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, 2004
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 6, 2004
Title Outstanding
Common Stock, par value $0.10 per share 27,661,831
ARGONAUT GROUP, INC.
TABLE OF CONTENTS
Page No.
Part I. FINANCIAL INFORMATION:
Item 1. Consolidated Financial Statements (unaudited):
Consolidated Balance Sheets
June 30, 2004 and December 31, 2003........................... 3
Consolidated Statements of Operations
Three and six months ended June 30, 2004 and 2003............. 4
Consolidated Statements of Comprehensive Income (Loss)
Three and six months ended June 30, 2004 and 2003............. 5
Consolidated Statements of Cash Flows
Three and six months ended June 30, 2004 and 2003............. 6
Notes to the Consolidated Financial Statements................. 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.................. 16
Item 3. Qualitative and Quantitative Disclosure About Market Risk....... 26
Item 4. Controls and Procedures......................................... 27
Part II. OTHER INFORMATION:
Item 1. Legal Proceedings............................................... 28
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases
of Equity Securities........................................... 28
Item 3. Defaults Upon Senior Securities................................. 28
Item 4. Submission of Matters to a Vote of Security Holders............. 28
Item 5. Other Information............................................... 29
Item 6. Exhibits and Reports on Form 8-K .............................. 29
2
Part I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
ARGONAUT GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in millions, except per share amounts)
June 30, December 31,
2004 2003
-------------- --------------
(Unaudited)
Assets:
Investments:
Fixed maturities, at fair value (cost: 2004 - $1,315.4; 2003 - $1,154.9) $ 1,319.8 $ 1,190.9
Equity securities, at fair value (cost: 2004 - $111.4; 2003 - $107.0) 175.5 170.7
Other long-term investments, at fair value (cost: 2004 - $17.1; 2003 - $12.1) 18.1 12.5
Short-term investments, at fair value which approximates cost 108.8 179.1
-------------- --------------
Total investments 1,622.2 1,553.2
-------------- --------------
Cash and cash equivalents 28.1 75.6
Accrued investment income 16.0 14.6
Premiums receivable 263.9 246.1
Reinsurance recoverables 561.0 535.0
Notes receivable 37.8 46.4
Goodwill 106.3 105.7
Deferred federal income tax asset, net 45.7 27.5
Deferred acquisition costs, net 65.1 62.5
Other assets 116.4 99.9
-------------- --------------
Total assets $ 2,862.5 $ 2,766.5
============== ==============
Liabilities:
Reserves for losses and loss adjustment expenses $ 1,509.9 $ 1,480.8
Unearned premiums 360.8 353.3
Funds held 196.4 187.2
Deferred gain, retroactive reinsurance 42.9 43.3
Junior subordinated debentures 67.0 27.5
Income taxes payable, net 7.5 19.7
Accrued expenses and other liabilities 122.4 115.5
-------------- --------------
Total liabilities 2,306.9 2,227.3
-------------- --------------
Shareholders' equity:
Preferred stock -$0.10 par, 5,000,000 shares authorized Series A mandatory
convertible preferred stock - 2,953,310 shares
issued and outstanding at June 30, 2004 and December 31, 2003 0.3 0.3
Common stock - $0.10 par, 70,000,000 shares authorized; 27,637,803 and 27,596,325
shares issued and outstanding at June 30, 2004 and December 31, 2003, respectively 2.8 2.8
Additional paid-in capital 224.0 220.5
Retained earnings 288.1 253.1
Deferred stock compensation (4.9) (2.6)
Accumulated other comprehensive income, net 45.3 65.1
-------------- --------------
Total shareholders' equity 555.6 539.2
-------------- --------------
Total liabilities and shareholders' equity $ 2,862.5 $ 2,766.5
============== ==============
See accompanying notes.
3
ARGONAUT GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share amounts)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- ----------------------------
2004 2003 2004 2003
------------- ------------- ------------- -------------
Premiums and other revenue:
Earned premiums $ 157.0 $ 144.9 $ 310.8 $ 269.0
Net investment income 15.7 13.3 30.4 26.8
Realized investment gains (losses), net (0.5) 7.7 2.0 63.7
------------- ------------- ------------- -------------
Total revenue 172.2 165.9 343.2 359.5
------------- ------------- ------------- -------------
Expenses:
Losses and loss adjustment expenses 96.3 101.5 192.3 188.8
Underwriting, acquisition, and
insurance expenses 55.6 52.2 110.2 99.6
Interest expense 2.4 1.9 4.5 4.1
------------- ------------- ------------- -------------
Total expenses 154.3 155.6 307.0 292.5
------------- ------------- ------------- -------------
Income before income taxes 17.9 10.3 36.2 67.0
Provision (benefit) for income taxes - (9.4) - 13.7
------------- ------------- ------------- -------------
Net income $ 17.9 $ 19.7 $ 36.2 $ 53.3
============= ============= ============= =============
Net income per common share:
Basic $ 0.63 $ 0.89 $ 1.27 $ 2.44
============= ============= ============= =============
Diluted $ 0.58 $ 0.80 $ 1.18 $ 2.31
============= ============= ============= =============
Weighted average common shares:
Basic 27,619,089 21,607,032 27,607,850 21,605,268
============= ============= ============= =============
Diluted 30,737,598 24,579,549 30,728,094 23,116,001
============= ============= ============= =============
See accompanying notes.
4
ARGONAUT GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in millions)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
2004 2003 2004 2003
------------ ----------- ----------- ------------
Net income $ 17.9 $ 19.7 $ 36.2 $ 53.3
------------ ----------- ----------- ------------
Other comprehensive income (loss):
Unrealized gains (losses) on securities:
Gains (losses) arising during the period (41.5) 35.4 (28.5) 26.4
Reclassification adjustment for (gains)/ losses
included in net income 0.5 (7.7) (2.0) (6.1)
------------ ----------- ----------- ------------
Other comprehensive income (loss) before tax (41.0) 27.7 (30.5) 20.3
Income tax provision (benefit) related to other
comprehensive income (loss) (14.4) 9.7 (10.7) 7.1
------------ ----------- ----------- ------------
Other comprehensive income (loss), net of tax (26.6) 18.0 (19.8) 13.2
------------ ----------- ----------- ------------
Comprehensive income (loss) $ (8.7) $ 37.7 $ 16.4 $ 66.5
============ =========== =========== ============
See accompanying notes
5
ARGONAUT GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
(Unaudited)
Six Months Ended
June 30,
---------------------------
2004 2003
------------ ------------
Cash flows from operating activities:
Net income $ 36.2 $ 53.3
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization and depreciation 7.1 4.8
Deferred federal income tax expense (benefit) (7.5) 7.2
Gains on sales of investments (2.0) (6.1)
Gains on sales of real estate - (57.6)
Change in:
Accrued investment income (1.4) (0.2)
Premiums receivable and reinsurance recoverables (43.8) (9.4)
Unearned premiums on ceded reinsurance (15.7) (26.0)
Reserves for losses and loss adjustment expenses 29.1 66.6
Unearned premiums 7.5 33.1
Other assets and liabilities, net (0.6) 8.5
------------ ------------
Cash provided by operating activities 8.9 74.2
------------ ------------
Cash flows from investing activities:
Sales of fixed maturity investments 178.2 36.8
Maturities and mandatory calls of fixed maturity investments 122.2 107.5
Sales of equity securities 2.7 10.9
Purchases of fixed maturity investments (468.0) (257.4)
Purchases of equity securities (6.5) (1.8)
Change in short-term investments 70.3 (62.3)
Cash collected on real estate notes receivables 8.6 10.5
Acquisition, net of cash received (0.6) -
Other, net (1.5) 6.0
------------ ------------
Cash used by investing activities (94.6) (149.8)
------------ ------------
Cash flows from financing activities:
Issuance of Series A mandatory convertible preferred stock - 34.9
Issuance of junior subordinated debentures 39.5 15.5
Related party note payable - 12.0
Stock options exercised 0.1 -
Secondary common stock offering expenses (0.2) -
Payment of cash dividend on preferred stock (1.2) -
------------ ------------
Cash provided (used) by financing activities: 38.2 62.4
------------ ------------
Change in cash and cash equivalents (47.5) (13.2)
Cash and cash equivalents, beginning of period 75.6 77.4
------------ ------------
Cash and cash equivalents, end of period $ 28.1 $ 64.2
============ ============
See accompanying notes
6
ARGONAUT GROUP, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)
Note 1 - Basis of Presentation
The accompanying Consolidated Financial Statements of Argonaut Group,
Inc. and its 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, 2003 that the Company filed with the
Securities and Exchange Commission on March 15, 2004.
