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 September 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 November 9, 2004
Title Outstanding
Common Stock, par value $0.10 per share 27,683,689
ARGONAUT GROUP, INC.
TABLE OF CONTENTS
Page No.
Part I. FINANCIAL INFORMATION:
Item 1. Consolidated Financial Statements (unaudited):
Consolidated Balance Sheets
September 30, 2004 and December 31, 2003.................... 3
Consolidated Statements of Operations
Three and nine months ended September 30, 2004 and 2003..... 4
Consolidated Statements of Comprehensive Income (Loss)
Three and nine months ended September 30, 2004 and 2003..... 5
Consolidated Statements of Cash Flows
Nine months ended September 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............ 19
Item 3. Qualitative and Quantitative Disclosure About Market Risk.... 32
Item 4. Controls and Procedures...................................... 33
Part II. OTHER INFORMATION:
Item 1. Legal Proceedings............................................ 34
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases
of Equity Securities........................................ 35
Item 3. Defaults Upon Senior Securities.............................. 35
Item 4. Submission of Matters to a Vote of Security Holders.......... 35
Item 5. Other Information............................................ 35
Item 6. Exhibits..................................................... 35
2
Part I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
ARGONAUT GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in millions, except per share amounts)
September 30, December 31,
2004 2003
-------------- --------------
(Unaudited)
Assets:
Investments:
Fixed maturities, at fair value (cost: 2004 - $1,378.1; 2003 - $1,154.9) $ 1,401.6 $ 1,190.9
Equity securities, at fair value (cost: 2004 - $113.0; 2003 - $107.0) 171.1 170.7
Other long-term investments, at fair value (cost: 2004 - $17.4; 2003 - $12.1) 18.9 12.5
Short-term investments, at fair value which approximates cost 146.4 179.1
-------------- --------------
Total investments 1,738.0 1,553.2
-------------- --------------
Cash and cash equivalents 40.8 75.6
Accrued investment income 15.3 14.6
Premiums receivable 264.0 246.1
Reinsurance recoverables 584.3 535.0
Notes receivable 38.0 46.4
Goodwill 106.3 105.7
Current income taxes receivable, net 8.3 -
Deferred federal income tax asset, net 40.3 27.5
Deferred acquisition costs, net 71.9 62.5
Other assets 123.9 99.9
-------------- --------------
Total assets $ 3,031.1 $ 2,766.5
============== ==============
Liabilities:
Reserves for losses and loss adjustment expenses $ 1,585.7 $ 1,480.8
Unearned premiums 401.5 353.3
Funds held 192.7 187.2
Deferred gain, retroactive reinsurance 41.7 43.3
Junior subordinated debentures 97.9 27.5
Current income taxes payable, net - 19.7
Accrued expenses and other liabilities 137.1 115.5
-------------- --------------
Total liabilities 2,456.6 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 September 30, 2004 and December 31, 2003 0.3 0.3
Common stock - $0.10 par, 70,000,000 shares authorized; 27,663,941 and 27,596,325
shares issued and outstanding at September 30, 2004 and December 31, 2003, respectively 2.8 2.8
Additional paid-in capital 226.2 220.5
Retained earnings 296.9 253.1
Deferred stock compensation (5.8) (2.6)
Accumulated other comprehensive income, net 54.1 65.1
-------------- --------------
Total shareholders' equity 574.5 539.2
-------------- --------------
Total liabilities and shareholders' equity $ 3,031.1 $ 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 Nine Months Ended
September 30, September 30,
----------------------------- ----------------------------
2004 2003 2004 2003
------------- ------------- ------------- -------------
Premiums and other revenue:
Earned premiums $ 157.5 $ 148.1 $ 468.3 $ 417.1
Net investment income 16.2 13.3 46.6 40.1
Realized investment gains, net 0.8 48.5 2.8 112.2
------------- ------------- ------------- -------------
Total revenue 174.5 209.9 517.7 569.4
------------- ------------- ------------- -------------
Expenses:
Losses and loss adjustment expenses 117.7 105.6 310.0 294.4
Underwriting, acquisition, and
insurance expenses 55.5 48.9 165.7 148.5
Interest expense 3.0 1.9 7.5 6.0
------------- ------------- ------------- -------------
Total expenses 176.2 156.4 483.2 448.9
------------- ------------- ------------- -------------
Income (loss) before income taxes (1.7) 53.5 34.5 120.5
Provision (benefit) for income taxes (11.1) 28.8 (11.1) 42.5
------------- ------------- ------------- -------------
Net income $ 9.4 $ 24.7 $ 45.6 $ 78.0
============= ============= ============= =============
Net income per common share:
Basic $ 0.32 $ 1.11 $ 1.59 $ 3.55
============= ============= ============= =============
Diluted $ 0.31 $ 1.00 $ 1.48 $ 3.30
============= ============= ============= =============
Weighted average common shares:
Basic 27,656,549 21,608,452 27,624,201 21,606,337
============= ============= ============= =============
Diluted 30,812,363 24,593,984 30,756,302 23,613,989
============= ============= ============= =============
See accompanying notes.
4
ARGONAUT GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in millions)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net income $ 9.4 $ 24.7 $ 45.6 $ 78.0
------------ ------------ ------------ ------------
Other comprehensive income (loss): Unrealized gains (losses) on securities:
Gains (losses) arising during the period 14.4 (7.6) (14.1) 18.8
Reclassification adjustment for gains
included in net income (0.8) (48.5) (2.8) (54.6)
------------ ------------ ------------ ------------
Other comprehensive income (loss) before tax 13.6 (56.1) (16.9) (35.8)
Income tax provision (benefit) related to other
comprehensive income (loss) 4.8 (19.6) (5.9) (12.5)
------------ ------------ ------------ ------------
Other comprehensive income (loss), net of tax 8.8 (36.5) (11.0) (23.3)
------------ ------------ ------------ ------------
Comprehensive income (loss) $ 18.2 $ (11.8) $ 34.6 $ 54.7
============ ============ ============ ============
See accompanying notes
5
ARGONAUT GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
(Unaudited)
Nine Months Ended
September 30,
--------------------------
2004 2003
------------ -----------
Cash flows from operating activities:
Net income $ 45.6 $ 78.0
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization and depreciation 10.6 8.3
Deferred federal income tax expense (benefit) (6.7) 26.8
Gains on sales of investments (2.8) (54.6)
Gains on sales of real estate - (57.6)
Change in:
Accrued investment income (0.7) 0.2
Premiums receivable and reinsurance recoverables (67.2) (52.2)
Unearned premiums on ceded reinsurance (23.4) (31.0)
Reserves for losses and loss adjustment expenses 104.9 118.2
Unearned premiums 48.2 70.4
Other assets and liabilities, net (28.4) 23.3
------------ -----------
Cash provided by operating activities 80.1 129.8
------------ -----------
Cash flows from investing activities:
Sales of fixed maturity investments 225.5 39.1
Maturities and mandatory calls of fixed maturity investments 246.2 156.7
Sales of equity securities 4.7 95.8
Purchases of fixed maturity investments (704.7) (396.9)
Purchases of equity securities (9.4) (2.0)
Change in short-term investments 32.7 (135.7)
Cash collected on real estate notes receivables 8.4 10.5
Acquisition, net of cash received (0.6) -
Other, net 13.6 24.3
------------ -----------
Cash used by investing activities (183.6) (208.2)
------------ -----------
Cash flows from financing activities:
Issuance of Series A mandatory convertible preferred stock - 34.6
Issuance of junior subordinated debentures 70.4 15.5
Related party note payable - 12.0
Stock options exercised and employee stock purchase plan issuance 0.5 -
Secondary common stock offering expenses (0.2) -
Preferred stock offering expense (0.2) -
Payment of cash dividend on preferred stock (1.8) (0.6)
------------ -----------
Cash provided (used) by financing activities: 68.7 61.5
------------ -----------
Change in cash and cash equivalents (34.8) (16.9)
Cash and cash equivalents, beginning of period 75.6 77.4
------------ -----------
Cash and cash equivalents, end of period $ 40.8 $ 60.5
============ ===========
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 September 30, 2004 and 2003 and for the three
and nine months ended September 30, 2004 and 2003 is unaudited. However, in the
opinion of management, the interim data includes all adjustments, consisting of
normal recurring accruals, necessary for a fair statement of the Company's
results for the interim periods. The operating results for the interim periods
are not necessarily indicative of the results to be expected for the full year.
