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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 MARCH 31, 2005
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 [ ]
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.
7,884,216 SHARES AS OF APRIL 30, 2005
ITEM 1. FINANCIAL STATEMENTS
ALLEGHANY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE THREE MONTHS ENDED
MARCH 31, 2005 AND 2004
(dollars in thousands, except share and per share amounts)
(unaudited)
2005 2004
---------- ----------
REVENUES
Net premiums earned $ 213,552 $ 189,668
Net mineral and filtration sales 69,738 67,081
Interest, dividend and other income 17,562 16,352
Net gain on investment transactions 47,227 33,183
---------- ----------
Total revenues 348,079 306,284
---------- ----------
COSTS AND EXPENSES
Loss and loss adjustment expenses 115,277 93,098
Commissions and brokerage 53,044 41,638
Cost of mineral and filtration sales 56,954 51,378
Salaries, administrative and other operating expenses 18,563 16,789
Corporate administration 9,081 8,802
Interest expense 1,352 1,088
---------- ----------
Total costs and expenses 254,271 212,793
---------- ----------
Earnings from continuing operations, before income taxes 93,808 93,491
Income taxes 32,937 32,795
---------- ----------
Earnings from continuing operations 60,871 60,696
Discontinued operations
Operations -- 2,287
Income taxes -- 919
---------- ----------
Earnings from discontinued operations, net -- 1,368
---------- ----------
Net earnings $ 60,871 $ 62,064
========== ==========
Basic earnings per share of common stock **
Continuing operations $ 7.74 $ 7.78
Discontinued operations -- 0.17
---------- ----------
$ 7.74 $ 7.95
========== ==========
Diluted earnings per share of common stock **
Continuing operations $ 7.72 $ 7.75
Discontinued operations -- 0.17
---------- ----------
$ 7.72 $ 7.92
========== ==========
Dividends per share of common stock * *
========== ==========
Average number of outstanding shares of common stock ** 7,896,309 7,835,784
========== ==========
* In March 2005 and 2004, 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 2005.
See Notes to Unaudited Consolidated Financial Statements.
1
ALLEGHANY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share amounts)
MARCH 31, DECEMBER 31,
2005 2004*
---------- ----------
(UNAUDITED)
ASSETS
Available for sale securities at fair value:
Equity securities (cost: 2005 $276,370; 2004 $290,597) $ 637,291 $ 645,184
Debt securities (cost: 2005 $1,481,008; 2004 $1,178,982) 1,466,558 1,179,210
Short-term investments 265,733 378,452
---------- ----------
2,369,582 2,202,846
Cash 240,729 288,436
Notes receivable 91,665 91,665
Accounts receivable, net 63,008 70,547
Premium balances receivable 181,466 203,141
Reinsurance recoverables 648,922 623,325
Ceded unearned premium reserves 275,131 286,451
Deferred acquisition costs 55,514 56,165
Property and equipment at cost, net of
accumulated depreciation and amortization 164,976 168,316
Inventory 39,950 41,521
Goodwill and other intangibles, net of amortization 221,339 223,706
Deferred tax assets 110,738 104,563
Other assets 121,131 67,043
---------- ----------
$4,584,151 $4,427,725
========== ==========
LIABILITIES AND COMMON STOCKHOLDERS' EQUITY
Losses and loss adjustment expenses $1,266,411 $1,232,337
Unearned premiums 729,517 751,131
Reinsurance payable 121,794 112,479
Deferred tax liabilities 225,384 224,847
Subsidiaries' debt 138,860 138,258
Current taxes payable 46,008 17,433
Other liabilities 228,389 177,824
---------- ----------
Total liabilities 2,756,363 2,654,309
Common stockholders' equity 1,827,788 1,773,416
---------- ----------
$4,584,151 $4,427,725
========== ==========
COMMON SHARES OUTSTANDING ** 7,885,205 7,829,721
========== ==========
* Certain amounts have been reclassified to conform to the 2005
presentation.
