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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
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 SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS.
YES X NO
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INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED IN RULE 12B-2 OF THE EXCHANGE ACT).
YES X NO
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INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF
COMMON STOCK, AS OF THE LAST PRACTICABLE DATE.
7,676,197 SHARES AS OF OCTOBER 31, 2004
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ITEM 1. FINANCIAL STATEMENTS
ALLEGHANY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS (LOSSES)
FOR THE THREE MONTHS ENDED
SEPTEMBER 30, 2004 AND 2003
(dollars in thousands, except share and per share amounts)
(unaudited)
2004 2003
----------- -----------
REVENUES
Net fastener sales $ 41,846 $ 30,559
Interest, dividend and other income 18,156 11,096
Net insurance premiums earned 198,606 167,819
Net mineral and filtration sales 73,276 67,502
Net gain on investment transactions 6,688 77,874
----------- -----------
Total revenues 338,572 354,850
----------- -----------
COSTS AND EXPENSES
Underwriting expenses 48,700 40,097
Salaries, administrative and other operating expenses 26,701 22,914
Loss and loss adjustment expenses 242,166 100,609
Cost of goods sold - fasteners 32,880 23,614
Cost of mineral and filtration sales 55,974 50,174
Interest expense 1,346 1,381
Corporate administration 10,299 8,218
----------- -----------
Total costs and expenses 418,066 247,007
----------- -----------
(Loss) earnings before income taxes (79,494) 107,843
Income tax (benefit) provision (32,490) 32,973
----------- -----------
Net (loss) earnings ($ 47,004) $ 74,870
=========== ===========
Basic (loss) earnings per share of common stock * ($ 6.12) $ 9.83
=========== ===========
Diluted (loss) earnings per share of common stock ** ($ 6.12) $ 9.79
=========== ===========
Dividends per share of common stock *** ***
=========== ===========
Average number of outstanding shares of common stock * 7,675,313 7,617,920
=========== ===========
* Adjusted to reflect the common stock dividend declared in March 2004.
** Adjusted to reflect the common stock dividend declared in March 2004. The
diluted loss per share amount in 2004 was anti-dilutive. Therefore, basic
loss per share is presented.
*** In March 2003 and 2004, Alleghany declared a stock dividend consisting of
one share of Alleghany common stock for every fifty shares outstanding.
See Notes to Unaudited Consolidated Financial Statements.
ALLEGHANY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 2004 AND 2003
(dollars in thousands, except share and per share amounts)
(unaudited)
2004 2003
---------- ----------
REVENUES
Net fastener sales $ 123,226 $ 85,804
Interest, dividend and other income 46,175 36,187
Net insurance premiums earned 591,489 234,759
Net mineral and filtration sales 211,603 198,410
Net gain on investment transactions 44,223 82,716
---------- ----------
Total revenues 1,016,716 637,876
---------- ----------
COSTS AND EXPENSES
Underwriting expenses 133,088 68,380
Salaries, administrative and other operating expenses 76,874 60,498
Loss and loss adjustment expenses 427,280 140,277
Cost of goods sold - fasteners 93,221 65,182
Cost of mineral and filtration sales 162,417 150,295
Interest expense 3,905 4,127
Corporate administration 29,193 21,001
---------- ----------
Total costs and expenses 925,978 509,760
---------- ----------
Earnings before income taxes 90,738 128,116
Income taxes 26,955 39,526
---------- ----------
Net earnings $ 63,783 $ 88,590
========== ==========
Basic earnings per share of common stock * $ 8.32 $ 11.68
========== ==========
Diluted earnings per share of common stock * $ 8.29 $ 11.64
========== ==========
Dividends per share of common stock ** **
========== ==========
Average number of outstanding shares of common stock * 7,665,295 7,586,665
========== ==========
* Adjusted to reflect the common stock dividend declared in March 2004.
** In March 2003 and 2004, Alleghany declared a stock dividend consisting of
one share of Alleghany common stock for every fifty shares outstanding.
See Notes to Unaudited Consolidated Financial Statements.
ALLEGHANY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2004 AND DECEMBER 31, 2003
(dollars in thousands, except share amounts)
SEPTEMBER 30,
2004 DECEMBER 31,
(UNAUDITED) 2003 *
---------- ----------
ASSETS
Available for sale securities at fair value: 9/30/2004 12/31/2003
Equity securities (cost: $321,155 $370,982 ) $612,454 $620,754
Debt securities (cost: $1,325,242 $910,307 ) 1,327,385 917,270
Short-term investments 74,422 135,079
---------- ----------
2,014,261 1,673,103
Cash 275,838 231,583
Notes receivable 91,804 92,082
Accounts receivable, net 76,592 75,154
Premium balances receivable 170,578 279,682
Reinsurance receivables 580,425 211,753
Ceded unearned premium reserves 284,589 231,166
Deferred acquisition costs 56,885 47,282
Property and equipment - at cost, net of accumulated depreciation 170,924 177,708
Inventory 85,696 84,612
Goodwill and other intangibles, net of amortization 230,483 233,739
Deferred tax assets 111,074 85,736
Current taxes receivable 21,555 0
Other assets 75,909 94,898
---------- ----------
$4,246,613 $3,518,498
========== ==========
LIABILITIES AND COMMON STOCKHOLDERS' EQUITY
Current taxes payable $ 0 $ 49,605
Losses and loss adjustment expenses 1,153,846 437,994
Other liabilities 224,738 211,000
Reinsurance payable 103,990 255,117
Unearned premiums 735,208 644,068
Subsidiaries' debt 158,724 167,050
Deferred tax liabilities 216,233 190,842
---------- ----------
Total liabilities 2,592,739 1,955,676
Common stockholders' equity 1,653,874 1,562,822
---------- ----------
$4,246,613 $3,518,498
========== ==========
COMMON SHARES OUTSTANDING ** 7,675,313 7,644,232
========== ==========
* Certain amounts have been restated and reclassified to conform to the 2004
presentation.
