UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the Quarterly Period Ended September 30, 2004
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or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the Transition Period From to
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Commission file number 1-11238
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NYMAGIC, INC.
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(Exact name of registrant as specified in its charter)
New York 13-3534162
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
919 Third Avenue, New York, New York 10022
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(Address of principal executive offices, including zip code)
(212) 551-0600
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
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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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On November 1, 2004 there were 9,739,098 shares of the registrant's common
stock, $1.00 par value, outstanding.
FORWARD-LOOKING STATEMENTS
This report contains certain forward-looking statements concerning the
Company's operations, economic performance and financial condition, including,
in particular, the likelihood of the Company's success in developing and
expanding its business. Any forward-looking statements concerning the Company's
operations, economic performance and financial condition contained herein,
including statements related to the outlook for the Company's performance in
2004 and beyond, are made under the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. These statements are based upon a
number of assumptions and estimates, which inherently are subject to
uncertainties and contingencies, many of which are beyond the control of the
Company. Some of these assumptions may not materialize and unanticipated events
may occur which could cause actual results to differ materially from such
statements. These include, but are not limited to, the cyclical nature of the
insurance and reinsurance industry, premium rates, investment results, the
estimation of loss reserves and loss reserve development, uncertainties
associated with asbestos and environmental claims, including difficulties with
assessing latent injuries and the impact of litigation settlements, bankruptcies
and potential legislation, the uncertainty surrounding the loss amounts related
to the attacks of September 11, 2001, the occurrence and effects of wars and
acts of terrorism, net loss retention, the effect of competition, the ability to
collect reinsurance receivables and the timing of such collections, the
availability and cost of reinsurance, the ability to pay dividends, regulatory
changes, changes in the ratings assigned to the Company by rating agencies,
failure to retain key personnel, the possibility that our relationship with
Mariner Partners, Inc. could terminate or change, and the fact that ownership of
our common stock is concentrated among a few major stockholders and is subject
to the voting agreement, as well as assumptions underlying any of the foregoing
and are generally expressed with words such as "intends," "intend," "intended,"
"believes," "estimates," "expects," "anticipates," "plans," "projects,"
"forecasts," "goals," "could have," "may have" and similar expressions. These
risks could cause actual results for the 2004 year and beyond to differ
materially from those expressed in any forward-looking statements made. The
Company undertakes no obligation to update publicly or revise any
forward-looking statements made.
NYMAGIC, INC.
INDEX
Page No.
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Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets
September 30, 2004 and December 31, 2003 2
Consolidated Statements of Income
Nine months ended September 30, 2004 and 3
September 30, 2003
Consolidated Statements of Income
Three months ended September 30, 2004 and 4
September 30, 2003
Consolidated Statements of Cash Flows 5
Nine months ended September 30, 2004 and
September 30, 2003
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk 21
Item 4. Controls and Procedures 22
Part II. Other Information
Item 1. Legal Proceedings 23
Item 2. Changes in Securities and Use of Proceeds 23
Item 3. Defaults Upon Senior Securities 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 5. Other Information 24
Item 6. Exhibits 24
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
NYMAGIC, INC.
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
------------- ------------
2004 2003
---- ----
(unaudited)
ASSETS
Investments:
Fixed maturities:
Available for sale at fair value
(amortized cost $102,717,127 and $92,594,971).............. $ 104,068,747 $93,470,691
Trading at fair value (cost $98,493,670 and $61,423,212)..... 99,208,543 61,736,951
Limited partnerships at equity
(cost $173,397,560 and $96,250,000)........................... 170,627,694 105,434,419
Short-term investments.......................................... 188,396,525 257,059,675
Cash............................................................. 11,583,764 1,940,541
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Total cash and investments............................... 573,885,273 519,642,277
----------- -----------
Accrued investment income........................................ 3,026,148 2,099,641
Receivable for securities sold................................... 52,826,394 ---
Premiums and other receivables, net.............................. 31,102,607 23,981,910
Reinsurance receivables on unpaid losses, net.................... 263,534,653 276,618,865
Reinsurance receivables on paid losses, net...................... 8,937,399 4,229,697
Deferred policy acquisition costs ............................... 12,242,364 8,245,600
Prepaid reinsurance premiums .................................... 17,293,853 20,906,056
Deferred income taxes ........................................... 11,414,156 11,772,721
Property, improvements and equipment, net ....................... 4,365,534 3,937,603
Other assets..................................................... 6,052,635 3,690,715
--------- ---------
Total assets............................................. $984,681,016 $875,125,085
=========== ===========
LIABILITIES
Unpaid losses and loss adjustment expenses....................... $513,862,057 $518,929,558
Reserve for unearned premiums ................................... 73,898,250 61,821,283
Ceded reinsurance payable........................................ 21,010,643 25,812,895
Notes payable ................................................... 100,000,000 ---
Dividends payable................................................ 584,331 583,305
Payable for securities not yet settled........................... --- 8,321,250
Other liabilities................................................ 23,470,916 15,365,694
---------- ----------
Total liabilities........................................ 732,826,197 630,833,985
=========== ===========
SHAREHOLDERS' EQUITY
Common stock..................................................... 15,293,740 15,279,390
Paid-in capital.................................................. 35,861,282 35,476,566
Accumulated other comprehensive income .......................... 878,553 569,220
Retained earnings................................................ 245,982,417 239,127,097
----------- -----------
298,015,992 290,452,273
Treasury stock, at cost, 5,554,642 and 5,554,642 shares.......... (46,161,173) (46,161,173)
------------ ------------
Total shareholders' equity............................... 251,854,819 244,291,100
----------- -----------
Total liabilities and shareholders' equity............... $984,681,016 $875,125,085
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
-2-
NYMAGIC, INC.
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
Nine months ended September 30,
-------------------------------
2004 2003
---- ----
Revenues:
Net premiums earned $83,586,985 $69,946,951
Net investment income 12,827,337 15,324,212
Net realized investment gains 619,517 531,520
Commission and other income 2,078,310 1,767,008
--------- ---------
Total revenues 99,112,149 87,569,691
---------- ----------
Expenses:
Net losses and loss adjustment expenses incurred 47,801,453 40,274,744
Policy acquisition expenses 17,385,504 13,436,684
General and administrative expenses 16,945,980 14,179,961
Interest expense 3,684,073 25,652
--------- ------
Total expenses 85,817,010 67,917,041
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Income before income taxes 13,295,139 19,652,650
---------- ----------
Income taxes:
Current 4,495,672 5,849,966
Deferred 192,001 994,576
------- -------
Total income tax expense 4,687,673 6,844,542
--------- ---------
Net income $ 8,607,466 $ 12,808,108
=========== ============
Weighted average shares of common stock outstanding-basic 9,731,336 9,661,692
Basic earnings per share $ .88 $ 1.33
=========== ============
Weighted average shares of common stock outstanding-diluted 9,924,901 9,788,880
Diluted earnings per share $ .87 $ 1.31
=========== ============
Dividends declared per share $ .18 $ .18
=========== ============
The accompanying notes are an integral part of these consolidated financial
statements.
-3-
NYMAGIC, INC.