** Adjusted to reflect the common stock dividend declared in March 2005.
See Notes to Unaudited Consolidated Financial Statements.
2
ALLEGHANY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED
MARCH 31, 2004 AND 2005
(dollars in thousands)
(unaudited)
2005 2004
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Earnings from continuing operations $ 60,871 $ 60,696
Adjustments to reconcile net earnings to cash provided by operations:
Depreciation and amortization 10,796 10,386
Net gain on investment transactions (47,227) (33,183)
Tax benefit on stock options exercised 137 375
Decrease in accounts and notes receivable 8,003 7,713
Decrease in inventory 1,571 363
(Increase) decrease in other assets (12,629) 15,282
Increase in reinsurance recoverables (16,282) (176,537)
Decrease in premium balances receivable 21,675 102,671
Decrease (increase) in ceded unearned premium reserves 11,320 (56,497)
Increase (decrease) in deferred acquisition costs 651 (750)
Increase in other liabilities and current taxes 40,533 22,562
(Decrease) increase in unearned premiums (21,614) 55,329
Increase in losses and loss adjustment expenses 34,074 118,728
--------- ---------
Net adjustments 31,008 66,442
--------- ---------
Net cash provided by operations 91,879 127,138
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investments (415,415) (474,840)
Sales of investments 181,736 294,088
Purchases of property and equipment (4,411) (3,596)
Net change in short-term investments 113,623 (14,839)
Other, net (14,853) (17,349)
--------- ---------
Net cash used in investing activities (139,320) (216,536)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on long-term debt (5,398) (6,122)
Proceeds of long-term debt 6,000 4,000
Other, net (868) 2,171
--------- ---------
Net cash (used in) provided by financing activities (266) 49
--------- ---------
Net decrease in cash (47,707) (89,349)
Cash at beginning of period 288,436 230,929
--------- ---------
Cash at end of period $ 240,729 $ 141,580
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 1,582 $ 990
Income taxes $ 4,740 $ 30,178
See Notes to Unaudited Consolidated Financial Statements.
3
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, 2004 (the "2004 Form 10-K") 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
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 ranging
from 17 to 19 percent; risk-free interest rates ranging from 3.21 percent to
4.40 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 first quarters of 2005 and 2004, no stock options were granted
under the Company's fixed option plans. The expense relating to options issued
in prior periods was $52,000 in the first quarter of 2005 and $20,000 in the
first quarter of 2004. With respect to its performance-based stock plan, the
Company recognized after-tax compensation expense of $2.5 million in the 2005
first quarter and $1.7 million in the 2004 first quarter (in each case
calculated pursuant to the prospective method under SFAS 123).
4
Had the Company applied SFAS 123 to all option awards outstanding under
its fixed option plans during the 2005 and 2004 first quarters, the Company
would have recognized after-tax expense of $73,000 in the 2005 first quarter and
$48,000 in the 2004 first 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 after-tax expense of $2.2 million in
the 2005 first quarter and $1.9 million in the 2004 first quarter.
In December 2004, SFAS 123 (revised) "Share-Based Payment," ("Revised SFAS
123") was issued. Revised SFAS 123 requires that the cost resulting from all
share-based payment transactions be recognized in the financial statements,
establishes fair value as the measurement objective in accounting for
share-based payment arrangements and requires the application of a fair value
based measurement method in accounting for share-based payment transactions with
employees. Revised SFAS 123 is effective as of the beginning of the first
interim or annual reporting period that begins after December 15, 2005. The
Company's present method of accounting for share-based payments is described
above. The pro forma effects of adoption of Revised SFAS 123 are also described
in the following table. The Company plans to adopt Revised SFAS 123 in the first
quarter of 2006.
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.