** Adjusted to reflect the common stock dividend declared in March 2004.
See Notes to Unaudited Consolidated Financial Statements.
ALLEGHANY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 2004 AND 2003
(dollars in thousands)
(unaudited)
2004 2003*
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings $ 63,783 $ 88,590
Adjustments to reconcile net earnings to cash provided by operations:
Depreciation and amortization 36,578 15,979
Net gain on investment transactions (44,223) (82,716)
Tax benefit on stock options exercised 1,251 3,388
Increase in accounts and notes receivable (1,160) (16,827)
(Increase) decrease in inventory (1,084) 27,352
Decrease (increase) in other assets 17,554 (141,559)
Increase in reinsurance receivable, net of reinsurance payable (519,799) 10,538
Decrease (increase) in premium balances receivable 109,104 (84,454)
Increase in ceded unearned premium reserves (53,423) (32,751)
Increase in deferred acquisition costs (9,603) (32,101)
(Decrease) increase in other liabilities and current taxes (41,831) 99,123
Increase in unearned premiums 91,140 369,572
Increase in losses and loss adjustment expenses 715,852 69,280
----------- -----------
Net adjustments 300,356 204,824
----------- -----------
Net cash provided by operating activities 364,139 293,414
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investments (1,161,234) (687,270)
Sales of investments 844,109 437,580
Purchases of property and equipment (12,389) (15,709)
Net change in short-term investments 60,657 120,005
Other, net (24,807) 114,837
Acquisition of insurance companies, net of cash acquired (17,742) (131,389)
----------- -----------
Net cash used in investing activities (311,406) (161,946)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on long-term debt (16,326) (82,931)
Proceeds of long-term debt 8,000 114,371
Other, net (152) 4,631
----------- -----------
Net cash (used in) provided by financing activities (8,478) 36,071
----------- -----------
Net increase in cash 44,255 167,539
Cash at beginning of period 231,583 27,423
----------- -----------
Cash at end of period $ 275,838 $ 194,962
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 4,095 $ 2,977
Income taxes $ 114,144 $ 9,019
* Certain amounts have been restated and reclassified to conform to the 2004
presentation.
See Notes to Unaudited Consolidated Financial Statements.
Notes to the Unaudited Consolidated Financial Statements
This report should be read in conjunction with the Annual Report on Form
10-K for the year ended December 31, 2003 (the "2003 Form 10-K") and the
Quarterly Reports on Form 10-Q for the quarters ended March 31, 2004 (the "2004
First Quarter Form 10-Q") and June 30, 2004 (the "2004 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.
Principles of Consolidation
The Company's consolidated financial statements include the financial
results of Alleghany Corporation and its majority-owned subsidiaries. All
significant inter-company balances and transactions have been eliminated in
consolidation.
Stock-Based Compensation Accounting
In December 2002, the Financial Accounting Standards Board issued SFAS No.
148, "Accounting for Stock-Based Compensation Transition and Disclosure" ("SFAS
148"). SFAS 148 amended FASB Statement No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123") to provide alternative methods of transition for
enterprises that elect to change to the SFAS 123 fair value method of accounting
for stock-based employee compensation and to amend the disclosure requirements
of SFAS 123.
The Company maintains fixed option plans and a performance-based stock
plan. Effective January 1, 2003, the Company adopted the fair value recognition
provisions of SFAS 123 prospectively for all employee and/or director awards
granted, modified or settled under any of its stock-based compensation plans
after January 1, 2003. Fair value is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions: no cash dividend yield for all years; expected volatility of 19
percent for all years; risk-free interest rates ranging from 3.02 percent to
3.75 percent; and expected lives of seven years. Prior to 2003, the Company
accounted for its fixed option plans and performance-based stock plan under the
recognition and measurement provisions of APB Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25").
During the third quarter of 2004 and 2003, no stock options were granted
under the Company's fixed option plans. The expense relating to options issued
in prior periods was $47,000 in the third quarter of 2004 and $21,000 in the
third quarter of 2003.
6
With respect to its performance-based stock plan, the Company recognized
after-tax compensation expense of approximately $2.5 million in the 2004 third
quarter and approximately $1.1 million in the 2003 third quarter (in each case
calculated pursuant to the prospective method under SFAS 123).