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
Three months ended September 30,
--------------------------------
2004 2003
---- ----
Revenues:
Net premiums earned $29,168,343 $21,393,649
Net investment income 5,429,304 9,835,425
Net realized investment gains 620,883 554,333
Commission and other income 131,113 12,289
------- ------
Total revenues 35,349,643 31,795,696
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Expenses:
Net losses and loss adjustment expenses incurred 14,475,153 12,752,793
Policy acquisition expenses 5,840,288 3,766,965
General and administrative expenses 5,638,581 4,639,691
Interest expense 1,671,459 ---
--------- -----------
Total expenses 27,625,481 21,159,449
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Income before income taxes 7,724,162 10,636,247
--------- ----------
Income taxes:
Current 3,449,963 3,305,318
Deferred (706,641) 409,777
--------- -------
Total income tax expense 2,743,322 3,715,095
--------- ---------
Net income $ 4,980,840 $ 6,921,152
=========== ===========
Weighted average shares of common stock outstanding-basic 9,738,851 9,706,498
Basic earnings per share $ .51 $ .71
=========== ===========
Weighted average shares of common stock outstanding-diluted 9,885,043 9,873,245
Diluted earnings per share $ .50 $ .70
=========== ===========
Dividends declared per share $ .06 $ .06
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
-4-
NYMAGIC, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Nine months ended September 30,
-------------------------------
2004 2003
---- ----
Cash flows from operating activities:
Net income $ 8,607,466 $ 12,808,108
----------- ------------
Adjustments to reconcile net income to net cash
used in operating activities:
Provision for deferred income taxes 192,001 994,576
Net realized investment gains (619,517) (531,520)
Equity in earnings of limited partnerships (701,471) (4,901,198)
Net bond amortization 894,291 425,165
Depreciation and other, net 478,808 302,075
Changes in:
Premiums and other receivables (7,120,697) 17,642,619
Reinsurance receivables, paid and unpaid, net 8,376,510 39,479,171
Ceded reinsurance payable (4,802,252) 1,943,634
Accrued investment income (926,507) (1,929,340)
Deferred policy acquisition costs (3,996,764) 146,214
Prepaid reinsurance premiums 3,612,203 (6,684,668)
Other assets, net (67,348) 739,752
Unpaid losses and loss adjustment expenses (5,067,501) 8,303,537
Reserve for unearned premiums 12,076,967 5,896,287
Other liabilities 8,105,222 (2,180,192)
Trading portfolio activities (37,471,592) (115,893,055)
------------ -------------
Total adjustments (27,037,647) (56,246,943)
------------ ------------
Net cash used in operating activities (18,430,181) (43,438,835)
------------ -----------
Cash flows from investing activities:
Fixed maturities, available for sale, acquired (65,990,340) (126,201,135)
Limited partnerships acquired (137,700,000) (53,750,000)
Fixed maturities, available for sale, sold 55,589,191 59,610,423
Fixed maturities matured ---- 2,810,000
Equity securities sold ---- 4,658,759
Limited partnerships sold 73,208,197 13,975,249
Net sale of short-term investments 68,667,366 198,993,281
Receivable for securities not yet settled (52,826,394) (52,454,281)
Payable for securities not yet settled (8,321,250) ----
Acquisition of property, improvements and equipment, net (906,740) (2,503,420)
------------ -----------
Net cash (used in) provided by investing activities (68,279,970) 45,138,876
------------ ----------
Cash flows from financing activities:
Proceeds from stock issuance and other 399,066 1,726,544
Cash dividends paid to shareholders (1,751,120) (1,164,780)
Net sale of treasury stock ---- 6,192,281
Proceeds from borrowings 97,705,428 -----
Loan principal repayments ---- (6,219,953)
----------- -----------
Net cash provided by financing activities 96,353,374 534,092
---------- ---------
Net increase in cash 9,643,223 2,234,133
Cash at beginning of period 1,940,541 980,109
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Cash at end of period $ 11,583,764 $ 3,214,242
=============== ===========
Supplemental disclosures:
Interest paid $ 3,322,222 $ 25,652
Federal income tax paid $ 4,161,220 $ 2,248,652
The accompanying notes are an integral part of these consolidated financial
statements.
-5-
NYMAGIC, INC.
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
1) The interim consolidated financial statements are unaudited but, in the
opinion of management, reflect all material adjustments necessary for a fair
presentation of results for such periods. Adjustments to financial
statements consist of normal recurring items. The results of operations for
any interim period are not necessarily indicative of results for the full
year. These financial statements should be read in conjunction with the
financial statements and notes thereto contained in the Company's Annual
Report on Form 10-K for the year ended December 31, 2003.
2) The Company's subsidiaries include two insurance companies and three
insurance agencies. These subsidiaries underwrite commercial insurance in
three major lines of business. The Company considers ocean marine, inland
marine/fire and other liability as appropriate segments for purposes of
evaluating the Company's overall performance. In addition, the runoff
operations in the aircraft business and MMO London are also considered a
segment. The Company ceased writing any new policies covering aircraft risks
subsequent to March 31, 2002. MMO London includes the operations of MMO EU,
Ltd. and MMO UK, Ltd., its limited liability corporate capital vehicle.
Since January 1, 2002, MMO UK, Ltd. has not provided capacity to any Lloyd's
syndicate.
The Company evaluates revenues and income or loss by the aforementioned
segments. Revenues include premiums earned and commission income. Income or
loss includes premiums earned and commission income less the sum of losses
incurred and policy acquisition costs.
The financial information by segment is as follows:
Nine Months Ended September 30,
------------------------------------------------------
2004 2003
------------------------------------------------------
(in thousands)
Income Income
Revenues (Loss) Revenues (Loss)
------------------------------------------------------
Ocean marine $56,779 $7,029 $52,912 $14,799
Inland marine/fire 3,680 1,539 2,942 570
Other liability 23,377 261 11,512 (666)
Runoff operations (Aircraft) 69 9,889 2,688 1,639
--------------------------------------------------------------------------------------
Subtotal 83,905 18,718 70,054 16,342
Net investment income 12,827 12,827 15,324 15,324
Net realized investment gains 620 620 532 532
Other income 1,760 1,760 1,660 1,660
General and administrative expenses --- (16,946) --- (14,179)
Interest expense --- (3,684) --- (26)
Income tax expense --- (4,688) --- (6,845)
--------------------------------------------------------------------------------------
Total $99,112 $8,607 $87,570 $12,808
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-6-
NYMAGIC, INC.
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
Three Months Ended September 30,
------------------------------------------------------
2004 2003
------------------------------------------------------
(in thousands)
Income Income
Revenues (Loss) Revenues (Loss)
------------------------------------------------------
Ocean marine $18,266 $(1,682) $15,455 $3,918
Inland marine/fire 1,355 1,018 1,077 463
Other liability 9,625 518 3,838 (409)
Runoff operations (Aircraft) 37 9,114 1,026 904
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Subtotal 29,283 8,968 21,396 4,876
Net investment income 5,429 5,429 9,835 9,835
Net realized investment gains 621 621 554 554
Other income 16 16 11 11
General and administrative expenses --- (5,639) --- (4,640)
Interest expense --- (1,671) --- ---
Income tax expense --- (2,743) --- (3,715)
--------------------------------------------------------------------------------------
Total $35,349 $4,981 $31,796 $6,921
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3) The Company's comparative comprehensive income is as follows:
Nine months ended Three months ended
September 30, September 30,
-------------------------------------------------------
2004 2003 2004 2003
---- ---- ---- ----
(in thousands)
Net income $8,607 $12,808 $4,981 $6,921
Other comprehensive income, net of tax:
Unrealized gains on securities, net of
deferred tax expenses of
$(383), $(259), $(582) and $(196) 712 481 1,082 364
Less: reclassification adjustment for
gains realized in net income, net of
deferred tax expenses of
$(217), $(186), $(217) and $(194) 403 345 404 360
--- --- --- ---
Other comprehensive income 309 136 678 4
--- --- --- -
Total comprehensive income $8,916 $12,944 $5,659 $6,925
===== ====== ===== =====
-7-
NYMAGIC, INC.
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
4) The Company maintains four stock-based employee compensation plans.
Awards under the Company's plans vest over periods ranging from three to five
years. Effective January 1, 2003 the Company adopted the fair value recognition
provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation
("SFAS 123"), prospectively to all employee awards granted, modified or settled
after January 1, 2003. Therefore, the cost related to stock-based employee
compensation included in the determination of net income for 2004 and 2003 is
less than that which would have been recognized if the fair value based method
had been applied to all awards since the original effective date of SFAS 123,
which includes awards issued after December 15, 1994.
The following table illustrates the effect on net income and earnings
per share if the fair value based method had been applied to all outstanding and
unvested awards in each period:
Nine months ended September 30, Three months ended September 30,
------------------------------------------------------------------
2004 2003 2004 2003
----- ---- ---- ----
(in thousands except per share data)
Net income, as reported $8,607 $12,808 $4,981 $6,921
Add: Stock based employee
compensation expense included in
reported net income, net of related
tax effects 23 14 8 10
Deduct: Total stock-based employee
compensation expense determined
under the fair value based method for all
awards, net of related tax effects (259) (268) (86) (89)
----- ----- ----- -----
Pro forma net income $8,371 $12,554 $4,903 $6,842
===== ====== ===== =====
Earnings per share:
Basic EPS - as reported $.88 $1.33 $.51 $.71
Basic EPS - pro forma $.86 $1.30 $.50 $.70
Diluted EPS - as reported $.87 $1.31 $.50 $.70
Diluted EPS - pro forma $.84 $1.28 $.50 $.69
On May 26, 2004, shareholders approved the NYMAGIC, INC. 2004 Long-Term
Incentive Plan (the "2004 Plan") and the NYMAGIC, INC. Employee Stock Purchase
Plan (the "ESPP").
