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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR QUARTER ENDED SEPTEMBER 30, 2003
COMMISSION FILE NUMBER 1-9371
ALLEGHANY CORPORATION
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EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER
DELAWARE
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STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION
51-0283071
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INTERNAL REVENUE SERVICE EMPLOYER IDENTIFICATION NUMBER
375 PARK AVENUE, NEW YORK NY 10152
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ADDRESS OF PRINCIPAL EXECUTIVE OFFICE, INCLUDING ZIP CODE
212-752-1356
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE
NOT APPLICABLE
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FORMER NAME, FORMER ADDRESS, AND FORMER FISCAL YEAR,
IF CHANGED SINCE LAST REPORT
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) 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 ISSUER'S CLASSES OF
COMMON STOCK, AS OF THE LAST PRACTICABLE DATE.
7,492,354 SHARES AS OF NOVEMBER 7, 2003
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ITEM 1. FINANCIAL STATEMENTS
ALLEGHANY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE THREE MONTHS ENDED
SEPTEMBER 3O, 2003 AND 2002
(dollars in thousands, except share and per share amounts)
(unaudited)
2003 2002
----------- -----------
REVENUES
Net fastener sales $ 30,559 $ 28,150
Interest, dividend and other income 11,096 12,947
Net premiums earned 167,819 32,700
Net mineral and filtration sales 67,502 65,017
Net gain on investment transactions 77,874 4,617
----------- -----------
Total revenues 354,850 143,431
----------- -----------
COSTS AND EXPENSES
Underwriting expenses 40,097 12,145
Salaries, administrative and other operating expenses 22,914 18,659
Loss and loss adjustment expenses 100,609 30,192
Cost of goods sold - fasteners 23,614 21,084
Cost of mineral and filtration sales 50,174 47,467
Interest expense 1,381 1,845
Corporate administration 8,218 6,940
----------- -----------
Total costs and expenses 247,007 138,332
----------- -----------
Earnings before income taxes 107,843 5,099
Income taxes 32,973 (16,621)
----------- -----------
Net earnings $ 74,870 $ 21,720
=========== ===========
Basic earnings per share of common stock ** $ 10.02 $ 2.93
=========== ===========
Diluted earnings per share of common stock ** $ 9.99 $ 2.91
=========== ===========
Dividends per share of common stock * *
=========== ===========
Average number of outstanding shares of common stock ** 7,468,549 7,409,912
=========== ===========
* In March 2002 and 2003, Alleghany declared a stock dividend consisting of
one share of Alleghany common stock for every fifty shares outstanding.
** Adjusted to reflect the common stock dividend declared in March 2003.
See Notes to Consolidated Financial Statements.
ALLEGHANY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 2003 AND 2002
(dollars in thousands, except share and per share amounts)
(unaudited)
2003 2002
---------- ----------
REVENUES
Net fastener sales $ 85,804 $ 85,035
Interest, dividend and other income 36,187 32,924
Net premiums earned 234,759 92,370
Net mineral and filtration sales 198,410 189,309
Net gain on investment transactions 82,716 43,564
---------- ----------
Total revenues 637,876 443,202
---------- ----------
COSTS AND EXPENSES
Underwriting expenses 68,380 32,505
Salaries, administrative and other operating expenses 60,498 54,370
Loss and loss adjustment expenses 140,277 73,419
Cost of goods sold - fasteners 65,182 64,171
Cost of mineral and filtration sales 150,295 139,849
Interest expense 4,127 5,141
Corporate administration 21,001 15,954
---------- ----------
Total costs and expenses 509,760 385,409
---------- ----------
Earnings before income taxes 128,116 57,793
Income taxes 39,526 1,369
---------- ----------
Net earnings $ 88,590 $ 56,424
========== ==========
Basic earnings per share of common stock ** $ 11.91 $ 7.56
========== ==========
Diluted earnings per share of common stock ** $ 11.87 $ 7.51
========== ==========
Dividends per share of common stock * *
========== ==========
Average number of outstanding shares of common stock ** 7,437,907 7,459,691
========== ==========
* In March 2002 and 2003, Alleghany declared a stock dividend consisting of
one share of Alleghany common stock for every fifty shares outstanding.
** Adjusted to reflect the common stock dividend declared in March 2003.
See Notes to Consolidated Financial Statements.