5
For the three months ended
dollars in thousands, -------------------------------
except per share amounts March 31, 2005 March 31, 2004
-------------- --------------
Net earnings, as reported $ 60,871 $ 62,064
Add: stock-based employee
compensation expense included in
reported net earnings, net of
related tax 2,547 1,739
Less: stock-based compensation
expense determined under fair
value method for all stock
options, net of related tax (2,172) (1,862)
---------- ----------
Pro forma net earnings $ 61,246 $ 61,941
========== ==========
Earnings per share
Basic - as reported $ 7.74 $ 7.95
Basic - pro forma $ 7.79 $ 7.94
Diluted - as reported $ 7.72 $ 7.92
Diluted - pro forma $ 7.76 $ 7.90
For certain stock compensation arrangements, the Company issues stock at
grant date or upon settlement date. These arrangements were previously included
in other liabilities in the consolidated balance sheet and have been
reclassified to stockholders' equity in the quarter. The reclassification
reflects that stock has been issued or is expected to be issued upon settlement,
if the terms of the compensation arrangements are met. The prior period
comparative information has been reclassified to conform to the current period
presentation. The amount of such reclassification at December 31, 2004 was $17.3
million.
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 highest average annual base salary over a consecutive three-year
period during the last
6
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 12 to the Consolidated Financial Statements
in the Company's 2004 Form 10-K. The Company plans to contribute $4.7 million to
the plans in 2005, compared with contributions of $5.6 million in 2004.
The components of net periodic benefit cost for the three months ended
March 31, 2005 and 2004 consisted of the following:
For the three months ended
----------------------------------
(in millions) March 31, 2005 March 31, 2004
- ------------- -------------- --------------
Net periodic cost included the following expense (income) components:
Service cost-benefits earned during the quarter $ 0.9 $ 0.9
Interest cost on projected benefit obligation 1.1 1.1
Expected return on plan assets (0.9) (0.9)
Net amortization 0.6 0.6
-------- --------
Net periodic pension cost $ 1.7 $ 1.7
======== ========
Comprehensive Income
The Company's total comprehensive income for the three months ended March
31, 2005 and 2004 was $51.7 million and $45.3 million. Comprehensive income
includes the Company's net earnings adjusted for changes in unrealized
(depreciation) of investments, which were $(6.2) million and $(14.6) million for
the three months ended March 31, 2005 and 2004 and cumulative translation
adjustments, which were $(3.1) million and $(2.2) million for the three months
ended March 31, 2005 and 2004.
Segment Information
Information related to the Company's reportable business operating
segments is shown in the tables below. The Company's reportable segments are
reported in a manner consistent with the way management evaluates the
businesses. As such, insurance underwriting activities are evaluated separately
from investment activities. Realized investment gains are not considered
relevant in evaluating investment performance on an annual basis.
7
For the three months ended
March 31, March 31,
(dollars in millions) 2005 2004
---- ----
REVENUES FROM CONTINUING OPERATIONS
AIHL insurance group
Net premiums earned
RSUI $ 155.5 $ 148.4
CATA 39.3 34.4
Darwin 18.7 6.9
------ ------
213.5 189.7
Interest, dividend and other income 14.3 10.3
Net gain on investment transactions 25.2 31.4
------ ------
Total insurance group 253.0 231.4
World Minerals 69.6 67.0
Corporate activities 3.5 6.2
Net gain on investment transactions 22.0 1.7
------ ------
Total $ 348.1 $ 306.3
====== ======
EARNINGS (LOSSES) FROM CONTINUING OPERATIONS, BEFORE INCOME TAXES
AIHL insurance group
Underwriting profit (loss)
RSUI $ 43.1 $ 54.9
CATA 1.6 0.4
Darwin 0.5 (0.4)
------ ------
45.2 54.9
Interest, dividend and other income 14.3 10.3
Net gain on investment transactions 25.2 31.4
Other expenses (7.5) (6.0)
------ ------
Total insurance group 77.2 90.6
World Minerals 2.2 5.8
Corporate activities
Interest, dividend and other income 3.5 6.2
Net gain on investment transactions 22.0 1.7
Other expenses (0.7) (1.0)
------ ------
104.2 103.3
Interest expense (1.4) (1.0)
Corporate administration (9.0) (8.8)
------ ------
Total 93.8 93.5
Income taxes 32.9 32.8
------ ------
Earnings from continuing operations $ 60.9 $ 60.7
====== ======
March 31, December 31,
(dollars in millions) 2005 2004
---- ----
IDENTIFIABLE ASSETS
AIHL Insurance group $3,510.5 $3,388.7
World Minerals 334.1 336.6
Corporate activities 739.6 702.4
-------- --------
Total $4,584.2 $4,427.7
======== ========
8
Segment accounting policies are the same as the Consolidated Accounting
Policies described in Note 17 to the Consolidated Financial Statements in the
2004 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 Alleghany
Properties, Inc. and corporate activities at the parent level.