All significant intercompany amounts have been eliminated. Certain amounts
applicable to prior periods have been reclassified to conform to the
presentation followed in 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 - 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 nine months ended September 30, 2004
and 2003.
7
Note 4 - Earnings Per Share
The following table presents the calculation of basic and diluted net income per
common share for the three and nine months ended September 30, 2004 and 2003:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- -------------------------------
(Dollars in millions except per share data) 2004 2003 2004 2003
-------------- -------------- -------------- --------------
Net income $ 9.4 $ 24.7 $ 45.6 $ 78.0
Preferred stock dividends (0.6) (0.6) (1.8) (1.2)
-------------- -------------- -------------- --------------
Income available to common shareholders 8.8 24.1 $ 43.8 $ 76.8
Effect of dilutive securities:
Preferred stock dividends 0.6 0.6 1.8 1.2
-------------- -------------- -------------- --------------
Income available to common shareholders
after assumed conversion $ 9.4 $ 24.7 $ 45.6 $ 78.0
Weighted average shares-basic 27,656,549 21,608,452 27,624,201 21,606,337
Effect of dilutive securities:
Stock options 202,504 32,222 178,791 17,143
Convertible preferred stock 2,953,310 2,953,310 2,953,310 1,990,509
-------------- -------------- -------------- --------------
Weighted average shares-diluted 30,812,363 24,593,984 30,756,302 23,613,989
============== ============== ============== ==============
Net income per common share-basic $ 0.32 $ 1.11 $ 1.59 $ 3.55
Net income per common share-diluted $ 0.31 $ 1.00 $ 1.48 $ 3.30
For the three and nine months ended September 30, 2004, options to purchase
1,015,100 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
nine months ended September 30, 2003, options to purchase 1,655,800 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 5 - Commitments and Contingencies
Argonaut Insurance Company v. Los Angeles Metropolitan Transit Authority. On
August 30, 1996, the Los Angeles County Metropolitan Transportation Authority
("MTA") filed a civil action against Argonaut Insurance Company alleging breach
of contract, breach of the covenant of good faith and fair dealing, and
requesting ancillary relief in the form of an accounting, an injunction and
restitution in connection with allegations regarding failures to perform under
certain contracts of insurance. The MTA contends that it has been damaged by an
unspecified amount.
Argonaut Insurance Company has responded to the complaint, and believes it has
meritorious defenses and intends to vigorously contest these claims.
Additionally, Argonaut Insurance Company brought certain counterclaims against
the MTA seeking reimbursement for amounts paid on claims that were within the
MTA's deductible limits, above the MTA's policy limits, or otherwise uncovered
by the MTA's policy. During the ten years prior to the dispute, the MTA
reimbursed Argonaut Insurance Company for similar expenditures on a regular
basis in the ordinary course of business. The Company currently has a receivable
in the amount of approximately $47.6 million relating to reimbursements due and
owing by the MTA. Management has consulted with its attorneys regarding the
merits of the Company's claim and based on these discussions, management
believes the $47.6 million owed to Argonaut Insurance Company is a valid claim.
Further, management believes the MTA has the financial wherewithal to pay the
Company's claim. In addition to the above amounts, Argonaut Insurance Company is
seeking collection of certain unpaid administrative claim handling fees and
prejudgment interest on all amounts due which are not included in the
aforementioned receivable.
8
The Court, by agreement of the parties, has ordered the first stage of this case
to be tried before a three-judge panel instead of jury to consider a portion of
Argonaut Insurance Company's counterclaim for sums it contends are due from the
MTA. Trial was set for November 1, 2004. On October 25, 2004, the Court ruled on
eight recently filed motions for summary adjudication relating to certain of the
MTA's defenses to Argonaut Insurance Company's action for reimbursement.
As was the case with a number of previous motions for summary adjudication
considered by the Court in the last three years relating to the recoverability
of the receivable, the Court again adopted the position asserted by Argonaut
Insurance Company as to each motion. Significantly, two of the motions addressed
the merits of Argonaut Insurance Company's cancellation and non-renewal of the
MTA's policy of insurance. The MTA asserted that Argonaut Insurance Company
wrongfully cancelled and non-renewed the MTA's policy of insurance, thus giving
rise to certain equitable defenses to Argonaut Insurance Company's collection
action. These same allegations formed the primary basis of the MTA's affirmative
claims against Argonaut Insurance Company for breach of contract and breach of
the covenant of good faith and fair dealing. The Court ruled, however, that
Argonaut Insurance Company properly cancelled and non-renewed the policies as a
matter of law.
Following the rulings, the MTA sought a postponement of the first stage of the
trial in order to pursue a request to the Court of Appeals for an expedited
appeal of the rulings. The trial court granted the MTA's request for a
postponement, and pleadings relating to the appeal are expected to be filed in
the fourth quarter.
Lila Mitchell, et. al. v. Argonaut Insurance Company, et. al. 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.
Note 6 - Income Taxes
The Company's income tax provision includes the following components:
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------- -------------------------------
(in millions) 2004 2003 2004 2003
--------------- --------------- -------------- ---------------
Current tax provision (benefit) $ (11.9) $ 9.2 $ (4.4) $ 15.7
Deferred tax provision (benefit) related to:
Future tax deductions 3.0 (4.2) 2.5 (10.2)
Net operating loss carryforward 1.5 22.4 4.2 49.6
Deferred alternative minimum tax provision (1.0) (9.1) 1.6 (10.7)
Valuation allowance change (2.7) 10.5 (15.0) (1.9)
--------------- --------------- -------------- ---------------
Income tax provision (benefit) $ (11.1) $ 28.8 $ (11.1) $ 42.5
=============== =============== ============== ===============
9
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 Nine Months Ended
September 30, September 30,
-------------------------------- -------------------------------
(in millions) 2004 2003 2004 2003
--------------- --------------- -------------- ---------------
Income tax provision (benefit) at statutory rates $ (0.6) $ 18.7 $ 12.1 $ 40.4
Tax effect of:
Tax exempt interest - - (0.1) (0.1)
Dividends received deduction (0.2) (0.1) (0.6) (0.6)
Valuation allowance change (2.7) 10.5 (15.0) (1.9)
Other permanent adjustments, net (0.4) (0.3) (0.3) (0.3)
State income tax provision (7.2) - (7.2) 5.0
--------------- --------------- -------------- ---------------
Income tax provision (benefit) at statutory rates $ (11.1) $ 28.8 $ (11.1) $ 42.5
=============== =============== ============== ===============
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
nine months ended September 30, 2004, the Company reduced the deferred tax asset
valuation allowance by $2.7 million and $15.0 million, respectively. At
September 30, 2004, the Company has a deferred tax asset of $40.3 million, net
of a deferred tax asset valuation allowance of $34.1 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.
California Assembly Bill 263 ("AB 263"), a bill providing for partial deduction
of certain intercompany insurance dividends for purposes of the California
Corporation Tax Law, became law on September 29, 2004. This bill was enacted in
response to a 1999 California appellate court decision known as the Ceridian
decision which held that the partial dividend received deduction for
intercompany insurance dividends that California companies were allowed to take
was unconstitutional. The Franchise Tax Board subsequently announced that no
dividend received deduction for intercompany insurance dividends would be
available for years after 1996, at which time the Company accrued a state tax
liability which was created by the disallowance while pursuing alternative
methods of resolution through the administrative appeal process. As a result of
the enactment of AB 263, the Company has reduced its state tax reserve by
approximately $10.9 million. The balance of the original reserve accrual,
approximately $2.8 million, will be retained pending resolution of the Company's
remaining claims arising out of the Ceridian decision before the California
Franchise Tax Board. While it is difficult to predict the final outcome or
timing of resolution of this issue, management believes the Company's remaining
reserve, including penalties and interest, reflects the probable outcome of this
contingency.