ALLEGHANY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2003 AND DECEMBER 31, 2002
(dollars in thousands, except share amounts)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2003 2002
---------- ----------
ASSETS
Available for sale securities: 9/30/2003 12/31/2002
--------- ----------
Equity securities (cost: $402,191 $239,669) $ 623,667 $ 486,353
Debt securities (cost: $766,585 $570,973) 774,783 580,606
Short-term investments 117,693 237,698
---------- ----------
1,516,143 1,304,657
Cash 194,962 27,423
Notes receivable 92,101 92,358
Insurance and accounts receivable 186,991 85,710
Reinsurance receivables 147,622 147,479
Deferred acquisition costs 54,648 22,547
Property and equipment - at cost, net of
accumulated depreciation and amortization 176,322 173,539
Inventory 86,744 81,978
Goodwill and other intangibles, net of amortization 228,663 112,858
Other assets 141,801 85,833
---------- ----------
$2,825,997 $2,134,382
========== ==========
LIABILITIES AND COMMON STOCKHOLDERS' EQUITY
Current taxes payable $ 34,086 $ 28,372
Losses and loss adjustment expenses 338,432 258,471
Other liabilities 240,820 147,411
Unearned premiums 452,046 64,115
Parent company debt 25,000 --
Subsidiaries' debt 158,947 152,507
Net deferred tax liability 111,986 104,164
---------- ----------
Total liabilities 1,361,317 755,040
Common stockholders' equity 1,464,680 1,379,342
---------- ----------
$2,825,997 $2,134,382
========== ==========
Shares of common stock outstanding * 7,487,885 7,409,282
========== ==========
* Adjusted to reflect the common stock dividend declared in March 2003.
See Notes to Consolidated Financial Statements.
ALLEGHANY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 2003 AND 2002
(dollars in thousands)
(unaudited)
2003 2002
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 88,590 $ 34,704
Adjustments to reconcile net earnings to cash provided by (used in) operations:
Depreciation and amortization 15,979 10,065
Net gain on investment transactions (82,716) (38,947)
Tax benefit on stock options exercised 3,388 1,176
Other charges, net 11,222 9,997
Increase in insurance and accounts receivable (101,281) (37,049)
Decrease (increase) in deferred acquisition costs (32,101) (4,833)
Decrease (increase) in other assets including goodwill (176,539) 29,430
Decrease (increase) in other liabilities and current taxes payable 99,123 (44,493)
(Decrease) increase in unearned premiums 387,931 7,838
Increase in losses and loss adjustment expenses 79,961 (20,542)
Decrease (increase) in reinsurance receivables (143) 26,357
--------- ---------
Net adjustments 204,824 (61,001)
--------- ---------
Cash provided by (used in) operations 293,414 (26,297)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investments (687,270) (561,331)
Sales of investments 437,580 325,661
Purchases of property and equipment (15,709) (5,579)
Net change in short-term investments 120,005 544,167
Other, net 114,837 (16,489)
Acquisition of insurance companies, net of cash acquired (131,389) (221,056)
--------- ---------
Net cash (used in) provided by investing activities (161,946) 65,373
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on debt (82,931) (90,641)
Proceeds of debt 114,371 82,316
Treasury stock acquisitions 0 (18,360)
Other, net 4,631 4,168
--------- ---------
Net cash provided by financing activities 36,071 (22,517)
--------- ---------
Net increase in cash 167,539 16,559
Cash at beginning of period 27,423 15,717
--------- ---------
Cash at end of period $ 194,962 $ 32,276
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 2,977 $ 2,876
Income taxes $ 9,019 $ 48,873
See Notes to Consolidated Financial Statements.
Notes to the Consolidated Financial Statements
This report should be read in conjunction with the Annual Report on Form
10-K for the year ended December 31, 2002 (the "2002 Form 10-K"), the Quarterly
Report on Form 10-Q for the quarter ended March 31, 2003 (the "2003 First
Quarter Form 10-Q") and the Quarterly Report on Form 10-Q for the quarter ended
June 30, 2003 (the "2003 Second Quarter Form 10-Q") of Alleghany Corporation
(the "Company").
The information included in this report is unaudited but reflects all
adjustments which, in the opinion of management, are necessary to a fair
statement of the results of the interim periods covered thereby. All adjustments
are of a normal and recurring nature except as described herein.
Stock-Based Compensation Accounting
The Company sponsors fixed option plans and a performance-based stock
plan, where awards are granted to eligible employees of the Company in the form
of non-qualified stock options or other stock-based awards. Prior to 2003, the
Company accounted for those plans under the recognition and measurement
provisions of APB Opinion No. 25, "Accounting for Stock Issued to Employees." No
compensation cost for the Company's fixed option plans is reflected in three and
nine months ended September 30, 2002 net income, as all options granted under
the plans had an exercise price equal to the market value of the underlying
common stock on the date of grant. Effective January 1, 2003, the Company
adopted the fair value recognition provisions of FAS Statement No. 123,
"Accounting for Stock-Based Compensation," prospectively for all employee awards
granted after January 1, 2003. Therefore, the costs related to the Company's
fixed option plans and performance-based stock plan included in the
determination of net income for the three and nine months ended September 30,
2003 is less than that which would have been recognized if the fair value based
method had been applied to all awards prior to January 1, 2003.
The following table illustrates the effect on net earnings and earnings
per share if the fair value based method had been applied to all outstanding and
unvested awards under all of the Company plans in each period.
