
June 30,
---------------------------
2003 2002
------------ ------------
Cash flows from operating activities:
Net income $ 53.3 $ 13.6
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization and depreciation 4.8 6.9
Deferred federal income tax benefit 7.2 4.9
Gains on sales of investments (6.1) (14.0)
Gains on sales of real estate (57.6) -
Change in:
Accrued investment income (0.2) (0.4)
Receivables (9.4) (11.8)
Unearned premiums on ceded reinsurance (26.0) (5.5)
Reserves for losses and loss adjustment expenses 66.6 (6.9)
Unearned premiums 33.1 37.4
Other assets and liabilities, net 8.5 (12.6)
------------ ------------
Cash provided by operating activities 74.2 11.6
------------ ------------
Cash flows from investing activities:
Sales of fixed maturity investments 36.8 36.4
Maturities and mandatory calls of fixed maturity investments 107.5 40.5
Sales of equity securities 10.9 20.2
Purchases of fixed maturity investments (257.4) (93.1)
Purchases of equity securities (1.8) (8.2)
Change in short-term investments (62.3) (0.9)
Sale of real estate 57.6 -
Notes receivable for real estate (47.1) -
Other, net 6.0 (0.3)
------------ ------------
Cash used by investing activities (149.8) (5.4)
------------ ------------
Cash flows from financing activities:
Issuance of Series A mandatory convertible preferred stock 34.9 -
Issuance of junior subordinated debentures 15.5 -
Related party note payable 12.0 -
Stock options exercised - 0.1
Payment of cash dividend - (6.5)
------------ ------------
Cash provided (used) by financing activities: 62.4 (6.4)
------------ ------------
Change in cash and cash equivalents (13.2) (0.2)
Cash and cash equivalents, beginning of period 77.4 14.0
------------ ------------
Cash and cash equivalents, end of period $ 64.2 $ 13.8
============ ============
Additional disclosure:
Income taxes paid $ 0.1 $ 0.8
============ ============
See accompanying notes
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 on Form
10-K for the year ended December 31, 2002 filed with the Securities and Exchange
Commission.
The interim financial data as of June 30, 2003 and 2002 and for the three months
and six months ended June 30, 2003 and 2002 is unaudited. However, in the
opinion of management, the interim data include 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 2003.
The balance sheet at December 31, 2002 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by GAAP for complete financial statements.
Note 2 - Recently Issued Accounting Pronouncements
In June 2002, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("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. In the first quarter of 2003, the
Company restructured the Risk Management segment of Argonaut Insurance Company
which was accounted for in accordance with SFAS No. 146. With the elimination of
non-strategic products, Argonaut Insurance Company has reduced its workforce by
63 employees as of June 30, 2003, and anticipates the reduction of an additional
eight employees over the remainder of the year. Severance costs of $0.9 million
and outplacement and relocation costs of $0.3 million have been recognized as of
June 30, 2003. Additionally, the Company closed three offices at a total cost of
$0.3 million. The costs associated with the restructuring are included in the
underwriting, acquisition and insurance expenses line item in the accompanying
condensed consolidated statements of operations. Any additional costs associated
with the restructuring will be recorded as incurred in the third quarter of
2003.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosures." SFAS No. 148 establishes alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based compensation. In addition, the statement amends the
disclosure requirements of SFAS No. 123, "Accounting for Stock-Based
Compensation" to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. SFAS No. 148
is effective for financial statements for fiscal years ending after December 15,
2002. The Company adopted the provisions of SFAS No. 148 relating to pro forma
reporting effective December 2002. The Company has not made a determination
regarding accounting for stock-based compensation on the fair value method (see
note 5.)
7
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liability and Equity". This Statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. One
requirement under the Statement is that trust preferred securities be presented
as liabilities. This statement is effective for financial instruments entered
into or modified after May 31, 2003, and otherwise is effective at the beginning
of the first interim period beginning after June 15, 2003. The Company elected
to adopt SFAS No. 150 in the second quarter of 2003, and accordingly, the
Floating Rate Junior Subordinated Deferrable Interest Debentures issued through
a trust preferred pool have been classified as liabilities in the accompanying
consolidated balance sheet. There was no impact from the adoption of SFAS No.
150 on the consolidated statement of operations.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" (FIN 46.) It requires that the assets, liabilities
and results of the activity of variable interest entities be consolidated into
the financial statements of the company that has controlling financial interest.
It also provides the framework for determining whether a variable interest
entity should be consolidated based on voting interest or significant financial
support provided to it. FIN 46 is effective for variable interest created after
January 31, 2003 in the second quarter of 2003 and for variable interest created
before February 1, 2003 the effective date is July 1, 2003. FIN 46 is not
expected to have a material impact on the Company's 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 six months ended June 30, 2003 and 2002:
Three Months Ended Six Months Ended
------------------------------- --------------------------------
June 30 June 30 June 30 June 30
(Dollars in millions except per share data) 2003 2002 2003 2002
-------------- --------------- --------------- --------------
Net income $ 19.7 $ 6.1 $ 53.3 $ 13.6
Preferred stock dividends (0.6) - (0.6) -
-------------- --------------- --------------- --------------
Income available to common shareholders $ 19.1 $ 6.1 $ 52.7 $ 13.6
Effect of dilutive securities:
Preferred stock dividends 0.6 - 0.6 -
Income available to common shareholders
after assumed conversion 19.7 6.1 53.3 13.6
Weighted average shares-basic 21,607,032 21,563,823 21,605,268 21,560,847
Effect of dilutive securities:
Stock options 19,207 134,743 9,603 116,811
Convertible preferred stock 2,953,310 - 1,501,130 -
-------------- --------------- --------------- --------------
Weighted average shares-diluted 24,579,549 21,698,566 23,116,001 21,677,658
============== =============== =============== ==============
Net income per common share-basic $ 0.89 $ 0.28 $ 2.44 $ 0.63
Net income per common share-diluted $ 0.80 $ 0.28 $ 2.31 $ 0.63
For the three and six months ended June 30, 2003, options to purchase 1,697,800
shares of common stock at a price ranging from $15.70 to $35.50 were not
included in the computation of diluted earnings per share because the options'
exercise price was greater than the average market price of the common shares.
These options expire at varying times from 2004 through 2013. For the three and
six months ended June 30, 2002, options to purchase 344,550 shares of common
stock at a price ranging from $22.56 to $35.50 were not included in the
computation of diluted earnings per share because the options' exercise price
was greater than the average market price of the common shares. These options
expire at varying times from 2003 through 2012.