Note 7 - 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.
10
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 certain executives and other key
employees, of which approximately 2,5000,000 are available for distribution. 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 and
participants in the plan are not entitled to any voting or dividend rights until
after the stock has been issued. As of September 30, 2004, 256,533 shares are
outstanding under the plan, net of forfeitures of 31,564 shares. Of the shares
outstanding, 43,774 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 September 30, 2004 and 2003, the Company recognized
compensation expense of $0.5 million and $0.2 million, respectively. For the
nine months ended September 30, 2004 and 2003, the Company recognized
compensation expense of $1.4 million and $0.7 million, respectively.
In August 2003, the Company granted certain 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
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 nine months ended September 30, 2004, the Company recognized
compensation expense related to these stock options of $0.1 million and $0.4
million, respectively.
In August 2004, the Company granted certain 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
will vest over a four year term. The options granted under this variable plan
resulted in approximately $1.5 million of compensation expense being deferred as
of September 30, 2004, which will be amortized over the vesting period of the
options. Compensation expense related to these options was approximately $0.1
million for the three and nine months ended September 30, 2004.
In August 2004, the Compensation Committee of the Board of Directors approved a
restorative options feature to all options granted prior to February 2, 2004
which had exercise prices greater than or equal to $16.21 per share. This
modification to the existing options grants resulted in compensation expense of
approximately $0.4 million for the three and nine months ended September 30,
2004.
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:
11
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
(in millions, except per share amounts) 2004 2003 2004 2003
------------- ------------ ------------- ------------
Net income, as reported $ 9.4 $ 24.7 $ 45.6 $ 78.0
Add: Total deferred stock compensation expense
included in reported net income, net of taxes 0.7 0.1 1.5 0.5
Deduct: Total stock-based employee compensation
determined under fair value based methods for
all awards, net of tax (1.1) (0.2) (2.3) (0.8)
------------- ------------ ------------- ------------
Pro forma net income $ 9.0 $ 24.6 $ 44.8 $ 77.7
============= ============ ============= ============
Earnings per share
Basic - as reported $ 0.32 $ 1.11 $ 1.59 $ 3.55
Basic - pro forma $ 0.30 $ 1.11 $ 1.56 $ 3.54
Diluted - as reported $ 0.31 $ 1.00 $ 1.48 $ 3.30
Diluted - pro forma $ 0.29 $ 1.00 $ 1.46 $ 3.29
Note 8 - 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 $50.1 million and
$22.7 million as of September 30, 2004 and 2003, respectively:
Nine Months Ended
September 30,
-----------------------
(in millions) 2004 2003
----------- -----------
Net reserves - beginning of year $ 965.5 $ 838.2
Net reserves from renewal rights acquisition - 3.2
Net reserves ceded under retroactive reinsurance contracts 1.6 (2.5)
Add:
Loss and LAE incurred during calendar year, net of reinsurance:
Current accident year 315.0 272.0
Prior accident years (5.0) 22.4
----------- -----------
Loss and LAE incurred during current calendar year, net of reinsurance 310.0 294.4
Deduct:
Loss and LAE payments made during current calendar year, net of reinsurance:
Current accident year 42.6 46.9
Prior accident years 183.0 146.9
----------- -----------
Loss and LAE payments made during current calendar year, net of reinsurance: 225.6 193.8
----------- -----------
Net reserves, end of period 1,051.5 939.5
Add:
Reinsurance recoverable on unpaid losses & LAE, end of period 534.2 460.3
----------- -----------
Gross reserves - end of period $ 1,585.7 $ 1,399.8
=========== ===========
12
Favorable loss development on prior accident years recognized during 2004 was
primarily the result of $6.6 million of favorable development recognized for the
risk management segment, mainly attributable to the 2001, 2002 and 2003 accident
years, of which $5.6 million was recognized in the third quarter. Beginning in
2001, management began re-underwriting its risk management book of business
emphasizing less hazardous insureds, and began shifting its book of business to
loss sensitive policies where the insured retains a significant amount of
losses. As a result of these initiatives and as the actuarial data for these
years matured, management has determined that its best estimate of losses should
be reduced.
Loss development on prior accident years recognized in 2003 was primarily the
result of the risk management segment recording adverse development on one large
construction 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. Additionally, the run-off segment decreased its
ceded loss and loss adjustment reserves, recording a corresponding increase to
net loss and loss adjustment expense reserves and a related expense of $10.2
million.
Note 9 - 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.
Revenues and income before taxes for each segment were as follows:
13
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- --------------------------------
(in millions) 2004 2003 2004 2003
-------------- -------------- --------------- ---------------
Revenues:
Earned premiums
Excess & surplus lines $ 76.6 $ 75.3 $ 226.0 $ 209.9
Risk management 23.6 31.7 90.5 95.7
Specialty commercial 40.3 31.9 107.2 90.1
Public entity 17.0 9.2 44.6 21.4
Run-off lines - - - -
-------------- -------------- --------------- ---------------
Total earned premiums 157.5 148.1 468.3 417.1
Net investment income
Excess & surplus lines 5.8 4.0 15.4 11.5
Risk management 7.1 6.9 21.8 20.8
Specialty commercial 2.7 2.4 7.8 7.1
Public entity 0.5 0.2 1.2 0.5
Run-off lines - - - -
Corporate & other 0.1 (0.2) 0.4 0.2
-------------- -------------- --------------- ---------------
Total net investment income 16.2 13.3 46.6 40.1
Realized investment gains, net 0.8 48.5 2.8 112.2
-------------- -------------- --------------- ---------------
Total revenue $ 174.5 $ 209.9 $ 517.7 $ 569.4
============== ============== =============== ===============
Income (loss) before income tax
Excess & surplus lines (3.7) 11.7 21.5 30.6
Risk management 4.8 2.8 13.7 (13.9)
Specialty commercial 4.6 2.5 10.9 5.9
Public entity (0.2) 1.1 1.6 1.7
Run-off lines - (10.2) - (10.2)
-------------- -------------- --------------- ---------------
Total segment income before taxes 5.5 7.9 47.7 14.1
Corporate & other (8.0) (2.9) (16.0) (5.8)
Net realized investment gains 0.8 48.5 2.8 54.6
Net realized gains on sales of real estate - - - 57.6
-------------- -------------- --------------- ---------------
Total income (loss) before income tax $ (1.7) $ 53.5 $ 34.5 $ 120.5
============== ============== =============== ===============
Identifiable assets for each segment were as follows:
September 30, December 31,
(in millions) 2004 2003
---------------- ----------------
Excess & surplus lines $ 907.1 $ 744.2
Risk management 1,495.7 1,483.7
Specialty commercial 419.4 370.2
Public entity 138.8 80.9
Run-off lines - -
Corporate & other 70.1 87.5
---------------- ----------------
Total $ 3,031.1 $ 2,766.5
================ ================
Note 10 - Underwriting, Acquisition and Insurance Expenses
Underwriting, acquisition and insurance expenses for the three and nine months
ended September 30, 2004 and 2003 were as follows:
14
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- ------------------------------
(in millions) 2004 2003 2004 2003
------------- ------------- -------------- --------------
Commissions $ 28.5 $ 32.9 $ 79.9 $ 78.9
General Expenses 27.4 15.6 78.5 60.8
State assessments 2.4 1.9 7.5 7.5
Taxes, licenses and bureau fees 4.0 3.8 9.9 9.7
------------- ------------- -------------- --------------
62.3 54.2 175.8 156.9
Deferral of policy acquisition costs (6.8) (5.3) (10.1) (8.4)
------------- ------------- -------------- --------------
Total underwriting, acquisition and
insurance expense $ 55.5 $ 48.9 $ 165.7 $ 148.5
============= ============= ============== ==============
Note 11 - 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 issued by Trust
IV 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 issued by Trust
VI 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.