The interim financial data as of June 30, 2004 and 2003 and for the three and
six months ended June 30, 2004 and 2003 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 2004.
The balance sheet at December 31, 2003 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 December 2003, the Financial Accounting Standards Board revised Statement of
Financial Accounting Standards ("SFAS") No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits". This Statement retains the
disclosures required by the original SFAS No. 132 and requires additional
disclosures regarding the assets, obligations, cash flows and net periodic
benefit cost of defined benefit pension and postretirement plans. In addition,
this Statement requires interim period disclosure of the components of net
period benefit cost and contributions if significantly different from previously
reported amounts. SFAS No. 132, as revised, is effective for fiscal years ending
after December 15, 2003. The Company adopted the provisions of SFAS No. 132, as
revised, effective December 15, 2003.
Effective November 2003, the Company curtailed its pension plan. This
curtailment resulted in a reduction of pension expense of $3.9 million, which
was recognized in November 2003. As of the curtailment date, the pension plan
was over funded, resulting in a prepaid pension asset of approximately $7.3
million. The estimated pension liability as of the curtailment date was $25.2
million (vested and non-vested participants). Based on the current funding
status of the pension plan, the effects of the curtailment, the expected changes
in pension plan asset values and pension obligations in 2004, the Company does
not believe any significant pension expense will be recognized during 2004.
Additionally, the Company believes that no significant funding of its pension
plan will be required during the year ended December 31, 2004.
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, 2004 and 2003:
7
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- -------------------------------
(Dollars in millions except per share data) 2004 2003 2004 2003
-------------- -------------- -------------- --------------
Net income $ 17.9 $ 19.7 $ 36.2 $ 53.3
Preferred stock dividends (0.6) (0.6) (1.2) (0.6)
-------------- -------------- -------------- --------------
Income available to common shareholders 17.3 19.1 $ 35.0 $ 52.7
Effect of dilutive securities:
Preferred stock dividends 0.6 0.6 1.2 0.6
-------------- -------------- -------------- --------------
Income available to common shareholders
after assumed conversion $ 17.9 $ 19.7 $ 36.2 $ 53.3
Weighted average shares-basic 27,619,089 21,607,032 27,607,850 21,605,268
Effect of dilutive securities:
Stock options 165,199 19,207 166,934 9,603
Convertible preferred stock 2,953,310 2,953,310 2,953,310 1,501,130
-------------- -------------- -------------- --------------
Weighted average shares-diluted 30,737,598 24,579,549 30,728,094 23,116,001
============== ============== ============== ==============
Net income per common share-basic $ 0.63 $ 0.89 $ 1.27 $ 2.44
Net income per common share-diluted $ 0.58 $ 0.80 $ 1.18 $ 2.31
For the three and six months ended June 30, 2004, options to purchase 1,056,550
shares of common stock at prices ranging from $18.38 to $35.50 were not included
in the computation of diluted earnings per share as the options' exercise price
was greater than the average market price of the common shares. These options
expire at varying times from 2005 through 2014. For the three and six months
ended June 30, 2003, options to purchase 1,697,800 shares of common stock at
prices ranging from $15.70 to $35.50 were not included in the computation of
diluted earnings per share as 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.
Note 4 - Common Stock
In April 2004, the Board of Directors recommended an amendment to the Company's
Amended and Restated Articles of Incorporation to increase the authorized shares
to 70 million from 35 million. The shareholders approved this recommendation at
the May 11, 2004 shareholder meeting.
Note 5 - Dividends to Common Shareholders
In conjunction with the sale of the Series A Mandatory Convertible Preferred
Stock in March 2003, the Company suspended dividend payments to common
shareholders for a period of two years. No dividends were declared or paid to
common shareholders during the three and six months ended June 30, 2004 and
2003.
Note 6 - Western MacArthur Settlement
On April 14, 2004, the Bankruptcy Court presiding over the Chapter 11 Bankruptcy
of MacArthur Company, Western MacArthur Company, and Western Asbestos Company
(the "MacArthur Companies") entered orders giving final approval to settlements
reached with all property and casualty insurers of the MacArthur Companies
currently in litigation, including Argonaut Insurance Company. A bankruptcy
reorganization plan filed by the MacArthur Companies will be implemented and all
existing and future claims against the MacArthur Companies related to asbestos
will be channeled solely to a trust. Argonaut Insurance Company contributed
$29.8 million into the bankruptcy trust and received a release from the
MacArthur Companies as to any and all existing or future asbestos-related
claims, including any claims for extra-contractual relief, arising directly or
indirectly out of any alleged coverage under the nine Argonaut Insurance Company
8
polices at issue. In addition, claimants seeking funds from the trust will be
required to execute release and indemnity agreements in favor of Argonaut
Insurance Company as a condition to receiving payment. The Company ceded the
majority of the $29.8 million contribution to reinsurers. Based on information
currently available to the Company, management's best estimate of Argonaut
Insurance Company's asbestos and environmental reserves remains unchanged
following the settlement.
Note 7 - Income Taxes
The Company's income tax provision includes the following components:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- -------------------------------
(in millions) 2004 2003 2004 2003
-------------- -------------- --------------- --------------
Current tax provision $ 4.1 $ 0.2 $ 7.5 $ 6.5
Deferred tax provision (benefit) related to:
Future tax deductions (0.7) (2.4) (0.5) (5.9)
Net operating loss carryforward - 5.8 2.7 27.1
Deferred alternative minimum tax provision 2.9 (0.3) 2.6 (1.6)
Valuation allowance change (6.3) (12.7) (12.3) (12.4)
-------------- -------------- --------------- --------------
Income tax provision $ - $ (9.4) $ - $13.7
============== ============== =============== ==============
A reconciliation of the Company's income tax provision 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) 2004 2003 2004 2003
-------------- -------------- --------------- --------------
Income tax provision at statutory rates $ 6.3 $ 3.7 $ 12.7 $ 21.7
Tax effect of:
Tax exempt interest (0.1) - (0.1) (0.1)
Dividends received deduction (0.2) (0.3) (0.4) (0.5)
Valuation allowance change (6.3) (12.7) (12.3) (12.4)
Other permanent adjustments, net 0.2 - 0.1 0.1
State income tax provision 0.1 (0.1) - 4.9
-------------- -------------- --------------- --------------
Income tax provision $ - $ (9.4) $ - $ 13.7
============== ============== =============== ==============
Deferred taxes arise from temporary differences in the recognition of revenues
and expenses for tax and financial reporting purposes. The Company's deferred
tax asset is supported by tax planning strategies, the reversal of taxable
temporary differences and the recognition of future income. For the three and
six months ended June 30, 2004, the Company reduced the deferred tax asset
valuation allowance by $6.3 million and $12.3 million, respectively. At June 30,
2004, the Company has a deferred tax asset of $45.7 million, net of a deferred
tax asset valuation allowance of $36.8 million. The reduction of the deferred
tax asset valuation allowance was based on management's evaluation of the
recoverability of the deferred tax asset. Management regularly evaluates the
recoverability of the deferred tax asset and will adjust the valuation allowance
accordingly.
Note 8 - 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.
9
In May 2004, the shareholders approved an amendment to the Company's Amended and
Restated Stock Incentive Plan (the "Amended Plan"). The Amended Plan provides
for the following: (a) prohibits any reduction in the exercise price of an
option without shareholder approval; (b) increases the number of shares
available under the plan by 1,750,000; (c) limits grants to individual employees
to 300,000 shares within any calendar year (except in the year of their initial
employment); (d) prohibits the granting of options with an exercise price below
fair market value on the date of grant; (e) reduces the maximum duration of
future grants to seven years; and (f) extends the expiration date of the Plan to
April 2, 2014. Under the Amended Plan, an aggregate of 6,250,000 shares of the
Company's common stock may be issued to select executives and other key
employees. The stock awards may be in the form of incentive stock options,
non-qualified stock options, non-vested stock awards and stock appreciation
rights.
Under the Amended Plan, up to 1,250,000 shares may be issued as non-vested stock
to officers and certain key employees. The shares vest in equal annual
installments over a period of three to four 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. As of June 30, 2004,
256,827 shares are outstanding, net of forfeitures of 28,865 shares. Of the
shares outstanding, 45,126 shares will vest subject to the achievement of an
objective performance goal. Upon granting of the non-vested stock, unearned
compensation equivalent to the market value at the date of grant is charged to
shareholders' equity and subsequently amortized to expense ratably over the
vesting period. For the three months ended June 30, 2004 and 2003, the Company
recognized compensation expense of $0.6 million and $0.3 million, respectively.