8
Note 4 - Income Taxes
The Company's income tax provision includes the following components:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
(in millions) 2003 2002 2003 2002
------------- ------------ ------------- ------------
Current tax provision related to:
Current tax provision $ 0.2 $ 0.4 $ 6.5 $ 0.8
Deferred tax provision (benefit) related to:
Future tax deductions (2.4) 0.5 (5.9) 0.2
Net operating loss carryforward 5.8 2.5 27.1 5.8
Deferred alternative minimum tax provision (0.3) (0.2) (1.6) (0.3)
Valuation allowance change (12.7) - (12.4) -
------------- ------------ ------------- ------------
Income tax provision (benefit) $ (9.4) $ 3.2 $ 13.7 $ 6.5
============= ============ ============= ============
A reconciliation of the Company's income tax provision or benefit to the
provision which would have resulted if the tax had been computed at the
statutory rate is as follows:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
(in millions) 2003 2002 2003 2002
------------- ------------ ------------- ------------
Income tax provision at statutory rates (35%) $ 3.7 $ 3.2 $ 21.7 $ 7.0
Tax effect of:
Tax exempt interest - (0.1) (0.1) (0.2)
Dividends received deduction (0.3) (0.3) (0.5) (0.6)
Valuation allowance change (12.7) - (12.4) -
Other permanent adjustments, net - 0.3 0.1 0.1
State income tax provision (0.1) 0.1 4.9 0.2
------------- ------------ ------------- ------------
Income tax provision (benefit) $ (9.4) $ 3.2 $ 13.7 $ 6.5
============= ============ ============= ============
Note 5 - Stock-Based Compensation
The Company accounts for its stock option plans in accordance with the
provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations. As such, compensation expense
would be recorded on the date of grant only if the current market price of the
underlying stock exceeded the exercise price.
As of June 30, 2003, the Company had 126,416 shares of non-vested stock issued
and outstanding. The non-vested 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. Compensation expense for non-vested stock awards
is based on the market price of the stock on the date of grant and is recognized
ratably over the vesting period of the award. For the three months ended June
30, 2003 and 2002, the Company recognized deferred stock compensation expense of
$0.3 million and $0.1 million, respectively. For the six months ended June 30,
2003 and 2002, the Company recognized deferred stock compensation expense of
$0.5 million and $0.1 million, respectively.
9
Had the Company determined compensation cost based on the fair value at the
grant date for its stock options under SFAS No. 123, "Accounting for Stock-Based
Compensation," the Company's net income and income per common share would have
been reduced to the pro forma amounts indicated below:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
(in millions, except per share amounts) 2003 2002 2003 2002
------------- ------------ ------------- ------------
Net income, as reported $ 19.7 $ 6.1 $ 53.3 $ 13.6
Add: Total deferred stock compensation expense included
in reported net income, net of taxes 0.2 0.1 0.3 0.1
Deduct: Total stock-based employee compensation
determined under fair value based methods for all
awards, net of tax (0.3) (0.1) (0.5) (0.2)
------------- ------------ ------------- ------------
Pro forma net income $ 19.6 $ 6.1 $ 53.1 $ 13.5
============= ============ ============= ============
Earnings per share
Basic - as reported $ 0.89 $ 0.28 $ 2.44 $ 0.63
Basic - pro forma $ 0.88 $ 0.28 $ 2.43 $ 0.62
Diluted - as reported $ 0.80 $ 0.28 $ 2.31 $ 0.63
Diluted - pro forma $ 0.80 $ 0.28 $ 2.30 $ 0.62
Note 6 - Reserves for Losses and Loss Adjustment Expenses
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 $21.4 million and
$38.7 million as of June 30, 2003 and 2002, respectively.
Six Months Ended
June 30,
-----------------------
(Dollars in millions) 2003 2002
----------- -----------
Net reserves - beginning of year $ 838.2 $ 929.6
Net reserves from renewal rights acquisition 0.7 -
Net reserves ceded under retroactive reinsurance contracts (0.5) -
Add:
Loss and LAE incurred during calendar year, net of reinsurance
Current accident year 177.3 123.9
Prior accident years 11.5 0.3
----------- -----------
Loss and LAE incurred during current accident year, net of reinsurance 188.8 124.2
Deduct:
Loss and LAE payments made during current calendar year, net of reinsurance:
Current accident year 22.5 19.7
Prior accident years 105.6 109.1
----------- -----------
Loss and LAE payments made during current calendar year, net of reinsurance: 128.1 128.8
----------- -----------
Net reserves, end of period 899.1 925.0
Add
Reinsurance recoverable on unpaid losses & LAE, end of period 449.1 215.9
----------- -----------
Gross reserves - end of period $ 1,348.2 $ 1,140.9
=========== ===========
10
Note 7 - Business Segments
The Company is primarily engaged in writing property and casualty insurance. The
Company has classified its business into the following four continuing segments:
excess and surplus lines, specialty commercial, risk management (formerly
specialty workers' compensation) and public entity. Additionally, the Company no
longer underwrites certain coverages and classifies the results as run-off for
purposes of segment reporting. The Company considers many factors, including the
nature of the segment's insurance products, production sources, distribution
strategies and regulatory environment in determining how to aggregate operating
segments.
In evaluating the operating performance of its segments, the Company focuses on
core underwriting and investing results before the consideration of realized
gains or losses from the sales of investments. Realized investment gains
(losses) are reported as a component of the corporate and other segment, as
decision regarding the acquisition and disposal of securities resides with the
executive management of Company and is not under the control of the individual
business segments. Identifiable assets by segment are those assets used in the
operation of each segment. Identifiable assets are not assigned to run-off
lines.
