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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
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________________TO _______________
COMMISSION FILE NUMBER 1-15259
PXRE GROUP LTD.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
BERMUDA 98-0214719
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
PXRE HOUSE P.O. BOX HM 1282
110 PITTS BAY ROAD HAMILTON HM FX
PEMBROKE HM 08 BERMUDA
BERMUDA
(ADDRESS, INCLUDING ZIP CODE,
OF PRINCIPAL EXECUTIVE OFFICES) (MAILING ADDRESS)
(441) 296-5858
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
---- ----
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes X No
---- ----
As of November 3, 2004 14,429,885 common shares, $1.00 par value per
share, of the Registrant were outstanding.
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PXRE GROUP LTD.
INDEX
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets as of September 30, 2004
and December 31, 2003..............................................3
Consolidated Statements of Operations and Comprehensive
Operations for the three and nine
months ended September 30, 2004 and 2003...........................4
Consolidated Statements of Shareholders' Equity
for the three and nine months ended
September 30, 2004 and 2003........................................5
Consolidated Statements of Cash Flows for the three
and nine months ended September 30, 2004 and 2003..................6
Notes to Consolidated Financial Statements...........................7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS...............................19
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..........42
ITEM 4. CONTROLS AND PROCEDURES.............................................42
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS...................................................42
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS...........................43
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.....................................44
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................44
ITEM 5. OTHER INFORMATION...................................................44
ITEM 6. EXHIBITS............................................................44
2
PXRE CONSOLIDATED BALANCE SHEETS
GROUP LTD. (Dollars in thousands, except par value per share)
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31,
2004 2003
---- ----
(Unaudited)
ASSETS Investments:
Fixed maturities:
Available-for-sale (amortized cost $668,807 and $613,833, respectively) $ 668,701 $ 617,658
Trading (cost $13,725 and $20,370, respectively) 14,160 21,451
Short-term investments 252,893 175,771
Hedge funds (cost $91,056 and $87,691, respectively) 129,601 121,466
Other invested assets (cost $5,837 and $9,365, respectively) 6,931 10,173
----------- -----------
Total investments 1,072,286 946,519
Cash 21,044 65,808
Accrued investment income 6,911 5,490
Premiums receivable, net 90,088 79,501
Other receivables 45,937 30,695
Reinsurance recoverable on paid losses 16,175 15,494
Reinsurance recoverable on unpaid losses 62,606 146,924
Ceded unearned premiums 7,001 10,454
Deferred acquisition costs 4,362 2,495
Income tax recoverable 30,221 14,133
Other assets 69,860 42,134
----------- -----------
Total assets $ 1,426,491 $ 1,359,647
=========== ===========
LIABILITIES Losses and loss expenses $ 517,501 $ 450,635
Unearned premiums 42,994 21,566
Subordinated debt 167,073 -
Reinsurance balances payable 26,800 53,373
Deposit liabilities 75,138 80,583
Other liabilities 27,739 32,133
----------- -----------
Total liabilities 857,245 638,290
----------- -----------
Minority interest in consolidated subsidiaries:
Company-obligated mandatorily redeemable capital trust
pass-through securities of subsidiary trusts holding solely a
company-guaranteed related subordinated debt - 156,841
----------- -----------
SHAREHOLDERS' Serial convertible preferred shares, $1.00 par value, $10,000 stated
EQUITY value -- 10 million shares authorized, 0.02 million shares
issued and outstanding 182,730 172,190
Common shares, $1.00 par value -- 50 million shares
authorized, 14.4 million and 13.3 million shares issued
and outstanding, respectively 14,426 13,277
Additional paid-in capital 215,334 192,078
Accumulated other comprehensive (loss) income net of deferred income
tax (benefit) expense of $(98) and $1,242, respectively (1,117) 1,692
Retained earnings 165,673 188,670
Restricted shares at cost (0.4 million and 0.3 million shares, respectively) (7,800) (3,391)
----------- -----------
Total shareholders' equity 569,246 564,516
----------- -----------
Total liabilities and shareholders' equity $ 1,426,491 $ 1,359,647
=========== ===========
The accompanying notes are an integral part of these statements.