Reinsurance
Through December, 31, 2004, business underwritten by Darwin was generally
reinsured on a treaty basis for individual losses in excess of $3.0 million for
directors and officers liability and managed care errors and omissions
liability. Commencing January 2005, Darwin changed its reinsurance structure to
reinsure on a treaty basis for individual losses in excess of $2.0 million for
directors and officers liability, managed care errors and omissions liability,
lawyers professional liability, insurance agents errors and omissions liability
and other miscellaneous professional liability business. Under such treaty,
losses in excess of $2.0 million are reinsured, with Darwin having a 15%
co-participation for losses in excess of $5.0 million up to Darwin's $10.0
million policy limits. Darwin reinsures on a treaty basis for individual losses
in excess of $0.5 million for medical professional liability insurance for
physicians and in excess of $1.0 million for medical professional liability for
medical facilities (with a 15.0 percent participation on losses in excess of
$2.0 million). The medical professional liability reinsurance program also
provides $2.0 million of "clash" protection (offering protection in the event
that multiple policies written by Darwin are involved in the same loss
occurrence) for losses in excess of $1.0 million. In addition, Darwin reinsures
on a 50 percent quota share basis for individual psychiatrists professional
liability. The reinsurance treaties contain swing-rated premiums that will vary,
within a range, depending upon the profitability of the underlying premium
subject to the treaty. In addition, Darwin obtains facultative reinsurance for
certain business.
Acquisition of Ulico Indemnity Company
On May 2, 2005, Darwin National Assurance Company purchased Ulico Indemnity
Company, an insurance company domiciled in Arkansas, from Ulico Casualty Company
to support future business underwritten by Darwin for cash consideration of
$25.3 million, $22.3 million of which represented consideration for Ulico's
investment portfolio and $3.0 million of which represented consideration for
licenses.
9
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 March 31, 2005.
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 months ended March 31, 2005 and 2004. 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 2004
Form 10-K.
The Company reported net earnings from continuing operations in the first
quarter of 2005 of $60.9 million, compared with $60.7 million in the first
quarter of 2004. 2005 first quarter net earnings were $60.9 million, compared
with $62.1 million in the corresponding 2004 period. Discontinued operations
consist of the operations of Heads & Threads International LLC prior to its
disposition in December 2004. The Company's 2005 first quarter net earnings
included net gains on investment transactions after tax of $30.7 million,
compared with $21.6 million in the 2004 first quarter, and net catastrophe
losses after tax of $5.4 million, compared with $0.3 million in the
corresponding 2004 period. The Company's common stockholders' equity per share
at March 31, 2005 was $231.80, an increase of 2.3% from common stockholders'
equity per share of $226.50 as of December 31, 2004 (as adjusted for the stock
dividend declared in March 2005). On a consolidated basis, cash and invested
assets were $2.6 billion at March 31, 2005, compared with $2.5 billion at
December 31, 2004.