For the six months ended June 30, 2004 and 2003, the Company recognized
compensation expense of $0.9 million and $0.5 million, respectively.
In August 2003, the Company granted selected executives and other key employees
stock option awards whose vesting was contingent upon the employee meeting
defined performance measures. Upon meeting the performance measures, the options
would vest over a four year term. As of February 2, 2004, all of the performance
measures were met and the performance based options were issued. Due to timing
differences between the grant date and the measurement date of the options, the
Company is recognizing compensation expense for the difference between the
exercise price of the option and the fair market value of the Company's common
stock as of the measurement date over the vesting period of these options. For
the three and six months ended June 30, 2004, the Company recognized
compensation expense related to these stock options of $0.1 million and $0.3
million, respectively.
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) 2004 2003 2004 2003
------------- ------------ ------------- ------------
Net income, as reported $ 17.9 $ 19.7 $ 36.2 $ 53.3
Add: Total deferred stock compensation expense
included in reported net income, net of taxes 0.5 0.2 0.8 0.3
Deduct: Total stock-based employee compensation
determined under fair value based methods for
all awards, net of tax (0.7) (0.3) (1.2) (0.5)
------------- ------------ ------------- ------------
Pro forma net income $ 17.7 $ 19.6 $ 35.8 $ 53.1
============= ============ ============= ============
Earnings per share
Basic - as reported $ 0.63 $ 0.89 $ 1.27 $ 2.44
Basic - pro forma $ 0.62 $ 0.88 $ 1.25 $ 2.43
Diluted - as reported $ 0.58 $ 0.80 $ 1.18 $ 2.31
Diluted - pro forma $ 0.57 $ 0.80 $ 1.16 $ 2.30
10
Note 9 - 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 $58.3 million and
$21.4 million as of June 30, 2004 and 2003, respectively:
Six Months Ended
June 30,
-----------------------
(in millions) 2004 2003
----------- -----------
Net reserves - beginning of year $ 965.5 $ 838.2
Net reserves from renewal rights acquisition - 0.7
Net reserves ceded under retroactive reinsurance contracts 0.4 (0.5)
Add:
Loss and LAE incurred during calendar year, net of reinsurance:
Current accident year 193.7 177.3
Prior accident years (1.4) 11.5
----------- -----------
Loss and LAE incurred during current accident year, net of reinsurance 192.3 188.8
Deduct:
Loss and LAE payments made during current calendar year, net of reinsurance:
Current accident year 20.1 22.5
Prior accident years 130.9 105.6
----------- -----------
Loss and LAE payments made during current calendar year, net of reinsurance: 151.0 128.1
----------- -----------
Net reserves, end of period 1,007.2 899.1
Add:
Reinsurance recoverable on unpaid losses & LAE, end of period 502.7 449.1
----------- -----------
Gross reserves - end of period $ 1,509.9 $ 1,348.2
=========== ===========
Loss development on prior accident years recognized in 2003 was primarily the
result of the risk management segment recording adverse development on one
wrap-up account of approximately $5.0 million, combined with an increase in the
allowance for doubtful accounts for balances due from reinsurers of
approximately $5.0 million.
Note 10 - 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, risk management, specialty commercial 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
decisions regarding the acquisition and disposal of securities reside with the
executive management of the Company and are 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.
11
Revenues and income before taxes for each segment were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- --------------------------------
(in millions) 2004 2003 2004 2003
-------------- -------------- --------------- ---------------
Revenues:
Earned premiums
Excess & surplus lines $ 75.4 $ 72.5 $ 149.4 $ 134.5
Risk management 32.5 35.6 66.9 64.1
Specialty commercial 35.1 30.2 66.9 58.3
Public entity 14.0 6.6 27.6 12.1
Run-off lines - - - -
-------------- -------------- --------------- ---------------
Total earned premiums 157.0 144.9 310.8 269.0
Net investment income
Excess & surplus lines 4.9 4.1 9.6 7.5
Risk management 7.7 6.6 14.7 13.9
Specialty commercial 2.6 2.5 5.1 4.7
Public entity 0.3 0.1 0.7 0.3
Run-off lines - - - -
Corporate & other 0.2 - 0.3 0.4
-------------- -------------- --------------- ---------------
Total net investment income 15.7 13.3 30.4 26.8
Realized investment gains, net (0.5) 7.7 2.0 63.7
-------------- -------------- --------------- ---------------
Total revenue $ 172.2 $ 165.9 $ 343.2 $ 359.5
============== ============== =============== ===============
Income (loss) before income tax
Excess & surplus lines 13.3 10.9 25.2 18.8
Risk management 4.5 (8.7) 8.9 (16.7)
Specialty commercial 3.7 1.2 6.3 3.5
Public entity 0.9 0.3 1.8 0.6
Run-off lines - - - -
-------------- -------------- --------------- ---------------
Total segment income before taxes 22.4 3.7 42.2 6.2
Corporate & other (4.0) (1.1) (8.0) (2.9)
Net realized investment gains (losses) (0.5) 7.7 2.0 6.1
Net realized gains on sales of real estate - - - 57.6
-------------- -------------- --------------- ---------------
Total income before income tax $ 17.9 $ 10.3 $ 36.2 $ 67.0
============== ============== =============== ===============
Identifiable assets for each segment were as follows:
June 30, December 31,
(in millions) 2004 2003
------------ ------------
Excess & surplus lines $ 844.9 $ 744.2
Risk management 1,493.3 1,483.7
Specialty commercial 404.0 370.2
Public entity 89.8 80.9
Run-off lines - -
Corporate & other 30.5 87.5
------------ ------------
Total $ 2,862.5 $ 2,766.5
============ ============
12
Note 11 -Underwriting, Acquisition and Insurance Expenses
Underwriting, acquisition and insurance expenses for the three and six months
ended June 30, 2004 and 2003 were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- ------------------------------
(in millions) 2004 2003 2004 2003
------------- ------------- -------------- --------------
Commissions $ 28.3 $ 24.2 $ 51.4 $ 46.0
General Expenses 26.4 22.1 51.1 45.2
State assessments 1.7 3.6 5.1 5.6
Taxes, licenses and bureau fees 2.6 3.0 5.9 5.9
------------- ------------- -------------- --------------
59.0 52.9 113.5 102.7
Deferral of policy acquisition costs (3.4) (0.7) (3.3) (3.1)
------------- ------------- -------------- --------------
Total underwriting, acquisition and
insurance expense $ 55.6 $ 52.2 $ 110.2 $ 99.6
============= ============= ============== ==============
Note 12 - Junior Subordinate Debentures
On April 29, 2004, Argonaut Group Statutory Trust IV, a wholly-owned subsidiary
of the Company, sold 13,000 Floating Rate Capital Securities (liquidation amount
$1,000 per Capital Security) in a private sale for $13.0 million. The Trust used
the proceeds from this sale, together with the proceeds from its sale of 403
shares of Floating Rate Common Securities (liquidation amount $1,000 per Common
Security) to the Company, to buy a series of Floating Rate Junior Subordinated
Debentures due 2034 from the Company. The Debentures have the same payment terms
as the Capital Securities.
The interest rate on the Debentures and the Capital Securities is equal to
3-Month LIBOR plus 3.85% (not to exceed 12.5% prior to May 15, 2009), which rate
is reset quarterly. The Debentures are unsecured and subordinated in right of
payment to all of the Company's future senior indebtedness. After April 29,
2009, 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 also has the
right to redeem all of the Debentures prior to April 29, 2009 upon the happening
of specified events at a price ranging from 105% to 101% of the principal amount
of the Debentures, plus accrued and unpaid interest to the date of redemption.
On May 12, 2004, Argonaut Group Statutory Trust VI, a wholly-owned subsidiary of
the Company, sold 13,000 Floating Rate Capital Securities (liquidation amount
$1,000 per Capital Security) in a private sale for $13.0 million. The Trust used
the proceeds from this sale, together with the proceeds from its sale of 403
shares of Floating Rate Common Securities (liquidation amount $1,000 per Common
Security) to the Company, to buy a series of Floating Rate Junior Subordinated
Debentures due 2034 from the Company. The Debentures have the same payment terms
as the Capital Securities.