The 2004 Plan provides for the granting to directors, officers,
employees and consultants of the Company and its subsidiaries of common stock,
options to purchase shares of common stock (both incentive stock options, or
ISOs, and non-ISOs, though only employees may receive ISOs), stock appreciation
rights, restricted stock units, deferred shares and performance units. A maximum
of 450,000 shares of common stock may be made the subject of grants under the
2004 Plan. The Company granted 14,100 shares of common stock to certain officers
and directors of the Company in the second quarter of 2004 for a total
compensation expense of approximately $369,000.
-8-
NYMAGIC, INC.
Notes to Consolidated Financial Statements
September 30, 2004 and 2003
The ESPP will allow eligible employees of the Company and its designated
affiliates to purchase, through payroll deductions, shares of common stock of
the Company. The ESPP is designed to retain and motivate the employees of the
Company and its designated affiliates by encouraging them to acquire ownership
in the Company on a tax-favored basis. The price per common share sold under the
ESPP will be 85% (or more if the Board of Directors or the Committee so
provides) of the closing price of the Company's shares on the New York Stock
Exchange on the day the Common Stock is offered. The Company has reserved 50,000
shares for issuance under the ESPP. There were no shares issued under the ESPP
as of September 30, 2004.
5) In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities, an interpretation of ARB No. 51 ("FIN 46"), which
requires an enterprise to assess whether consolidation of an entity is
appropriate based upon its interests in a variable interest entity ("VIE"). A
VIE is an entity in which the equity investors do not have the characteristics
of a controlling financial interest or do not have sufficient equity at risk for
the entity to finance its activities without additional subordinated financial
support from other parties. The initial determination of whether an entity is a
VIE shall be made on the date at which an enterprise becomes involved with the
entity. An enterprise shall consolidate a VIE if it has a variable interest that
will absorb a majority of the VIEs expected losses if they occur, receive a
majority of the entity's expected residual returns if they occur or both.
In December 2003, the FASB issued a revised version of FIN 46 ("FIN
46R"), which incorporates a number of modifications and changes made to the
original version. FIN 46R replaces the previously issued FIN 46 and, subject to
certain special provisions, is effective no later than the end of the first
reporting period that ends after December 15, 2003 for entities considered to be
special-purpose entities and no later than the end of the first reporting period
that ends after March 15, 2004 for all other VIEs. Early adoption is permitted.
The adoption of FIN 46R did not result in the consolidation of any VIEs.
In March 2004, the Emerging Issues Task Force (EITF) of the FASB reached
a consensus on Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment
and its Application to Certain Investments." This consensus provided recognition
and measurement guidance for determining when an investment is
other-than-temporarily impaired, specifically, when the investor has the ability
and intent to hold an investment until recovery. This guidance was effective for
reporting periods beginning after June 15, 2004. In September 2004, the guidance
contained within some of the paragraphs in EITF 03-1 were delayed by FSP EITF
Issue 03-1-1, "Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments," until new guidance is issued. Gross unrealized gains and losses on
fixed maturity investments available for sale amounted to approximately $1.7
million and $.4 million, respectively, at September 30, 2004. As of September
30, 2004, there were unrealized losses greater than one year from the date of
purchase on fixed income securities available for sale amounting to $184,000.
The Company does not believe the adoption of this guidance will have a material
impact on its results or financial condition.
6) On March 11, 2004, the Company issued $100,000,000 in 6.5% senior notes
due March 15, 2014. The notes provide for semi-annual interest payments and are
to be repaid in full on March 15, 2014. The indenture contains certain covenants
that restrict our ability and our restricted subsidiaries' ability to, among
other things, incur indebtedness, make restricted payments, incur liens on any
shares of capital stock or evidences of indebtedness issued by any of our
restricted subsidiaries or issue or dispose of voting stock of any of our
restricted subsidiaries.
7) The Company previously entered into reinsurance contracts with a
reinsurer that is now in liquidation. On October 23, 2003, the Company was
served with a Notice to Defend and a Complaint by the Insurance Commissioner of
the Commonwealth of Pennsylvania, who is the liquidator of this
-9-
reinsurer, alleging that approximately $3 million in reinsurance claims paid to
the Company in 2000 and 2001 by the reinsurer are voidable preferences and are
therefore subject to recovery by the liquidator. The proceeding was brought in
the Commonwealth Court of Pennsylvania. The Company has filed Preliminary
Objections to Plaintiff's Complaint, denying that the payments are voidable
preferences and asserting affirmative defenses. On February 18, 2004, the
Plaintiff filed Preliminary Objections to our Preliminary Objections and an
Answer and Memorandum of Law in opposition to our Preliminary Objections. No
trial date has been set for this matter, but we intend to defend ourselves
vigorously in connection with this lawsuit and believe we have strong defenses
against these claims. While there can be no assurance as to the ultimate outcome
of this litigation, management believes the ultimate resolution of this
litigation is not expected to materially impact the Company's financial
position.
8) The Company's investments are monitored by management and the Finance
Committee of the Board of Directors. The Company entered into an investment
management agreement with Mariner Partners, Inc. ("Mariner") effective October
1, 2002 that was amended and restated on December 6, 2002. Under the terms of
the agreement, Mariner manages the Company's investment portfolios. Fees paid to
Mariner are based on a percentage of the investment portfolio as follows: .20%
of liquid assets, .30% of fixed maturity investments and 1.25% of hedge fund
(limited partnership) investments. William J. Michaelcheck, a Director of the
Company, is Chairman, Chief Executive Officer and owns a majority of the stock
of Mariner. George R. Trumbull, Chairman, Chief Executive Officer and a Director
of the Company, and William D. Shaw, Jr., Vice Chairman and a Director of the
Company, are also shareholders of Mariner, and A. George Kallop, Executive Vice
President and Chief Operating Officer is a consultant to Mariner. We incurred
Mariner investment expenses of $2.4 million and $1.2 million pursuant to this
agreement for the nine months ended September 30, 2004 and 2003, respectively.
In 2003, the Company entered into a limited partnership hedge fund agreement
with a Mariner affiliated company. In 2003, the Company made an investment of
$11.0 million, representing a 100% interest, into this limited partnership hedge
fund, which is consolidated in the financial statements. An additional
investment of $650,000 was made as of September 30, 2004. This hedge fund
invests in collateralized debt obligations. The Company cannot withdraw funds
from this limited partnership for a minimum period of three years without the
consent of the hedge fund manager.
Under the provisions of the limited partnership hedge fund agreement with
the Mariner affiliated company, it is also entitled to 50% of the net profit
realized upon the sale of certain collateralized debt obligations held by the
Company. We incurred investment expenses of $0.7 million and $1.8 million
pursuant to these agreements for the nine months ended September 30, 2004 and
2003, respectively.
Investment income, net of investment fees, from each major category of
investments is as follows:
Nine months ended September 30, Three month ended September 30,
------------------------------- -------------------------------
2004 2003 2004 2003
---- ---- ---- ----
(in millions)
Fixed maturities, available for sale................. $ 3.2 $ 2.1 $ 1.2 $ 1.1
Fixed maturities, trading securities................. 10.4 9.9 4.2 9.6
Short-term investments............................... 1.7 1.5 0.6 ---
Equity in earnings of limited partnerships........... 0.7 4.9 0.5 1.4
-----------------------------------------------------
Total investment income..................... 16.0 18.4 6.5 12.1
Investment expenses.................................. (3.2) (3.1) (1.1) (2.3)
-----------------------------------------------------
Net investment income................................ $ 12.8 $ 15.3 $ 5.4 $ 9.8
=====================================================
9) Certain accounts in the prior year's financial statements have been
reclassified to conform to the 2004 presentation.
-10-
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Description of Business
NYMAGIC, INC., a New York corporation (the "Company" or "NYMAGIC"), is a
holding company, which owns and operates insurance companies, risk bearing
entities and insurance underwriters and managers.
The Company's two insurance subsidiaries, New York Marine And General
Insurance Company ("New York Marine") and Gotham Insurance Company ("Gotham"),
each maintains a rating of "A" (Excellent) from A.M. Best Company. This is the
third highest of fifteen rating levels in A.M. Best's classification system. The
Company's insureds rely on ratings issued by rating agencies. Any adverse change
in the ratings assigned to New York Marine or Gotham may adversely impact their
ability to write premiums.