Alleghany Insurance Holdings LLC ("AIHL") recorded pre-tax earnings of
$77.2 million on revenues of $253.0 million in the 2005 first quarter, compared
with pre-tax earnings of $90.6 million on revenues of $231.4 million in the
first quarter of 2004. AIHL's 2005 first quarter pre-tax earnings include
investment income before tax of $14.3 million and net gains on investment
transactions before tax of $25.2 million, compared with $10.3 million and $31.4
million, respectively, in the corresponding 2004 period.
The comparative pre-tax contributions to AIHL's results made by its
operating units RSUI, CATA and Darwin were as follows (in millions, except
ratios):
10
Three Months Ended March 31,
----------------------------
RSUI CATA Darwin(1) AIHL
---- ---- --------- ----
2005
Gross premiums written (2) $270.9 $43.2 $33.9 $348.0
Net premiums written (2) 141.6 41.1 20.5 203.2
Net premiums earned $155.5 $39.3 $18.7 $213.5
Loss and loss adjustment expenses 82.4 20.0 12.9 115.3
Underwriting expenses 30.0 17.7 5.3 53.0
---- ---- --- ----
Underwriting profit (3) 43.1 1.6 0.5 45.2
==== === ===
Interest, dividend and other income 14.3
Net gain on investment transactions 25.2
Other expenses 7.5
---
Earnings before income taxes $77.2
=====
Loss ratio (4) 53.0% 50.9% 68.9% 54.0%
Expense ratio (5) 19.2% 45.1% 28.5% 24.8%
Combined ratio (6) 72.2% 96.0% 97.4% 78.8%
2004
Gross premiums written (2) $294.4 $41.7 $20.6 $356.7
Net premiums written (2) 137.7 36.8 14.0 188.5
Net premiums earned $148.4 $34.4 $6.9 $189.7
Loss and loss adjustment expenses 70.0 18.8 4.3 93.1
Underwriting expenses 23.5 15.2 3.0 41.7
---- ---- --- ----
Underwriting profit (loss) (3) $54.9 $0.4 $(0.4) 54.9
===== ==== ======
Interest, dividend and other income 10.3
Net gain on investment transactions 31.4
Other expenses (6.0)
-----
Earnings before income taxes $90.6
=====
Loss ratio (4) 47.2% 54.6% 62.3% 49.1%
Expense ratio (5) 15.8% 44.1% 43.5% 22.0%
Combined ratio (6) 63.0% 98.7% 105.8% 71.1%
(1) 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.
(2) Amounts do not reflect the impact of an inter-company pooling agreement.
(3) Represents net premiums earned less loss and loss adjustment expenses and
underwriting expenses, all as determined in accordance with U.S. generally
accepted accounting principles ("GAAP"), and does not include interest, dividend
and other income or net gains on investment transactions. Underwriting profit
(loss) does not replace net earnings (loss) determined in accordance with GAAP
as a measure of profitability; rather, Alleghany believes that underwriting
profit (loss) enhances the understanding of AIHL's insurance operating units'
operating results by highlighting net earnings attributable to their
underwriting performance. With the addition of interest, dividend and other
income and net gains on
11
investment transactions, reported pre-tax net earnings (a GAAP measure) may show
a profit despite an underlying underwriting loss. Where such underwriting losses
persist over extended periods, an insurance company's ability to continue as an
ongoing concern may be at risk. Therefore, Alleghany views underwriting profit
(loss) as an important measure in the overall evaluation of the performance of
its insurance operations.
(4) Loss and loss adjustment expenses divided by net premiums earned, all as
determined in accordance with GAAP.
(5) Underwriting expenses divided by net premiums earned, all as determined in
accordance with GAAP.
(6) 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 spends on losses (including loss adjustment expenses) and underwriting
expenses.