Revenues and income before taxes for each reporting group were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
(in millions) 2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenues:
Earned premiums
Excess & surplus lines $ 72.5 $ 30.9 $ 134.5 $ 59.6
Specialty commercial 30.2 25.8 58.3 50.7
Risk management 35.6 25.4 64.1 54.6
Public entity 6.6 1.9 12.1 3.7
Run-off lines - - - -
------------ ------------ ------------ ------------
Total earned premiums 144.9 84.0 269.0 168.6
Net investment income
Excess & surplus lines 4.1 2.7 7.5 4.8
Specialty commercial 2.5 2.4 4.7 5.0
Risk management 6.6 8.2 13.9 16.6
Public entity 0.1 0.1 0.3 0.3
Run-off lines - - - -
Corporate & other - 0.4 0.4 0.4
------------ ------------ ------------ ------------
Total net investment income 13.3 13.8 26.8 27.1
Realized investment gains, net 7.7 5.9 63.7 14.0
------------ ------------ ------------ ------------
Total revenue $ 165.9 $ 103.7 $ 359.5 $ 209.7
============ ============ ============ ============
Income (loss) before income tax
Excess & surplus lines 10.9 $ 3.4 $ 18.8 $ 6.2
Specialty commercial 1.2 2.5 3.5 4.5
Risk management (8.7) (0.8) (16.7) (2.1)
Public entity 0.3 (0.1) 0.6 (0.1)
Run-off lines - (0.6) - (0.6)
------------ ------------ ------------ ------------
Total segment income before taxes 3.7 4.4 6.2 7.9
Corporate & other (1.1) (1.0) (2.9) (1.8)
Net realized investment gains (losses) 7.7 5.9 6.1 14.0
Net realized gains on sales of real estate - - 57.6 -
------------ ------------ ------------ ------------
Total income before income tax $ 10.3 $ 9.3 $ 67.0 $ 20.1
============ ============ ============ ============
11
Identifiable assets for each reporting group were as follows:
June 30, December 31,
(in millions) 2003 2002
--------------- ---------------
Excess & Surplus Lines $ 612.4 $ 498.6
Specialty Commercial 352.5 351.3
Risk Management 1,433.6 1,324.5
Public Entity 58.2 33.4
Run-off Lines - -
Corporate & Other (2.6) 1.1
--------------- ---------------
Total $ 2,454.1 $ 2,208.9
=============== ===============
Note 8 - Underwriting, Acquisition and Insurance Expenses
Underwriting, acquisition and insurance expenses for the three and six months
ended June 30, 2003 and 2002 were as follows:
Three Months Ended Six Months Ended
----------------------------- ------------------------------
June 30, June 30,
(Dollars in millions) 2003 2002 2003 2002
------------- ------------- -------------- --------------
Commissions $ 24.2 $ 16.1 $ 46.0 $ 29.1
General Expenses 22.1 18.0 45.2 35.6
State assessments 3.6 2.3 5.6 4.0
Taxes, licenses and bureau fees 3.0 3.2 5.9 6.3
------------- ------------- -------------- --------------
52.9 39.6 102.7 75.0
Deferral of policy acquisition costs (0.7) (6.8) (3.1) (9.6)
------------- ------------- -------------- --------------
Total underwriting, acquisition and
insurance expense $ 52.2 $ 32.8 $ 99.6 $ 65.4
============= ============= ============== ==============
Note 9 - Related Party Transactions
The Company utilizes Fayez Sarofim & Co. to manage a portion of its investment
portfolio, for which an investment advisory fee is calculated and payable
quarterly based upon the fair market value of the assets under management. Fayez
Sarofim & Co. is wholly owned by Sarofim Group, Inc., of which Fayez Sarofim is
the majority shareholder. Mr. Sarofim is a member of the Company's board of
directors. As of June 30, 2003, Fayez Sarofim & Co. managed $194.6 million of
the Company's investments. The Company believes that this transaction has been
entered into on terms no less favorable than could have been negotiated with
non-affiliated third parties.
On March 31, 2003, the Company sold 2,453,310 shares of Series A Mandatory
Convertible Preferred Stock ("the preferred shares") at an offering price of $12
per share to HCC Insurance Holdings, Inc. ("HCC"). Additionally, effective March
31, 2003, the Company sold an additional 500,000 shares to an unrelated
investor. The preferred shares will initially pay a 7 percent dividend on a
quarterly basis. The dividend is cumulative, and is payable when declared by the
board of directors. Dividends of approximately $0.6 million were declared by the
board of directors in May 2003 and were accrued as of June 30, 2003.
On March 31, 2003, the Company borrowed $18.0 million from HCC. The note payable
is due March 31, 2006, bears interest at 12% annually and is prepayable at the
Company's option at anytime. The note contains certain covenants, one of which
requires repayment should the Company enter into other debt agreements or issue
additional shares of Series A Mandatory Convertible Preferred Stock. On April
16, 2003, the Company repaid $6.0 million principal amount of the note, plus
accrued interest in conjunction with the issuance and proceeds of the additional
preferred shares. On May 7, 2003, the Company received a waiver from HCC
Insurance Holdings, Inc. of the requirement to use proceeds from the Company's
issuance of its Floating Rate Junior Subordinated Deferrable Interest Debentures
due 2033 to repay the note payable (see note 10).
12
On March 31, 2003, Colony Insurance Company entered into a quota share
reinsurance agreement with HCC. Under the terms of this agreement, the Company
will cede 15% of the gross written premiums from the excess and surplus lines
segment to HCC. HCC will, in turn, assume 15% of the losses from the excess and
surplus lines segment. As of June 30, 2003, the Company ceded approximately
$11.3 million of gross written premiums, $1.7 million of earned premiums and
$1.0 million of losses and loss adjustment expenses. The Company receives a
ceding commission to offset its acquisition costs related to these premiums. As
of June 30, 2003, the Company earned a ceding commission of $0.3 million.
Effective January 1, 2003, Argonaut Insurance Company entered into a quota share
reinsurance agreement with HCC. Under the terms of the agreement, the Company
will assume 3.33% of the losses under HCC's USA Directors and Officers Liability
program. Additionally, the Company will assume 5.0% of the losses under HCC's
International Directors and Officers Liability program. In turn, HCC will cede
3.33% and 5.0% of gross written premiums under each respective program to the
Company. For the six months ended June 30, the Company assumed gross written
premiums of $5.8 million, earned premium of $1.5 million and assumed losses of
$0.8 million. The Company will pay to HCC ceding and other commissions to offset
costs related to these premiums. For the six months ended June 30, 2003, the
Company expensed ceding and other commissions of $0.5 million.
Note 10 - Floating Rate Junior Subordinated Deferrable Interest Debentures
On April 25, 2003, Argonaut Group Statutory Trust, a recently-created
Connecticut statutory trust and wholly-owned subsidiary of the Company, sold
15,000 Floating Rate Capital Securities (the "Capital Securities") (liquidation
amount $1,000 per Capital Security) to I-Preferred Term Securities II, Ltd. in a
private sale for $15.0 million. The Trust used the proceeds from this sale,
together with the proceeds from its sale of 464 Floating Rate Common Securities
(liquidation amount $1,000 per Common Security) to the Company, to buy a series
of Floating Rate Junior Subordinated Deferrable Interest Debentures (the
"Debentures") due 2033 from the Company. The Debentures will have the same
payment terms as the Capital Securities. The sale closed on May 15, 2003.
The interest rate on the Debentures and the Capital Securities is equal to
3-Month LIBOR plus 4.10%, reset quarterly, not to exceed 12.5%. The Debentures
are unsecured and are subordinated in right of payment to all of the Company's
future senior indebtedness. Beginning in May 2008, the Company will have the
right to redeem the Debentures, in whole or in part, at a price equal to 100% of
the principal amount of the Debentures, plus accrued and unpaid interest to the
date of redemption. The Company will also have the right to redeem all of the
Debentures before May 2008 upon the happening of specified events at a price
equal to 107.5% of the principal amount of the Debentures, plus accrued and
unpaid interest to the date of redemption.
The Company used $12.0 million of the net proceeds from the sale of the
Debentures to increase the statutory capital of its insurance company
subsidiaries.