The Company specializes in underwriting ocean marine, inland marine/fire
and other liability insurance through insurance pools managed by the Company's
insurance underwriters and managers, Mutual Marine Office, Inc., Pacific Mutual
Marine Office, Inc. and Mutual Marine Office of the Midwest, Inc. (collectively
referred to as "MMO"). The original members of the pools were insurance
companies that were not affiliated with the Company. Several years later, New
York Marine and Gotham joined the pools. Over the years, New York Marine and
Gotham steadily increased their participation in the pools, while the
unaffiliated insurance companies reduced their participation or withdrew from
the pools entirely. Since January 1, 1997, New York Marine and Gotham have been
the only members of the pools, and therefore we now write 100% of all of the
business produced by the pools.
In prior years, the Company issued policies covering aircraft insurance;
however, the Company ceased writing any new policies covering aircraft risks as
of March 31, 2002. The Company decided to exit the commercial aviation insurance
business because it is highly competitive, generated underwriting losses for
most years during the 1990s and is highly dependent on the purchase of
substantial amounts of reinsurance, which became increasingly expensive after
the events of September 11, 2001. This decision has enabled the Company to
concentrate on its core lines of business, which include ocean marine, inland
marine/fire and other liability.
From 1998 to 2001, the Company provided capacity, or the ability to
underwrite a certain amount of business, to certain syndicates within Lloyd's of
London ("Lloyd's") through MMO UK, a wholly owned limited liability corporate
capital vehicle. Lloyd's is currently rated "A-" (Excellent), which is the
fourth highest rating level in A.M. Best's classification system. MMO UK, Ltd.,
as a corporate member of Lloyd's, is not separately rated. Since January 1,
2002, MMO UK has not provided capacity to any Lloyd's syndicate. Business
obtained through MMO UK is hereinafter referred to as "MMO London."
Results of Operations
Net income for the third quarter ended September 30, 2004 totaled $5.0
million, or $.50 per diluted share, compared with net income of $6.9 million, or
$.70 per diluted share, for the third quarter of 2003. The decrease in net
income for the third quarter of 2004 was primarily attributable to a decline in
net investment income and an increase in interest expense arising from the
Company's issuance of $100 million of 6.5% senior notes on March 11, 2004. The
third quarter of 2004 reflected an after-tax benefit of $5.4 million, or $.55
per diluted share, from a reduction in loss reserves in the aircraft line
relating to the
-11-
events occurring on September 11, 2001. After-tax losses of $2.1 million, or
$.21 per share, from Hurricane Ivan were also recorded in the third quarter of
2004.
Net income for the nine months ended September 30, 2004 totaled $8.6
million, or $.87 per diluted share, compared with $12.8 million, or $1.31 per
diluted share, for the nine months ended September 30, 2003. The decline in net
income for the nine months ended September 30, 2004 is primarily attributable to
a decline in investment income derived from limited partnership hedge funds, a
slightly higher combined ratio, and an increase in interest expense.
Net realized investment gains after taxes in the third quarter of 2004 were
$404,000, or $.04 per diluted share, compared with $360,000, or $.04 per diluted
share, for the same period in 2003. Net realized investment gains after taxes
for the nine months ended September 30, 2004 were $403,000, or $.04 per diluted
share, compared with $345,000, or $.04 per diluted share, for the same period in
2003.
Shareholders' equity increased to $251.9 million as of September 30, 2004
compared to $244.3 million as of December 31, 2003. The increase was primarily
attributable to net income partially offset by dividends declared.
The Company's gross premiums written, net premiums written and net premiums
earned increased by 31%, 44% and 20%, respectively, for the nine months ended
September 30, 2004, when compared to the same period of 2003. The Company's
gross premiums written, net premiums written and net premiums earned increased
by 47%, 58% and 36%, respectively, for the three months ended September 30,
2004, when compared to the same period of 2003.
NYMAGIC Gross Premiums Written
by Segment Nine months ended September 30, Three months ended September 30,
---------- ----------------------------------------------------------------------------------
2004 2003 Change 2004 2003 Change
--------------------------------------------------------------------------------
(Dollars in thousands)
Ocean marine ............. $80,276 $68,792 17% $24,463 $20,084 22%
Inland marine/fire........ 11,469 10,392 10% 4,368 3,204 36%
Other liability........... 36,676 15,795 132% 17,805 7,831 127%
---------------------------------------------------------------------------------
Subtotal.................. 128,421 94,979 35% 46,636 31,119 50%
Runoff lines (Aircraft)... 350 3,441 (90%) 95 732 (87%)
-----------------------------------------------------------------------------------
Total..................... $128,771 $98,420 31% $46,731 $31,851 47%
================================================================================
NYMAGIC Net Premiums Written
by Segment Nine months ended September 30, Three months ended September 30,
---------- ----------------------------------------------------------------------------------
2004 2003 Change 2004 2003 Change
--------------------------------------------------------------------------------
(Dollars in thousands)
Ocean marine ............. $64,153 $49,431 30% $18,358 $13,753 33%
Inland marine/fire........ 3,677 2,971 24% 1,375 848 62%
Other liability........... 31,437 14,145 122% 15,606 6,827 129%
---------------------------------------------------------------------------------
Subtotal 99,267 66,547 49% 35,339 21,428 65%
Runoff lines (Aircraft)... 9 2,612 (100%) 18 1,007 (98%)
----------------------------------------------------------------------------------
Total..................... $99,276 $69,159 44% $35,357 $22,435 58%
================================================================================
-12-
NYMAGIC Net Premiums Earned
by Segment Nine months ended September 30, Three months ended September 30,
- ------------------ ----------------------------------------------------------------------------------
2004 2003 Change 2004 2003 Change
--------------------------------------------------------------------------------
(Dollars in thousands)
Ocean marine ............. $56,534 $52,732 7% $18,151 15,454 17%
Inland marine/fire........ 3,680 2,942 25% 1,355 1,077 26%
Other liability........... 23,376 11,512 103% 9,624 3,837 151%
---------------------------------------------------------------------------------
Subtotal 83,590 67,186 24% 29,130 20,368 43%
Run-off lines (Aircraft).. (3) 2,761 NM 38 1,026 (96%)
----------------------------------------------------------------------------------
Total..................... $83,587 $69,947 20% $29,168 $21,394 36%
==================================================================================
Premiums for each segment are as follows:
o Ocean marine gross premiums written, net premiums written and net
premiums earned grew by 17%, 30% and 7%, respectively, during the first
nine months of 2004 when compared to the same period of the prior year.
Current year premiums reflect an increase in cargo premium production as
a result of our agreement with Southern Marine & Aviation, a leading
provider of insurance for bulk petroleum cargo shipments, which
commenced underwriting in the fourth quarter of 2003. Gross premiums in
2004 also reflect a leveling to slight decline in premium rates across
all classes with the largest rate decreases occurring in the drill rig
class. The leveling of premium rates follows a few years of rate
increases. Net premiums written reflect higher net retentions per loss
as a result of increasing the Company's net loss retention to a maximum
of $4 million for any one risk or any one occurrence effective on
policies incepting on or after January 1, 2004 compared with $2 million
for any one risk or any one occurrence effective on policies incepting
on or after January 1, 2003.
Ocean marine gross premiums written, net premiums written and net
premiums earned grew by 22%, 33% and 17%, respectively, during the third
quarter of 2004 when compared to the same period of the prior year. The
current quarter reflects an increase in cargo premium production from
Southern Marine & Aviation, reduced ceded premiums written due to
increases in net loss retention and flat to declining rates on premium
renewals. Partially offsetting the reduction in ceded written premiums
in the third quarter of 2004 were $1.5 million in reinsurance
reinstatement costs incurred as a result of Hurricane Ivan. There were
no reinsurance reinstatement costs incurred in the third quarter of
2003.
o Inland marine/fire gross premiums written, net premiums written and net
premiums earned increased by 10%, 24% and 25%, respectively, for the
nine months ended September 30, 2004 when compared to the same period of
2003. The increases in premium writings reflect additional production
from policies covering inland marine, fire, or motor truck cargo and new
production sources in the surety class. Gross premiums written in 2004
reflect mildly lower market rates. Net premiums written in 2004 reflect
slightly higher retention levels. The increase in net premiums earned
reflected the earnings of premium increases achieved toward the end of
2003 from an underwriting program insuring excess and surplus lines
property risks.