The interest rate on the Debentures and the Capital Securities is equal to
3-Month LIBOR plus 3.8% (not to exceed 12.5% prior to June 17, 2009), which rate
is reset quarterly. The Debentures are unsecured and subordinated in right of
payment to all of the Company's future senior indebtedness. After June 17, 2009,
the Company has 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 also has the right to
redeem all of the Debentures prior to June 17, 2009 upon the happening specified
events as a price equal to 107.5% of the principal amount of the Debentures,
plus accrued and unpaid interest to the date of redemption.
13
On May 26, 2004, Argonaut Group Statutory Trust V, a wholly-owned subsidiary of
the Company, sold 12,000 Floating Rate Capital Securities (liquidation amount
$1,000 per Capital Security) in a private sale for $12.0 million. The Trust used
the proceeds from this sale, together with the proceeds from its sale of 372
shares of Floating Rate Common Securities (liquidation amount $1,000 per Common
Security) to the Company, to buy a series of Floating Rate Junior Subordinated
Debentures due 2034 from the Company. The Debentures have the same payment terms
as the Capital Securities.
The interest rate on the Debentures and the Capital Securities is equal to
3-Month LIBOR plus 3.85% (not to exceed 12.5% prior to May 24, 2009), which rate
is reset quarterly. The Debentures are unsecured and subordinated in right of
payment to all of the Company's future senior indebtedness. After May 24, 2009,
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 also has the right to
redeem all of the Debentures prior to May 24, 2009 upon the happening of
specified events at a price ranging from 105% to 101% of the principal amount of
the Debentures, plus accrued and unpaid interest to the date of redemption.
The Company used the net proceeds from the sale of the Debentures to increase
the capital of its insurance subsidiaries and for general corporate purposes.
Note 13 - 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. For
the six months ended June 30, 2004, these payments totaled $0.2 million. 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, 2004, Fayez Sarofim & Co. managed $156.3 million fair
value 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, Colony Insurance Company entered into a quota share
reinsurance agreement with HCC Insurance Holdings, Inc. ("HCC"), a greater than
10% shareholder. For the six months ended June 30, 2004, the Company ceded
approximately $30.7 million of gross written premiums, $27.4 million of earned
premiums and $15.8 million of losses and loss adjustment expenses. The Company
earned a ceding commission of $5.3 million.
Effective January 1, 2003, Argonaut Insurance Company entered into a quota share
reinsurance agreement with HCC. Under the original terms of the agreement, the
Company assumed 3.33% of the premiums and losses under HCC's USA Directors and
Officers Liability program, and 5.0% of the premiums and losses under HCC's
International Directors and Officers Liability program. Effective January 1,
2004, the agreement was amended and Argonaut Insurance Company now assumes 1.5%
of the premiums and losses under each program. For the six months ended June 30,
2004, gross written premiums under this program totaled $5.2 million. For the
six months ended June 30, 2004, the Company expensed ceding and other
commissions of $3.2 million related to this business.
Note 14 - Supplemental Cash Flows Information
Income taxes paid. The Company paid income taxes of $19.6 million and $0.1
million during the six months ended June 30, 2004 and 2003, respectively.
14
Interest paid. The Company paid interest on the junior subordinated debentures
of $0.6 million during the six months ended June 30, 2004. The Company paid
interest on a note payable of $0.4 million during the six months ended June 30,
2003.
Notes receivable. The Company received non-cash proceeds in the form of notes
receivable in the amount of $51.2 million in conjunction with the sales of
certain real estate holdings during the six months ended June 30, 2003. Cash
payments in the amount of $8.5 million were received during the six months ended
June 30, 2004, and the balance of these notes was $37.8 million as of June 30,
2004.
15
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following is a discussion and analysis of the consolidated results of
financial condition and operations of Argonaut Group, Inc. and its subsidiaries
(collectively, "Argonaut Group" or the "Company") for the three and six months
ended June 30, 2004 and 2003. 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 Financial Condition and Results
of Operation contained in the Company's Annual Report on Form 10-K for the year
ended December 31, 2003 that the Company filed with the Securities and Exchange
Commission on March 15, 2004.
Forward Looking Statements
Management's Discussion and Analysis of Financial Condition and Results of
Operation, Qualitative and Quantitative Disclosures 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.
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) 2004 2003 2004 2003
------------- ------------- ------------ ------------
Gross written premiums $ 221.6 $ 199.5 $ 421.7 $ 373.5
============= ============= ============ ============
Earned premiums $ 157.0 $ 144.9 $ 310.8 $ 269.0
Net investment income 15.7 13.3 30.4 26.8
Realized investment gains (losses), net (0.5) 7.7 2.0 63.7
------------- ------------- ------------ ------------
Total revenue $ 172.2 $ 165.9 $ 343.2 $ 359.5
============= ============= ============ ============
Income before taxes 17.9 10.3 36.2 67.0
Provision (benefit) for income taxes - (9.4) - 13.7
------------- ------------- ------------ ------------
Net income $ 17.9 $ 19.7 $ 36.2 $ 53.3
============= ============= ============ ============
Combined ratio 96.7% 106.2% 97.3% 107.2%
============= ============= ============ ============
The increase in consolidated gross written premiums was primarily attributable
to an increase in renewal business. For the three months ended June 30, 2004,
consolidated gross written premiums from renewal business totaled $108.8
million, compared to $85.8 million for the same period in 2003. For the six
months ended June 30, 2004, consolidated gross written premiums from renewal
business totaled $210.5 million, compared to $167.7 million for the same period
in 2003. The increase in premiums on renewal business was primarily the result
of rate increases across virtually all lines of business.
16
Also included in consolidated gross written premiums were premiums from new
business of $106.8 million and $199.0 million for the three and six months ended
June 30, 2004, respectively, compared to $116.1 million and $217.0 million for
the same periods in 2003. The Company entered into two renewal rights agreements
in December 2003, which accounted for approximately $19.6 million and $27.7
million of premiums from new business for the three and six months ended June
30, 2004, respectively. Consolidated gross written premiums for the three and
six months ended June 30, 2004 were also impacted by approximately $10.2 million
and $22.3 million, respectively, from premiums written and assumed under various
reinsurance agreements, partially offset by endorsements and cancellations of
$4.1 million and $10.1 million, respectively.
The increase in consolidated earned premiums for the three and six months ended
June 30, 2004 as compared to the same periods in 2003 were primarily the result
of growth in all lines due to rate increases and new business written in 2003 as
well as business emanating from renewal rights acquisitions entered into in 2002
and 2003.
Consolidated net investment income was greater for the three and six months
ended June 30, 2004 compared to the same periods in 2003 due to higher invested
balances resulting from the investment of proceeds from various capital raising
initiatives combined with positive cash flows from operations, partially offset
by lower yields. Consolidated invested assets totaled $1,622.2 million and
$1,372.3 million at June 30, 2004 and 2003, respectively.
The Company manages its investment portfolio to minimize losses, both realized
and unrealized. Realized investment losses for the three months ended June 30,
2004 were $0.5 million, which were primarily attributable to the Company
reallocating its fixed income portfolio. Realized investment gains for the six
months ended June 30, 2003 included gains on sales of three real estate holdings
totaling $57.6 million. Included in realized investment gains for the three and
six months ended June 30, 2003 were write downs of $1.5 million and $3.8
million, respectively, due to the recognition of other than temporary
impairments of securities. During the same periods in 2004, the Company did not
incur any other than temporary impairments losses in its investment portfolio.
The Company's unrealized gains, net of tax, on investment securities declined by
$26.6 million and $19.8 million during the three and six months ended June 30,
2004, respectively, to $45.3 million as of June 30, 2004. The decrease was
primarily attributable to rising interest rates, which negatively impacted the
fair market value of the Company's fixed maturity portfolio. The Company has the
ability and intent to hold these investment securities until such time as they
recover their value.
The consolidated loss ratios were 61.3% and 61.9% for the three and six months
ended June 30, 2004, respectively, compared to 70.1% and 70.2% for the three and
six months ended June 30, 2003, respectively. The improvement in the loss ratios
was primarily attributable to the effects of rate increases and improved terms
and conditions implemented over the past two years coupled with the
restructuring of the risk management segment during 2003. Adverse loss
development for the three months ended June 30, 2003 was the result of a $5.0
million increase to the allowance for doubtful accounts for balances due from
reinsurers. There was also adverse loss development of $5.0 million on one
construction account during the first quarter of 2003. The total of these two
adjustments accounted for the majority of the loss development for the six
months ended June 30, 2003. (See the discussion under "Risk Management" below.)