RSUI's 2005 first quarter underwriting profit was $43.1 million, compared
with $54.9 million in the corresponding 2004 period, primarily reflecting an
increase in loss and loss adjustment expenses in certain property lines of
business and higher underwriting expenses primarily reflecting the absence of
profit sharing payments under certain property reinsurance treaties due to 2004
catastrophe losses. Gross premiums written decreased in the 2005 first quarter
from the 2004 first quarter, primarily reflecting price decreases in RSUI's
property, general liability and umbrella lines due to market competition.
Although RSUI believes that rates are still adequate to support acceptable
profit margins, rates in the 2005 first quarter continued to reflect overall
industry trends, with decreased rates in its property lines of business and flat
or decreased rates in casualty lines of business (except for professional
liability which experienced increases in rates). The continuation of these rate
trends may result in lower levels of gross premiums written by RSUI during 2005,
as premium per policy may decrease and RSUI is expected to write less business
when it considers prices inadequate to support acceptable profit margins.
RSUI's net premiums earned increased in the 2005 first quarter from the
corresponding 2004 period primarily reflecting the positive impact on RSUI's
casualty lines of business of increased retentions under its reinsurance
programs, partially offset by a decrease in property net premiums earned,
primarily reflecting a decrease in property gross premiums written. Loss and
loss adjustment expenses increased in the 2005 first quarter from the 2004 first
quarter, primarily reflecting an increase in certain property lines of business
and an increase in the percentage of total business written by RSUI attributable
to casualty lines of business as such business is recorded at a higher loss
ratio compared with property lines of business.
CATA reported an underwriting profit of $1.6 million in the 2005 first
quarter, compared with $0.4 million in the 2004 first quarter, primarily
reflecting a decrease in reinsurance costs as well as improved loss experience
in its property and casualty lines of business. Gross premiums written increased
modestly in the 2005 first
12
quarter from the corresponding 2004 period, primarily reflecting the continued
expansion of CATA's business into the excess and surplus markets, partially
offset by the loss of premiums attributable to the contract surety lines of
business that CATA exited in the 2005 first quarter. Gross premiums written
attributable to contract surety lines during 2004 were $11.6 million; in the
first quarter of 2005 such premiums were $1.0 million. Rates at CATA for the
2005 first quarter as compared with the 2004 first quarter reflect lower levels
of increases in its property and casualty lines of business, primarily due to
increased competition, and flat commercial surety rates. Net premiums earned at
CATA increased in the 2005 first quarter from the 2004 first quarter, primarily
reflecting growth in both excess and surplus markets and commercial surety lines
and lower reinsurance costs partially offset by a reinstatement premium for
contract surety booked in the first quarter of 2004. The increase in loss and
loss adjustment expenses in the first quarter of 2005 from the corresponding
period in 2004 reflects the increase in net premiums earned in the 2005 first
quarter.
Darwin reported an underwriting profit of $0.5 million in the 2005 first
quarter, compared with an underwriting loss of $0.4 million in the 2004 first
quarter, primarily reflecting a significant increase in net premiums earned due
to increased levels of gross premiums written across all lines of business,
partially offset by increased loss and loss adjustment expenses and underwriting
expenses primarily attributable to such premium growth. 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.
Through December, 31, 2004, business underwritten by Darwin was generally
reinsured on a treaty basis for individual losses in excess of $3.0 million for
directors and officers liability and managed care errors and omissions
liability. Commencing January 2005, Darwin changed its reinsurance structure to
reinsure on a treaty basis for individual losses in excess of $2.0 million for
directors and officers liability, managed care errors and omissions liability,
lawyers professional liability, insurance agents errors and omissions liability
and other miscellaneous professional liability business. Under such treaty,
losses in excess of $2.0 million are reinsured, with Darwin having a 15%
co-participation for losses in excess of $5.0 million up to Darwin's $10.0
million policy limits. Darwin reinsures on a treaty basis for individual losses
in excess of $0.5 million for medical professional liability insurance for
physicians and in excess of $1.0 million for medical professional liability for
medical facilities (with a 15.0 percent participation on losses in excess of
$2.0 million). The medical professional liability reinsurance program also
provides $2.0 million of "clash" protection (offering protection in the event
that multiple policies written by Darwin are involved in the same loss
occurrence) for losses in excess of $1.0 million. In addition, Darwin reinsures
on a 50 percent quota share basis for individual psychiatrists professional
liability. The reinsurance treaties contain swing-rated premiums that will vary,
within a range, depending upon the profitability of the underlying premium
subject to the treaty. In addition, Darwin obtains facultative reinsurance for
certain business.