Had the Company applied SFAS 123 to all option awards outstanding under
its fixed option plans during the 2004 and 2003 third quarters, the Company
would have recognized after-tax expense of $64,000 in the 2004 third quarter and
$30,000 in the 2003 third quarter. Had the Company applied SFAS 123 to all
awards outstanding under its performance-based stock plan during the same
periods, the Company would have recognized additional after-tax expense of
approximately $1.9 million in the 2004 third quarter and approximately $1.2
million in the 2003 third quarter.
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.
For the three months ended For the nine months ended
(dollars in thousands, except per September 30, September 30, September 30, September 30,
share amounts) 2004 2003 2004 2003
---------- ---------- ---------- ----------
Net (loss) earnings, as reported $ (47,004) $ 74,870 $ 63,783 $ 88,590
Add: stock-based employee
compensation expense included in
reported net earnings, net of
related tax 2,534 1,167 6,994 2,504
Less: stock-based compensation
expense determined under fair
value method for all stock
options, net of related tax 1,983 1,288 6,556 3,543
---------- ---------- ---------- ----------
Pro forma net (loss) earnings $ (46,453) $ 74,749 $ 64,221 $ 87,551
========== ========== ========== ==========
(Loss) earnings per share
Basic - as reported $ (6.12) $ 9.83 $ 8.32 $ 11.68
Basic - pro forma $ (6.05) $ 9.81 $ 8.29 $ 11.54
Diluted - as reported $ (6.12)* $ 9.79 $ 8.38 $ 11.64
Diluted - pro forma $ (6.05)* $ 9.78 $ 8.34 $ 11.50
* As diluted net loss per share was anti-dilutive, basic net loss per share
figures are presented.
7
Employee Benefit Plans
The Company has several noncontributory defined benefit pension plans,
including plans in place at its World Minerals, Inc. operating unit. Under
executive retirement plans, defined benefits are based on years of service and
the employee's average annual base salary over a consecutive three-year period
during the last ten years or, if applicable, shorter period of employment, plus
one-half of the highest average annual bonus over a consecutive five-year period
during the last ten years, or, if applicable, shorter period of employment. With
respect to its funded plans, the Company's policy is to contribute annually the
amount necessary to satisfy the Internal Revenue Service's funding requirements.
Contributions are intended to provide not only for benefits attributed to
service to date but also for those expected to be earned in the future.
Additional details regarding the Company's noncontributory defined benefit
pension plans can be found in Note 11 to the Consolidated Financial Statements
in the Company's 2003 Form 10-K. The Company plans to contribute approximately
$4.9 million to the plans in 2004, compared with contributions of approximately
$6.9 million in 2003.
The components of net periodic pension cost for the three and nine months
ended September 30, 2004 and 2003 consisted of the following:
For the three months ended For the nine months ended
September 30, September 30, September 30, September 30,
(dollars in thousands) 2004 2003 2004 2003
------------- ------------- ------------- -------------
Net periodic pension cost included the
following expense (income) components:
Service cost-benefits earned during the
quarter $0.9 $0.8 $2.6 $2.4
Interest cost on projected benefit 1.1 1.0 3.3 3.1
obligation
Expected return on plan assets (0.9) (0.8) (2.8) (2.3)
Net amortization 0.6 0.7 1.9 2.0
Settlement loss 1.1 -- 1.1 --
---- ---- ---- ----
Net periodic pension cost $2.8 $1.7 $6.1 $5.2
==== ==== ==== ====
Pursuant to the requirements of SFAS No. 88 "Employers' Accounting for
Settlements and Curtailments of Defined Benefit Pension Plans and for
Termination Benefits," the Company recognized a $1.1 million settlement loss in
the 2004 third quarter due to an amendment of the parent company executive
retirement plan from a funded to an unfunded plan and the resulting distribution
of all accrued benefits to date to vested participants.
8
Comprehensive Income
The Company's total comprehensive (loss) income for the three months ended
September 30, 2004 and 2003 was $(21.1) million and $20.1 million, and $86.3
million and $(16.4) million for the nine months ended September 30, 2004 and
2003. Comprehensive income (loss) includes the Company's net earnings (losses)
adjusted for changes in unrealized appreciation (depreciation) of investments,
which were $24.5 million and $(54.9) million for the three months ended
September 30, 2004 and 2003, and $24.1 million and $(17.6) million for the nine
months ended September 30, 2004 and 2003, and cumulative translation
adjustments, which were $1.5 million and $(0.1) million for the three months
ended September 30, 2004 and 2003, and $(1.6) million and $6.2 million for the
nine months ended September 30, 2004 and 2003.