The consolidated expense ratios were 35.4% and 36.1% for the three months ended
June 30, 2004 and 2003, respectively. The consolidated expense ratios were 35.4%
and 37.0% for the six months ended June 30, 2004 and 2003, respectively. The
improvement in the expense ratios was primarily due to increased premium
volumes, partially offset by increased expenses related to the start up of the
renewal rights agreements acquired in December 2003.
17
Consolidated interest expense was $2.4 million and $1.9 million for the three
months ended June 30, 2004 and 2003, respectively. Consolidated interest expense
was $4.5 million and $4.1 million for the six months ended June 30, 2004 and
2003, respectively. Interest expense of approximately $1.6 million and $3.2
million for the three and six months ended June 30, 2004, respectively, was
incurred by the Company for funds withheld by the Company under a retroactive
reinsurance contract, compared to $1.4 million and $3.5 million for the same
periods in 2003. Additionally, for the three and six months ended June 30, 2004,
the Company incurred approximately $0.6 million and $1.0 million, respectively,
of interest expense related to the junior subordinated debentures issued by the
Company during 2003 and 2004. The Company incurred $0.5 million in interest
expense for the three and six months ended June 30, 2003 for these debentures.
The Company paid interest on a note payable of $0.4 million during the six
months ended June 30, 2003.
The consolidated provision for income taxes for the three and six months ended
June 30, 2004 was $0, due to a reduction of the deferred tax asset valuation
allowance of $6.3 million and $12.3 million, respectively. The reduction of the
deferred tax asset valuation allowance was based on management's evaluation of
the recoverability of the deferred tax asset. Management anticipates that the
deferred tax asset valuation allowance will ultimately be recovered in the
future. Management regularly evaluates the recoverability of the deferred tax
asset and will adjust the valuation allowance accordingly. The consolidated
benefit for income taxes for the three months ended June 30, 2003 was $9.4
million, primarily due to a decrease in the deferred tax asset valuation
allowance of $12.7 million. The consolidated provision for income taxes for the
six months ended June 30, 2003 was $13.7 million, primarily due to the
recognition of federal and state taxes on the gains from the sale of real estate
during the period partially offset by a decrease in the deferred tax asset
valuation allowance of $12.4 million.
Segment Results
As of June 30, 2004, the Company's operations include four on-going business
segments: excess and surplus lines, risk management, specialty commercial and
public entity. Additionally, the Company has one run-off segment for products it
no longer underwrites. 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 reside with the executive management of the Company and are not under
the control of the individual business segments.
Excess and Surplus Lines. The following table summarizes the results of
operations for excess and surplus lines segment for the three and six months
ended June 30, 2004 and 2003:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- -----------------------------
(in millions) 2004 2003 2004 2003
------------- ------------- ------------- -------------
Gross written premiums $ 110.4 $ 99.4 $ 210.1 $ 184.1
============= ============= ============= =============
Earned premiums 75.4 72.5 149.4 134.5
Losses and loss adjustment expenses 44.5 43.7 89.1 82.2
Underwriting expense 22.5 22.0 44.7 41.0
------------- ------------- ------------- -------------
Underwriting income 8.4 6.8 15.6 11.3
Investment income, net 4.9 4.1 9.6 7.5
------------- ------------- ------------- -------------
Income before taxes $ 13.3 $ 10.9 $ 25.2 $ 18.8
============= ============= ============= =============
Combined ratio 88.9% 90.7% 89.6% 91.6%
============= ============= ============= =============
The increase in gross written premiums for the three and six months ended June
30, 2004 was primarily attributable to increases in renewal business. For the
18
three months ended June 30, 2004, gross written premiums derived from renewal
business was $48.4 million compared to $30.5 million for the same period in
2003. Gross written premiums from renewal business were $94.3 million and $55.4
million for the six months ended June 30, 2004 and 2003, respectively. Gross
written premiums related to new business declined to $66.1 million for the three
months ended June 30, 2004, compared to $73.9 million for the same period of
2003. Gross written premiums from new business were $125.9 million and $140.0
million for the six months ended June 30, 2004 and 2003, respectively. The
decline was primarily attributable to increased competition in the excess and
surplus market, as well as from the standard market, primarily in property lines
of business. Also impacting gross written premiums were cancellations and
endorsements, which reduced gross written premiums by approximately $4.1 million
and $10.1 million for the three and six months ended June 30, 2004,
respectively, compared to $5.0 million and $11.3 million for the same periods in
2003.
Earned premiums increased to $75.4 million and $149.4 million for the three and
six months ended June 30, 2004, compared to $72.5 million and $134.5 million for
the same periods in 2003. The increase in earned premiums was primarily due to
written premium growth in 2003. Partially offsetting the increase in earned
premiums are premiums ceded under a quota share reinsurance agreement of
approximately $14.7 million and $27.4 million for the three and six month
periods ended June 30, 2004, respectively. Earned premiums ceded for the three
and six months ended June 30, 2003 were $1.7 million, as the agreement was
effective March 31, 2003.
The excess and surplus lines segment's loss ratios were 59.1% and 59.6% for the
three and six months ended June 30, 2004, respectively, compared to 60.3% and
61.1% for the same periods in 2003. The improvement was primarily the result of
rate increases realized over the past year. Loss reserves for the excess and
surplus lines were $398.4 million as of June 30, 2004, compared to $225.6
million as of June 30, 2003.
The expense ratios for the three and six months ended June 30, 2004 were 29.8%
and 30.0%, respectively compared to 30.4% and 30.5% for the same periods in
2003. The improvement was due to economies of scale resulting from the increase
in gross written premiums related to fixed expenses which was partially offset
by increases in variable expenses.
The increase in net investment income for the three and six months ended June
30, 2004 as compared to the same periods in 2003 was the result of an increase
in invested assets due to positive cash flow over the past twelve months,
combined with capital contributions of $22.5 million. Net invested assets
increased to $545.9 million as of June 30, 2004, compared to $443.9 million as
of June 30, 2003.
Risk Management. The following table summarizes the results of operations for
the risk management segment for the three and six months ended June 30, 2004 and
2003:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- -----------------------------
(in millions) 2004 2003 2004 2003
------------- ------------- ------------- -------------
Gross written premiums $ 41.5 $ 53.1 $ 84.6 $ 96.7
============= ============= ============= =============
Earned premiums 32.5 35.6 66.9 64.1
Losses and loss adjustment expenses 20.4 31.7 42.8 58.0
Underwriting expense 15.3 19.2 29.9 36.7
------------- ------------- ------------- -------------
Underwriting loss (3.2) (15.3) (5.8) (30.6)
Investment income, net 7.7 6.6 14.7 13.9
------------- ------------- ------------- -------------
Income (loss) before taxes $ 4.5 $ (8.7) $ 8.9 $ (16.7)
============= ============= ============= =============
Combined ratio 109.7% 143.0% 108.7% 147.8%
============= ============= ============= =============
Gross written premiums for the three and six months ended June 30, 2004 were
impacted by the shift in written premiums toward casualty risk management
solutions for upper-middle market accounts implemented in March 2003. Gross
19
written premiums for the upper middle market accounts were $31.9 million for the
three months ended June 30, 2004, of which $9.9 million was new business and
$22.0 million was renewal business. Gross written premiums for the upper middle
market accounts were $17.4 million for the three months ended June 30, 2003.
Gross written premiums for the upper middle market accounts were $63.1 million
and $37.3 million for the six months ended June 30, 2004 and 2003, respectively.
As a result of the product shift discussed above, the Company discontinued the
active underwriting of select programs during 2003 to focus on the upper middle
market accounts. These non-strategic products resulted in gross written premiums
of $0.2 million and $2.0 million for the three and six months ended June 30,
2004, respectively, compared to $17.4 million and $33.1 million for the same
periods in 2003.
Included in gross written premiums in the three and six months ended June 30,
2004 were $6.7 million and $11.5 million, respectively, for certain agreements
for which the Company cedes a majority of the premiums and receives a ceding
commission. Gross written premiums under these agreements were $4.5 million and
$11.5 million for the same periods ended 2003.
Premiums assumed under a quota share agreement from insurance subsidiaries of
HCC Insurance Holdings, Inc. ("HCC") for directors and officers coverage were
$3.4 million and $5.1 million for the three and six months ended June 30, 2004,
respectively. Gross written premiums under this agreement were $5.8 million for
the three and six months ended June 30, 2003, respectively, as the agreement was
initiated during the second quarter of 2003. The decrease in the gross written
premiums under the HCC contract in 2004 as compared to 2003 was the result of a
reduction of the ceding percentages from 3.33% for premiums written under the
domestic program and 5.0% of premium written under the international program to
1.5% of premiums written under all programs effective January 1, 2004.