Inland marine/fire gross premiums written, net premiums written and net
premiums earned grew by 36%, 62% and 26%, respectively, during the third
quarter of 2004 when compared to the same period of the prior year. The
increases in premiums writings reflect additional production from
policies covering inland marine, fire, or motor truck cargo and new
production sources in the
-13-
surety class. Net premiums written in 2004 reflect slightly higher
retention levels in existing classes and higher net retentions from the
surety class. Contributing to net premiums earned for the third quarter
of 2004 were the earnings of premium increases achieved toward the end
of 2003 from an underwriting program insuring excess and surplus lines
property risks.
o Other liability gross premiums written rose by 132% for the nine months
ended September 30, 2004 when compared to the same period in 2003,
primarily due to premium volume increases from existing classes and new
classes of business. The growth in gross premiums written from existing
classes of business was derived from the professional liability class,
which rose from $3.8 million in 2003 to $12.8 million in 2004. Volume
increases from new classes of business in 2004 include gross premiums
written of $6.0 million in excess workers compensation. Premium rates in
the professional liability class are flat in 2004; however, premium
rates in some of the Company's other casualty classes have decreased by
as much as 15% in 2004 when compared to the same period in 2003. The
leveling of premium rates follows a few years of significant rate
increases. Net premiums written and net premiums earned grew by 122% and
103% for the nine months ended September 30, 2004, respectively, when
compared to the same period in 2003 primarily due to growth in premium
volume. Net premiums written increased in 2004 to a lesser extent than
the increase in gross premiums written for the same period as a result
of additional quota share and excess of loss reinsurance on the new
classes of business written.
Other liability gross premiums written, net premiums written and net
premiums earned grew by 127%, 129% and 151%, respectively, during the
third quarter of 2004 when compared to the same period of the prior
year. Contributing to gross premiums written were volume increases from
existing classes and new classes of business. The growth in gross
premiums written from existing classes of business during the third
quarter of 2004 were derived from the professional liability class,
which rose from $.7 million in 2003 to $7.4 million in 2004. Volume
increases from new classes of business in 2004 include gross premiums
written of $1.3 million in excess workers compensation. Net premiums
written increased in 2004 to a lesser extent than the increase in gross
premiums written for the same period as a result of additional quota
share and excess of loss reinsurance on the new classes of business
written.
o Runoff lines (Aircraft) premiums have decreased substantially in 2004 as
a result of the Company having ceased writing new aircraft policies
subsequent to March 31, 2002.
Net losses and loss adjustment expenses incurred as a percentage of net
premiums earned (the loss ratio) were 49.6% for the three months ended September
30, 2004 as compared to 59.6% for the same period of 2003. For the nine months
ended September 30, 2004, the loss ratio was 57.2% compared to 57.6% for the
same period of the prior year. Contributing to the lower loss ratio for the
third quarter and nine months ended September 30, 2004 was a reduction in net
loss reserves of $8.3 million in the aircraft line relating to the events
occurring on September 11, 2001. Specifically, the loss reserves relating to the
terrorist attacks of September 11, 2001 on the Pentagon and the hijacked
airliner that crashed in Pennsylvania were reduced as a result of lower than
expected losses. The Company has not changed its loss reserves with respect to
losses sustained on the World Trade Center. Offsetting this benefit were net
catastrophe losses arising from Hurricane Ivan that increased losses incurred by
$1.7 million and reduced premiums earned by $1.5 million due to reinsurance
reinstatement costs as well as a few large current accident year losses
occurring in the ocean marine line of business. There were no catastrophe losses
reported in the prior year's third quarter. The inland marine/fire loss ratios
for the third quarter and nine months ended September 30, 2004 were lower than
the same periods in 2003, reflecting a lower frequency of claims and favorable
loss development. The other liability loss ratio also improved in 2004 when
compared to the ratio in 2003 primarily due to the growth in professional
liability writings.
-14-
Policy acquisition costs as a percentage of net premiums earned (the
acquisition cost ratio) for the three months ended September 30, 2004 were 20.0%
as compared with 17.6% for the same period of the prior year. The same ratio was
20.8% for the nine months ended September 30, 2004 as compared with 19.2% for
the same period in 2003. The acquisition cost ratio for the three and nine
months ended September 30, 2004 reflects an increase in the ocean marine ratio
as a result of higher acquisition costs associated with new sources of cargo
premium production. Partially offsetting this increase were lower commission
rates on existing business and the favorable impact of lower excess of loss
reinsurance costs on the overall ratio. In addition, 2004 reflects lower
acquisition costs from new production sources in the other liability line.
However, premiums earned in the nine months ended September 30, 2003 reflected
larger amounts of aircraft premiums, which generally have a lower acquisition
cost ratio than other lines of business.
General and administrative expenses as a percentage of net premiums earned
for the three months ended September 30, 2004 were 19.3% as compared with 21.7%
for the same period of 2003. General and administrative expenses as a percentage
of net premiums earned for the nine months ended September 30, 2004 and 2003
were each at 20.3%. The decreased percentage in the third quarter of 2004
reflects a greater increase in the growth of premiums from the Company's
business operations when compared to increases in employee related expenses.
The Company's combined ratio (the loss ratio, the acquisition cost ratio and
general and administrative expenses divided by premiums earned) was 89.0% for
the three months ended September 30, 2004 as compared with 98.9% for the same
period of 2003. The Company's combined ratio was 98.3% for the nine months ended
September 30, 2004 as compared with 97.1% for the same period of 2003.
Interest expense increased to $1.7 million for the three months ended
September 30, 2004 as compared to $0 for the same period of 2003. Interest
expense increased to $3.7 million for the nine months ended September 30, 2004
as compared to $26,000 for the same period of 2003. The increase in interest
expense in 2004 is due to the Company's issuance of $100 million of 6.5% senior
notes on March 11, 2004.
Net investment income for the three months ended September 30, 2004
decreased by 45% to $5.4 million from $9.8 million in the same period of 2003.
Although the Company maintained a larger invested asset base in 2004 than it did
in 2003 as a result of favorable cash flow from operations and the proceeds
received from the $100 million of 6.5% senior notes issued on March 11, 2004,
net investment income decreased reflecting lower income derived from trading
portfolio activities as well as from limited partnerships. The equity method of
accounting is used to account for the Company's limited partnership hedge fund
investments. Under the equity method, the Company records all changes in the
underlying value of the limited partnership hedge fund to net investment income
in results of operations. Trading portfolio investments are marked to market
with the change recognized in net investment income during the current period As
the Company invests a greater percentage of its investment portfolio in limited
partnership hedge funds and trading securities, there may also be a greater
volatility associated with the Company's investment income.
Net investment income for the nine months ended September 30, 2004 decreased
by 16% to $12.8 million from $15.3 million in the same period of the prior year.
Although the Company maintained a larger invested asset base in 2004 than it did
in 2003 as a result of favorable cash flow from operations and the proceeds
received from the $100 million of 6.5% senior notes issued on March 11, 2004,
net investment income decreased reflecting declines in income from limited
partnerships. As of September 30, 2004 investments in limited partnerships and
the fixed maturities-trading portfolio amounted to approximately $170.6 million
and $99.2 million, respectively, as compared to $83.1 million and $118.8 million
as of September 30, 2003, respectively.
-15-
Investment income, net of investment fees, from each major category of
investments is as follows:
Three months ended September 30, Nine month ended September 30,
-------------------------------- ------------------------------
2004 2003 2004 2003
---- ---- ---- ----
(in millions)
Fixed maturities, available for sale................ $ 1.2 $ 1.1 $ 3.2 $ 2.1
Fixed maturities, trading securities................ 4.2 9.6 10.4 9.9
Short-term investments.............................. 0.6 -- 1.7 1.5
Equity in earnings of limited partnerships.......... 0.5 1.4 0.7 4.9
------------------------------------------------------
Total investment income.................... 6.5 12.1 16.0 18.4
Investment expenses................................. (1.1) (2.3) (3.2) (3.1)
------------------------------------------------------
Net investment income...................... $5.4 $ 9.8 $ 12.8 $ 15.3
===================================================
Commission and other income increased to $131,000 for the three months ended
September 30, 2004 from $12,000 for the same period in the prior year.
Commission and other income increased to $2.1 million for the nine months ended
September 30, 2004 from $1.8 million for the same period in the prior year
primarily as a result of other income received from litigation and arbitration
settlements.
Net realized investment gains were $621,000 for the third quarter ended
September 30, 2004 as compared to $554,000 for the same period of 2003. Net
realized investment gains were $620,000 for the nine months ended September 30,
2004 as compared to $532,000 for the same period of the prior year. The sale of
fixed maturities led to realized investment gains in the current and prior year.
Write-downs from other-than-temporary declines in the fair value of securities
amounted to $104,000 and $0 for the nine months ended September 30, 2004 and
2003, respectively.