Segment Information
Summary information concerning the Company's operations is as follows:
For the three months ended For the nine months ended
September 30, September 30, September 30, September 30,
(dollars in millions) 2004 2003 2004 2003
------------- ------------- ------------- -------------
REVENUES
Property and casualty
insurance $ 216.4 $ 221.5 $ 664.7 $ 298.5
Mining and filtration 72.9 67.4 211.2 198.6
Corporate activities 49.2 66.0 140.8 140.8
-------- -------- -------- --------
Total $ 338.6 $ 354.9 $1,016.7 $ 637.9
======== ======== ======== ========
EARNINGS (LOSSES) BEFORE INCOME TAXES
Property and casualty
insurance $ (81.5) $ 75.0 $ 84.4 $ 82.6
Mining and filtration 6.0 6.9 16.8 18.3
Corporate activities (4.0) 25.9 (10.5) 27.2
-------- -------- -------- --------
Total (79.5) 107.8 90.7 128.1
======== ======== ======== ========
Income tax (benefit) provision (32.5) 32.9 26.9 39.5
-------- -------- -------- --------
Net (loss) earnings $ (47.0) $ 74.9 $ 63.8 $ 88.6
======== ======== ======== ========
September 30, December 31,
(dollars in millions) 2004 2003
---------- ----------
IDENTIFIABLE ASSETS
Property and casualty
insurance $ 3,257.3 $ 2,557.4
Mining and filtration 338.8 331.3
Corporate activities 650.5 629.8
---------- ----------
Total $ 4,246.6 $ 3,518.5
========== ==========
9
The Company's operating businesses are segmented based on the nature of
products and services provided. Segment accounting policies are the same as the
Consolidated Accounting Policies described in Note 1 to the Consolidated
Financial Statements in the 2003 Form 10-K. Property and casualty insurance
operations, which are conducted by Alleghany Insurance Holdings LLC ("AIHL") and
its subsidiaries RSUI Group, Inc. ("RSUI"), Capitol Transamerica Corporation
("CATA") and Darwin Professional Underwriters, Inc. ("Darwin"), and mining and
filtration operations, which are conducted by World Minerals, Inc. ("World
Minerals"), are the Company's largest businesses. The primary components of
"corporate activities" are Heads & Threads International LLC ("Heads &
Threads"), Alleghany Properties, Inc. and corporate activities at the parent
level.
Correction of Error
The Consolidated Balance Sheet at December 31, 2003 has been restated to
reflect the correction of an accounting error made at one of the Company's
insurance businesses. The asset and liability accounts affected by the
correction, the amount previously reported, the amount of the correction and the
restated amount are as follows:
AMOUNT PREVIOUSLY AMOUNT OF DECEMBER 31, 2003
(in millions) REPORTED CORRECTION RESTATED AMOUNT
----------------- ---------- -----------------
ASSETS
Reinsurance receivables $ 228.4 $ (16.7) $ 211.8
Ceded unearned premium reserves $ 264.0 (32.8) $ 231.2
--------
Total assets $ 3,568.0 $ 49.5 $ 3,518.5
========
LIABILITIES
Loss and loss adjustment expenses $ 454.7 $ (16.7) $ 438.0
Unearned premiums $ 676.9 (32.8) $ 644.1
--------
Total liabilities $ 2,005.2 $ 49.5 $ 1,955.7
========
The correction recorded in the 2004 third quarter was identified by
management during a financial statement review and relates to certain
inter-company reinsurance balances that had not been eliminated on the
Consolidated Balance Sheet. The correction had no impact on the Statement of
Earnings (Losses) and Stockholders' Equity. The Statements of Cash Flow have
been adjusted for the correction. There was no impact on cash flows from
operating activities, investing activities and financing activities.
10
Contingencies
The Company's subsidiaries are parties to pending claims and litigation
in the ordinary course of their businesses. Each such subsidiary 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, 2004.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following discussion and analysis presents a review of the Company
and its subsidiaries for the three and nine months ended September 30, 2004 and
2003. 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 2003 Form 10-K, 2004 First Quarter Form 10-Q and 2004 Second Quarter
Form 10-Q.
The Company reported a net loss in the third quarter of 2004 of $47.0
million, compared with net earnings of $74.9 million in the third quarter of
2003. The Company's 2004 third quarter results primarily reflect $97.8 million
of after-tax catastrophe losses, net of reinsurance and $6.9 million of
reinsurance reinstatement premiums, at its RSUI and CATA operating units due to
the impact of Hurricanes Charley, Frances, Ivan and Jeanne during the period.
The 2004 third quarter net losses include net gains on investment transactions
after taxes (taxed at the federal income tax rate) of $4.3 million, compared
with $50.6 million in the corresponding 2003 period. In the first nine months of
2004, the Company's net earnings were $63.8 million, compared with net earnings
of $88.6 million in the first nine months of 2003. The 2004 nine-month net
earnings results include net gains on investment transactions after taxes (taxed
at the federal income tax rate) of $28.7 million, compared with $53.8 million in
the corresponding 2003 period. The Company's common stockholders' equity per
share at September 30, 2004 was $215.48, a decrease from common stockholders'
equity per share of $218.32 as of June 30, 2004, but an increase from common
stockholders' equity per share of $204.44 as of December 31, 2003 (all as
adjusted for the stock dividend declared in March 2004).