Premiums assumed from involuntary pools were ($0.7) million for the three months
ended June 30, 2004 compared to $7.9 million for the same period in 2003.
Premiums assumed from involuntary pools were $2.9 million and $8.9 million for
the six months ended June 30, 2004 and 2003, respectively. The decrease in the
premiums assumed in 2004 as compared to 2003 was due to a reduction of the
assessments due to a decline in premiums written in the state of Massachusetts.
Earned premiums for the three months ended June 30, 2004 were $3.1 million lower
than the same period in 2003. This decrease was primarily driven by a $9.8
million reduction in earned premiums for non-strategic products for which the
Company is exiting and a $4.4 million reduction in earned premiums on the
premiums assumed from involuntary pools. Partially offsetting these decreases
were $7.0 million in additional premiums earned for the upper middle market
accounts, coupled with a $4.6 million increase for premiums earned under the HCC
agreement. Earned premiums for the six months ended June 30, 2004 were $2.8
million higher than for the same period in 2003. The increase was primarily due
to $12.0 million of additional earned premiums on the upper middle market
accounts, combined with $7.7 million of additional earned premiums under the HCC
agreement. Partially offsetting these increases were decreases in earned
premiums in the non-strategic products for which the Company is exiting
combined, with a reduction of earned premiums on the premiums assumed from
involuntary pools.
Loss and loss adjustment expenses for the three and six months ended June 30,
2004 resulted in a loss ratio of 62.8% and 64.1%, respectively, compared to
88.8% and 90.6% for the same periods in 2003. Losses and loss adjustment expense
for the three months ended June 30, 2003 included $5.0 million of adverse
development due to an increase in the allowance for doubtful accounts balances
from reinsurers. Additionally, losses and loss adjustment expense for the six
months ended June 30, 2003 included adverse development of $5.0 million
attributable to one multi-year construction account that was non-renewed in
January 2004. Beginning in 2003, the Company has focused on writing accounts
targeting casualty risk management solutions for upper-middle market insureds,
and as a result, focused on underwriting large deductible policies. These large
deductible accounts have produced a better loss ratio than the products that the
Company has exited. Loss reserves were $647.7 million and $644.4 million as of
June 30, 2004 and 2003, respectively.
20
The expense ratios for the three and six months ended June 30, 2004 were 46.9%
and 44.6%, respectively, compared to 54.2% and 57.2% for the same periods in
2003. During the three months ended June 30, 2003, administrative expenses of
$2.3 million were recorded related to the assumption of premium from involuntary
pools. Restructuring efforts initiated in March 2003 resulted in $0.6 million
and $1.5 million in expense being recorded during the three and six months ended
June 30, 2003, respectively, for personnel costs and other associated costs.
This effort along with continued expense management initiatives have resulted in
decreased levels of expenses in the three and six months ended June 30, 2004.
Investment income increased in the three and six months ended June 30, 2004 as
compared to 2003 due to higher invested balances. Invested assets were $724.2
million as of June 30, 2004, compared to $645.5 million as of June 30, 2003.
Specialty Commercial. The following table summarizes the results of operations
for the specialty commercial segment for the three and six months ended June 30,
2004 and 2003:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- -----------------------------
(in millions) 2004 2003 2004 2003
------------- ------------- ------------- -------------
Gross written premiums $ 54.1 $ 35.6 $ 95.3 $ 70.0
============= ============= ============= =============
Earned premiums 35.1 30.2 66.9 58.3
Losses and loss adjustment expenses 23.1 22.6 44.1 42.1
Underwriting expense 10.9 8.9 21.6 17.4
------------- ------------- ------------- -------------
Underwriting income 1.1 (1.3) 1.2 (1.2)
Investment income, net 2.6 2.5 5.1 4.7
------------- ------------- ------------- -------------
Income before taxes $ 3.7 $ 1.2 $ 6.3 $ 3.5
============= ============= ============= =============
Combined ratio 96.8% 104.5% 98.1% 102.1%
============= ============= ============= =============
The increase in gross written premiums was primarily attributable to new
business written under a renewal rights acquisition entered into in the fourth
quarter of 2003. Gross written premiums from new business were $24.3 million for
the three months ended June 30, 2004, compared to $9.4 million for the same
period ended 2003. For the six months ended June 30, 2004 and 2003, gross
written premiums from new business were $37.6 million and $16.3 million,
respectively. Of the new business written in 2004, the renewal rights
acquisition contributed approximately $17.3 million and $23.1 million to gross
written premiums for the three and six months ended June 30, 2004, respectively.
Renewal premiums were $29.2 million and $56.9 million for the three and six
months ended June 30, 2004, respectively compared to $23.5 million and $53.5
million for the same periods in 2003. The increases in renewal premiums were
primarily due to rate increases. The increase in earned premiums in 2004 as
compared to 2003 was primarily a result of the increase in gross written
premiums in 2003.
The specialty commercial segment's loss ratio was 65.9% for both the three and
six months ended June 30, 2004, compared to 75.1% and 72.4% for the three and
six months ended June 30, 2003, respectively. The improvement in the loss ratio
was primarily the result of rate increases over the past year. In addition, for
the three months ended June 30, 2003, catastrophe losses of approximately $1.9
million were recorded relating to storms in the South and Midwest. No
significant catastrophe losses were experienced during the three and six months
ended June 30, 2004. The specialty commercial segment's loss reserves were
$197.2 million and $174.6 million as of June 30, 2004 and 2003, respectively.
The expense ratios for the specialty commercial segment were 30.9% and 32.2% for
the three and six months ended June 30, 2004, respectively, compared to 29.4%
21
and 29.7% for the same periods ended in 2003. The increase in the expense ratios
in 2004 as compared to 2003 was primarily attributable to start-up costs
relating to the renewal rights acquisition previously discussed of approximately
$1.4 million and $2.3 million for the three and six months ended June 30, 2004,
respectively.
The increase in investment income for the three months ended June 30, 2004, as
compared to the same period in 2003, was primarily the result of an increase in
invested assets due to positive cash flows. Invested assets were $252.6 million
as of June 30, 2004, compared to $242.6 million as of June 30, 2003.
Public Entity. The following table summarizes the results of operations for the
public entity segment for the three and six months ended June 30, 2004 and 2003:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- -----------------------------
(in millions) 2004 2003 2004 2003
------------- ------------- ------------- -------------
Gross written premiums $ 15.6 $ 11.4 $ 31.7 $ 22.7
============= ============= ============= =============
Earned premiums 14.0 6.6 27.6 12.1
Losses and loss adjustment expenses 8.7 4.3 17.2 8.0
Underwriting expense 4.7 2.1 9.3 3.8
------------- ------------- ------------- -------------
Underwriting income 0.6 0.2 1.1 0.3
Investment income, net 0.3 0.1 0.7 0.3
------------- ------------- ------------- -------------
Income before taxes $ 0.9 $ 0.3 $ 1.8 $ 0.6
============= ============= ============= =============
Combined ratio 96.1% 97.4% 96.0% 98.0%
============= ============= ============= =============
The increase in gross written premiums for the three and six months ended June
30, 2004 as compared to 2003 was primarily the result of renewal business
written in 2004. For the three months ended June 30, 2004, the public entity
segment's renewal business was approximately $9.1 million compared to $4.8
million for the same period in 2003. For the six months ended June 30, 2004, the
public entity segment's renewal business was approximately $19.6 million
compared to $8.9 million for the six months ended June 30, 2003. Additionally,
during the three and six months ended June 30, 2004, the public entity segment's
new business was approximately $6.5 million and $12.1 million, respectively,
compared to $6.5 million and $13.7 million, respectively, for the same periods
in 2003. Included in the new business for the three and six months ended June
30, 2004 was $2.3 million and $4.6 million, respectively, attributable to a
renewal rights agreement entered into in the fourth quarter of 2003. Gross
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. The increase in earned premiums for the
three and six months ended June 30, 2004, as compared to the same periods in
2003 was primarily attributable to premium growth during 2003.
Losses and loss adjustment expenses for the three and six months ended June 30,
2004 resulted in a loss ratio of 62.1% and 62.4%, respectively, compared to
65.0% and 65.1%, respectively, for the same periods in 2003. The decrease in the
loss ratio is attributable to the maturation of the book of business as well as
a decrease in the percentage of business reinsured through quota share
arrangements. Loss reserves for the public entity segment were $39.4 million and
$17.8 million as of June 30, 2004 and 2003, respectively.