15
The interest rate on the Debentures and the Capital
Securities issued by Trust V 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.
On September 17, 2004, Argonaut Group Statutory Trust VII, a wholly owned
subsidiary of the Company, sold 15,000 Floating Rate Capital Securities
(liquidation amount $1,000 per Capital Security) in a private sale for $15.0
million. The Trust used the proceeds from this sale, together with the proceeds
from its sale of 464 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 issued by Trust
VII is equal to 3-month LIBOR plus 3.6% (not to exceed the highest rate
permitted by New York law, currently 16.0%, prior to September 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 September
15, 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 September 15, 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 September 22, 2004, Argonaut Group Statutory Trust VIII, a wholly owned
subsidiary of the Company, sold 15,000 Floating Rate Capital Securities
(liquidation amount $1,000 per Capital Security) in a private sale for $15.0
million. The Trust used the proceeds from this sale, together with the proceeds
from its sale of 464 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 issued by Trust
VIII is equal to 3-month LIBOR plus 3.55% (not to exceed the highest rate
permitted by New York law, currently 16.0%, prior to September 22, 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 September
22, 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 September 22, 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 intends to use the net proceeds from the sale of the Debentures to
increase the capital of its insurance subsidiaries and for general corporate
purposes.
Note 12 - 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 nine months ended September 30, 2004, these payments totaled
$0.3 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 September 30, 2004, Fayez Sarofim & Co.
managed $151.6 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.
16
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 nine months ended September 30, 2004, the Company ceded
approximately $46.4 million of gross written premiums, $42.9 million of earned
premiums and $29.2 million of losses and loss adjustment expenses. The Company
earned a ceding commission of $8.6 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 nine months ended
September 30, 2004, gross written premiums under this program totaled $7.2
million. For the nine months ended September 30, 2004, the Company expensed
ceding and other commissions of $3.6 million related to this business.
Note 13 - Supplemental Cash Flows Information
Income taxes paid. The Company paid income taxes of $23.6 million and $4.1
million during the nine months ended September 30, 2004 and 2003, respectively.
Interest paid. The Company paid interest on the junior subordinated debentures
of $1.6 million during the nine months ended September 30, 2004. The Company
paid interest on a note payable of $0.8 million during the nine months ended
September 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 nine months ended September 30, 2003.
Cash payments in the amount of $8.4 million were received during the nine months
ended September 30, 2004, and the balance of these notes was $38.0 million as of
September 30, 2004.
Note 14 - Subsequent Events
On October 22, 2004, Argonaut Group Statutory Trust IX, a wholly owned
subsidiary of the Company, sold 15,000 Floating Rate Capital Securities
(liquidation amount $1,000 per Capital Security) in a private sale for $15.0
million. The Trust used the proceeds from this sale, together with the proceeds
from its sale of 464 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 issued by Trust
IX is equal to 3-month LIBOR plus 3.6% (not to exceed the highest rate permitted
by New York law, currently 16.0%, prior to December 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 December 15,
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 December 15, 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.
17
The Company intends to use the net proceeds from the sale of the Debentures to
increase the capital of its insurance subsidiaries and for general corporate
purposes.
18
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 nine months
ended September 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
Operations, Qualitative and Quantitative Disclosures About Market Risk and the
accompanying 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, the frequency and/or severity of catastrophic events not
experienced by the industry in recent history, accuracy in projecting loss
reserves, the impact on the markets in which the Company participates of
government and regulatory investigations into certain pricing and commission
practices historically undertaken by the industry, 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 Nine Months Ended
September 30, September 30,
---------------------------- ---------------------------
(in millions) 2004 2003 2004 2003
------------- ------------- ------------ ------------
Gross written premiums $ 261.5 $ 220.1 $ 683.2 $ 593.6
============= ============= ============ ============
Earned premiums $ 157.5 $ 148.1 $ 468.3 $ 417.1
Net investment income 16.2 13.3 46.6 40.1
Realized investment gains, net 0.8 48.5 2.8 112.2
------------- ------------- ------------ ------------
Total revenue $ 174.5 $ 209.9 $ 517.7 $ 569.4
============= ============= ============ ============
Income (loss) before taxes (1.7) 53.5 34.5 120.5
Provision (benefit) for income taxes (11.1) 28.8 (11.1) 42.5
------------- ------------- ------------ ------------
Net income $ 9.4 $ 24.7 $ 45.6 $ 78.0
============= ============= ============ ============
Combined ratio 109.9% 104.3% 101.6% 106.2%
============= ============= ============ ============
The increase in consolidated gross written premiums was primarily attributable
to an increase in renewal business. For the three months ended September 30,
2004, consolidated gross written premiums from renewal business totaled $139.7
million, compared to $97.7 million for the same period in 2003. For the nine
19
months ended September 30, 2004, consolidated gross written premiums from
renewal business totaled $357.0 million, compared to $265.4 million for the same
period in 2003. The increase in premiums on renewal business was primarily the
result of an increase in the amount of business inforce subject to renewal.
Also included in consolidated gross written premiums were premiums from new
business of $117.4 million and $318.4 million for the three and nine months
ended September 30, 2004, respectively, compared to $128.0 million and $345.1
million for the same periods in 2003. The Company entered into two renewal
rights agreements in December 2003, which accounted for approximately $30.1
million and $57.7 million of premiums from new business for the three and nine
months ended September 30, 2004, respectively. Consolidated gross written
premiums for the three and nine months ended September 30, 2004 were also
impacted by approximately $9.0 million and $22.6 million, respectively, from
premiums written and assumed under various reinsurance agreements, partially
offset by endorsements and cancellations of $4.6 million and $14.7 million,
respectively.
The increase in consolidated earned premiums for the three and nine months ended
September 30, 2004 as compared to the same periods in 2003 were primarily the
result of the increase in gross written premiums noted above.
Consolidated net investment income was greater for the three and nine months
ended September 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.
Consolidated invested assets totaled $1, 738.0 million and $1,438.1 million at
September 30, 2004 and 2003, respectively.
The Company manages its investment portfolio to minimize losses, both realized
and unrealized. Realized investment gains for the three months ended September
30, 2004 were $0.8 million. Realized investment gains for the three months ended
September 30, 2003 were $48.5 million, which were primarily attributable to the
Company re-allocating its investment portfolio. Realized investment gains for
the nine months ended September 30, 2003 included gains on sales of three real
estate holdings totaling $57.6 million. Included in realized investment gains as
of September 30, 2003 were write downs of $4.0 million 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 impairment losses in its
investment portfolio.
The Company's unrealized gains, net of tax, on investment securities declined by
$11.0 million during the nine September 30, 2004 to $54.1 million as of
September 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 for a sufficient period of time to allow them to recover
their value.
The consolidated loss ratios were 74.7% and 66.2% for the three and nine months
ended September 30, 2004, respectively, compared to 71.3% and 70.6% for the
three and nine months ended September 30, 2003, respectively. Included in losses
for the three and nine months ended September 30, 2004 was $17.7 million
resulting from the four hurricanes that made landfall in the southeastern United
States during the quarter. These catastrophe losses contributed 11.2 and 3.8
percentage points to the three and nine month loss ratios, respectively.
Partially offsetting these losses for the three and nine months ended September
30, 2004 were $5.8 million and $6.8 million, respectively, in favorable
development in the risk management segment (see discussion under "Risk
Management" below). Losses and loss adjustment expenses for the three months
ended September 30, 2003 include $10.2 million of reserve strengthening in the
run-off lines (see discussion under "Run-off Lines" below). Additionally, losses
and loss adjustment expenses for the nine months ended September 30, 2003
include approximately $10.0 million of reserve strengthening in the risk
management segment (see the discussion under "Risk Management" below).