Alleghany Insurance Holdings LLC ("AIHL") recorded a net loss of $52.1
million on revenues of $216.4 million in the 2004 third quarter, compared with
net earnings of $48.5 million on revenues of $221.5 million in the third quarter
of 2003, and net earnings of $56.9 million on revenues of $664.7 million in the
first nine months of 2004, compared with net earnings of $55.2 million on
revenues of $298.5 million in the first nine months of 2003. AIHL's 2004 third
quarter results primarily reflect $97.8 million of after-tax catastrophe losses,
net of reinsurance and $6.9 million of reinsurance reinstatement premiums, from
third quarter hurricane activity. AIHL's 2004 third quarter net losses include
net investment income after taxes (taxed at the federal income tax rate) of
$5.9 million and net gains on
11
investment transactions after taxes (taxed at the federal income tax rate) of
$4.3 million, compared with net investment income after taxes (taxed at the
federal income tax rate) of $3.7 million and net gains on investment
transactions after taxes (taxed at the federal income tax rate) of $30.1 million
in the corresponding 2003 period.
AIHL's net earnings for the first nine months in 2004 include net
investment income after taxes (taxed at the federal income tax rate) of $19.5
million and net gains on investment transactions after taxes (taxed at the
federal income tax rate) of $27.6 million, compared with net investment income
after taxes (taxed at the federal income tax rate) of $10.0 million and net
gains on investment transactions after taxes (taxed at the federal income tax
rate) of $30.6 million in the corresponding 2003 period. AIHL's increase in net
investment income after taxes reflects a larger invested asset base, principally
due to capital contributions by the Company and the acquisition of the
operations of RSUI in July 2003. At September 30, 2004, AIHL had reinsurance
receivables of $580.4 million, compared with $211.8 at December 31, 2003. The
increase in such receivables primarily reflects increased business written by
RSUI and Darwin, as well as $263.3 million of 2004 third quarter catastrophe
losses ceded to reinsurers. The Company currently believes that its reinsurance
receivables are collectible. The Company regularly reviews the credit quality of
its reinsurance counterparties and limits exposure in terms of amount and
duration based on its assessment of each reinsurer's credit quality.
Approximately 94.0 percent of the Company's reinsurance receivables balances are
from reinsurers that are rated A or better by A.M. Best Company, Inc. ("A.M.
Best"). Of the remaining 6.0 percent of reinsurance receivables balances which
are placed with reinsurers rated A- or less by A.M. Best, 75.0 percent are
collateralized.
The comparative pre-tax contributions to AIHL's results made by its
operating units RSUI, CATA and Darwin, and total AIHL results, were as follows
(in thousands, except ratios):
12
Three Months Ended September 30,
RSUI(1) CATA(2) Darwin(3) AIHL
--------- -------- -------- ---------
2004
- ----
Gross premiums written (4) $305,460 $43,750 $25,283 $374,493
Net premiums written (4) 155,736 39,134 17,212 212,082
Net premiums earned $147,498 $37,687 $13,421 $198,606
Loss and loss adjustment expenses 212,199 21,238 8,729 242,166
Underwriting expenses 23,252 20,918 4,530 48,700
------ ------ ----- ------
Underwriting (loss) profit (5) $(87,953) $(4,469) $162 (92,260)
========= ======== =======
Interest, dividend and other income 11,094
Net gain on investment transactions 6,688
Other expenses (6,982)
---------
Earnings (losses) before income taxes $(81,460)
=========
Loss ratio (6) 143.9 56.4 65.0 121.9
Expense ratio (7) 15.7 55.5 33.8 24.5
Combined ratio (8) 159.6 111.9 98.8 146.4
2003
Gross premiums written (4) $489,868 (9) $43,003 $6,177 $539,383
Net premiums written (4) 457,157 35,217 5,547 497,921
Net premiums earned $135,777 $30,935 $1,107 $167,819
Loss and loss adjustment expenses 81,645 18,239 725 100,609
Underwriting expenses 25,439 12,837 1,821 40,097
------ ------ ----- ---------
Underwriting profit (loss) (5) $28,693 $(141) $(1,439) 27,113
========= ======== ========
Interest, dividend and other income 7,359
Net gain on investment transactions 46,275
Other expenses (5,780)
---------
Earnings before income taxes $74,967
=========
Loss ratio (6) 60.1 59.0 65.5 59.9
Expense ratio (7) 18.7 41.5 164.5 23.9
Combined ratio (8) 78.8 100.5 230.0 83.8
13
Nine Months Ended September 30,
RSUI(1) CATA(2) Darwin(3) AIHL
--------- -------- -------- -----------
2004
- ----
Gross premiums written (4) $907,941 $132,130 $66,065 $1,106,136
Net premiums written (4) 465,241 118,134 45,831 629,206
Net premiums earned $449,810 $111,660 $30,019 $591,489
Loss and loss adjustment expenses 345,565 62,628 19,087 427,280
Underwriting expenses 70,241 51,679 11,168 133,088
--------- -------- -------- ---------
Underwriting profit (loss) (5) $34,004 $(2,647) $(236) 31,121
========= ======== ========
Interest, dividend and other income 30,754
Net gain on investment transactions 42,488
Other expenses (19,947)
---------
Earnings before income taxes $84,416
=========
Loss ratio (6) 76.8 56.1 63.6 72.3
Expense ratio (7) 15.6 46.3 37.2 22.4
Combined ratio (8) 92.4 102.4 100.8 94.7
2003
Gross premiums written (4) $489,868 (9) $123,477 $8,273 $621,618
Net premiums written (4) 457,157 106,892 7,531 571,580
Net premiums earned $135,777 $97,768 $1,214 $234,759
Loss and loss adjustment expenses 81,645 57,843 789 140,277
Underwriting expenses 25,439 39,683 3,258 68,380
--------- -------- -------- ---------
Underwriting profit (loss) (5) $28,693 $242 $(2,833) 26,102
========= ======== ========
Interest, dividend and other income 16,569
Net gain on investment transactions 47,147
Other expenses (7,257)
---------
Earnings before income taxes $82,561
=========
Loss ratio (6) 60.1 59.2 65.0 59.8
Expense ratio (7) 18.7 40.6 268.4 29.1
Combined ratio (8) 78.8 99.8 333.4 88.9
(1) Since July 1, 2003.