The expense ratio for the three and six months ended June 30, 2004 was 34.0% and
33.6%, respectively, compared to 32.4% and 32.9%, respectively, for the same
periods in 2003. The increase in the expense ratios from 2003 to 2004 was
primarily related to operations associated with a renewal rights agreement
entered into in the fourth quarter of 2003 for which the bulk of the premium
volume will be written in the period from July through October, corresponding
with the insured's fiscal year end.
The increase in investment income for the three and six months ended June 30,
2004, as compared to the same periods in 2003, was primarily a result of an
increase in invested assets due to positive cash flow. Invested assets were
$41.8 and $15.1 million as of June 30, 2004 and 2003, respectively.
22
Run-off Lines. The Company has discontinued underwriting 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 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:
June 30,
---------------------------------------------
2004 2003
--------------------- ---------------------
(in millions) Gross Net Gross Net
---------- ---------- --------- ----------
Environmental and asbestos:
Loss reserves, beginning of the period $219.5 $180.0 $236.5 $178.3
Incurred losses - - (0.7) 0.8
Losses paid 38.9 9.5 5.3 6.1
---------- ---------- --------- ----------
Loss reserves - environmental and
asbestos, end of the period 180.6 170.5 230.5 173.0
Other run-off lines 46.6 37.5 55.4 43.0
Net reserves ceded - retroactive
reinsurance contract - (42.4) - (40.0)
---------- ---------- --------- ----------
Total reserves - run-off lines $227.2 $165.6 $285.9 $176.0
========== ========== ========= ==========
The Company regularly monitors the activity of claims within the run-off lines,
particularly those claims related to asbestos and environmental liabilities.
Management believes the reserves for losses and loss adjustment expenses are
adequate based on current facts and circumstances. The Company expects to
complete its annual review of its reserves prior to the end 2004.
On April 14, 2004, the Bankruptcy Court presiding over the Chapter 11 Bankruptcy
of MacArthur Company, Western MacArthur Company, and Western Asbestos Company
(the "MacArthur Companies") entered orders giving final approval to settlements
reached with all property and casualty insurers of the MacArthur Companies
currently in litigation, including Argonaut Insurance Company. A bankruptcy
reorganization plan filed by the MacArthur Companies will be implemented and all
existing and future claims against the MacArthur Companies related to asbestos
will be channeled solely to a trust. Argonaut Insurance Company contributed
$29.8 million into the bankruptcy trust and received a release from the
MacArthur Companies as to any and all existing or future asbestos-related
claims, including any claims for extra-contractual relief, arising directly or
indirectly out of any alleged coverage under the nine Argonaut Insurance Company
polices at issue. In addition, claimants seeking funds from the trust will be
required to execute release and indemnity agreements in favor of Argonaut
Insurance Company as a condition to receiving payment. The Company ceded the
majority of the $29.8 million contribution to reinsurers. Based on information
currently available to the Company, management's best estimate of Argonaut
Insurance Company's asbestos and environmental reserves remains unchanged
following the settlement.
Reinsurance
Certain of the Company's reinsurance carriers have experienced deteriorating
financial condition and/or have been downgraded by rating agencies. Amounts due
from such reinsurers on paid loss recoverables and case reserves totaled $27.5
million as of June 30, 2004. Amounts due from such reinsurers on incurred but
not reported claims totaled $22.1 million as of June 30, 2004. Through the date
of this filing, the reinsurers have not defaulted on their obligations to pay
claims due to the Company. The aforementioned reinsurance balances recoverable
are primarily due from insurance subsidiaries of Trenwick Group Ltd., which
announced in August 2003 its intent to restructure its operations under the U.S.
Bankruptcy Code. The balances are due from the insurance subsidiaries, not
Trenwick Group Ltd.
23
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. At present, the Company
carries a reserve of $23.9 million as an estimate of the amount of uncollectable
reinsurance. Management will continue to monitor the collectibility of
reinsurance balances recoverable and adjust this reserve as appropriate. It is
possible that future financial deterioration of reinsurers could result in the
uncollectibility of additional balances and therefore impact the Company's
financial results.
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. For
the six months ended June 30, 2004, these payments totaled $0.2 million. 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, 2004, Fayez Sarofim & Co. managed $156.3 million fair
value 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, Colony Insurance Company entered into a quota share
reinsurance agreement with HCC Insurance Holdings, Inc. ("HCC"), a greater than
10% shareholder. For the six months ended June 30, 2004, the Company ceded
approximately $30.7 million of gross written premiums, $27.4 million of earned
premiums and $15.8 million of losses and loss adjustment expenses. The Company
earned a ceding commission of $5.3 million.
Effective January 1, 2003, Argonaut Insurance Company entered into a quota share
reinsurance agreement with HCC. Under the original terms of the agreement, the
Company assumed 3.33% of the premiums and losses under HCC's USA Directors and
Officers Liability program, and 5.0% of the premiums and losses under HCC's
International Directors and Officers Liability program. Effective January 1,
2004, the agreement was amended and Argonaut Insurance Company now assumes 1.5%
of the premiums and losses under each program. For the six months ended June 30,
2004, gross written premiums recorded under this program totaled $5.2 million.
For the six months ended June 30, 2004, the Company expensed ceding and other
commissions of $3.2 million related to this business.
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 six months ended June 30, 2004, consolidated net cash provided by
operating activities was $8.8 million, compared to $74.2 million for the same
period in 2003. The decrease in cash flows from operating activities for the six
months ended June 30, 2004 as compared to 2003 was primarily attributable to an
increase in claims payments in run-off lines (see "Results of Operations -
Run-off Lines), coupled with a slower growth rate in gross written premiums in
2004 as compared to 2003.
On April 29, 2004, Argonaut Group Statutory Trust IV, a wholly-owned subsidiary
of the Company, sold 13,000 Floating Rate Capital Securities (liquidation amount
$1,000 per Capital Security) in a private sale for $13.0 million. The Trust used
the proceeds from this sale, together with the proceeds from its sale of 403
24
shares of Floating Rate Common Securities (liquidation amount $1,000 per Common
Security) to the Company, to buy a series of Floating Rate Junior Subordinated
Debentures due 2034 from the Company. The Debentures have the same payment terms
as the Capital Securities.
The interest rate on the Debentures and the Capital Securities is equal to
3-Month LIBOR plus 3.85% (not to exceed 12.5% prior to May 15, 2009), which rate
is reset quarterly. The Debentures are unsecured and subordinated in right of
payment to all of the Company's future senior indebtedness. After April 29,
2009, 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 also has the
right to redeem all of the Debentures prior to April 29, 2009 upon the happening
of specified events at a price ranging from 105% to 101% of the principal amount
of the Debentures, plus accrued and unpaid interest to the date of redemption.
On May 12, 2004, Argonaut Group Statutory Trust VI, a wholly-owned subsidiary of
the Company, sold 13,000 Floating Rate Capital Securities (liquidation amount
$1,000 per Capital Security) in a private sale for $13.0 million. The Trust used
the proceeds from this sale, together with the proceeds from its sale of 403
shares of Floating Rate Common Securities (liquidation amount $1,000 per Common
Security) to the Company, to buy a series of Floating Rate Junior Subordinated
Debentures due 2034 from the Company. The Debentures have the same payment terms
as the Capital Securities.
The interest rate on the Debentures and the Capital Securities is equal to
3-Month LIBOR plus 3.8% (not to exceed 12.5% prior to June 17, 2009), which rate
is reset quarterly. The Debentures are unsecured and subordinated in right of
payment to all of the Company's future senior indebtedness. After June 17, 2009,
the Company has 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 also has the right to
redeem all of the Debentures prior to June 17, 2009 upon the happening specified
events as 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 26, 2004, Argonaut Group Statutory Trust V, a wholly-owned subsidiary of
the Company, sold 12,000 Floating Rate Capital Securities (liquidation amount
$1,000 per Capital Security) in a private sale for $12.0 million. The Trust used
the proceeds from this sale, together with the proceeds from its sale of 372
shares of Floating Rate Common Securities (liquidation amount $1,000 per Common
Security) to the Company, to buy a series of Floating Rate Junior Subordinated
Debentures due 2034 from the Company. The Debentures have the same payment terms
as the Capital Securities.