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The table below presents, as of March 31, 2005, the components of reserves
established in connection with the loss and loss adjustment expense liabilities
of AIHL's insurance operating units, as well as the changes in such reserve
levels since December 31, 2004. Such loss reserve amounts represent the
accumulation of estimates of ultimate losses (including losses incurred but not
reported) and loss adjustment expenses, before reinsurance protection.
LOSSES AND LOSS LOSSES AND LOSS
ADJUSTMENT EXPENSE ADJUSTMENT EXPENSE CHANGE FROM LOSSES AND LOSS
(in millions) RESERVES AT RESERVES AT ADJUSTMENT EXPENSE RESERVES
MARCH 31, 2005 DECEMBER 31, 2004 AT DECEMBER 31, 2004
-------------- ----------------- --------------------
Property $372.2 $449.7 $(77.5)
Casualty 678.9 563.2 115.7
CMP 84.9 82.6 2.3
Surety 16.0 15.8 0.2
All Other 114.4 121.0 (6.6)
----- ----- -----
Total $1,266.4 $1,232.3 $34.1
The increase in total losses and loss adjustment expense reserves at March
31, 2005 from the year ended December 31, 2004 primarily reflects an increase in
casualty loss reserves and a decrease in property loss reserves.
With respect to property lines of business, the decrease in loss and loss
adjustment expense reserves primarily reflects payments made in the first
quarter of 2005 relating to losses attributable to the 2004 third quarter
catastrophe losses. 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 net premiums
earned for general liability, umbrella and professional liability exposures.
With respect to commercial multiple peril ("CMP") lines of business, which
include both property and casualty exposures, the increase in loss and loss
adjustment expense reserves primarily reflects an increase in CMP premiums
earned in the first quarter of 2005.
The "All Other" lines of business primarily consist of loss reserves for
lines of business discontinued in 2004 and prior and loss reserves acquired in
connection with the acquisition of companies in which the seller provided loss
reserve guarantees. The decrease in loss and loss adjustment expense reserves in
connection with the "All Other" lines primarily reflects a decrease in loss
reserves acquired as part of the acquisition of Platte River Insurance Company
in January 2002 for which the seller provided loss reserve guarantees.
Additional information regarding the assumptions and estimates used in the
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establishment of liabilities for unpaid losses and loss adjustment expenses, and
the techniques involved in making such assumptions and estimates, can be found
in the Company's 2004 Form 10-K.
World Minerals recorded pre-tax earnings of $1.5 million on revenues of
$69.6 million in first quarter 2005, compared with pre-tax earnings of $5.3
million on revenues of $67.0 million in the corresponding period in 2004. The
increase in revenues from the 2004 first quarter to the 2005 first quarter
reflects a modest increase in net sales, slightly higher average prices and the
favorable impact of the strength of the euro against the dollar. The decrease in
pre-tax earnings in the 2005 first quarter from the 2004 first quarter primarily
reflects higher operating, production and transportation costs, primarily at
World Minerals' Lompoc, California plant, which were exacerbated by unusually
heavy rainfall in California during the quarter, competitive pricing pressures
and an increase in selling, general and administrative expenses primarily
related to the implementation of a new computer system in the U.S.
Corporate activities recorded pre-tax earnings of $15.1 million on revenues
of $25.5 million in the 2005 first quarter, compared with a pre-tax loss of $2.4
million on revenues of $7.9 million in the corresponding period in 2004.