(2) Includes the results of Platte River Insurance Company, which was acquired
contemporaneously with CATA in January 2002 and operates in conjunction
with CATA.
(3) Although Darwin is an underwriting manager for Platte River and certain
subsidiaries of CATA, Darwin is managed on an operating unit basis and
therefore, the results of business generated by Darwin have been separated
from CATA's results for purposes of this table.
14
(4) Amounts do not reflect the impact of an inter-company pooling agreement.
(5) Represents net premiums earned less loss and loss adjustment expenses and
underwriting expenses, all as determined in accordance with generally
accepted accounting principles in the United States of America ("GAAP"),
and does not include interest, dividend and other income or net gains on
investment transactions. 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.
(6) Loss and loss adjustment expenses divided by net premiums earned, all as
determined in accordance with GAAP.
(7) Underwriting expenses divided by net premiums earned, all as determined in
accordance with GAAP.
(8) 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.
(9) Includes $320.8 million of unearned premiums which were acquired with RSUI
in July 2003 and $169. 9 million of premiums assumed on a net basis.
RSUI recorded an underwriting loss of $87.9 million in the 2004 third
quarter, primarily reflecting $146.7 million of pre-tax catastrophe losses, net
of reinsurance and $10.5 million of reinsurance reinstatement premiums, from
Hurricanes Charley, Francis, Ivan and Jeanne. An underwriting profit of $28.7
million was earned for the comparable period in 2003 during which there were
$16.6 million of catastrophe losses. Despite the hurricane losses in the 2004
third quarter, RSUI reported an underwriting profit of $34.0 million for the
first nine months of 2004, primarily reflecting strong property results in the
first half of 2004.
RSUI uses reinsurance on an extensive basis in order to build stable
capacity and provide protection against the accumulation of catastrophe risk.
For the first nine months of 2004, RSUI ceded 48.8% of its gross premium written
to reinsurers. While the amount retained by RSUI varies by line of business, as
of September 30, 2004, RSUI retained a maximum net exposure for any single risk
of $7.5 million. To protect against multiple losses due to catastrophes, RSUI
maintains excess of loss reinsurance coverage in an amount estimated to be its
loss exposure from a one-in-250 year catastrophic event. Of RSUI's $410.0
million of estimated gross losses from the third quarter hurricanes, $263.3
million were ceded to RSUI's reinsurers under all of RSUI's reinsurance programs
and represented 54.0% of RSUI's reinsurance receivables as of September 30,
2004.
RSUI's reported hurricane losses represent management's current best
estimate and are based on management's assessment of information from actual
claim reports, information derived from catastrophe computer modeling, as well
as industry loss estimates. Due to the unusual frequency and strength of the
third quarter hurricanes, as well as the proximity of Hurricanes Ivan and Jeanne
to the end of the 2004 third quarter, the ultimate, actual amount of RSUI losses
attributable to Hurricanes Charley, Frances, Ivan and Jeanne could vary from
current estimated losses.
15
Gross premiums written by RSUI during the 2004 third quarter decreased
from 2003 third quarter levels, reflecting overall industry trends, with flat or
marginally increased rates in RSUI's casualty lines of business (except for
professional liability which experienced more significant increases in rates)
and decreased rates in its property lines of business primarily due to increased
competition. The continuation of such trends may result in lower levels of gross
premiums written by RSUI during the remainder of 2004, since RSUI is expected to
write less business when it considers prices inadequate to support acceptable
profit margins. Gross premiums written by RSUI during the 2003 third quarter
include $320.0 million of unearned premiums which were acquired with RSUI in
July 2003 and $169.9 million of net premiums assumed pursuant to arrangements
entered into in connection with the acquisition of RSUI from Royal Group, Inc.,
a subsidiary of Royal & Sun Alliance Insurance Group plc ("R&SA") in July 2003.