6
For the three months ended For the nine months ended
(in thousands, except per share September 30, September 30, September 30, September 30,
amounts) 2003 2002 2003 2002
---------- ---------- ---------- ----------
Net earnings, as reported $ 74,870 $ 21,720 $ 88,590 $ 56,424
Add: stock-based employee
compensation expense included
in reported net earnings, net
of related tax 1,167 491 2,504 (254)
Less: stock-based compensation
expense determined under fair
value method for all stock
options, net of related tax 1,288 462 3,543 1,385
---------- ---------- ---------- ----------
Pro forma net earnings $ 74,749 $ 21,749 $ 87,551 $ 54,785
========== ========== ========== ==========
Earnings per share
Basic - as reported $ 10.02 $ 2.93 $ 11.91 $ 7.56
Basic - pro forma $ 10.01 $ 2.94 $ 11.77 $ 7.34
Diluted - as reported $ 9.99 $ 2.91 $ 11.87 $ 7.51
Diluted - pro forma $ 9.97 $ 2.91 $ 11.73 $ 7.29
Acquisition of Royal Specialty Underwriting, Inc.
On July 1, 2003, Alleghany Insurance Holdings LLC ("AIHL") completed the
acquisition of Royal Specialty Underwriting, Inc. ("RSUI"), a wholesale
underwriting agency, from Royal Group, Inc., a subsidiary of Royal & Sun
Alliance Insurance Group plc ("R&SA"), for cash consideration, including
capitalized expenditures, of approximately $108.1 million. The acquisition also
included renewal rights to the ongoing business underwritten by RSUI for the
insurance affiliates of R&SA and the related net unearned premium reserve
portfolio of approximately $320.0 million. The transaction did not include loss
reserves associated with business underwritten by RSUI for insurance affiliates
of R&SA prior to the date of the transaction.
7
In connection with the acquisition of RSUI, on June 30, 2003, AIHL
acquired Underwriters Reinsurance Company ("URC") from Swiss Re America Holding
Corporation for consideration of approximately $19.7 million. On August 13,
2003, URC's name was changed to RSUI Indemnity Company ("RIC"). On September 2,
2003, RIC purchased Landmark American Insurance Company ("Landmark"), a
non-admitted insurance company domiciled in Oklahoma, to write non-admitted
business underwritten by RSUI, from R&SA for cash consideration of $33.9
million, $30.3 of which represented consideration for Landmark's investment
portfolio and approximately $3.5 million of which represented consideration for
licenses.
Change in Accounting
In April 2003, the Financial Accounting Standards Board ("FASB") issued
FAS Statement No. 149, "Amendment to Statement No. 133 on Derivative Instruments
and Hedging Activities." This statement amends and clarifies financial
accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities under FAS Statement No. 133 "Accounting
for Derivative Instruments and Hedging Activities." The changes in FAS Statement
No. 149 improve financial reporting by requiring that contracts with comparable
characteristics be accounted for similarly. Those changes will result in more
consistent reporting of contracts as either derivatives or hybrid instruments.
FAS Statement No.149 is effective for contracts entered into or modified after
June 30, 2003 except in certain instances detailed in the Statement, and hedging
relationships designated after June 30, 2003. Except as otherwise stated in FAS
Statement No. 149, all provisions should be applied prospectively. FAS Statement
No. 149 will not have an impact on the Company.
In May 2003, the FASB issued FAS Statement No. 150, "Accounting for
Certain Financial Instruments with Characteristics of Both Liabilities and
Equity." FAS Statement No. 150 establishes standards for the classification and
measurement of certain financial instruments that have both liability and equity
characteristics. It requires that an issuer classify a financial instrument that
is within the scope of the Statement as a liability (or as an asset in some
circumstances). Many of those instruments were previously classified as equity.
FAS Statement No. 150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of the
first interim period commencing after June 15, 2003, except for mandatorily
redeemable financial instruments. FAS Statement No. 150 will not have an impact
on the Company.
FASB Interpretation No. 46 "Consolidation of Variable Interest Entities"
("FIN 46") provides accounting and disclosure rules for variable interest
entities. A variable interest entity is an entity in which equity investors do
not have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to
8
finance its activities without additional subordinated financial support from
other parties. Variable interest entities are often created for a single
specific purpose, for example, to facilitate asset securitization. FIN 46 became
effective in the first quarter of 2003 for variable interest entities created,
or in which an enterprise obtains an interest, after January 31, 2003. It became
effective July 1, 2003 for variable interest entities in which an enterprise
holds a variable interest that it acquired before February 1, 2003. FIN 46
requires variable interest entities to be consolidated by their primary
beneficiaries if the entities do not effectively disperse risk among the parties
involved. FIN 46 requires disclosures for entities that have either a primary or
significant variable interest in a variable interest entity. FIN 46 will not
have an impact on the Company.