20
The consolidated expense ratios were 35.2% and 33.0% for the three months ended
September 30, 2004 and 2003, respectively. The expense ratio for the three
months ended September 30, 2004 was adversely impacted by reinsurance
reinstatement premiums of approximately $1.8 million related to the hurricane
activity during the period, coupled with a special assessment of $1.2 million
being levied to the risk management segment. The consolidated expense ratios
were comparable at 35.4% and 35.6% for the nine months ended September 30, 2004
and 2003, respectively.
Consolidated interest expense was $3.0 million and $1.9 million for the three
months ended September 30, 2004 and 2003, respectively. Consolidated interest
expense was $7.5 million and $6.0 million for the nine months ended September
30, 2004 and 2003, respectively. Interest expense of approximately $1.9 million
and $5.1 million for the three and nine months ended September 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 $5.0
million for the same periods in 2003. Additionally, for the three and nine
months ended September 30, 2004, the Company incurred approximately $1.0 million
and $2.0 million, respectively, of interest expense related to the junior
subordinated debentures issued by the Company during 2003 and 2004. The Company
incurred $0.2 million and $0.3 million in interest expense for the three and
nine months ended September 30, 2003 for these debentures. The Company paid
interest on a note payable of $0.7 million during the nine months ended
September 30, 2003.
The consolidated income tax benefit for the three and nine months ended
September 30, 2004 was $11.1 million. The income tax benefit was the result of
the Company reducing its accrued tax liabilities by $10.9 million due to the
state of California enacting a law providing for a partial tax deduction for
certain insurance company dividends received by a company subject to California
corporate income tax. The Company's consolidated provision for Federal income
tax was $0 due to a reduction of the deferred tax asset valuation of $2.6
million and $15.0 million for the three and nine months ended September 30,
2004, 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 provision for income taxes for the three and nine
months ended September 30, 2003 was $28.8 million and $42.5 million,
respectively, primarily attributable to the recognition of federal and state
income taxes on the gains from the sale of equity securities coupled with the
sale of real estate during this period.
Segment Results
As of September 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 nine months
ended September 30, 2004 and 2003:
21
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- -----------------------------
(in millions) 2004 2003 2004 2003
------------- ------------- ------------- -------------
Gross written premiums $ 105.5 $ 100.5 $ 315.6 $ 284.6
============= ============= ============= =============
Earned premiums 76.6 75.3 226.0 209.9
Losses and loss adjustment expenses 63.1 45.4 152.2 127.6
Underwriting expense 23.0 22.2 67.7 63.2
------------- ------------- ------------- -------------
Underwriting income (9.5) 7.7 6.1 19.1
Investment income, net 5.8 4.0 15.4 11.5
------------- ------------- ------------- -------------
Income before taxes $ (3.7) $ 11.7 $ 21.5 $ 30.6
============= ============= ============= =============
Combined ratio 112.5% 89.7% 97.3% 90.9%
============= ============= ============= =============
The increase in gross written premiums for the three and nine months ended
September 30, 2004 was primarily attributable to increases in renewal business.
For the three months ended September 30, 2004, gross written premiums derived
from renewal business was $52.4 million compared to $41.4 million for the same
period in 2003. Gross written premiums from renewal business were $146.7 million
and $96.8 million for the nine months ended September 30, 2004 and 2003,
respectively. Gross written premiums related to new business declined to $57.7
million for the three months ended September 30, 2004, compared to $64.7 million
for the same period of 2003, as the Company did not issue new policies in
Florida from August 13 to September 27 as a result of the hurricane activity
throughout Florida. Gross written premiums from new business were $183.6 million
and $204.7 million for the nine months ended September 30, 2004 and 2003,
respectively. The decline was primarily attributable to increased competition
primarily in property lines of business and the hurricane activity in the third
quarter of 2004. Also impacting gross written premiums were cancellations and
endorsements, which reduced gross written premiums by approximately $4.6 million
and $14.7 million for the three and nine months ended September 30, 2004,
respectively, compared to $5.6 million and $16.9 million for the same periods in
2003.
Earned premiums increased to $76.6 million and $226.0 million for the three and
nine months ended September 30, 2004, compared to $75.3 million and $209.9
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 $15.5 million and $42.9 million for the three and
nine month periods ended September 30, 2004, respectively. Earned premiums ceded
for the three and nine months ended September 30, 2003 were $5.8 million and
$7.5 million.
The excess and surplus lines segment's loss ratios were 82.5% and 67.3% for the
three and nine months ended September 30, 2004, respectively, compared to 60.2%
and 60.8% for the same periods in 2003. Included in losses and loss adjustment
expenses for the three and nine months ended September 30, 2004 was $15.4
million in catastrophe losses resulting from the four hurricanes that made
landfall in the southeastern United States during the quarter. These catastrophe
losses contributed 20.1 and 6.8 percentage points to the three and nine month
loss ratios, respectively. Loss reserves for the excess and surplus lines were
$454.7 million as of September 30, 2004, compared to $258.2 million as of
September 30, 2003.
The expense ratios for the three months ended September 30, 2004 and 2003 were
30.0% and 29.5%, respectively. The increase in the expense ratio was primarily
attributable to the reinsurance reinstatement premiums incurred as a result of
the hurricane activity during the period. The expense ratios for the nine months
ended September 30, 2004 and 2003 were comparable at 30.0% and 30.1%,
respectively.
The increase in net investment income for the three and nine months ended
September 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. Invested assets
increased to $580.8 million as of September 30, 2004, compared to $483.9 million
as of September 30, 2003.
22
Risk Management. The following table summarizes the results of operations for
the risk management segment for the three and nine months ended September 30,
2004 and 2003:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- -----------------------------
(in millions) 2004 2003 2004 2003
------------- ------------- ------------- -------------
Gross written premiums $ 52.3 $ 54.6 $ 136.9 $ 151.3
============= ============= ============= =============
Earned premiums 23.6 31.7 90.5 95.7
Losses and loss adjustment expenses 15.8 22.7 58.6 80.7
Underwriting expense 10.1 13.1 40.0 49.7
------------- ------------- ------------- -------------
Underwriting loss (2.3) (4.1) (8.1) (34.7)
Investment income, net 7.1 6.9 21.8 20.8
------------- ------------- ------------- -------------
Income (loss) before taxes $ 4.8 $ 2.8 $ 13.7 $ (13.9)
============= ============= ============= =============
Combined ratio 109.5% 112.8% 108.9% 136.2%
============= ============= ============= =============
Gross written premiums for the three and nine months ended September 30, 2004
continued to be impacted by the shift in written premiums toward casualty risk
management solutions for upper-middle market accounts implemented in March 2003.
Gross written premiums for the upper middle market accounts were $38.5 million
for the three months ended September 30, 2004, of which $8.9 million was new
business, $25.5 million was renewal business and $4.1 was related to
endorsements and cancellations. Gross written premiums for the upper middle
market accounts were $36.9 million for the three months ended September 30,
2003. Gross written premiums for the upper middle market accounts were $101.5
million and $74.1 million for the nine months ended September 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 $1.1 million and $3.0 million for the three and nine months ended September
30, 2004, respectively, compared to $9.1 million and $42.3 million for the same
periods in 2003.
Included in gross written premiums for the three and nine months ended September
30, 2004 were $9.0 million and $20.4 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 $4.0
million and $15.5 million for the same periods ended 2003.
Premiums assumed under quota share agreements with insurance subsidiaries of HCC
Insurance Holdings, Inc. ("HCC") for directors and officers coverage were $2.0
million and $7.2 million for the three and nine months ended September 30, 2004,
respectively. Gross written premiums under these agreements were $3.8 million
and $9.6 million for the three and nine months ended September 30, 2003,
respectively. The agreements were 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 in the percentage of business
assumed from 3.33% for premiums written under the domestic program and 5.0% for
premiums written under the international program to 1.5% of premiums written
under all programs effective January 1, 2004.
Premiums assumed from involuntary pools were $1.8 million for the three months
ended September 30, 2004 compared to $0.8 million for the same period in 2003.
Premiums assumed from involuntary pools were $4.7 million and $9.7 million for
the nine months ended September 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.