The Company acquired RSUI Indemnity Company ("RIC") to write business
underwritten by RSUI on an admitted basis. As RIC did not possess all necessary
licenses to be able to write business on an admitted basis in most states at the
time of acquisition, R&SA agreed to provide policy issuing services to RIC
through June 2004. Under such service arrangement and in respect of the unearned
premiums acquired with RSUI, RIC assumed the policy and the related premiums
(net of reinsurance paid by R&SA), from R&SA by reinsuring the obligations of
the R&SA carrier under the policy.
CATA's 2004 third quarter underwriting results primarily reflect $3.8
million of catastrophe losses, higher underwriting expenses and continued
unfavorable results in its surety lines of business, partially offset by better
underwriting margins in its casualty lines of business on the current accident
year. The increase in CATA's gross premiums written in the first nine months of
2004 compared with the corresponding 2003 periods reflect the continued
expansion of its business into the excess and surplus markets. Rates at CATA for
the 2004 third quarter as compared with the 2003 third quarter reflect slightly
lower levels of rate increases in its casualty lines of business and rate
decreases in its property lines of business, primarily due to increased
competition.
Darwin's results in the third quarter and first nine months of 2004
reflect organizational build-up expenses incurred to support premium levels, as
well as increased competition across all of its lines of business. As Darwin
commenced operations in May 2003, it does not have any meaningful claims
experience on which to base its reserves. In the absence of such history,
Darwin's management and outside actuaries have used industry data related to the
lines of business underwritten by Darwin to establish reserves until sufficient
claims experience exists.
The table below presents, as of September 30, 2004, the components of
reserves established in connection with the loss and loss adjustment expense
liabilities of the Company's insurance operating units, as well as the changes
in such reserve levels since December 31, 2003. Such loss reserve amounts
represent the accumulation of estimates of ultimate losses (including losses
incurred but not reported) and loss adjustment
16
expenses, before reinsurance protection.
LOSSES AND LOSS ADJUSTMENT CHANGE FROM LOSSES AND LOSS
EXPENSE RESERVES AT ADJUSTMENT EXPENSE RESERVES
(in millions) SEPTEMBER 30, 2004 AT DECEMBER 31, 2003
------------------ --------------------
Property $484.4 $426.4
Casualty 440.2 303.9
Commercial Multiple
Peril 79.8 9.7
Surety 17.6 (0.1)
All Other 131.8 (24.2)
------- ------
Total $1,153.8 $715.8
======= ======
The increase in total loss and loss adjustment expense reserves at
September 30, 2004 from the year ended December 31, 2003 primarily reflects
losses incurred in connection with 2004 third quarter hurricane losses and an
increase in business generated by the Company's insurance businesses. The
Company had no significant development in loss reserve estimates during 2004 in
its loss reserves at December 31, 2003 of $438.0 million.
With respect to property lines of business, the increase in loss and
loss adjustment expense reserves primarily reflects $413.5 million of gross
catastrophe losses from 2004 third quarter hurricanes. The increase in loss and
loss adjustment expense reserves for casualty lines of business (which include,
among others, excess and umbrella liability, directors and officers' liability,
professional liability, general liability and workers' compensation) primarily
reflects increased business generated by the Company's insurance businesses.
With respect to commercial multiple peril ("CMP") line of business, which
includes both property and casualty exposures, the increase in loss and loss
adjustment expense reserves primarily reflects $3.8 million of catastrophe
losses, as well as adverse development on prior year loss reserves related to
higher than expected CMP claims settlements which also resulted in an increase
of loss development tail factors.
All other lines of business primarily consists of non-core loss
reserves exposure reported on the balance sheet of the Company's insurance
businesses that are from discontinued lines of business or loss reserves
acquired in the acquisition of companies in which the seller guaranteed the loss
reserves. The decrease in loss and loss adjustment expense reserve in connection
with such lines of business reflects a $2.9 million decrease in reserves related
to assumed reinsurance written by CATA during the years 1969-1976 as a result of
settlement of losses and loss commutations, as well as a $11.2 million decrease
in loss reserves acquired in connection with Platte River in January 2002 which
were guaranteed by the seller.
17
Additional information regarding the assumptions and estimates, and the
techniques involved in making such assumptions and estimates, used in the
establishment of liabilities for unpaid losses and loss adjustment expenses can
be found in the Company's 2003 Form 10-K.
On October 14, 2004, the New York State Attorney General brought a
lawsuit against Marsh & McLennan Companies, Inc. and Marsh Inc. challenging
certain insurance broker contingent commission compensation practices, and
containing allegations of bid-rigging and price-fixing. Currently, neither the
Company nor any of its subsidiaries has been subpoenaed by the New York State
Attorney General regarding any matters related to insurance broker contingent
commission compensation practices, bid-rigging or price-fixing. Darwin has in
place two broker contingent commission agreements of the type covered the New
York State Attorney General's lawsuit. After a review, the Company does not
believe that Darwin has participated in any activities involving bid-rigging or
price-fixing. In the first nine months of 2004, Darwin paid approximately $1.0
million in contingent commissions and accrued an additional $0.3 million under
such contingent commission agreements. Such contingent commission agreements
have been suspended.