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 six months
ended June 30, 2003 and 2002. 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 Annual Report on Form 10-K for
the year ended December 31, 2002.
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) contain "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 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, 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, adverse state
and federal legislation and regulations, developments relating to existing
agreements, heightened competition, changes in pricing environments, 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.
Risk-Based Capital
The Company's insurance subsidiaries are subject to Risk-Based Capital ("RBC")
under The Insurers Model Act. RBC is designed to measure the adequacy of capital
for an insurance company based on the inherent specific risks of each insurer.
RBC is calculated on an annual basis, in conjunction with statutory financial
filings with the departments of insurance in which the Company transacts
business. At December 31, 2002, Argonaut Insurance Company's RBC was within the
Company Action Level Event. However, Argonaut Insurance Company requested from
the California Department of Insurance permission to report a parcel of its real
estate at its agreed upon sales price. The California Department of Insurance
granted Argonaut Insurance Company the permitted practice. Without the permitted
practice Argonaut Insurance Company's RBC would have been within the Regulatory
Action Level Event, which would have required the Company's corrective action
plan to be approved by the California Department of Insurance. During the first
quarter of 2003 this parcel of real estate was sold in accordance with the
permitted practice granted by the California Department of Insurance.
Pursuant to the requirements under the Company Action Level, Argonaut Insurance
Company submitted to the California Department of Insurance, on April 8, 2003, a
Comprehensive Plan of Action ("the Plan"). The Plan included an analysis of the
conditions that contributed to Argonaut Insurance Company's RBC condition,
proposals to increase the RBC ratio, projections of Argonaut Insurance Company's
RBC ratio, and key assumptions underlying the proposals.
During the six months ended June, 2003, the Company contributed $53.4 million in
capital to Argonaut Insurance Company. If the Company's actual results differ
materially from the plan submitted to the California Department of Insurance,
Argonaut Insurance Company's RBC could fall within the Company Action Level as
of December 31, 2003, and therefore subject Argonaut Insurance Company to
increasing levels of regulatory actions. Additionally, a decline of the
statutory surplus may limit the growth opportunities of the insurance companies
and may result in the downgrading of the insurance subsidiaries by the national
rating agencies, potentially impacting the Company's ability to write new
business and retain existing insureds.
14
Results of operations
The following is a comparison of selected data from the Company's operations:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ---------------------------
(in millions) 2003 2002 2003 2002
------------- ------------- ------------- ------------
Gross written premiums $ 199.5 $ 136.6 $ 373.5 $ 259.4
============= ============= ============= ============
Earned premiums $ 144.9 $ 84.0 $ 269.0 $ 168.6
Net investment income 13.3 13.8 26.8 27.1
Realized investment gains, net 7.7 5.9 63.7 14.0
------------- ------------- ------------- ------------
Total revenue $ 165.9 $ 103.7 $ 359.5 $ 209.7
============= ============= ============= ============
Income before taxes 10.3 9.3 67.0 20.1
Provision for income taxes (9.4) 3.2 13.7 6.5
------------- ------------- ------------- ------------
Net income $ 19.7 $ 6.1 $ 53.3 $ 13.6
============= ============= ============= ============
Combined ratio 106.2% 112.1% 107.2% 112.2%
============= ============= ============= ============
The increase in consolidated gross written premiums and earned premiums was
primarily attributable to new business written during the three and six months
ended June 30, 2003. For the three months ended June 30, 2003, gross written
premiums related to new business were $116.1 million compared to $58.5 million
for the same period in 2002. For the six months ended June 30, 2003, gross
written premiums related to new business were $217.0 million compared to $108.7
million for the same period in 2002. The increase in new business was primarily
attributable to a renewal rights acquisition within the excess and surplus lines
segment, which was effective in May 2002. Renewal gross written premiums
accounted for $85.8 million and $167.7 million for the three and six months
ended June 30, 2003, respectively, compared to $79.3 million and $154.8 million
for the three and six months ended June 30, 2002, respectively. The increase in
renewal gross written premiums was primarily attributable to rate increases.
The decline in consolidated net investment income was the result of lower yields
partially offset by higher invested balances due to the investment of positive
cash flows. Consolidated invested assets totaled $1,372.3 million and $1,176.2
million at June 30, 2003 and 2002, respectively.
The Company manages its investment portfolio to minimize losses, both realized
and unrealized. Consolidated realized investment gains increased to $7.7 million
during the three months ended June 30, 2003, as compared to $5.9 million for the
same period ended 2002. Realized investment gains for the three months ended
June 30, 2003 are net of write downs for other than temporary impairment of
securities totaling $2.7 million. No other than temporary impairments of
securities were recognized during the same period in 2002. Realized investment
gains for the six months ended June 30, 2003 include gains on sales of three
real estate holdings. Total gains on sales of the real estate holdings were
$57.6 million. Excluding the gains on the sale of real estate, the Company
realized gains of $6.1 million on the investment portfolio for the six months
ended June 30, 2003. Included in realized investment gains as of June 30, 2003,
are write downs of $3.8 million due to the recognition of other than temporary
impairments of securities.
The consolidated loss ratios were 70.1% and 70.2% for the three and six
months ended June 30, 2003, respectively, compared to 73.4% and 73.7% for the
three and six months ended June 30, 2002, respectively. The improvement in the
loss ratios was primarily attributable to the effects of rate increases
implemented over the past two years, which was partially offset by an increase
in the allowance for uncollectible reinsurance recoverables recorded during
the second quarter in the Risk Management segment, combined with loss
development in one large construction account in the Risk Management
segment recorded during the first quarter of 2003 (see discussion in
"Segment Results - Risk Management" below).
15
The consolidated expense ratios were 36.1% and 38.7% for the three months ended
June 30, 2003 and 2002, respectively. The consolidated expense ratios were 37.0%
and 38.5% for the six months ended June 30, 2003 and 2002, respectively. The
improvement in the expense ratios were due to increased premiums volumes and
cost containment, which offset increases in underwriting expenses in the risk
management segment (see discussion below).
The tax provision is the sum of the provision (benefit) on income before
federal income taxes, change in the deferred tax asset valuation allowance,
and state income tax expense. A deferred tax asset is recognized only to
the extent of income taxes on current taxable income, taxable income
resulting from future reversals of existing taxable temporary differences,
changes in unrealized gains on the Company's available for sale investment
securities and a tax planning strategy related to the unrecorded gains on
real estate owned by the Company. During the three months ending June 30,
2003 the increase in the deferred tax liability on unrealized gains on
securities available for sale recorded in other comprehensive income
reduced the net deferred tax asset and the related amount of deferred tax
asset valuation allowance required by approximately $9.4 million. Future
changes in the fair value of available for sale investment securities is
subject to market fluctuation as is the impact on the related deferred tax
valuation allowance and resulting income tax expense (benefit).