23
Earned premiums for the three months ended September 30, 2004 were $8.1 million
lower than the same period in 2003. This decrease was driven by a combination of
an $8.3 million reduction in earned premiums for non-strategic products for
which the Company is exiting, together with a $7.0 million reduction in earned
premiums for retrospectively rated policies. The Company recognized favorable
loss experience on retrospectively rated policies from prior years, which
reduced earned premiums because retrospectively rated policy premium is reduced
by favorable loss experience. Partially offsetting these decreases was $6.5
million of additional earned premiums for the upper middle market accounts
excluding the $7.0 million noted above, and $1.0 million in additional earned
premiums assumed from involuntary pools.
Earned premiums for the nine months ended September 30, 2004 were $5.2 million
lower than for the same period in 2003. The decrease was driven by a combination
of a $22.7 million reduction in earned premiums for non-strategic products for
which the Company is exiting, a $10.0 million reduction in earned premiums for
retrospectively rated policies, a $1.2 million reduction in earned premiums for
certain agreements for which the Company cedes a majority of the premium and
receives a ceding commission, and a $0.8 million reduction in earned premiums
assumed from involuntary pools. Partially offsetting these decreases was $21.5
million of additional earned premiums for upper middle market accounts excluding
the $10.0 million noted above, and $8.0 million of additional earned premiums
under the HCC agreement.
Losses and loss adjustment expenses for the three and nine months ended
September 30, 2004 resulted in a loss ratio of 66.7% and 64.7%, respectively,
compared to 71.5% and 84.3% for the same periods in 2003. Losses and loss
adjustment expenses for the three and nine months ended September 30, 2004 have
been reduced by $5.6 million and $6.6 million, respectively, for favorable
development on prior accident years recognized during 2004, mainly attributable
to the 2001, 2002 and 2003 accident years. Beginning in 2001, management began
re-underwriting the book of business emphasizing less hazardous insureds, and
began shifting the book of business to loss sensitive policies where the insured
retains a significant amount of losses. Loss sensitive products generally have a
lower loss ratio than guaranteed cost products. As a result of these initiatives
and as the actuarial data for these years matured, management has determined
that its best estimate of loss and loss adjustment expense should be reduced.
Losses and loss adjustment expense for the nine months ended September 30, 2003
included an increase to the allowance for doubtful accounts for balances due
from reinsurers of $5.0 million and adverse development of $5.0 million
attributable to one multi-year construction account that was non-renewed in
January 2004. Loss reserves were $643.5 million and $655.5 million as of
September 30, 2004 and 2003, respectively.
The expense ratios for the three and nine months ended September 30, 2004 were
42.8% and 44.2%, respectively, compared to 41.3% and 51.9% for the same periods
in 2003. Underwriting expenses for the three months ended September 30, 2004
were increased by a special assessment of $1.2 million levied to the Company by
the National Council of Compensation Insurers. During the nine months ended
September 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 $1.6 million in expense being
recorded during the nine months ended September 30, 2003, for personnel and
other associated costs. This effort along with continued expense management
initiatives have resulted in decreased levels of expenses in the nine months
ended September 30, 2004.
Investment income increased in the three and nine months ended September 30,
2004 as compared to 2003 due to higher invested balances. Invested assets were
$721.6 million as of September 30, 2004, compared to $678.1 million as of
September 30, 2003.
Specialty Commercial. The following table summarizes the results of operations
for the specialty commercial segment for the three and nine months ended
September 30, 2004 and 2003:
24
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- -----------------------------
(in millions) 2004 2003 2004 2003
------------- ------------- ------------- -------------
Gross written premiums $ 60.7 $ 39.7 $ 156.0 $ 109.7
============= ============= ============= =============
Earned premiums 40.3 31.9 107.2 90.1
Losses and loss adjustment expenses 27.2 23.0 71.3 65.1
Underwriting expense 11.2 8.8 32.8 26.2
------------- ------------- ------------- -------------
Underwriting income 1.9 0.1 3.1 (1.2)
Investment income, net 2.7 2.4 7.8 7.1
------------- ------------- ------------- -------------
Income before taxes $ 4.6 $ 2.5 $ 10.9 $ 5.9
============= ============= ============= =============
Combined ratio 95.1% 99.9% 97.0% 101.3%
============= ============= ============= =============
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 $27.8 million for
the three months ended September 30, 2004, compared to $5.2 million for the same
period ended 2003. For the nine months ended September 30, 2004 and 2003, gross
written premiums from new business were $65.3 million and $21.6 million,
respectively. Of the new business written in 2004, the renewal rights
acquisition contributed approximately $20.0 million and $43.0 million to gross
written premiums for the three and nine months ended September 30, 2004,
respectively. Renewal premiums were $33.0 million and $89.8 million for the
three and nine months ended September 30, 2004, respectively compared to $34.5
million and $88.1 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 67.4% and 66.5% for the three
and nine months ended September 30, 2004, compared to 72.2% and 72.3% for the
same periods in 2003, respectively. Losses and loss adjustment expenses for the
three and nine months ended September 2004, included approximately $1.1 million
in catastrophe losses related to the four hurricanes that made landfall in the
southeastern United States. For the three months ended September 30, 2003,
catastrophe losses of approximately $1.9 million were incurred primarily
resulting from food spoilage resulting from the power outage that affected the
northern United States in August 2003. Losses and loss adjustment expenses for
the nine months ended September 30, 2003, included an additional $2.1 million in
catastrophe losses related to May 2003 storms in the southern and mid-western
United States. The specialty commercial segment's loss reserves were $206.8
million and $181.0 million as of September 30, 2004 and 2003, respectively.
The expense ratios for the specialty commercial segment for the three and nine
months ended September 30, 2004 were 27.7% and 30.5%, respectively, compared to
27.7% and 29.0% for the same periods ended in 2003. The increase in the expense
ratios in 2004, as compared to 2003 on a year to date basis, was primarily
attributable to start-up costs relating to the renewal rights acquisition
previously discussed.
The increase in investment income for the three and nine months ended September
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
$282.1 million as of September 30, 2004, compared to $266.5 million as of
September 30, 2003.
Public Entity. The following table summarizes the results of operations for the
public entity segment for the three and nine months ended September 30, 2004 and
2003:
25
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- -----------------------------
(in millions) 2004 2003 2004 2003
------------- ------------- ------------- -------------
Gross written premiums $ 43.0 $ 25.3 $ 74.7 $ 48.0
============= ============= ============= =============
Earned premiums 17.0 9.2 44.6 21.4
Losses and loss adjustment expenses 12.0 5.6 29.2 13.5
Underwriting expense 5.7 2.7 15.0 6.7
------------- ------------- ------------- -------------
Underwriting income (0.7) 0.9 0.4 1.2
Investment income, net 0.5 0.2 1.2 0.5
------------- ------------- ------------- -------------
Income before taxes $ (0.2) $ 1.1 $ 1.6 $ 1.7
============= ============= ============= =============
Combined ratio 104.5% 89.9% 99.3% 94.6%
============= ============= ============= =============
The increase in gross written premiums for the three and nine months ended
September 30, 2004 was due to an increase in renewal business written in 2004
compared to 2003 and new business generated from a renewal rights acquisition.
For the three and nine months ended September 30, 2004, the public entity
segment's renewal business was approximately $22.6 million and $42.2 million
respectively, compared to $13.3 million and $22.2 million, respectively, for the
same periods in 2003. Additionally, during the three and nine months ended
September 30, 2004, the public entity segment's new business was approximately
$20.4 million and $32.5 million respectively, compared to $12.0 million and
$25.8 million, respectively, for the same periods in 2003. Included in new
business for the three and nine months ended September 30, 2004 was $10.1
million and $14.7 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
insureds' fiscal year ends. The increase in earned premiums for the three and
nine months ended September 30, 2004 as compared to the same periods in 2003 was
primarily attributable to premium growth during 2003 as well as 2004.