3
PXRE CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE OPERATIONS
GROUP LTD. (Dollars in thousands, except per share amounts)
- ------------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
---- ---- ---- ----
(Unaudited)
REVENUES Net premiums earned $ 89,799 $ 69,082 $ 228,316 $ 237,870
Net investment income 5,157 5,994 16,941 20,026
Net realized investment (losses) gains (40) 502 11 611
Fee income 695 1,148 1,556 3,533
--------- -------- --------- ---------
95,611 76,726 246,824 262,040
--------- -------- --------- ---------
LOSSES AND Losses and loss expenses incurred 156,335 35,245 192,551 112,500
EXPENSES Commissions and brokerage 8,900 3,218 28,286 37,863
Operating expenses 8,272 9,788 30,760 29,451
Foreign exchange (gains) losses (382) 927 (22) 676
Interest expense 3,817 - 10,947 2,504
Minority interest in consolidated subsidiaries - 2,817 - 7,350
--------- -------- --------- ---------
176,942 51,995 262,522 190,344
--------- -------- --------- ---------
(Loss) income before income taxes, cumulative
effect of accounting change and convertible
preferred share dividends (81,331) 24,731 (15,698) 71,696
Income tax (benefit) provision (8,157) 1,007 (6,844) 2,887
--------- -------- --------- ---------
(Loss) income before cumulative effect of
accounting change and convertible preferred
share dividends (73,174) 23,724 (8,854) 68,809
Cumulative effect of accounting change, net of
$0.2 million tax expense - - (1,053) -
--------- -------- --------- ---------
Net (loss) income before convertible preferred
share dividends $ (73,174) $ 23,724 $ (9,907) $ 68,809
--------- -------- --------- ---------
Convertible preferred share dividends 3,583 3,310 10,540 9,737
--------- -------- --------- ---------
Net (loss) income available to common
shareholders $ (76,757) $ 20,414 $ (20,447) $ 59,072
========= ======== ========= =========
COMPREHENSIVE Net (loss) income before convertible preferred
INCOME, NET share dividends $ (73,174) $ 23,724 $ (9,907) $ 68,809
OF TAX Net unrealized appreciation (depreciation) on
investments 6,556 (4,008) (2,809) (2,262)
Net unrealized appreciation on cash flow hedge - - - 946
--------- -------- --------- ---------
Comprehensive (loss) income $ (66,618) $ 19,716 $ (12,716) $ 67,493
========= ======== ========= =========
PER SHARE Basic:
(Loss) income before cumulative effect of
accounting change and convertible
preferred share dividends $ (5.22) $ 1.99 $ (0.64) $ 5.77
Cumulative effect of accounting change - - (0.08) -
Convertible preferred share dividends (0.26) (0.28) (0.77) (0.82)
--------- -------- --------- ---------
Net (loss) income available to common
shareholders $ (5.48) $ 1.71 $ (1.49) $ 4.95
========= ======== ========= =========
Average shares outstanding (000's) 13,995 11,925 13,753 11,931
========= ======== ========= =========
Diluted:
(Loss) income before cumulative effect of
accounting change $ (5.48) $ 1.01 $ (1.41) $ 2.97
Cumulative effect of accounting change - - (0.08) -
--------- -------- --------- ---------
Net (loss) income $ (5.48) $ 1.01 $ (1.49) $ 2.97
========= ======== ========= =========
Average shares outstanding (000's) 13,995 23,583 13,753 23,201
========= ======== ========= =========
The accompanying notes are an integral part of these statements.