Segment Results
As of June 30, 2003, the Company's operations include four continuing business
segments: excess and surplus lines, specialty commercial, risk management
(formerly specialty workers' compensation) and public entity. In evaluating the
operating performance of its segments, the Company focuses on core underwriting
and investing results before the consideration of realized gains or losses from
the sales of investments. Realized investment gains (losses) are reported as a
component of the corporate and other segment, as decisions regarding the
acquisition and disposal of securities resides with the executive management of
Company and is not under the control of the individual business segments.
Excess and Surplus Lines. The following table summarizes the excess and surplus
lines results of operations for the three and six months ended June 30, 2003 and
2002.
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- -----------------------------
(in millions) 2003 2002 2003 2002
-------------- ------------- -------------- -------------
Gross written premiums $ 99.4 $ 49.8 $ 184.1 $ 90.7
============== ============= ============== =============
Earned premiums 72.5 30.9 134.5 59.6
Losses and loss adjustment expenses 43.7 19.7 82.2 37.6
Underwriting expense 22.0 10.5 41.0 20.6
-------------- ------------- -------------- -------------
Underwriting income 6.8 0.7 11.3 1.4
Interest income, net 4.1 2.7 7.5 4.9
-------------- ------------- -------------- -------------
Income before taxes $ 10.9 $ 3.4 $ 18.8 $ 6.3
============== ============= ============== =============
Combined ratio 90.7% 97.7% 91.6% 97.6%
============== ============= ============== =============
The increases in gross written premiums and earned premiums for the three and
six months ended June 30, 2003 were primarily the result of new business and
rate increases. For the three months ended June 30, 2003, gross written premiums
derived from new business increased $40.2 million to $73.9 million. For the six
months ended June 30, 2003, gross written premiums derived from new business
increased $83.1 million to $140.0 million, primarily due to business written
through the renewal rights acquisition of Fulcrum Insurance Company. Renewal
gross written premiums increased $12.9 million to $30.5 million for the three
months ended June 30, 2003 and $17.2 million to $55.4 million for the six months
then ended. Rate increases were the primary driver for the increase in renewal
premiums. This trend is a reflection of the current environment of the excess
and surplus lines market, in that the current year premium has a similar risk
profile to expiring policies, and is being written at higher rates. Partially
offsetting these increases were cancellations and endorsements which reduced
gross written premiums by approximately $5.0 million and $11.4 million for the
three and six month ended June 30, 2003, respectively.
16
On March 31, 2003, Colony Insurance Group entered into a quota share reinsurance
agreement with HCC Insurance Holdings, Inc. ("HCC"). Under the terms of this
agreement, the Company will cede 15% of the gross written premiums from the
excess and surplus lines segment to HCC. HCC will, in turn, assume 15% of the
losses from the excess and surplus lines segment. As of June 30, 2003, the
Company ceded approximately $11.3 million of gross written premiums, $1.7
million of earned premiums and $1.0 million of losses and loss adjustment
expense. The Company receives a ceding commission to offset its acquisition
costs related to these premiums. As of June 30, 2003, the Company earned a
ceding commission of $0.3 million.
The excess and surplus lines segment's loss ratio improved to 60.3% and 61.1%
for the three and six months ended June 30, 2003, respectively, compared to
63.7% and 63.1% for the same periods in 2002. The improvement is primarily
attributable to a reduction of the current year loss ratio, reflecting the
effects of rate increases realized over the past year. Loss reserves for the
excess and surplus lines were $225.6 million as of June 30, 2003, compared to
$147.9 million as of June 30, 2002.
The expense ratio for the three months ended June 30, 2003 was 30.4% compared to
34.0% for the same period in 2002. The expense ratio for the six months ended
June 30, 2003 was 30.5% compared to 34.5% for the same period in 2002. Increases
in variable expenses were offset by economies of scale resulting from the
increase in gross written premiums related to fixed expenses.
Increases in net investment income were the result of an increase in invested
assets due to positive cash flows over the past twelve months, combined with a
capital contribution of $12.0 million. Net invested assets increased to $443.9
million as of June 30, 2003, compared to $251.1 million as of June 30, 2002.
Specialty Commercial. The following table summarizes the specialty commercial
results of operations for the three and six months ended June 30, 2003 and 2002.
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- --------------------------
(in millions) 2003 2002 2003 2002
-------------- ------------- ------------ ------------
Gross written premiums $ 35.6 $ 30.0 $ 70.0 $ 59.7
============== ============= ============ ============
Earned premiums 30.2 25.8 58.3 50.7
Losses and loss adjustment expenses 22.6 17.9 42.1 35.5
Underwriting expense 8.9 7.8 17.4 15.7
-------------- ------------- ------------ ------------
Underwriting income (loss) (1.3) 0.1 (1.2) (0.5)
Interest income, net 2.5 2.4 4.7 5.0
-------------- ------------- ------------ ------------
Income before taxes $ 1.2 $ 2.5 $ 3.5 $ 4.5
============== ============= ============ ============
Combined ratio 104.5% 99.8% 102.1% 101.0%
============== ============= ============ ============
The increase in gross written premiums and earned premiums was primarily
attributable to rate increases and new business. Renewal premiums increased from
$21.9 million for the three months ended June 30, 2002 to $23.5 million for the
same period in 2003. Renewal premiums for the six months ended June 30, 2003
were $53.5 million compared to $46.1 million for the same period in 2002. The
increases in renewal premiums were primarily due to average rate increases of
approximately 8%. Premiums related to new business written increased from $8.1
million for the three months ended June 30, 2002 to $9.4 million for the same
period in 2003. Premiums related to new business were $16.3 million for the six
months ended June 30, 2003, compared to $13.6 million for the same period in
2002.
17
The specialty commercial segment's loss ratios were 75.1% and 72.4% for the
three and six months ended June 30, 2003, respectively, compared to 69.4% and
70.1% for the same periods in 2002. During the three month period ended June 30,
2003, the specialty commercial segment incurred approximately $1.9 million in
catastrophe losses related to the May storms in the South and Midwest.
Additionally, five large liability losses were reported during this period,
resulting in approximately $1.0 million in losses. The specialty commercial
segment's loss reserves were $174.6 million and $164.6 million as of June 30,
2003 and 2002, respectively.
The expense ratios for the specialty commercial segment were 29.4% and 29.7% for
the three and six months ended June 30, 2003, respectively, compared to 30.4%
and 30.9% for the same periods in 2002. The continued improvement in the expense
was primarily the result of increased premium volumes and cost containment.
The changes in investment income for the three and six months ended June 30,
2003, as compared to the same periods in 2002, was primarily the result of lower
investment yields partially offset by an increase in invested assets due to
positive cash flows. Invested assets were $242.6 million as of June 30, 2003,
compared to $232.8 million as of June 30, 2002.