Comprehensive Income (Loss)
The Company's total comprehensive income(loss) was $20.1 million and
$(48.1) million for the three months ended September 30, 2003 and 2002, and
$77.2 million and $(16.4) million for the nine months ended September 30, 2003
and 2002. Comprehensive income(loss) includes the Company's net earnings
adjusted for changes in unrealized appreciation (depreciation) of investments,
which were $(54.9) million and $(69.4) million for the three months ended
September 30, 2003 and 2002, and $(17.6) million and $(74.8) million for the
nine months ended September 30, 2003 and 2002, and cumulative translation
adjustments, which were $0.1 million and $(0.5) million for the three months
ended September 30, 2003 and 2002, and $6.2 million and $1.9 million for the
nine months ended September 30, 2003 and 2002.
Segment Information
Information concerning the Company's operations by industry segment is
summarized below:
For the three months ended For the nine months ended
September 30, September 30, September 30, September 30,
(dollars in millions) 2003 2002 2003 2002
------- ------- ------- -------
REVENUES
Property and casualty
insurance $ 221.5 $ 32.5 $ 298.5 $ 96.4
Mining and filtration 67.4 65.6 198.6 189.5
Corporate activities 66.0 45.3 140.8 157.3
------- ------- ------- -------
Total $ 354.9 $ 143.4 $ 637.9 $ 443.2
======= ======= ======= =======
9
For the three months ended For the nine months ended
September 30, September 30, September 30, September 30,
(dollars in millions) 2003 2002 2003 2002
------- ------- ------- -------
EARNINGS (LOSSES) BEFORE INCOME
TAXES
Property and casualty
insurance $ 75.0 $ (10.4) $ 82.6 $ (11.4)
Mining and filtration 6.9 7.3 18.3 18.0
Corporate activities 25.9 8.2 27.2 51.2
------- ------- ------- -------
Total 107.8 5.1 128.1 57.8
Income taxes 32.9 (16.6) 39.5 1.4
------- ------- ------- -------
Net earnings $ 74.9 $ 21.7 $ 88.6 $ 56.4
======= ======= ======= =======
September 30, December 31,
(dollars in millions) 2003 2002
-------- --------
IDENTIFIABLE ASSETS
Property and casualty
insurance $1,900.5 $ 666.8
Mining and filtration 316.6 320.9
Corporate activities 608.9 1,146.7
-------- --------
Total $2,826.0 $2,134.4
======== ========
10
Contingencies
The Company's subsidiaries are parties to pending claims and litigation in
the ordinary course of their businesses. Each such operating unit makes
provisions on its books in accordance with generally accepted accounting
principles for estimated losses to be incurred as a result of such claims and
litigation, including related legal costs. In the opinion of management, such
provisions are adequate as of September 30, 2003.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
The following discussion and analysis presents a review of the Company and
its subsidiaries for the three and nine months ended September 30, 2003 and
2002. This review should be read in conjunction with the consolidated financial
statements and other data presented herein as well as Management's Discussion
and Analysis of Financial Condition and Results of Operation contained in the
Company's 2002 Form 10-K, 2003 First Quarter Form 10-Q and 2003 Second Quarter
Form 10-Q.
The Company reported net earnings in the third quarter of 2003 of $74.9
million, compared with net earnings of $21.7 million in the third quarter of
2002. Third quarter 2003 net earnings include the results of operations of RSUI
Group, Inc. ("RSUI"), acquired on July 1, 2003 from Royal & Sun Alliance Group
plc ("R&SA"), and net gains on investment transactions after taxes of $50.6
million, primarily reflecting the proceeds from the disposition of approximately
4.4 million shares of common stock of Burlington Northern Santa Fe Corporation.
Such disposition generated $119.1 million of aggregate cash proceeds, $87.7
million of which was generated at the Company's insurance operating units for
the purpose of diversifying their investment portfolios. In the first nine
months of 2003, the Company's net earnings were $88.6 million, compared with net
earnings of $56.4 million in the first nine months of 2002. The 2003 nine-month
results include net gains on investment transactions after taxes of $53.8
million, compared with $28.3 million in the corresponding 2002 period.
The Company's common stockholders' equity per share at September 30, 2003
was $195.61, an increase from common stockholders' equity per share of $186.16
as of December 31, 2002 (both as adjusted for the stock dividend declared in
March 2003).
AIHL recorded pre-tax earnings of $75.0 million on revenues of $221.5
million in the third quarter of 2003, compared with a pre-tax loss of $10.4
million on revenues of $32.5 million in the 2002 third quarter, and pre-tax
earnings of $82.6 million on revenues of $298.5 million in the first nine months
of 2003, compared with a pre-tax loss of $11.4 million on revenues of $96.4
million in the first nine months of 2002. AIHL's 2003 third quarter net earnings
include pre-tax investment income of $7.4 million and a realized pre-tax net
gain on investment transactions of $46.3 million, compared with pre-tax
11
investment income of $3.6 million and a realized pre-tax net loss on investment
transactions of $3.8 million in the corresponding 2002 period. AIHL's 2003
pre-tax investment income reflects a larger invested asset base, principally due
to capital contributions by Alleghany and the acquisition of RSUI. AIHL's 2003
pre-tax net gain on investment transactions primarily reflects the disposition
of 3.2 million shares of common stock of Burlington Northern Santa Fe for
aggregate cash proceeds of $87.7 million for the purpose of diversifying the
investment portfolios of the insurance operating units.