Total income tax expense as a percentage of income before taxes for the nine
months ended September 30, 2004 was 35.3% as compared to 34.8% for the same
period of 2003. Total income tax expense decreased by 32% for the nine months
ended September 30, 2004 when compared to the same period of 2003. The decrease
was comparable to the decrease in income before taxes for the same period.
Liquidity and Capital Resources
Cash, total investments and receivable for securities sold collectively
increased to $626.7 million at September 30, 2004 from $519.6 million at
December 31, 2003, principally as a result of the receipt of net proceeds from
the issuance of $100 million of 6.5% senior notes.
On March 11, 2004, the Company issued $100,000,000 in 6.5% senior notes due
March 15, 2014 and received proceeds of $98,763,000 net of underwriting
discount, but before other transaction expenses. The senior notes provide for
semi-annual interest payments and are to be repaid in full on March 15, 2014. On
July 1, 2004 the Company completed the exchange of registered 6.5% senior notes
for the unregistered senior notes issued on March 11, 2004, as required by the
registration rights agreement with the purchaser of the senior notes. The
indenture relating to the senior notes provides that the Company and its
restricted subsidiaries may not incur indebtedness unless the total indebtedness
of the Company and its restricted subsidiaries, calculated on a pro forma basis
after such issuance, would not exceed 50% of our total consolidated
capitalization (defined as the aggregate amount of our shareholders' equity as
shown on our most recent quarterly or annual consolidated balance sheet plus the
aggregate amount of indebtedness of the Company and its restricted
subsidiaries). The indenture also provides that the Company and its restricted
subsidiaries will not pay dividends or make other payments or distributions on
the Company's stock or the stock of any restricted subsidiary (excluding
payments by any restricted
-16-
subsidiary to the Company), purchase or redeem the Company's stock or make
certain payments on subordinated indebtedness unless, after making any such
payment, the total indebtedness of the Company and its restricted subsidiaries
would not exceed 50% of our total consolidated capitalization (as defined
above). In addition, the indenture contains certain other covenants that
restrict our ability and our restricted subsidiaries' ability to, among other
things, incur liens on any shares of capital stock or evidences of indebtedness
issued by any of our restricted subsidiaries or issue or dispose of voting stock
of any of our restricted subsidiaries. The Company intends to use the net
proceeds from the sale of the senior notes for working capital and other general
corporate purposes, and, potentially, for acquisitions. The Company has no
agreement with respect to any acquisition, although we assess opportunities on
an ongoing basis and from time to time have discussions with other companies
about potential transactions.
Cash flows used in operating activities were $18.4 million for the nine
months ended September 30, 2004 as compared to $43.4 million for the same period
in 2003. Any increases in the Company's trading portfolio are considered uses of
cash flows from operations. Accordingly, the cash flows for the nine months
ended September 30, 2004 and 2003 reflect uses of $37.5 million and $115.9
million, respectively, for trading portfolio activities. As the Company's
trading portfolio balance may fluctuate significantly from period to period,
cash flows from operating activities may also be significantly impacted by such
trading activities.
Cash flows used in investing activities were $68.3 million for the nine
months ended September 30, 2004 as compared with cash flows provided by
investing activities of $45.1 million for the same period in 2003. Each period
reflected additional net purchases of limited partnerships and fixed maturities
available for sale; however, these amounts were offset by reductions in short
term investments. Contributing to the use of cash flows in 2004 and 2003 were
$61.1 million and $52.4 million relating to securities purchased/sold but not
yet settled.
On February 26, 2004, the Company declared a dividend of six (6) cents per
share to shareholders of record on March 31, 2004, payable on April 6, 2004. On
May 26, 2004, the Company declared a dividend of six (6) cents per share to
shareholders of record on June 30, 2004, payable on July 6, 2004. On September
15, 2004, the Company declared a dividend of six (6) cents per share to
shareholders of record on September 30, 2004, payable on October 6, 2004.
The Company's domestic insurance company subsidiaries are limited by
statute in the amount of dividends that may be declared or paid during a year.
The limitation restricts dividends paid or declared to the lower of 10% of
policyholders' surplus or 100% of adjusted net investment income as defined
under New York Insurance Law. In connection with the application for approval of
acquisition of control of NYMAGIC, INC., filed by Mariner Partners, Inc.
("Mariner") and William J. Michaelcheck with the New York State Insurance
Department (the "Department") pursuant to Section 1506 of the New York Insurance
Law, New York Marine and Gotham agreed for a period of two years from July 31,
2002, the date of the acquisition of such control, not to pay any dividends
without the consent of the Department. The obligation to obtain such consent
expired in July 2004. The limitations on dividends from the insurance company
subsidiaries did not have a material impact on the Company's ability to meet
current cash obligations as cash flow provided by operating activities assisted
the Company in providing adequate funds to meet our short term liquidity
requirements.
During the first quarter of 2004, the Company's insurance subsidiary, New
York Marine, requested and received approval from the State of New York
Insurance Department to pay an extraordinary dividend of $15,000,000 to the
Company, which amount was also paid to the Company in the first quarter of 2004.
During the first quarter of 2004, the Company granted options to a new
Director to purchase 10,000 shares of the Company's common stock. The exercise
price of the stock option was equal to the closing price of the Company's stock
on the New York Stock Exchange on the date of the underlying stock grant.
-17-
Under the 2004 Long-Term Incentive Plan, the Company granted 14,100 shares
of common stock to certain officers and directors of the Company in the second
quarter of 2004 for a total compensation expense of approximately $369,000.
There were no repurchases of common stock made during the first nine months
of 2004.
Ceded reinsurance payable decreased to $21.0 million at September 30, 2004
from $25.8 million at December 31, 2003 as a result of decreases in ceded
premiums written and the timing of reinsurance payments.
Other assets increased to $6.1 million as of September 30, 2004 from $3.7
million as of December 31, 2003 primarily as a result of deferred bond issuance
costs incurred on the Company's 6.5% senior notes.
Premiums and other receivables, net increased to $31.1 million as of
September 30, 2004 from $24.0 million as of December 31, 2003. Unearned premiums
increased to $73.9 million as of September 30, 2004 from $61.8 million as of
December 31, 2003. Each increase was the result of increased gross premiums in
2004 when compared to 2003.
Investments
The following table summarizes our investments at September 30, 2004 and
December 31, 2003 at fair value:
September 30, 2004 December 31, 2003
------------------ -----------------
(Dollars in thousands, except percentages)
Fair Value Percent Fair Value Percent
--------------------------------------------------
Fixed maturities available for sale:
U. S. treasury securities $ 9,407 1.6% $ 9,185 1.8%
Municipalities 8,749 1.5% 17,352 3.3%
Corporate bonds 85,913 15.0% 66,934 12.9%
-----------------------------------------------
Subtotal 104,069 18.1% 93,471 18.0%
-----------------------------------------------
Fixed maturities held for trading:
Collateralized debt obligations 99,208 17.3% 61,737 11.9%
-----------------------------------------------
Total fixed maturities 203,277 35.4% 155,208 29.9%
Cash & short-term investments 199,980 34.9% 259,000 49.8%
-----------------------------------------------
Total fixed maturities and short-term investments 403,257 70.3% 414,208 79.7%
Limited partnership hedge funds 170,628 29.7% 105,434 20.3%
-----------------------------------------------
Total cash & investment portfolio $573,885 100.0% $519,642 100.0%
===============================================
As of September 30, 2004, 87% of the fair value of our fixed maturities and
short-term investment portfolio was in obligations rated "Baa3" or better by
Moody's or the equivalent Standard & Poor's rating.
The Company's investments are monitored by management and the Finance
Committee of the Board of Directors. The Company entered into an investment
management agreement with Mariner Partners, Inc. ("Mariner") effective October
1, 2002 that was amended and restated on December 6, 2002. Under
-18-
the terms of the agreement, Mariner manages the Company's investment portfolios.
Fees paid to Mariner are based on a percentage of the investment portfolio as
follows: .20% of liquid assets, .30% of fixed maturity investments and 1.25% of
hedge fund (limited partnership) investments. William J. Michaelcheck, a
Director of the Company, is Chairman, Chief Executive Officer and owns a
majority of the stock of Mariner. George R. Trumbull, Chairman, Chief Executive
Officer and a Director of the Company, and William D. Shaw, Jr., Vice Chairman
and a Director of the Company, are also shareholders of Mariner, and A. George
Kallop, Executive Vice President and Chief Operating Officer is a consultant to
Mariner. We incurred Mariner investment expenses of $2.4 million and $1.2
million pursuant to this agreement for the nine months ended September 30, 2004
and 2003, respectively. There were no other fees incurred through September 30,
2004 and 2003, respectively.