4
PXRE CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
GROUP LTD. (Dollars in thousands)
- ------------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
---- ---- ---- ----
(Unaudited)
CONVERTIBLE Balance at beginning of period $ 179,147 $ 165,504 $ 172,190 $ 159,077
PREFERRED SHARES Dividends to convertible preferred shareholders 3,583 3,310 10,540 9,737
--------- --------- --------- ---------
Balance at end of period $ 182,730 $ 168,814 $ 182,730 $ 168,814
========= ========= ========= =========
COMMON SHARES Balance at beginning of period $ 14,384 $ 12,169 $ 13,277 $ 12,030
Issuance of shares, net 42 8 1,149 147
--------- --------- --------- ---------
Balance at end of period $ 14,426 $ 12,177 $ 14,426 $ 12,177
========= ========= ========= =========
ADDITIONAL Balance at beginning of period $ 214,703 $ 172,096 $ 192,078 $ 168,866
PAID-IN CAPITAL Issuance of shares 615 118 21,832 3,259
Other 16 - 1,424 89
--------- --------- --------- ---------
Balance at end of period $ 215,334 $ 172,214 $ 215,334 $ 172,214
========= ========= ========= =========
ACCUMULATED Balance at beginning of period $ (7,673) $ 9,834 $ 1,692 $ 7,142
OTHER Change in unrealized gains 6,556 (4,008) (2,809) (2,262)
COMPREHENSIVE Change in cash flow hedge - - - 946
INCOME --------- --------- --------- ---------
Balance at end of period $ (1,117) $ 5,826 $ (1,117) $ 5,826
========= ========= ========= =========
RETAINED Balance at beginning of period $ 243,297 $ 145,256 $ 188,670 $ 108,062
EARNINGS Net (loss) income before convertible
preferred share dividends (73,174) 23,724 (9,907) 68,809
Dividends to convertible preferred shareholders (3,583) (3,310) (10,540) (9,737)
Dividends to common shareholders (867) (731) (2,550) (2,195)
--------- --------- --------- ---------
Balance at end of period $ 165,673 $ 164,939 $ 165,673 $ 164,939
========= ========= ========= =========
RESTRICTED Balance at beginning of period $ (8,654) $ (4,328) $ (3,391) $ (1,713)
SHARES Issuance of restricted shares - 26 (7,336) (4,582)
Amortization of restricted shares 854 464 2,927 2,457
--------- --------- --------- ---------
Balance at end of period $ (7,800) $ (3,838) $ (7,800) $ (3,838)
========= ========= ========= =========
TOTAL Balance at beginning of period $ 635,204 $ 500,531 $ 564,516 $ 453,464
SHAREHOLDERS' Issuance of shares 657 126 22,981 3,406
EQUITY Restricted shares, net 854 490 (4,409) (2,125)
Unrealized appreciation (depreciation) on
investments, net of deferred income tax 6,556 (4,008) (2,809) (2,262)
Unrealized appreciation on cash flow hedge,
net of deferred income tax - - - 946
Net (loss) income before convertible preferred
share dividends (73,174) 23,724 (9,907) 68,809
Dividends to common shareholders (867) (731) (2,550) (2,195)
Other 16 - 1,424 89
--------- --------- --------- ---------
Balance at end of period $ 569,246 $ 520,132 $ 569,246 $ 520,132
========= ========= ========= =========
The accompanying notes are an integral part of these statements.
5
PXRE CONSOLIDATED STATEMENTS OF CASH FLOWS
GROUP LTD. (Dollars in thousands)
- ------------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
---- ---- ---- ----
(Unaudited)
CASH FLOW Premiums collected, net of reinsurance $ 73,662 $ 58,581 $ 216,037 $ 209,775
FROM OPERATING Loss and loss adjustment expenses paid, net of
ACTIVITIES reinsurance (27,310) (25,453) (65,103) (59,172)
Commission and brokerage paid, net of fee income (9,972) (1,262) (27,543) (19,403)
Operating expenses paid (8,951) (9,599) (30,644) (24,839)
Net investment income received 3,516 4,757 12,798 9,941
Interest paid (5,978) (5,381) (13,346) (10,175)
Income taxes paid (132) (1,170) (6,093) (12,793)
Trading portfolio purchased - - - (5,688)
Trading portfolio disposed 6,965 - 6,965 8,496
Deposit (paid) received 2,373 6,450 (5,445) 40,668
Other (571) (15,257) (15,269) (17,734)
--------- -------- --------- ---------
Net cash provided by operating activities 33,602 11,666 72,357 119,076
--------- -------- --------- ---------
CASH FLOW Fixed maturities available for sale purchased (133,889) (176,403) (350,946) (330,862)
FROM INVESTING Fixed maturities available for sale disposed
ACTIVITIES or matured 58,133 149,005 296,853 213,581
Hedge funds purchased (8,123) (5,000) (13,123) (12,000)
Hedge funds disposed 4,127 3,095 10,160 19,936
Other invested assets purchased - (12) - (133)
Other invested assets disposed 1,425 530 4,083 1,568
Net change in short-term investments 44,199 (88,880) (77,122) (99,328)
Payable for securities 48 45,548 30 82,919
--------- -------- --------- ---------
Net cash used by investing activities (34,080) (72,117) (130,065) (124,319)
--------- -------- --------- ---------
CASH FLOW Proceeds from issuance of common shares 690 129 16,432 671