The comparative pre-tax contributions to AIHL's results made by RSUI
(since July 1, 2003) and Capitol Transamerica Corporation ("CATA") were as
follows (in thousands, except ratios):
THREE MONTHS ENDED SEPTEMBER 30
2003 RSUI CATA(1) TOTAL
- ---- ---- ------- -----
Gross premiums written $489,868 $ 49,519 $539,387
Net premiums earned $135,777 $ 32,042 $167,819
Loss and loss adjustment expenses 81,645 18,964 100,609
Underwriting expenses 25,439 14,658 40,097
-------- --------- --------
Underwriting profit (loss) (2) $ 28,693 $ (1,580) $ 27,113
======== ========= ========
Loss ratio (3) 60.1% 59.2% 59.9%
Expense ratio (4) 18.8% 45.7% 23.9%
Combined ratio (5) 78.9% 104.9% 83.8%
2002
Gross premiums written -- $ 37,705 $ 37,705
Net premiums earned -- $ 32,700 $ 32,700
Loss and loss adjustment expenses -- 30,192 30,192
Underwriting expenses -- 12,145 12,145
-------- --------- --------
Underwriting loss (2) -- $ (9,637) $ (9,637)
======== ========= ========
Loss ratio (3) -- 92.3% 92.3%
Expense ratio (4) -- 37.1% 37.1%
Combined ratio (5) -- 129.4% 129.4%
NINE MONTHS ENDED SEPTEMBER 30
2003 RSUI CATA(1) TOTAL
- ---- ---- ------- -----
Gross premiums written $489,868 $ 132,089 $621,957
Net premiums earned $135,777 $ 98,982 $234,759
Loss and loss adjustment expenses 81,645 58,632 140,277
12
2003 RSUI CATA(1) TOTAL
- ---- ---- ------- -----
Underwriting expenses 25,439 42,941 68,380
-------- --------- --------
Underwriting profit (loss) (2) $ 28,693 $ (2,591) $ 26,102
======== ========= ========
Loss ratio (3) 60.1% 59.2% 59.8%
Expense ratio (4) 18.8% 43.4% 29.1%
Combined ratio (5) 78.9% 102.6% 88.9%
2002
Gross premiums written -- $ 113,188 $113,188
Net premiums earned -- $ 92,370 $ 92,370
Loss and loss adjustment expenses -- 73,419 73,419
Underwriting expenses -- 32,505 32,505
-------- --------- --------
Underwriting loss (2) -- $ (13,554) $(13,554)
======== ========= ========
Loss ratio (3) -- 79.5% 79.5%
Expense ratio (4) -- 35.2% 35.2%
Combined ratio (5) -- 114.7% 114.7%
(1) Includes the results of Platte River Insurance Company and other insurance
operations.
(2) Represents net premiums earned less loss and loss adjustment expenses and
underwriting expenses, all as determined in accordance with generally accepted
accounting principles ("GAAP"), and does not include income derived from
investments. Underwriting profit (loss) does not replace net income (loss)
determined in accordance with GAAP as a measure of profitability; rather, it
provides a basis for management to evaluate the underwriting performance of its
insurance operating units.
(3) Loss and loss adjustment expenses divided by net premiums earned, all as
determined in accordance with GAAP.
(4) Underwriting expenses divided by net premiums earned, all as determined in
accordance with GAAP.
(5) The sum of the Loss Ratio and Expense Ratio, all as determined in accordance
with GAAP, representing the percentage of each premium dollar an insurance
company has to spend on losses (including loss adjustment expenses) and
underwriting expenses.
RSUI's 2003 third quarter gross premiums written include $320.0 million of
unearned premiums which were acquired with RSUI in July 2003, as well as $169.9
million of gross premiums written since acquisition, reflecting continued strong
markets in its lines of business. In addition, RSUI's 2003 third quarter results
reflect pre-tax catastrophe losses of approximately $10.0 million due to the
East Coast blackout in August 2003 and approximately $4.8 million due to
Hurricane Isabel in September 2003.