In 2003, the Company entered into a limited partnership hedge fund agreement
with a Mariner affiliated company. In 2003, the Company made an investment of
$11.0 million, representing a 100% interest, into this limited partnership hedge
fund, which is consolidated in the financial statements. An additional
investment of $650,000 was made as of September 30, 2004. This hedge fund
invests in collateralized debt obligations. The partnership agreement also
provides for other fees payable to the manager based upon the operations of the
hedge fund. The Company cannot withdraw funds from this limited partnership for
a minimum period of three years without the consent of the hedge fund manager.
Under the provisions of the limited partnership hedge fund agreement with
the Mariner affiliated company, it is also entitled to 50% of the net profit
realized upon the sale of certain collateralized debt obligations held by the
Company. We incurred investment expenses of $0.7 million and $1.8 million
pursuant to these agreements as of September 30, 2004 and 2003, respectively.
Unpaid losses and loss adjustment expenses
Unpaid losses and loss adjustment expenses for each segment were as follows:
September 30, 2004 December 31, 2003
------------------ -----------------
Gross Net Gross Net
---------------------- ---------------------
(in thousands) (in thousands)
Ocean marine $212,590 $121,748 $199,406 $109,035
Inland marine/fire 22,530 7,233 26,483 7,142
Other liability 115,087 70,107 96,555 55,741
Runoff lines (Aircraft) 163,655 51,239 196,486 70,393
---------------------------------------------------------
Total $513,862 $250,327 $518,930 $242,311
-------- -------- -------- --------
During 2001, the Company recorded losses of $154.9 million and $8.0 million,
respectively, on a gross and net of reinsurance basis in its aircraft line of
business as a result of the terrorist attacks of September 11, 2001 on the World
Trade Center, the Pentagon and the hijacked airliner that crashed in
Pennsylvania (collectively the "WTC attack"). Additional reinsurance costs were
also incurred in 2001 and amounted to $5.0 million. Since 2001, reinsurance
recoverables have decreased and the net liability has increased relative to the
WTC attack as a result of the commutation of certain reinsurance recoverables.
The Company received loss notices with respect to the third quarter of 2004,
from the market leaders who provide loss estimates, indicating a reduction in
the loss reserves relating to the terrorist attacks of September 11, 2001 on the
Pentagon and the hijacked airliner that crashed in Pennsylvania. This amounted
to a reduction of $16.3 million and $8.3 million in gross and net loss reserves,
respectively, to the Company. The ultimate gross and net liability for unpaid
losses resulting from the WTC attack represent the estimated ultimate costs of
all incurred claims and claim adjustment expenses. Since the gross liability and
related reinsurance recoverables are based on estimates, the
-19-
ultimate liability may change from the amount provided currently depending upon
revisions in gross loss estimates and the interpretation as to the number of
occurrences involved in the WTC attack as defined in the aircraft ceded
reinsurance treaties.
The loss settlement period for payment of insurance claims may be many
years, and during this period it often becomes necessary to adjust the estimate
of liability on a claim either upward or downward. The classes of marine,
aircraft and non-marine liability insurance written by the Company include
liability classes which historically have had longer periods of time between
occurrence of an insurable event, reporting of the claim to the Company and
final settlement. In such cases, the Company is forced to estimate reserves with
the possibility of making several adjustments to reserves during this time
period. Other classes of insurance, such as property and claims-made non-marine
liability, historically have had shorter periods of time between occurrence of
an insurable event, reporting of the claim to the Company and final settlement.
The reserves with respect to such classes are less likely to be readjusted. As
the Company increases its production in the other liability line of business,
there may be changes in the level of loss reserves that the Company carries
depending upon the ultimate payout pattern of these losses. Our professional
liability class is written on a claims-made basis and other sources of new
production are derived from liability classes written on an occurrence basis.
Therefore, depending on the level of writings achieved in each of these classes,
the overall level of loss reserves carried may vary at the end of any reporting
period.
The process of establishing reserves for claims involves uncertainties and
requires the use of informed estimates and judgments. Our estimates and
judgments may be revised as claims develop and as additional experience and
other data become available and are reviewed, as new or improved methodologies
are developed or as current laws change. There were no significant changes in
assumptions made in the evaluation of loss reserves during 2004.
Off-Balance Sheet Arrangements
None
Critical Accounting Policies
Management considers certain accounting policies to be critical with respect
to the understanding of the Company's financial statements. Such policies
require significant management judgment and the resulting estimates have a
material effect on reported results and will vary to the extent that future
events affect such estimates and cause them to differ from the estimates
provided currently. These critical accounting policies include unpaid losses and
loss adjustment expenses, allowance for doubtful accounts, accounting for
limited partnerships and trading portfolio, stock option expense and impairment
of investments.
Unpaid losses and loss adjustment expenses are based on individual case
estimates for losses reported. A provision is also included, based on actuarial
estimates utilizing historical trends in the frequency and severity of paid and
reported claims, for losses incurred but not reported, salvage and subrogation
recoveries and for loss adjustment expenses. Unpaid losses with respect to
asbestos/environmental risks are difficult for management to estimate and
require considerable judgment due to the uncertainty regarding the significant
issues surrounding such claims. Unpaid losses and loss adjustment expenses
amounted to $513.9 million and $518.9 million at September 30, 2004 and December
31, 2003, respectively. Unpaid losses and loss adjustment expenses, net of
reinsurance amounted to $250.3 million and $242.3 million at September 30, 2004
and December 31, 2003, respectively. Management continually reviews and updates
the estimates for unpaid losses, and any changes resulting therefrom are
reflected in operating results currently. The potential for future adverse or
favorable loss development is highly uncertain and subject to a variety of
factors including, but not limited to, court decisions, legislative actions and
inflation.
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The allowance for doubtful accounts is based on management's review of
amounts due from insolvent or financially impaired companies. Allowances are
estimated for both premium receivables and reinsurance receivables. Management
continually reviews and updates such estimates for any changes in the financial
status of companies. The allowance for doubtful accounts on both premiums and
reinsurance receivables amounted to $12.8 million and $13.3 million at September
30, 2004 and December 31, 2003, respectively.
Impairment of investments, included in realized investment gains or losses,
results from declines in the fair value of investments which are considered by
management to be other-than-temporary. Management reviews investments for
impairment based upon specific criteria that include the duration and extent of
declines in fair value of the security below its cost or amortized cost. The
Company performs a qualitative and quantitative review of all securities in a
loss position in order to determine if any impairment is considered to be
other-than-temporary. With respect to fixed income investments, declines in fair
value of less than 10% are normally considered to be temporary, unless the fixed
income security has been downgraded at least two levels by a major rating
agency. Additionally, the Company reviews those securities held for six months
or more, with fair value declines of greater than 10% at the end of each
reporting period. The Company also reviews all securities with any rating agency
declines during the reporting period. The Company will record an impairment
charge to earnings if the fair value decline is greater than 20%, if the fixed
income security has been downgraded at least two levels by a major rating
agency, or if the fair value decline is greater than 10% and the security has
been downgraded one level by a major rating agency. This review includes
considering the effect of rising interest rates and the Company's intent and
ability to hold impaired securities in the foreseeable future to recoup any
losses. Approximately $104,000 and $0 were charged to results from operations
for the nine months ended September 30, 2004 and 2003, respectively, resulting
from fair value declines considered to be other-than-temporary. Gross unrealized
gains and losses on fixed maturity investments available for sale amounted to
approximately $1.7 million and $.4 million, respectively, at September 30, 2004.
As of September 30, 2004, there were unrealized losses greater than one year
from the date of purchase on fixed income securities available for sale
amounting to $184,000.
The Company utilizes the equity method of accounting to account for its
limited partnership hedge fund investments. Under the equity method, the Company
records all changes in the underlying value of the limited partnership to net
investment income in results of operations. Net investment income derived from
investments in limited partnerships amounted to $701,000 and $4.9 million for
the nine months ended September 30, 2004 and 2003, respectively. See Item 3
"Quantitative and Qualitative Disclosures About Market Risk" with respect to
market risks associated with investments in limited partnership hedge funds.