FROM FINANCING Cash dividends paid to common shareholders (866) (731) (2,550) (2,195)
ACTIVITIES Proceeds from issuance of minority interest in
consolidated subsidiaries - - - 32,500
Repayment of debt - - - (30,000)
Cost of shares repurchased (32) 24 (938) (1,848)
--------- -------- --------- ---------
Net cash (used) provided by financing
activities (208) (578) 12,944 (872)
--------- -------- --------- ---------
Net change in cash (686) (61,029) (44,764) (6,115)
Cash, beginning of period 21,730 101,544 65,808 46,630
--------- -------- --------- ---------
Cash, end of period $ 21,044 $ 40,515 $ 21,044 $ 40,515
========= ======== ========= =========
RECONCILIATION OF NET (LOSS) INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES:
Net (loss) income before convertible preferred
share dividends $ (73,174) $ 23,724 $ (9,907) $ 68,809
Adjustments to reconcile net (loss) income to
net cash provided by operating activities:
Losses and loss expenses 89,032 (5,687) 66,866 (10,518)
Unearned premiums 22,836 960 24,880 (16,439)
Deferred acquisition costs (2,170) 1,646 (1,867) 14,940
Receivables (22,870) (19,197) (25,827) (9,636)
Reinsurance balances payable (15,884) (6,500) (26,573) (21,088)
Reinsurance recoverable 63,050 15,480 83,638 63,847
Income taxes (8,286) (259) (12,933) (10,001)
Equity in earnings of limited partnerships (1,328) (1,892) (6,013) (9,741)
Trading portfolio purchased - - - (5,688)
Trading portfolio disposed 6,965 - 6,965 8,496
Deposit liability 2,373 6,450 (5,445) 40,668
Receivable on commutation (23,054) - (23,054) -
Other (3,888) (3,059) 1,627 5,427
--------- -------- --------- ---------
Net cash provided by operating activities $ 33,602 $ 11,666 $ 72,357 $ 119,076
========= ======== ========= =========
The accompanying notes are an integral part of these statements.
6
PXRE GROUP LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- -------------------------------------------------------------------------------
1. ORGANIZATION
PXRE Group Ltd. (the "Company" or collectively with its subsidiaries,
"PXRE") is an insurance holding company incorporated in Bermuda. PXRE provides
reinsurance products and services to a worldwide marketplace through subsidiary
operations in Bermuda, Barbados, Europe and the United States. PXRE's primary
focus is providing property catastrophe reinsurance and retrocessional coverage.
PXRE also provides marine, aviation and aerospace products and services.
The Company was formed in 1999 as part of the reorganization of PXRE
Corporation, a Delaware corporation ("PXRE Delaware"). Prior to the
reorganization, PXRE Delaware was the ultimate parent holding company of the
various PXRE companies and its common shares were publicly traded on the New
York Stock Exchange. As a result of the reorganization, the Company became the
ultimate parent holding company of PXRE Delaware and the holders of PXRE
Delaware common stock automatically became holders of the same number of the
Company's common shares. The reorganization was consummated at the close of
business on October 5, 1999 and, on October 6, 1999 the Company's common shares
commenced trading on the New York Stock Exchange under the symbol "PXT." The
reorganization also involved the establishment of a Bermuda based reinsurance
subsidiary, PXRE Reinsurance Ltd. ("PXRE Bermuda") and a Barbados based
reinsurance subsidiary, PXRE Reinsurance (Barbados) Ltd. ("PXRE Barbados").
2. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Consolidation
The consolidated financial statements have been prepared in U.S.
dollars in conformity with accounting principles generally accepted ("GAAP") in
the United States of America. These statements reflect the consolidated
operations of the Company and its wholly owned subsidiaries, including PXRE
Delaware, PXRE Reinsurance Company ("PXRE Reinsurance"), PXRE Bermuda, PXRE
Barbados, PXRE Solutions, Inc., PXRE Solutions, S.A. ("PXRE Europe") and PXRE
Limited. All material inter-company transactions have been eliminated in
preparing these consolidated financial statements.
GAAP requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
The interim consolidated financial statements are unaudited. In the
opinion of management, such consolidated financial statements include all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair statement of the results for the interim periods. These interim statements
should be read in conjunction with the 2003 consolidated financial statements
and related notes. The preparation of interim consolidated financial statements
relies significantly upon estimates. Use of such estimates and the seasonal
nature of the reinsurance business necessitate caution in drawing specific
conclusions from interim results.