Corporate activities' 2005 first quarter results primarily reflect $22.0 million
of net gains on investment transactions before tax, compared with $1.7 million
in the corresponding 2004 period.
As of March 31, 2005, Alleghany beneficially owned 8.0 million shares, or
2.1 percent, of the outstanding common stock of Burlington Northern Santa Fe
Corporation, which had an aggregate market value on that date of $431.4 million,
or $53.93 per share. The aggregate cost of such shares is $96.6 million, or
$12.07 per share.
As of March 31, 2005, Alleghany had 7,885,205 shares of common stock
outstanding (which includes the stock dividend declared in March 2005).
The Company's results in the 2005 first 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.
Information regarding the Company's accounting policies is included in the
Company's 2004 Form 10-K and the Notes to the Consolidated Financial Statements
included in this report on Form 10-Q.
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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, as well as
equity securities which are subject to fluctuations in market value. The Company
holds its equity securities and debt securities as available for sale. Any
changes in the fair value in these securities, net of tax, would be reflected in
the Company's accumulated other comprehensive income as a component of
stockholders' equity.
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 +/- 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 hypothetical March 31, 2005 ending prices based on
yields adjusted to reflect a +/ - 300 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 March 31, 2005
(dollars in millions)
Interest Rate Shifts -300 -200 -100 0 100 200 300
- -------------------- ---- ---- ---- - --- --- ---
ASSETS
Debt securities, fair value $1,580.2 $1,542.5 $1,504.9 $1,466.6 $1,427.6 $1,387.9 $1,350.3
Estimated change in fair value $113.6 $75.9 $38.3 -- $(39.0) $(78.7) $(116.3)
LIABILITIES
Subsidiaries' debt, fair value $140.6 $141.7 $142.9 $144.0 $145.2 $146.3 $147.5
Estimated change in fair value $(3.4) $(2.3) $(1.1) -- $1.2 $2.3 $3.5
The Company's 2004 Form 10-K provides a more detailed discussion of the
market risks affecting its operations.
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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.
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 as defined in the
Private Securities Litigation Reform Act of 1995. 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," "believe," "potential," "should,"
"continue" or the negative versions of those words or other comparable words.
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 risks
relating to the Company's insurance subsidiaries such as
- the cyclical nature of the property casualty industry;
- the long-tail and potentially volatile nature of certain casualty
lines of business written by such subsidiaries;
- the availability of reinsurance;
- exposure to terrorist acts;
17
- the willingness and ability of such subsidiaries' reinsurers to pay
reinsurance recoverables owed to such subsidiaries;
- changes in the ratings assigned to such subsidiaries;
- claims development and the process of estimating reserves;
- legal and regulatory changes;
- the uncertain nature of damage theories and loss amounts;
- increases in the levels of risk retention by such subsidiaries;
- adverse loss development for events insured by such subsidiaries in
either the current year or prior years; and
- significant weather-related or other natural or human-made
catastrophes and disasters.
Additional risks and uncertainties include 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; risks relating to conducting operations
in a competitive environment and conducting operations in foreign countries;
effects of acquisition and disposition activities, inflation rates or
recessionary or expansive trends, changes in market prices of the Company's
significant equity investments; extended labor disruptions, 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 its 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.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS
Exhibit Number Description
-------------- -----------
31.1 Certification of the Chief Executive Officer of the Company
pursuant to Rule 13a-14(a) or Rule 15(d)-14(a) of the
Securities Exchange Act of 1934, as amended.
31.2 Certification of the Chief Financial Officer of the Company
pursuant to Rule 13a-14(a) or Rule 15(d)-14(a) of the
Securities Exchange Act of 1934, as amended.
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.
18
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.
19
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: May 9, 2005 /s/ Roger B. Gorham
-------------------
Roger B. Gorham
Senior Vice President
(and chief financial officer)
20