CATA's 2003 third quarter results reflect a $3.3 million pre-tax reduction
in loss reserves due to better than expected loss emergence in the current year
following an independent actuarial review, an increase in gross premiums written
due to price increases and increased submission activity in its property and
casualty lines of business. CATA's 2003 third quarter results also reflect the
recording of additional prior year loss reserve development of $3.4 million
pre-tax ($1.4 million of which was pursuant to an arbitration settlement)
related to assumed reinsurance treaties written prior to 1980. CATA has
commenced a review of claims and coverages related to its assumed reinsurance
reserves and expects to complete such review in the 2003 fourth quarter,
13
prior to its next independent actuarial review. Should such review result in the
need for an increase in assumed reinsurance reserves, such increase would be
reflected as an expense in the Company's statement of earnings in the period in
which the determination is made.
Although the results of RSUI and CATA reflect their continued ability to
achieve rate increases across their lines of business, rates have increased at a
slower rate or declined in certain lines of business, particularly with respect
to RSUI's property line of business.
In connection with the acquisition of RSUI, AIHL also acquired RSUI
Indemnity Company ("RIC") to write business on an admitted basis, and RIC
acquired Landmark American Insurance Company ("Landmark") to write business on a
non-admitted basis. In order to be able to write admitted business in a state, a
company must be licensed by the state and become subject to the state's form and
rate regulations. It is anticipated that it will take up to mid-2004 for RIC to
obtain all necessary licenses to be able to write business on an admitted basis
in most states, while Landmark (which, as a non-admitted company, is not subject
to state form and rate regulations and thus has more flexibility in its rates
and coverages for specialized or hard-to-place risks) is currently approved to
write business on a non-admitted basis in 48 states. Although R&SA agreed to
provide policy issuance services to RIC through June 2004 to cover this
regulatory transition period, all of the major rating agencies downgraded the
ratings of R&SA's issuing carriers in the 2003 third quarter to levels that have
substantially reduced the acceptability of their insurance policies to agents,
brokers, and insureds. As an alternative, RSUI has been offering coverage
written by Landmark on a non-admitted basis for classes of business
predominantly written on an admitted basis. This may reduce RSUI's premium
volume for those classes of business that are predominantly written on admitted
paper, including the excess umbrella liability and general liability insurance
lines.
World Minerals recorded pre-tax earnings of $6.9 million on revenues of
$67.4 million in the 2003 third quarter, compared with pre-tax earnings of $7.3
million on revenues of $65.6 million in the 2002 third quarter, and pre-tax
earnings of $18.3 million on revenues of $198.6 million in the first nine months
of 2003, compared with pre-tax earnings of $18.0 million on revenues of $189.4
million in the first nine months of 2002. The 2003 nine-month results reflect
the favorable impact of the strengthening of the Euro and pound sterling against
the dollar (had foreign exchange rates remained constant with those of the first
nine months in 2002, World Minerals' revenues would have been approximately
flat), lower margins due to competitive pricing pressures and increased labor
and benefit costs.
As of September 30, 2003, the Company beneficially owned approximately
11.6 million shares, or 3.1 percent, of the outstanding common stock of
Burlington Northern
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Santa Fe Corporation, which had an aggregate market value on that date of
approximately $335.7 million, or $28.87 per share. The aggregate cost of such
shares is approximately $138.1 million, or $11.88 per share.
The Company has previously announced that it may purchase shares of its
common stock in open market transactions from time to time. In the third quarter
of 2003, the Company did not purchase any shares of its common stock. As of
September 30, 2003, the Company had 7,487,885 shares of common stock outstanding
(which includes the stock dividend declared in March 2003).
The Company's results in the first nine months of 2003 are not indicative
of operating results in future periods. On September 26, 2003, the Company
borrowed $25.0 million under its three-year credit agreement for the purpose of
making equity investments. The Company repaid in full such borrowings on
November 12, 2003. The Company and its subsidiaries have adequate internally
generated funds and unused credit facilities to provide for the currently
foreseeable needs of its and their businesses.
Information regarding the Company's accounting policies is included in the
Company's 2002 Form 10-K and the Notes to the Consolidated Financial Statements
included in this report on Form 10-Q.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Market risk is the risk of loss from adverse changes in market prices and
rates, such as interest rates, foreign currency exchange rates and commodity
prices. The primary market risk related to the Company's non-trading financial
instruments is the risk of loss associated with adverse changes in interest
rates. The investment portfolios of the Company and its insurance subsidiaries
may contain, from time-to-time, debt securities with fixed maturities that
expose them to risk related to adverse changes in interest rates.
The table below presents a sensitivity analysis of the debt securities of
the Company and its insurance subsidiaries that are sensitive to changes in
interest rates. Sensitivity analysis is defined as the measurement of potential
changes in future earnings, fair values or cash flows of market sensitive
instruments resulting from one or more selected hypothetical changes in interest
rates over a selected period of time. In this sensitivity analysis model, the
Company uses fair values to measure the potential change, and a +/- 300 basis
point range of change in interest rates to measure the hypothetical change in
fair value of the financial instruments included in the analysis. The change in
fair value is determined by calculating a hypothetical September 30, 2003 ending
price based on yields adjusted to reflect a +/- 300 basis point range of change
in interest rates, comparing such hypothetical ending price to actual ending
price and multiplying the difference by the par outstanding.