The Company maintained a trading portfolio at September 30, 2004 consisting
of collateralized debt obligations (CDOs). These investments are marked to
market with the change recognized in net investment income during the current
period. Any realized gains or losses resulting from the sales of such securities
are also recognized in net investment income. The Company recorded $10.4 million
and $9.9 million in net trading portfolio income for the nine months ended
September 30, 2004 and 2003, respectively. See Item 3 "Quantitative and
Qualitative Disclosures About Market Risk" with respect to market risks
associated with investments in CDOs.
Effective January 1, 2003, the Company adopted the fair value recognition
provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation,
("SFAS 123"), prospectively to all employee awards granted, modified, or settled
after January 1, 2003. Stock option expense amounted to $35,000 and $22,000 for
the nine months ended September 30, 2004 and 2003, respectively.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The investment portfolio has exposure to market risks, which include the
effect on the portfolio of adverse changes in interest rates, credit quality,
hedge fund values, and collateralized debt obligations (CDO) values. Interest
rate risk includes the changes in the fair value of fixed maturities based upon
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changes in interest rates. Credit quality risk includes the risk of default by
issuers of debt securities. Hedge fund risk includes the potential loss from the
diminution in the value of the underlying investment of the hedge fund. CDO risk
includes exposure to the private placement market including its lack of
liquidity and volatility in changes in market prices. The only significant
change to the Company's exposure to market risks during the nine months ended
September 30, 2004 as compared to those disclosed in the Company's financial
statements for the year ended December 31, 2003 related to the level of
investments in hedge funds. The investment in hedge funds amounted to $170.6
million and $105.4 million as of September 30, 2004 and December 31, 2003,
respectively.
Hedge fund investments are subject to various economic and market risks. The
risks associated with hedge fund investments may be substantially greater than
the risks associated with fixed income investments. Consequently, our hedge fund
portfolio results may be more volatile, and the risk of loss greater, than that
associated with fixed income investments. As the Company invests a greater
percentage of its investment portfolio in limited partnership hedge funds, there
may also be a greater volatility associated with the Company's investment
income. Each of the insurance company subsidiaries limits the amount of hedge
fund investments to the greater of 30% of invested assets or 50% of
policyholders' surplus. Except for certain minimum liquidity requirements, there
is currently no restriction as to the level of hedge fund investments at the
holding company as of September 30, 2004.
The Company does seek to mitigate market risk associated with its
investments in hedge funds by maintaining a diversified portfolio of hedge fund
investments. Diversification is achieved through the use of many investment
managers employing a variety of different investment strategies in determining
the underlying characteristics of their hedge funds. The Company is dependent
upon these managers to obtain market prices for the underlying investments of
the hedge funds. Some of these investments may be difficult to value and actual
values may differ from reported amounts. The hedge funds in which we invest
usually impose limitations on the timing of withdrawals from the hedge funds
(most are within 90 days), and may affect our liquidity. With respect to an
investment in a limited partnership managed by a Mariner affiliated Company and
consolidated in the Company's financial statements, the Company cannot withdraw
funds for a minimum period of three years without the consent of the hedge fund
manager.
Item 4. Controls and Procedures
As of the end of the period covered by this report, the Company's
management, with the participation of the Company's Chief Executive Officer and
Chief Financial Officer, evaluated the effectiveness of the design and operation
of the Company's disclosure controls and procedures as defined in Rule 13a-15(e)
under the Securities Exchange Act of 1934. Based upon that evaluation, the
Company's Chief Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures (a) are effective to ensure that
information required to be disclosed by us in reports filed or submitted under
the Securities Exchange Act of 1934 is timely recorded, processed, summarized
and reported and (b) include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by us in reports
filed or submitted under the Securities and Exchange Act of 1934 is accumulated
and communicated to our management, including its Chief Executive Officer and
Chief Financial Officer, as appropriate to allow timely decisions regarding
required disclosure.
There have been no significant changes in our "internal control over
financial reporting" (as defined in rule 13a-15(f) under the Securities and
Exchange Act of 1934) that occurred during the period covered by this report
that has materially affected or is reasonably likely to materially affect our
internal control over financial reporting.
As a result of the Sarbanes-Oxley Act of 2002, management is required to
report on the effectiveness of the Company's internal controls over financial
reporting in its Form 10-K for the fiscal year ending December 31, 2004. The
Company's independent auditor is also required to attest to this report. The
Company has expended a significant amount of resources, and expects to continue
to expend additional resources in the foreseeable future, to evaluate the
effectiveness of the Company's internal controls. However, there can be no
assurance that management will be able to complete its evaluation in a timely
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manner and issue its report or that management or the Company's independent
auditor will conclude that the Company's internal controls are effective.
PART II - OTHER INFORMATION
Item 1. - Legal Proceedings
The Company previously entered into reinsurance contracts with a reinsurer that
is now in liquidation. On October 23, 2003, the Company was served with a Notice
to Defend and a Complaint by the Insurance Commissioner of the Commonwealth of
Pennsylvania, who is the liquidator of this reinsurer, alleging that
approximately $3 million in reinsurance claims paid to the Company in 2000 and
2001 by the reinsurer are voidable preferences and are therefore subject to
recovery by the liquidator. The proceeding was brought in the Commonwealth Court
of Pennsylvania. The Company has filed Preliminary Objections to Plaintiff's
Complaint, denying that the payments are voidable preferences and asserting
affirmative defenses. On February 18, 2004, the Plaintiff filed Preliminary
Objections to our Preliminary Objections and an Answer and Memorandum of Law in
opposition to our Preliminary Objections. No trial date has been set for this
matter, but we intend to defend ourselves vigorously in connection with this
lawsuit and believe we have strong defenses against these claims. While there
can be no assurance as to the ultimate outcome of this litigation, management
believes the ultimate resolution of this litigation is not expected to
materially impact the Company's financial position.
Item 2. - Changes in Securities and Use of Proceeds
On March 11, 2004, the Company issued $100,000,000 in 6.5% senior notes due
March 15, 2014 and received proceeds of $98,763,000 net of underwriting discount
but before other transaction expenses. The senior notes provide for semi-annual
interest payments and are to be repaid in full on March 15, 2014. On July 1,
2004 the Company completed the exchange of registered 6.5% senior notes for the
unregistered senior notes issued on March 11, 2004, as required by the
registration rights agreement with the purchaser of the senior notes. The
indenture relating to the senior notes provides that the Company and its
restricted subsidiaries may not incur indebtedness unless the total indebtedness
of the Company and its restricted subsidiaries, calculated on a pro forma basis
after such issuance, would not exceed 50% of our total consolidated
capitalization (defined as the aggregate amount of our shareholders' equity as
shown on our most recent quarterly or annual consolidated balance sheet plus the
aggregate amount of indebtedness of the Company and its restricted
subsidiaries). The indenture also provides that the Company and its restricted
subsidiaries will not pay dividends or make other payments or distributions on
the Company's stock or the stock of any restricted subsidiary (excluding
payments by any restricted subsidiary to the Company), purchase or redeem the
Company's stock or make certain payments on subordinated indebtedness unless,
after making any such payment, the total indebtedness of the Company and its
restricted subsidiaries would not exceed 50% of our total consolidated
capitalization (as defined above). In addition, the indenture contains certain
other covenants that restrict our ability and our restricted subsidiaries'
ability to, among other things, incur liens on any shares of capital stock or
evidences of indebtedness issued by any of our restricted subsidiaries or issue
or dispose of voting stock of any of our restricted subsidiaries. The Company
intends to use the net proceeds from the sale of the senior notes for working
capital and other general corporate purposes, and, potentially, for
acquisitions. The Company has no agreement with respect to any acquisition,
although we assess opportunities on an ongoing basis and from time to time have
discussions with other companies about potential transactions.
Item 3. - Defaults Upon Senior Securities
None
Item 4. - Submission of Matters to a Vote of Security Holders
None
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Item 5. - Other Information
None
Item 6. - Exhibits
31.1 Certification of George R. Trumbull, III, Chief Executive Officer,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 Certification of Thomas J. Iacopelli, Chief Financial Officer, as
adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of George R. Trumbull, III, Chief Executive Officer,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Thomas J. Iacopelli, Chief Financial Officer,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
99.1 Forms of Election for Deferred Compensation.
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.
NYMAGIC, INC.
-------------
(Registrant)
Date: November 8, 2004 /s/ George R. Trumbull, III
--------------------- ----------------------------
George R. Trumbull, III
Chairman and Chief Executive Officer
Date: November 8, 2004 /s/ Thomas J. Iacopelli
--------------------- -----------------------
Thomas J. Iacopelli
Chief Financial Officer
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