Risk Management (formerly Specialty Workers' Compensation). The following table
summarizes the results of operations for the risk management segment for the
three and six months ended June 30, 2003 and 2002.
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- --------------------------
(in millions) 2003 2002 2003 2002
------------- ------------- ----------- ------------
Gross written premiums $ 53.1 $ 52.6 $ 96.7 $ 98.8
============== ============= ============ ============
Earned premiums 35.6 25.4 64.1 54.6
Losses and loss adjustment expenses 31.7 22.7 58.0 48.4
Underwriting expense 19.2 11.7 36.7 24.9
-------------- ------------- ------------ ------------
Underwriting loss (15.3) (9.0) (30.6) (18.7)
Interest income, net 6.6 8.2 13.9 16.6
-------------- ------------- ------------ ------------
Loss before taxes $ (8.7) $ (0.8) $ (16.7) $ (2.1)
============== ============= ============ ============
Combined ratio 143.0% 135.6% 147.8% 134.7%
============== ============= ============ ============
Gross written premiums in the three months ended June 30, 2003 were consistent
with the same period in 2002. New business for the directly written voluntary
portion of the Company's business increased $11.4 million to $26.3 million while
renewal gross written premiums decreased $10.9 million as compared to the same
period in 2002. The decrease in gross written premiums for the six months ended
June 30, 2003 as compared to the same period in 2002 was primarily the result of
a decline in renewal premiums due to the restructuring in this segment discussed
below. For the six months ended June 30, 2003, renewal premiums were $49.8
million, compared to $66.4 million for the same period in 2002. Premiums related
to new business were $46.9 million for the six months ended June 30, 2003
compared to $33.4 million for the same period in 2002.
The Company, through its subsidiary Argonaut Insurance Company, has entered into
an agreement with Kemper Insurance Company ("Kemper") to purchase the renewal
rights to its bundled large risk national accounts. Under the terms of the
agreement, the Company has the right to acquire the assets and liabilities of
certain policies originally underwritten by Kemper. The Company can acquire and
for such accounts selected will be liable for all losses and will be entitled to
any unearned premiums from the account, less commissions, paid to Kemper. The
Company has sole discretion as to which accounts it will acquire, and is
guaranteed at least one renewal of the policy. The Company acquired these
policies during the three month period ended June 30, 2003. All unearned
premiums acquired are being recognized as income ratably over the remaining life
of the policy. The Company entered into this agreement in accordance with its
previously announced plan to concentrate on casualty risk management solutions
for upper-middle market accounts. As part of this focus, $6.6 million of the
$11.4 million of new business represents premium written under the renewal
rights agreement signed with Kemper in the spring of 2003.
18
Effective January 1, 2003, Argonaut Insurance Company entered into a quota share
reinsurance agreement with HCC Insurance Holdings, Inc. (HCC). Under the terms
of the agreement, the Company will assume 3.33% of the losses under HCC's USA
Directors and Officers Liability program. Additionally, the Company will assume
5.0% of the losses under HCC's International Directors and Officers Liability
program. HCC will cede 3.33% and 5.0% of gross written premiums under each
respective program to the Company. For the three and six months ending June 30,
2003, gross written premiums recorded under this program totaled $5.8 million.
The Company will pay to HCC ceding and other commissions to offset costs related
to these premiums. For the six months ended June 30, 2003, the Company expensed
ceding and other commissions of $0.5 million.
The Company assumed $7.9 million of gross written premiums from involuntary
pools in the quarter, as compared to $0.9 million for the same period in 2002.
The increase in the assumption of pool premium and related pool operating
results was a function of an increase in the amount of premium being placed with
involuntary pools, as well as an increase in the Company's pool percentage
participation in certain states in which the Company writes premium.
Earned premiums for the three and six months ended June 30, 2003 were $10.2
million and $9.5 million greater, respectively than the same period in 2002.
This three and six month increase was attributable to the following factors: (a)
earning of higher unearned premium on directly written voluntary inforce
business during the three months ended June 30, 2003 produced $3.8 million of
additional net earned premium as compared to the same period in 2002; (b) the
assumption of business underwritten by HCC accounted for $1.5 million of
increased earned premium; and (c) the involuntary pool assumption added $4.9
million to net earned premium as compared to the same quarter in 2002.
Losses and loss adjustment expenses for the three and six months ended June 30,
2003 resulted in loss ratios of 88.8% and 90.6%, respectively, compared to 89.8%
and 88.9% for the same periods in 2002. Adverse loss development for the quarter
ended June 30, 2003 was caused by an increase to the allowance for doubtful
accounts for balances due from reinsurers. The $10.0 million of adverse loss
development for the six months ended June 30, 2003 includes $5.0 million of
adverse development recognized in the first quarter of 2003. The adverse loss
development was primarily attributable to one construction account that was a
multi-year policy. This account was not renewed in January of 2003 and
additional adverse development may occur but management is unable to determine
the amount, if any, of additional possible loss. Loss reserves totaled $644.4
million and $604.6 million as of June 30, 2003 and 2002, respectively.
The expense ratio was 54.2% for the three months ended June 30, 2003, compared
to 45.8% for the same period in 2002. Continued restructuring charges for the
program initiated in March 2003 (see discussion below) resulted in an additional
$0.6 million of underwriting expense. The increase in the assumption of
involuntary pool premium discussed above was accompanied by an additional $2.3
million of administrative charges for the pools. Deferred policy acquisition
costs were $0.4 million for the three months ended June 30, 2003, a $4.8 million
increase over the same period in 2002. This increase in expense was due to
acquisition costs not being deferred in the year prior to 2002.
The expense ratios were 57.2% and 45.8% for the six months ended June 30, 2003
and 2002, respectively. The increase in the expense ratio was due primarily to
$1.5 million in restructuring charges for the six month period, combined with an
increase in deferred policy acquisition costs of approximately $7.7 million for
the reasons discussed above.
19
In March 2003, Argonaut Insurance Company began to restructure its operations to
concentrate on casualty risk management solutions for upper-middle market
accounts. With the elimination of non-strategic products, Argonaut Insurance
Company has reduced its workforce by 63 employees as of June 30, 2003, and
anticipates the reduction of an additional eight employees over the remainder of
the year. Severance costs of $0.9 million and outplacement and relocation costs
of $0.3 million have been recognized as of June 30, 2003. Additionally, the
Company closed three offices at a total cost of $0.3 million. Any additional
costs associated with the restructuring will be recorded as incurred.
Public Entity. The following table summarizes the results of operations for the
public entity segment for the three and six months ended June 30, 2003 and 2002.