World Minerals recorded pre-tax earnings of $6.0 million on revenues of
$72.9 million in the 2004 third quarter, compared with pre-tax earnings of $6.9
million on revenues of $67.4 million in the 2003 third quarter, and pre-tax
earnings of $16.8 million on revenues of $211.2 million in the first nine months
of 2004, compared with pre-tax earnings of $18.3 million on revenues of $198.6
million in the first nine months of 2003. The 2004 nine-month results reflect
lower margins due to competitive pricing pressures, increased energy, labor and
benefit costs and expenses in connection with information technology
initiatives, partially offset by an increase in net shipments and the continuing
favorable impact of the strong euro versus the U.S. dollar.
Corporate activities recorded a pre-tax loss of $4.0 million on revenues
of $49.3 million in the third quarter of 2004, compared with pre-tax earnings of
$25.9 million on revenues of $66.0 million in the corresponding period in 2003,
and a pre-tax loss of $10.5 million on revenues of $140.8 million in the first
nine months of 2004, compared with pre-tax earnings of $27.2 million on revenues
of $140.8 million in the corresponding 2003 period. The 2004 third quarter net
earnings include no net gains or (losses) on investment transactions, compared
with net gains on investment transactions after taxes (taxed at the federal
income tax rate) of $20.5 million in the corresponding 2003 period. 2004 nine
month net earnings include net gains on investment transactions after taxes
(taxed at the federal income tax rate) of $1.1 million, compared with $23.1
million in the first nine months of 2003.
18
As of September 30, 2004, the Company beneficially owned 8.0 million
shares, or approximately 2.0 percent, of the outstanding common stock of
Burlington Northern Santa Fe Corporation, which had an aggregate market value on
that date of approximately $306.5 million, or $38.31 per share, compared with a
market value on June 30, 2004 of $280.6 million, or $35.07 per share. The
aggregate cost of such shares is approximately $96.6 million, or $12.07 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 2004, the Company did not purchase any shares of its common stock. As of
September 30, 2004, the Company had 7,675,313 shares of common stock outstanding
(which includes the stock dividend declared in March 2004).
The Company's results in the 2004 third quarter are not indicative of
operating results in future periods. 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. In this regard,
AIHL has adequate internally generated funds and sufficient liquidity to pay
claims, including all claims relating to 2004 third quarter hurricane activity.
Information regarding the Company's accounting policies is included in
the Company's 2003 Form 10-K, 2004 First Quarter Form 10-Q, the 2004 Second
Quarter Form 10-Q 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 time. In this sensitivity analysis model, the Company uses
fair values to measure its potential change, and a +/- 200 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
19
hypothetical September 30, 2004 ending prices based on yields adjusted to
reflect a +/ -200 basis point range of change in interest rates, comparing such
hypothetical ending price to actual ending prices, and multiplying the
difference by the par outstanding.
SENSITIVITY ANALYSIS
At September 30, 2004
(dollars in millions)
Interest Rate Shifts -200 -100 0 100 200
- -------------------- -------- ------- ------- ------- -------
ASSETS
Debt securities, fair value $1,395.6 $1,362.3 $1,327.3 $1,259.0 $1,254.2
Estimated change in fair value $68.4 $35.1 -- $(36.4) $(73.1)
LIABILITIES
Subsidiaries' debt, fair value $156.8 $157.9 $159.1 $160.3 $161.5
Estimated change in fair value $(2.3) $(1.2) -- $1.2 $2.4
The Company's 2003 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, 2004, no material change has occurred in these liabilities, as
compared with amounts disclosed in the 2003 Form 10-K.
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 U.S. Securities and
Exchange Commission. Additionally, as of the end of the period covered by this
report on Form 10-Q, the Company's CEO and CFO have concluded that there have
been no significant changes in internal control over financial reporting that
have occurred during the period covered by this report on Form 10-Q that have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
20
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
catastrophes and disasters, especially with respect to their impact on losses at
the Company's insurance subsidiaries, acts of terrorism, 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, 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.
21
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
--------------------------------
(a) Exhibits.
--------
Exhibit Number Description
-------------- -----------
3.2 By-laws of the Company, as amended September 21, 2004
10.1 Description of Compensatory Arrangement between the Company and John J. Burns, Jr.
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 exhibit
shall not be deemed "filed" as a part of this Report on Form 10-Q.
(b) Reports on Form 8-K.
-------------------
On September 23, 2004, the Company filed a report on Form 8-K under
Items 1.01, 5.02 and 5.03 relating to the retirement of John J. Burns, Jr. as
President and chief executive officer of the Company, effective December 30,
2004, the appointment of Weston M. Hicks as a director and President and chief
executive officer of the Company, effective December 31, 2004 and an amendment
to the Company's By-laws to provide for the position of Vice Chairman of the
Board of Directors of the Company.
On November 9, 2004, the Company filed a report on Form 8-K under Item
2.02 thereof regarding a press release reporting on the Company's financial
results as of and for the quarter ended September 30, 2004.
22
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 9, 2004 /s/ David B. Cuming
--------------------
David B. Cuming
Senior Vice President
(and chief financial officer)
23