Losses and loss adjustment expenses for the three and nine months ended
September 30, 2004 resulted in a loss ratio of 70.7% and 65.6%, respectively,
compared to 60.0% and 63.0%, respectively, for the same periods in 2003. Losses
and loss adjustment expenses for the three and nine months ended September 2004,
included approximately $1.2 million in catastrophe losses related to the four
hurricanes that made landfall in the southeastern United States. The loss ratio
by 7.2 and 2.7 percentage points, respectively. Loss reserves for the public
entity segment were $52.3 million and $23.3 million as of September 30, 2004 and
2003, respectively.
The expense ratios for the three and nine months ended September 30, 2004 were
33.8% and 33.7%, respectively, compared to 29.9% and 31.6%, respectively, for
the same periods in 2003. The increase in the expense ratios from 2003 to 2004
are primarily related to higher acquisition expenses and operations associated
with a renewal rights agreement entered into in the fourth quarter of 2003.
The increase in investment income for the three and nine months ended September
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
$55.8 and $20.9 million as of September 30, 2004 and 2003, respectively.
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:
26
September 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 4.7 - 0.5 10.1
Losses paid 41.2 11.7 8.2 6.8
---------- ---------- --------- ----------
Loss reserves - environmental and
asbestos, end of the period 183.0 168.3 228.8 181.6
Other run-off lines 45.4 35.4 53.0 43.0
Net reserves ceded - retroactive
reinsurance contract - (41.8) - (42.3)
---------- ---------- --------- ----------
Total reserves - run-off lines $228.4 $161.9 $281.8 $182.3
========== ========== ========= ==========
The Company regularly monitors the activity of claims within the run-off lines,
particularly those claims related to asbestos and environmental liabilities.
Additionally, the Company performs an extensive actuarial analysis of the
asbestos and environmental reserves on an annual basis. The Company completed
this 2004 analysis during the three months ended September 30, 2004. The reserve
analysis indicated that no adjustments to carried reserves were required. Based
on the results of this reserve analysis, management believes the reserves for
losses and loss adjustment expenses are adequate based on current facts and
circumstances.
The loss and loss adjustment expense reserves at September 30, 2003 included an
increase to the loss and loss adjustment reserves of $10.2 million. This
increase to the reserves was as a result of the Company changing its estimate of
reserves to be ceded to its reinsurance carriers.
In April 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 trust was
established to administer all future asbestos-related claims filed against the
MacArthur Companies. 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. The Company ceded the
majority of the $29.8 million contribution to reinsurers.
Reinsurance
Property Catastrophe Reinsurance. The Company purchases Excess of Loss property
catastrophe reinsurance ("Property Cat Treaty") for the following three business
segments: Excess and Surplus, Specialty Commercial, and Public Entity. This
coverage is purchased to provide the Company with protection against high
severity property loss events. Under the terms of the Property Cat Treaty,
coverage is provided to the Company as follows: Layer 1- 95% of $2.5 million
excess of $1.5 million (applies only to the Specialty Commercial segment), Layer
2 - 95% of $3.5 million excess of $4 million, Layer 3 - 95% of $7.5 million
excess of $7.5 million, Layer 4 - 95% of $10 million excess of $15 million,
Layer 5 - 95% of $20 million excess of $25 million. The above reinsurance limits
apply to losses and loss adjustment expenses incurred by the Company on a per
occurrence basis, after any recoveries from underlying reinsurance contracts.
The Property Cat Treaty provides the Company with coverage for each occurrence
during the term of the Property Cat Treaty. Maximum coverage for all occurrences
provided by a layer is stated in terms of Reinstatements. Reinstatements provide
an additional full limit of coverage for an event with respect to a stated layer
for consideration of premium. The maximum amount of coverage provided the
Company by a reinsurance layer for all events during the term of the contract is
the stated per occurrence coverage provided by the layer, plus the original
coverage provided by the layer times the number of reinstatements. The Company
is provided with one reinstatement for Layers 1 and 3 through 5. The Company is
provided with two reinstatements for Layer 2.
27
As a result of the four hurricanes that made landfall in the southeastern United
States in the third quarter of 2004, the Company ceded approximately $10.2
million in losses under this treaty. The Company incurred reinstatement premiums
in the amount of $1.8 million, and has fully utilized the amount of protection
provided in the second layer of the Property Cat Treaty. Subsequent to September
30, 2004, the Company purchased additional reinsurance coverage for the second
layer of the Property Cat Treaty that provides identical protection and one
reinstatement.
Reinsurance Recoverable. 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 $26.7 million as of September 30, 2004. Amounts due from
such reinsurers on incurred but not reported claims totaled $22.0 million as of
September 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.
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 nine months ended September 30, 2004, these payments totaled $0.3 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 September 30, 2004, Fayez Sarofim & Co. managed $151.6
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 nine months ended September 30, 2004, the Company ceded
approximately $46.4 million of gross written premiums, $42.9 million of earned
premiums and $29.2 million of losses and loss adjustment expenses. The Company
earned a ceding commission of $8.6 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 nine months ended
September 30, 2004, gross written premiums under this program totaled $7.2
million. For the nine months ended September 30, 2004, the Company expensed
ceding and other commissions of $3.6 million related to this business.
28
Goodwill
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" requires goodwill to be tested at least for impairment. The
Company completes its annual test during the fourth quarter of each year based
on the results of operations through September 30. There has been no indication
of goodwill impairment as of September 30, 2004.
Liquidity and Capital Resources
The Company's principal operating cash flow sources are premiums and investment
income. The primary operating cash outflows are for claim payments and operating
expenses.
For the nine months ended September 30, 2004, consolidated net cash provided by
operating activities was $79.9 million, compared to $129.8 million for the same
period in 2003. The decrease in cash flows from operating activities for the
nine months ended September 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
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 issued by Trust
IV 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.
29
The interest rate on the Debentures and the Capital Securities issued by Trust
VI 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 issued by Trust V
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.
On September 17, 2004, Argonaut Group Statutory Trust VII, a wholly owned
subsidiary of the Company, sold 15,000 Floating Rate Capital Securities
(liquidation amount $1,000 per Capital Security) in a private sale for $15.0
million. The Trust used the proceeds from this sale, together with the proceeds
from its sale of 464 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 issued by Trust
VII is equal to 3-month LIBOR plus 3.6% (not to exceed the highest rate
permitted by New York law, currently 16.0%, prior to September 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 September
15, 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 September 15, 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 September 22, 2004, Argonaut Group Statutory Trust VIII, a wholly owned
subsidiary of the Company, sold 15,000 Floating Rate Capital Securities
(liquidation amount $1,000 per Capital Security) in a private sale for $15.0
million. The Trust used the proceeds from this sale, together with the proceeds
from its sale of 464 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 issued by Trust
VIII is equal to 3-month LIBOR plus 3.55% (not to exceed the highest rate
permitted by New York law, currently 16.0%, prior to September 22, 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 September
22, 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 September 22, 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.
30
On October 22, 2004, Argonaut Group Statutory Trust IX, a wholly owned
subsidiary of the Company, sold 15,000 Floating Rate Capital Securities
(liquidation amount $1,000 per Capital Security) in a private sale for $15.0
million. The Trust used the proceeds from this sale, together with the proceeds
from its sale of 464 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 issued by Trust
IX is equal to 3-month LIBOR plus 3.6% (not to exceed the highest rate permitted
by New York law, currently 16.0%, prior to December 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 December 15,
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 December 15, 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 intends to use the net proceeds from the sale of the Debentures to
increase the capital of its insurance subsidiaries and for general corporate
purposes.
On September 22, 2004, the Company entered into a $25,000,000 Credit Facility
(the "Revolver Facility") with LaSalle Bank National Association as
Administrative Agent and various other financial institutions as lenders. This
Revolver Facility was arranged to meet short-term working capital needs of the
Company.
The Revolver Facility provides for interest at a variable interest rate based on
LIBOR plus a margin ranging from 200 to 250 basis points, as determined by the
underlying leverage ratio (debt to total capitalization) of the Company. As of
September 30, 2004, no borrowing capacity had been utilized under the Revolver
Facility agreement.