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- --------------------------
(in millions) 2003 2002 2003 2002
-------------- ------------- ------------ ------------
Gross written premiums $ 11.4 $ 4.2 $ 22.7 $ 10.2
============== ============= ============ ============
Earned premiums 6.6 1.9 12.1 3.7
Losses and loss adjustment expenses 4.3 1.3 8.0 2.6
Underwriting expense 2.1 0.8 3.8 1.5
-------------- ------------- ------------ ------------
Underwriting (loss) income 0.2 (0.2) 0.3 (0.4)
Interest income, net 0.1 0.1 0.3 0.3
-------------- ------------- ------------ ------------
Income (loss) before taxes $ 0.3 $ (0.1) $ 0.6 $ (0.1)
============== ============= ============ ============
Combined ratio 97.4% 109.4% 98.0% 111.0%
============== ============= ============ ============
The increase in gross written premiums and earned premiums was primarily the
result of new business written in 2003. For the three and six months ended June
30, 2003, the public entity segment's new business was approximately $6.5
million and $13.7 million respectively. Additionally, the segment wrote $4.8
million of renewal business for the three months ended June 30, 2003, of which
$0.2 million was the result of rate increases. For the six months ended June 30,
2003, gross written premiums on renewal business were $8.9 million, of which
$0.7 million was due to rate increases. Premium volume for the public entity
sector tends to be seasonal, with the bulk of premiums being written in the
period from July through October, corresponding with the insured's fiscal year
end.
Losses and loss adjustment expenses for the three months and six months ended
June 30, 2003 resulted in a loss ratio of 65.0% and 65.1%, respectively,
compared to 69.0% and 70.5%, respectively, for the same periods in 2002. The
decrease in the loss ratios was attributable to increased rates. Loss reserves
for the public entity segment were $17.8 million and $6.3 million as of June,
2003 and 2002, respectively.
The expense ratios for the three months and six months ended June 30, 2003 were
32.4% and 32.9%, respectively, compared to 40.4% and 40.5%, respectively, for
the same periods in 2002. The decrease in the expense ratio primarily resulted
from operational efficiencies gained from increased premium volume.
Run-off Lines. The Company has discontinued active underwriting of certain lines
of business. The Company is still obligated to pay losses incurred on these
lines which include general liability, asbestos and environmental liabilities
and medical malpractice policies written in past years. The lines currently in
run-off are characterized by long elapsed periods between the occurrence of a
claim and any ultimate payment to resolve the claim. The Company utilizes a
specialized staff dedicated to administer and settle these claims. Loss reserves
for the run-off lines were as follows:
20
June 30,
--------------------------------------------
2003 2002
--------------------- ---------------------
(in millions) Gross Net Gross Net
---------- ---------- ---------- ----------
Environmental and asbestos:
Loss reserves, beginning of the period $236.5 $178.3 $168.2 $130.7
Incurred losses (0.7) 0.8 3.6 3.2
Losses paid 5.3 6.1 14.9 7.7
---------- ---------- ---------- ----------
Loss reserves - environmental and
asbestos, end of the period 230.5 173.0 156.9 126.2
Other run-off lines 55.4 43.0 60.6 48.4
Net reserves ceded - retroactive
reinsurance contract - (40.0) - -
---------- ---------- ---------- ----------
Total reserves - run-off lines $285.9 $176.0 $217.5 $174.6
========== ========== ========== ==========
The Company regularly monitors the activity of claims within the run-off lines,
particularly those claims related to asbestos and environmental liabilities. For
the three and six months ended June 30, 2003, the run-off lines did not
experience adverse loss development. The Company expects to complete its annual
review of its reserves prior to the end 2003.
Goodwill
The Company reviewed goodwill of approximately $27.1 million allocated to the
risk management segment, due to the restructuring of Argonaut Insurance Company
combined with the sale of the real estate holdings during the three months ended
March 31, 2003. No impairment of the goodwill balances was indicated. However,
continued operating losses within the risk management segment could result in an
impairment of the goodwill assigned to this reporting unit, resulting in a write
down of the goodwill in future periods. The Company will conduct its annual
review of goodwill impairment prior to the end 2003.
Reinsurance
Certain of the Company's reinsurance carriers have experienced deteriorating
financial condition or have been downgraded by rating agencies. Amounts due
from such reinsurers on paid loss recoverables and case reserves totaled $25.8
million. Amounts due from such reinsurers on incurred but not reported claims
totaled $27.1 million. Through the date of this filing, the reinsurers have
not defaulted on their obligations to pay claims due to the Company.
Included in the aforementioned reinsurance balances recoverable is
approximately $44.5 million due from insurance subsidiaries of Trenwick
Group Ltd., which has announced its intent to restructure its operations in
August 2003. The balances are due from the insurance subsidiaries not Trenwick
Group Ltd; accordingly, the Company is unable to estimate the amount that
may be uncollectible, if any. The Company will continue to monitor these
reinsurers; however, to date, the Company has not received any indication that
the reinsurers will fail to honor their obligations under the reinsurance
agreements. It is possible that future financial deterioration of such
reinsurers could result in the uncollectibility of certain balances and
therefore impact the financial results of the Company. During the three
months ended June 30, 2003, the Company increased its allowance for
uncollectible reinsurance recoverables by $5.0 million.
Liquidity
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.
21
For the six months ended June 30, 2003, net cash provided by operating
activities was $74.2 million, compared to $11.6 million for the same period in
2002. The increase in cash inflows was primarily attributable to improved
underwriting results. The Company also holds marketable investment securities of
approximately $1,372.3 million that could be sold to cover liquidity.
On April 25, 2003, Argonaut Group Statutory Trust, a Connecticut statutory trust
and wholly-owned subsidiary of the Company, sold 15,000 Floating Rate Capital
Securities (liquidation amount $1,000 per Capital Security) to I-Preferred Term
Securities II, Ltd. in a private sale for $15.0 million. The Trust used the
proceeds from this sale, together with the proceeds from its sale of Common
Securities to the Company, to buy a series of Floating Rate Junior Subordinated
Deferrable Interest Debentures due 2033 from the Company. The Debentures will
have the same payment terms as the Capital Securities. The sale closed on May
15, 2003.
The interest rate on the Debentures and the Capital Securities will be equal to
3-Month LIBOR plus 4.10% (not to exceed 12.5%), which rate will be reset
quarterly. The Debentures will be unsecured and will be subordinated in right of
payment to all of the Company's future senior indebtedness. Beginning in May
2008, the Company will have the right to redeem the Debentures, in whole or in
part, at a price equal to 100% of the principal amount of the Debentures, plus
accrued and unpaid interest to the date of redemption. The Company will also
have the right to redeem all of the Debentures before May 2008 upon the
happening of specified events at a price equal to 107.5% of the principal amount
of the Debentures, plus accrued and unpaid interest to the date of redemption.
On May 7, 2003, the Company received a waiver from HCC of the requirement to use
the proceeds from the issuance of the Debentures to repay the HCC note described
above. The Company used $12.0 million of the net proceeds from the sale of the
Debentures to increase the statutory capital of its insurance company
subsidiaries.