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SENSITIVITY ANALYSIS
At September 30, 2003
(dollars in millions)
Interest Rate Shifts -300 -200 -100 0 100 200 300
---- ---- ---- - --- --- ---
ASSETS
Debt securities 839.3 832.7 814.5 774.8 772.8 752.1 732.7
Estimated change in value 64.5 57.9 39.7 -- (2.0) (22.7) (42.1)
LIABILITIES
Parent and subsidiaries' debt 183.8 183.8 183.4 183.9 184.5 185.1 185.7
Estimated change in value (0.1)* (0.1) (0.5) -- 0.6 1.2 1.8
*The weighted average interest rate for parent and subsidiaries' debt is 2.73%.
For purposes of this table, no change in value of such debt is reflected below
- -200 basis points as any decrease in interest rates greater than 273 basis
points (or 2.73%) would result in an effective interest rate of 0%.
The Company's 2002 Form 10-K provides a more detailed discussion of the
market risks affecting its operations. Based on the Company's estimates as of
September 30, 2003, no material change has occurred in its assets and
liabilities, as compared with amounts disclosed in its 2002 Form 10-K.
16
ITEM 4. CONTROLS AND PROCEDURES
The Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Chief Executive Officer
(the "CEO") and the Chief Financial Officer (the "CFO"), of the effectiveness of
the design and operation of the Company's disclosure controls and procedures as
of the end of the period covered by this report on Form 10-Q pursuant to Rule
13a-15 promulgated under the Securities Exchange Act of 1934. Based on that
evaluation, the Company's management, including the CEO and CFO, concluded that
the Company's disclosure controls and procedures are effective in timely
alerting them to material information required to be included in the Company's
periodic reports required to be filed with the Securities and Exchange
Commission. It should be noted that the design of any system of controls is
based in part upon certain assumptions about the likelihood of future events,
and there can be no assurance that any design will succeed in achieving its
stated goals under all potential future conditions, regardless of how remote.
There have been no significant changes in internal control over financial
reporting that have materially affected, or are reasonably likely to materially
affect, the Company's internal control over financial reporting subsequent to
the date of such evaluation, including any corrective actions with regard to
significant deficiencies or material weaknesses.
Forward-Looking Statements
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Quantitative and Qualitative Disclosures About Market Risk"
contain disclosures which are forward-looking statements. Forward-looking
statements include all statements that do not relate solely to historical or
current facts, and can be identified by the use of words such as "may," "will,"
"expect," "project," "estimate," "anticipate," "plan" or "continue." These
forward-looking statements are based upon the Company's current plans or
expectations and are subject to a number of uncertainties and risks that could
significantly affect current plans, anticipated actions and the Company's future
financial condition and results. These statements are not guarantees of future
performance, and the Company has no specific intention to update these
statements. The uncertainties and risks include, but are not limited to, those
relating to conducting operations in a competitive environment and conducting
operations in foreign countries, effects of acquisition and disposition
activities, adverse loss development for events insured by the Company's
insurance operations in either the current year or prior years, general economic
and political conditions, including the effects of a prolonged U.S. or global
economic downturn or recession, changes in costs, including changes in labor
costs, energy costs and raw material prices, variations in political, economic
or other factors such as currency exchange rates, inflation rates or
recessionary or expansive trends, changes in market prices of the Company's
significant equity investments, tax, legal and regulatory changes, extended
labor disruptions, significant weather-related or other natural or human-made
disasters, especially with respect to their impact on losses at the Company's
insurance subsidiaries, civil unrest or other external factors over which the
Company has no control, and changes in the Company's plans, strategies,
objectives, expectations or intentions,
17
which may happen at any time at the Company's discretion. As a consequence,
current plans, anticipated actions and future financial condition and results
may differ from those expressed in any forward-looking statements made by or on
behalf of the Company.
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PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES.
(c) Recent Sales of Unregistered Securities.
On July 15, 2003, the Company issued 867 shares of common stock to Paul F.
Woodberry, a director of Alleghany Properties, Inc., a wholly owned subsidiary
of the Company, pursuant to a long-term incentive arrangement with the Company
in respect of sales of real estate assets by Alleghany Properties, Inc. The
issuance of common stock was exempt from registration under the Securities Act
of 1933 pursuant to Section 4(2) thereof, as a transaction not involving a
public offering.