The interest rate on the Debentures and the Capital Securities is equal to
3-Month LIBOR plus 3.85% (not to exceed 12.5% prior to May 24, 2009), which rate
is reset quarterly. The Debentures are unsecured and subordinated in right of
payment to all of the Company's future senior indebtedness. After May 24, 2009,
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 also has the right to
redeem all of the Debentures prior to May 24, 2009 upon the happening of
specified events at a price ranging from 105% to 101% of the principal amount of
the Debentures, plus accrued and unpaid interest to the date of redemption.
Refer to Part I, Item 7 - "Management's Discussion and Analysis of Financial
Condition and Operating Results - Liquidity" in the Company's Annual Report on
Form 10-K for the year ended December 31, 2003 that the Company filed with the
Securities and Exchange Commission on March 15, 2004 for further discussion on
the Company's liquidity.
25
Recent Accounting Pronouncements and Critical 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, 2003 that the Company filed with the
Securities and Exchange Commission on March 15, 2004 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. Qualitative and Quantitative Disclosures About Market Risk
The primary market risk exposures that result in an impact to the investment
portfolio relate to equity price changes and interest rate changes.
The Company has an exposure to foreign currency risks in conjunction with the
reinsurance agreement with HCC and investments in foreign securities. Accounts
under the International Directors and 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 or losses related to the exchange rates. For the six months ended
June, 2004, the Company received payments of $0.8 million on this contract.
Gains on the foreign currency translation were insignificant. Management is
unable at this time to estimate future foreign currency gains or losses, if any.
Changes in the value of foreign investments related to fluctuations in foreign
currency exchange rates are included in unrealized gains or losses. The amount
of unrealized gains as of June 30, 2004 was $0.8 million, compared to $0.2
million as of June 30, 2003.
The Company holds a 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. The marketable
equity securities are carried on the balance sheet at fair market value, and are
subject to the risk of potential loss in market value resulting from adverse
changes in prices. Equity price risk is managed primarily by monitoring funds
committed to the various types of securities owned and by limiting the exposure
in any one investment or type of investment. No issuer (exclusive of the U.S.
government and U.S. governmental agencies) of fixed income or equity securities
represents more than 10% of shareholders' equity as of June 30, 2004.
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 if issuers
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 for municipal bonds, corporate
bonds and preferred stocks). Less than 1.0% of the fixed income portfolio is
invested in bonds rated lower than "BBB".
26
The Company regularly evaluates its investment portfolio for indication of other
than temporary impairments to the individual securities. 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 same periods in 2004, the Company did not incur any
other than temporary impairments losses in its investment portfolio. Management
has assessed these risks and believes that there have been no material changes
since December 31, 2003.
Item 4. Controls and Procedures
In connection with the filing of this Form 10-Q, management, including the
Company's chief executive officer and 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 Company's chief
executive officer and chief financial officer, concluded that the Company's
disclosure controls and procedures were effective as of June 30, 2004.
There have been no changes in the Company's internal controls over financial
reporting during the three and six months ended June, 2004 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.
27
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
Refer to Part I, Item 3 - "Legal Proceedings" in the Company's Annual Report on
Form 10-K for the year ended December 31, 2003 that the Company filed with the
Securities and Exchange Commission on March 15, 2004 and Part II, Item 1 -
"Legal Proceedings" in the Company's Quarterly Report on Form 10-Q for the three
months ended March 31, 2004 that was filed with the Securities and Exchange
Commission on May 7, 2004 for additional discussion on the Company's pending
legal proceedings.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities
None
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 11, 2004. The following
matters were 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:
Broker
Votes For Votes Withheld Non-Votes
------------- --------------- -----------
Hector De Leon 26,506,890 2,058,471 -
Frank W. Maresh 26,833,268 1,732,093 -
Allan W. Fulkerson 26,873,094 1,692,267 -
David Hartoch 26,833,789 1,731,572 -
John R. Power, Jr. 26,518,394 2,046,967 -
George A. Roberts 26,805,583 1,759,778 -
Fayez S. Sarofim 23,245,915 5,319,446 -
Mark E. Watson III 26,891,159 1,674,202 -
Gary V. Woods 26,849,589 1,715,772 -
Votes were cast in the following manner in connection with the proposal to
increase the amounts of authorized shares of common stock of the Company from
35,000,000 to 70,000,000:
Broker
Votes For Votes Against Abstain Non-Votes
- ----------------- --------------- --------------- ---------------
25,660,282 2,837,039 68,040 -
Votes were cast in the following manner in connection with the proposal to
replace the Company's Employee Stock Incentive Plan with the 2004 Employee Stock
Purchase Plan:
Broker
Votes For Votes Against Abstain Non-Votes
- ----------------- --------------- --------------- ---------------
24,573,845 1,386,528 109,878 2,495,110
28
Votes were cast in the following manner in connection with the proposal to amend
the Company's Amended and Restated Stock Incentive Plan:
Broker
Votes For Votes Against Abstain Non-Votes
- ----------------- --------------- --------------- ---------------
20,079,452 5,853,706 137,093 2,495,110
Votes were cast in the following manner in connection with the proposal to amend
the Company's Non-Employee Director Stock Option Plan:
Broker
Votes For Votes Against Abstain Non-Votes
- ----------------- --------------- --------------- ---------------
20,447,940 5,497,296 125,015 2,495,110
Item 5. Other Information
None
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 May 25, 2004, the Company filed a current report on Form 8-K to file
with the Securities and Exchange Commission an amendment to its
certificate of incorporation.
On May 5, 2004, the Company furnished a current report on Form 8-K under
Item 12 of Form 8-K announcing its operating results for the quarter
ended March 31, 2004. This current report on Form 8-K shall not be deemed
to be incorporated by reference into this quarterly report on Form 10-Q.
29
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 9, 2004
30
EXHIBIT INDEX
Exhibit
No. Description
12.1 Statement of Computation of Ratio of Earnings to Fixed Charges
and Preferred Stock Dividends
31.1 Certificate of the Chief Executive Officer pursuant to Section 302
Act of 2002.
31.2 Certificate of the Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certificate of the Chief Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Certificate of the Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
31
EXHIBIT 12.1
ARGONAUT GROUP, INC.
STATEMENT OF COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
AND PREFERRED STOCK DIVIDENDS
Six months ended
June 30, Years Ended December 31,
--------------------- ---------------------------------------------------------
2004 2003 2003 2002 2001 2000 1999
--------------------- ---------------------------------------------------------
(in millions, except ratios)
Earnings:
Income (loss) from continuing
operations before provision for
income taxes $ 17.9 $ 67.0 $ 135.3 $(21.1) $ 3.3 $ (129.2) $(25.5)
Add:
Fixed charges 6.7 5.7 12.3 2.6 2.9 2.3 1.5
--------- ---------- --------- --------- --------- ---------- ---------
Total earnings (loss) $ 24.6 $ 72.7 $ 147.6 $(18.5) $ 6.2 $ (126.9) $(24.0)
========= ========== ========= ========= ========= ========== =========
Fixed charges
Interest expense, net $ 4.5 $ 4.1 $ 8.4 $ 0.4 $ 0.2 $ - $ -
Preferred stock dividends 1.2 0.6 1.8 - - - -
Rental interest factor 1.0 1.0 2.1 2.2 2.7 2.3 1.5
--------- ---------- --------- --------- --------- ---------- ---------
Total fixed charges $ 6.7 $ 5.7 $ 12.3 $ 2.6 $ 2.9 $ 2.3 $ 1.5
========= ========== ========= ========= ========= ========== =========
Ratio of earnings to fixed charges 3.7:1 12.8:1 12.0:1 (A) 2.1:1 (B) ( C )
========= ========== ========= ========= ========= ========== =========
(A) Earnings were inadequate to cover fixed charges by $21.1 million
(B) Earnings were inadequate to cover fixed charges by $129.2 million
(C) Earnings were inadequate to cover fixed charges by $25.5 million
32
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 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 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 9th day of August, 2004.
/s/ Mark E. Watson III
---------------------------
Mark E. Watson III
President and Chief Executive Officer
33
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 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 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 9th day of August, 2004.
/s/ Mark W. Haushill
---------------------------
Mark W. Haushill
Vice President
Chief Financial Officer and Treasurer
34
EXHIBIT 32.1
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 Quarterly Report on
Form 10-Q for the three months ended June 30, 2004 ("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 9th day of August, 2004.
/s/ Mark E. Watson III
----------------------------
Mark E. Watson III
President and Chief Executive Officer
35
EXHIBIT 32.2
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 months ended June 30, 2004 ("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 9th day of August, 2004.
/s/ Mark W. Haushill
---------------------------
Mark W. Haushill
Vice President
Chief Financial Officer and Treasurer
36