Refer to Part I, Item 7 - "Management's Discussion and Analysis of Operating
Results and Financial Condition - Liquidity" in the Company's Annual Report on
Form 10-K for the year ended December 31, 2002 for further discussion on the
Company's liquidity.
Recent Accounting Pronouncements and Significant Accounting Policies
New Accounting Pronouncements
The discussion of the adoption and pending adoption of recently issued
accounting policies is included in "Note 2 - Recently Issued Accounting
Pronouncements" in the Notes to the Condensed Financial Statements, included in
Item 1.
Critical Accounting Policies
Refer to "Critical Accounting Policies" in the Company's Annual Report on Form
10-K for the year ended December 31, 2002 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.
Item 3. Market Risks
The primary market risk exposures that result in an impact to the investment
portfolio relates to equity price changes and interest rate changes. The Company
does not hold any derivative instruments.
The Company has an exposure to foreign currency risks in conjunction with the
reinsurance agreement with HCC. Accounts under the International Directors &
Officers Liability Quota Share program may settle in the following currencies:
U.S dollars, British pounds, Canadian dollars or Euros. Remittances are due
within 60 days of quarter end, one quarter in arrears. Due to the extended time
frame for settling the accounts plus the fluctuation in currency exchange rates,
the potential exists for the Company to realize gains and or losses related to
the exchange rates. Management is unable at this time to estimate the future
gain or losses, if any.
22
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 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 June 30, 2003, investments in equity
securities included an investment in the common stock of Curtiss-Wright
Corporation which represents approximately 6.9% (pre-tax) of the total
shareholders' equity, down from 12.4% as of December 31, 2002. The Company has
implemented steps to reduce its exposure to any individual security, and
therefore, has reduced its holdings by 167,400 shares as of June 30, 2003. The
Company realized gains on the sales of these securities of approximately $9.1
million. Additionally, through August 11, 2003, the Company sold an additional
173,400 shares of Curtiss-Wright, resulting in a realized gain of $9.2 million,
which will be recognized in the third quarter of 2003. The Company also reduced
its holdings in International Paper, selling 50,541 shares in July for a
realized gain of $1.6 million, also to be recognized in the third quarter of
2003.
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 and Argonaut Group reinvests the proceeds at lower
interest rates.
Exposure to interest rate risks 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 rated municipal bonds, corporate bonds and preferred stocks).
Less than 1.0% of the fixed income portfolio is invested in bonds rated lower
than "BBB", with a 20-year maximum effective maturity. During the three and six
months ended June 30, 2003, the Company recognized other than temporary losses
on the investment portfolio of $1.5 million and $3.8 million, respectively.
During the three and six months ended June 30, 2002, there was no other than
temporary impairment to the Company's investment portfolio.
Management has assessed these risks and believes that there have been no
material changes since December 31, 2002.
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 June 30, 2003.
There have been no changes in the Company's internal controls over financial
reporting during the three months ended June 30, 2003 that were identified in
connection with the evaluation referred to above that have materially affected,
or are reasonably likely to materially affect, the Company's internal control
over financial reporting.
23
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
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 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. Upon appeal, the amount of the
award was reduced further to $1,930,824 inclusive of all actual and punitive
damages, interest and attorneys fees. The judgment was paid in full on June 19,
2003.
Refer to Part I, Item 3 - "Legal Proceedings" in the Company's Annual Report on
Form 10-K for the year ended December 31, 2002 for additional discussion on the
Company's pending legal proceedings.
Item 2. Changes in Securities and Use of Proceeds
Refer to Part II, Item 2 - "Changes in Securities and Use of Proceeds: in the
Company's Quarterly Report on Form 10-Q for the three months ended March 31,
2003 for discussion on the Company's issuance of Series A Mandatory Convertible
Preferred Stock.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
The annual meeting of Argonaut Group, Inc. was held May 14, 2003. The following
matter was submitted to the shareholders at the meeting:
Votes were cast in the following manner in connection with the election of each
Director to serve until the next Annual Meeting of Shareholders:
No other items were submitted for a vote by the shareholders.
Item 5. Other Information
None
24
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
A list of exhibits filed herewith is contained on the Exhibit Index
immediately preceding such exhibits and is incorporated herein by
reference.
(b) Reports on Form 8-K
On August 6, 2003, the Company filed a current report on Form 8-K
announcing its operating results for the three and six months ended June
30, 2003.
25
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
August 14, 2003
26
EXHIBIT INDEX
Exhibit
No. Description
31.1 Certificate of the Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certificate of the Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32 Certificate of the Chief Executive Officer and the Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
27
EXHIBIT 31.1
CERTIFICATE OF COMPLIANCE
I, Mark E. Watson III, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Argonaut
Group, Inc;
2. Based on my knowledge, this report does not contain any untrue
statements of 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 report;
3. Based on my knowledge, the financial statements, and other
financial information included in this 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 report;
4. The registrant's other certifying officer and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and
15d-15(e)) for the registrant and have:
a. Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, 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 report is being prepared;
b. Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and
procedures, as of the end of the period covered by this report
based on such evaluation; and
c. Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially affect,
the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation of internal control over
financial reporting, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons
performing the equivalent functions):
a. All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which
are reasonably likely to adversely affect the registrant's ability
to record, process, summarize and report financial information;
and
b. Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
CERTIFIED this 14th day of August, 2003.
/s/ Mark E. Watson III
--------------------------
Mark E. Watson III
President and Chief Executive Officer
EXHIBIT 31.2
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 report does not contain any untrue
statements of 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 report;
3. Based on my knowledge, the financial statements, and other
financial information included in this 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 report;
4. The registrant's other certifying officer and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and
15d-15(e)) for the registrant and have:
a. Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, 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 report is being prepared;
b. Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and
procedures, as of the end of the period covered by this report
based on such evaluation; and
c. Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially affect,
the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation of internal control over
financial reporting, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons
performing the equivalent functions):
a. All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which
are reasonably likely to adversely affect the registrant's ability
to record, process, summarize and report financial information;
and
b. Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
CERTIFIED this 14th day of August, 2003.
/s/ Mark W. Haushill
-----------------------------------
Mark W. Haushill
Vice President
Chief Financial Officer and Treasurer
EXHIBIT 32
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 Quarterly Report on
Form 10-Q for the three and six months ended June 30, 2003 ("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 14th day of August, 2003.
/s/ Mark E. Watson III
--------------------------
Mark E. Watson III
President and Chief Executive Officer
EXBIBIT 32
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
Quarterly Report on Form 10-Q for the three and six months ended June 30, 2003
("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 14th day of August, 2003.
/s/ Mark W. Haushill
-----------------------------------
Mark W. Haushill
Vice President
Chief Financial Officer and Treasurer