On August 25, 2003, the Company sold 10,000 shares of common stock
to Weston M. Hicks, Executive Vice President of the Company, for a purchase
price of $200.185 per share. The sale was exempt from registration under the
Securities Act of 1933, as amended, pursuant to Section 4(2) thereof, as a
transaction not involving a public offering. Pursuant to a Restricted Stock Unit
Matching Grant Agreement dated as of October 7, 2002 with Mr. Hicks, which
provided for the grant of two restricted stock units for each share of common
stock purchased by Mr. Hicks on or before September 30, 2003, the Company
granted 20,000 restricted stock units to Mr. Hicks on August 25, 2003. Mr. Hicks
paid no consideration for such units. Upon the satisfaction of vesting and
certain other conditions, the restricted stock units are payable in cash, shares
of common stock or a combination thereof, based on the fair market value on the
payment date of a number of shares of common stock equal to the number of
restricted stock units in respect of which Mr. Hicks is entitled to payment.
The above does not include unregistered issuances of the Company's common
stock that did not involve a sale, consisting of issuances of common stock and
other securities pursuant to employee incentive plans.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
Exhibit Number Description
-------------- -----------
10.1 Assignment and Assumption Agreement, dated as of July 1, 2003,
by and between AIHL and Underwriters Reinsurance Company
(regarding the transfer of rights under the Stock Purchase
Agreement, dated as
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Exhibit Number Description
-------------- -----------
of June 6, 2003, by and between AIHL and Guaranty National
Insurance Company).
10.2 RIC Quota Share Reinsurance Agreement, dated as of September
2, 2003, by and between Landmark and RIC (the "RIC (Landmark)
Quota Share Reinsurance Agreement").
10.3 List of Contents of Exhibits and Schedules to the RIC
(Landmark) Quota Share Reinsurance Agreement. Alleghany
agrees to furnish supplementally a copy of any omitted
exhibit or schedule to the Securities and Exchange Commission
upon request.
10.4 RIC Administrative Services Agreement, dated as of September
2, 2003, by and between RIC and Landmark (the "RIC (Landmark)
Administrative Services Agreement").
10.5 List of Contents of Exhibits and Schedules to the RIC
(Landmark) Administrative Services Agreement. Alleghany agrees
to furnish supplementally a copy of any omitted exhibit or
schedule to the Securities and Exchange Commission upon
request.
10.6 Assumption of Liabilities Agreement, dated as of September 2,
2003, by and between Landmark and RIC.
10.7 Amendment to the Trust Agreement, dated as of September 2,
2003, amending the Trust Agreement, dated as of July 1, 2003,
by and among RIC, Royal Surplus Lines Insurance Company,
Landmark, RIC (f/k/a Underwriters Reinsurance Company) and
LaSalle Bank National Association, as Trustee.
10.8 Amendment to the Assignment of Net Premium Receivables, dated
as of September 2, 2003, amending the Assignment of Net
Premium Receivables, dated as of July 1, 2003, by and between
LaSalle Bank National Association and RIC, Royal Surplus Lines
Insurance Company and Landmark.
10.9 Amendment to the Assignment of Reinsurance Recoverables, dated
as of September 2, 2003, amending the Assignment of
Reinsurance Recoverables, dated as of July 1, 2003, by and
among RIC (f/k/a Underwriters Reinsurance Company),
20
Exhibit Number Description
-------------- -----------
LaSalle Bank National Association , RIC, Royal Surplus Lines
Insurance Company and Landmark.
10.10 Third Amendment to 364-Day Revolving Credit Agreement, dated
as of September 30, 2003, amending the 364-Day Revolving
Credit Agreement, dated as of June 14, 2002, by and among the
Company, the Banks named therein and U.S. Bank National
Association, as agent for the Banks.
10.11 Fourth Amendment to 364-Day Revolving Credit Agreement, dated
as of October 17, 2003, amending the 364-Day Revolving Credit
Agreement, dated as of June 14, 2002, by and among the
Company, the Banks named therein and U.S. Bank National
Association, as agent for the Banks.
10.12 Fifth Amendment to 364-Day Revolving Credit Agreement, dated
as of November 10, 2003, amending the 364-Day Revolving Credit
Agreement, dated as of June 14, 2002, by and among the
Company, the Banks named therein and U.S. Bank National
Association, as agent for the Banks.
10.13 Second Amendment to Three-Year Revolving Credit Agreement,
dated as of October 17, 2003, amending the Three-Year
Revolving Credit Agreement, dated as of June 14, 2002, among
the Company, the Banks named therein and U.S. Bank National
Association, as agent for the Banks.
31.1 Certification of the Chief Executive Officer of the Company
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer of the Company
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002. This exhibit shall not be deemed
"filed" as a part of this Report on Form 10-Q.
32.2 Certification of the Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002. This
21
Exhibit Number Description
-------------- -----------
exhibit shall not be deemed "filed" as a part of this Report
on Form 10-Q.
22
(b) Reports on Form 8-K.
On November 13, 2003, the Company furnished a report on Form 8-K under
Item 12 thereof regarding a press release reporting on the Company's financial
results as of and for the quarter ended September 30, 2003.
23
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.
ALLEGHANY CORPORATION
Registrant
Date: November 13, 2003 /s/ David B. Cuming
David B. Cuming
Senior Vice President
(and chief financial officer)
24