The Revolver Facility expires on September 22, 2006, and is thereafter renewable
on an annual basis. The facility has four significant covenants, including (i)
the ratio of total funded debt to total capitalization; (ii) the level of the
Company's consolidated net worth; (iii) interest coverage ratios; and (iv) RBC
ratios of the key operating units. The Company is in compliance with all
financial covenants of the Revolver Facility as of September 30, 2004.
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.
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.
31
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 nine months ended
September 30, 2004, the Company received payments of $5.7 million on this
contract. Gains/losses 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 September 30, 2004 was $1.3
million, compared to $0.2 million as of September 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 September 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".
The Company regularly evaluates its investment portfolio for indication of other
than temporary impairments to the individual securities. During the three and
nine months ended September 30, 2003, the Company recognized other than
temporary losses on the investment portfolio of $0.2 million and $4.0 million,
respectively. During the same periods in 2004, the Company did not incur any
other than temporary impairment losses in its investment portfolio.
Management has assessed these risks and believes that there have been no
material changes since December 31, 2003.
32
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 September 30, 2004.
There have been no changes in the Company's internal controls over financial
reporting during the three and nine months ended September 30, 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.
Section 404 of the Sarbanes-Oxley Act of 2002 requires management to include a
report assessing the Company's internal control over financial reporting for the
year ending December 31, 2004 with its annual report on Form 10-K. Section 404
of the Sarbanes Oxley Act also requires the Company's independent auditor to
issue an opinion on whether management's assessment is fairly stated and whether
the Company has maintained effective internal control over financial reporting
as of December 31, 2004.
As of November 9, 2004, the Company has substantially documented its internal
control systems and testing of such controls is in process. The Company's
independent auditor has begun its required reviews and testing as well. As a
result of these procedures, the Company has not identified any material
weaknesses in internal controls over financial reporting to date.
Since these requirements and rules are new, management is unable to predict with
certainty the possible consequences of failing to comply with all Section 404
requirements or the disclosure of the existence of a material weakness. Some of
the adverse consequences could include (a) possible adverse legal or regulatory
consequences; (b) possible adverse impact on the price of our common stock; or
(c) possible delay in the issuance of the opinion of the Company's independent
auditor regarding our fiscal 2004 financial statements if expanded audit
procedures are required due to the detection of a material weakness in internal
control.
Management believes adequate internal and external resources are available to
allow the Company to meet its current implementation schedule for compliance
with Section 404 and that all reports required of the Company and its
independent auditor will be completed on a timely basis.
33
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
Argonaut Insurance Company v. Los Angeles Metropolitan Transit Authority. On
August 30, 1996, the Los Angeles County Metropolitan Transportation Authority
("MTA") filed a civil action against Argonaut Insurance Company alleging breach
of contract, breach of the covenant of good faith and fair dealing, and
requesting ancillary relief in the form of an accounting, an injunction and
restitution in connection with allegations regarding failures to perform under
certain contracts of insurance. The MTA contends that it has been damaged by an
unspecified amount.
Argonaut Insurance Company has responded to the complaint, and believes it has
meritorious defenses and intends to vigorously contest these claims.
Additionally, Argonaut Insurance Company brought certain counterclaims against
the MTA seeking reimbursement for amounts paid on claims that were within the
MTA's deductible limits, above the MTA's policy limits, or otherwise uncovered
by the MTA's policy. During the ten years prior to the dispute, the MTA
reimbursed Argonaut Insurance Company for similar expenditures on a regular
basis in the ordinary course of business. The Company currently has a receivable
in the amount of approximately $47.6 million relating to reimbursements due and
owing by the MTA. Management has consulted with its attorneys regarding the
merits of the Company's claim and based on these discussions, management
believes the $47.6 million owed to Argonaut Insurance Company is a valid claim.
Further, management believes the MTA has the financial wherewithal to pay the
Company's claim. In addition to the above amounts, Argonaut Insurance Company is
seeking collection of certain unpaid administrative claim handling fees and
prejudgment interest on all amounts due which are not included in the
aforementioned receivable.
The Court, by agreement of the parties, has ordered the first stage of this case
to be tried before a three-judge panel instead of jury to consider a portion of
Argonaut Insurance Company's counterclaim for sums it contends are due from the
MTA. Trial was set for November 1, 2004. On October 25, 2004, the Court ruled on
eight recently filed motions for summary adjudication relating to certain of the
MTA's defenses to Argonaut Insurance Company's action for reimbursement.
As was the case with a number of previous motions for summary adjudication
considered by the Court in the last three years relating to the recoverability
of the receivable, the Court again adopted the position asserted by Argonaut
Insurance Company as to each motion. Significantly, two of the motions addressed
the merits of Argonaut Insurance Company's cancellation and non-renewal of the
MTA's policy of insurance. The MTA asserted that Argonaut Insurance Company
wrongfully cancelled and non-renewed the MTA's policy of insurance, thus giving
rise to certain equitable defenses to Argonaut Insurance Company's collection
action. These same allegations formed the primary basis of the MTA's affirmative
claims against Argonaut Insurance Company for breach of contract and breach of
the covenant of good faith and fair dealing. The Court ruled, however, that
Argonaut Insurance Company properly cancelled and non-renewed the policies as a
matter of law.
Following the rulings, the MTA sought a postponement of the first stage of the
trial in order to pursue a request to the Court of Appeals for an expedited
appeal of the rulings. The trial court granted the MTA's request for a
postponement, and pleadings relating to the appeal are expected to be filed in
the fourth quarter.
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.
34
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None
Item 6. Exhibits
A list of exhibits filed herewith is contained on the Exhibit Index immediately
preceding such exhibits and is incorporated herein by reference.
35
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, Senior Vice President and Treasurer
(principal financial and accounting officer)
/s/ Byron L. LeFlore, Jr.
- -----------------------------
Byron L. LeFlore, Jr.
General Counsel, Senior Vice President and Secretary
November 9, 2004
35
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 of
the Sarbanes-Oxley Act of 2002.
31.2 Certificate of the Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 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.
37
EXHIBIT 12.1
ARGONAUT GROUP, INC.
STATEMENT OF COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
AND PREFERRED STOCK DIVIDENDS
Nine months ended
September 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 $ 34.5 $ 120.5 $ 135.3 $(21.1) $ 3.3 $ (129.2) $(25.5)
Add:
Fixed charges 10.8 8.6 12.3 2.6 2.9 2.3 1.5
--------- ---------- --------- --------- --------- ---------- ---------
Total earnings (loss) $ 45.3 $ 129.1 $ 147.6 $(18.5) $ 6.2 $ (126.9) $(24.0)
========= ========== ========= ========= ========= ========== =========
Fixed charges
Interest expense, net $ 7.5 $ 6.0 $ 8.4 $ 0.4 $ 0.2 $ - $ -
Preferred stock dividends 1.8 1.2 1.8 - - - -
Rental interest factor 1.5 1.4 2.1 2.2 2.7 2.3 1.5
--------- ---------- --------- --------- --------- ---------- ---------
Total fixed charges $ 10.8 $ 8.6 $ 12.3 $ 2.6 $ 2.9 $ 2.3 $ 1.5
========= ========== ========= ========= ========= ========== =========
Ratio of earnings to fixed charges 4.2:1 15.0:1 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
38
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 November, 2004.
/s/ Mark E. Watson III
--------------------------------
Mark E. Watson III
President and Chief Executive Officer
39
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 November, 2004.
/s/ Mark W. Haushill
-----------------------------------
Mark W. Haushill
Senior Vice President
Chief Financial Officer and Treasurer
40
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 September 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 November, 2004.
/s/ Mark E. Watson III
--------------------------------
Mark E. Watson III
President and Chief Executive Officer
41
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 September 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 November, 2004.
/s/ Mark W. Haushill
-----------------------------------
Mark W. Haushill
Senior Vice President
Chief Financial Officer and Treasurer
42