7
PXRE GROUP LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- -------------------------------------------------------------------------------
Certain reclassifications have been made for 2003 to conform to the
2004 presentation.
Share-Based Compensation
At September 30, 2004, PXRE has share option plans which are accounted
for under the recognition and measurement principles of the Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and
related Interpretations. No share-based compensation cost related to the options
granted under the plans is reflected in net income, as the options granted had
an exercise price equal to the market value of the underlying common shares on
the date of grant. The following table illustrates the effect on net income and
earnings per share if PXRE had applied the fair value recognition provisions of
the Financial Accounting Standards Board ("FASB") Statement of Financial
Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation"
to share-based employee compensation:
THREE MONTHS ENDED NINE MONTHS ENDED
($000'S, EXCEPT PER SHARE DATA) SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Net (loss) income before convertible
preferred share dividends:
As reported $ (73,174) $ 23,724 $ (9,907) $ 68,809
Deduct:
Total share-based compensation expense determined
under fair value based method for all awards, net
of related tax effects (393) (537) (1,726) (2,510)
---------- ---------- ---------- ----------
Pro-forma $ (73,567) $ 23,187 $ (11,633) $ 66,299
========== ========== ========== ==========
Basic (loss) income per share:
As reported $ (5.48) $ 1.71 $ (1.49) $ 4.95
Pro-forma $ (5.51) $ 1.67 $ (1.61) $ 4.74
Diluted (loss) income per share:
As reported $ (5.48) $ 1.01 $ (1.49) $ 2.97
Pro-forma $ (5.51) $ 0.98 $ (1.61) $ 2.86
Debt and Equity Classification
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." This
statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within the scope of the statement as a liability or an asset in some
circumstances. PXRE adopted this statement during the quarter ended September
30, 2003, however, due to certain parts of this statement being deferred by the
FASB, the adoption of this statement did not have any impact on PXRE's
Consolidated Financial Statements, financial position or results of operations
until the quarter ended March 31, 2004. Accordingly, as of March 31, 2004,
PXRE's mandatorily redeemable capital trust pass-through securities were
reclassified on its Consolidated Balance Sheet to liabilities and entitled
"Subordinated debt." In PXRE's Consolidated Statements of Operations and
Comprehensive Operations for the three and nine months ended September 30, 2004,
the interest expense related to these securities was included with "Interest
expense," whereas for the three and nine months ended September 30, 2003 it was
included with "Minority interest in consolidated subsidiaries" as SFAS 150 did
not permit these changes to be made retroactively.
8
PXRE GROUP LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- -------------------------------------------------------------------------------
Consolidation of Variable Interest Entities
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"), which requires
consolidation of all "Variable Interest Entities" ("VIEs") by the "primary
beneficiary," as these terms are defined in FIN 46, and on October 9, 2003 the
FASB issued FASB Staff Position FIN 46-6, "Effective Date of FASB Interpretation
No. 46, Consolidation of VIE's", which required PXRE to implement FIN 46 during
the quarter ended March 31, 2004. The adoption of this statement resulted in
PXRE deconsolidating the five special purpose trusts which issued PXRE's trust
preferred securities. As a result, the subordinated loans from the trusts are
reflected as liabilities under the caption "Subordinated debt" on PXRE's
September 30, 2004 Consolidated Balance Sheet, while PXRE's investments of
approximately $5.2 million in such trusts in the form of equity, which prior to
March 31, 2004 were eliminated on consolidation, are reflected as assets under
the caption "Other assets" with a corresponding increase in liabilities under
the caption "Subordinated debt." FIN 46 did not permit these changes to be made
retroactively. In addition, gains on the repurchase of $5.2 million of PXRE's
trust preferred securities in prior periods of $1.1 million, net of tax, that
were previously accounted for as extinguishments of debt, were reversed during
the quarter ended March 31, 2004 and presented as a cumulative effect of an
accounting change in PXRE's Consolidated Statement of Operations and
Comprehensive Operations during 2004. These repurchased securities are reflected
in PXRE's September 30, 2004 Consolidated Balance Sheet under the caption "Fixed
Maturities: Available-for-sale."
Consolidated Statement of Changes in Cash Flow
In the first quarter of 2004, the Company changed the presentation of
its Consolidated Statement of Changes in Cash Flow to the direct cash flow
method, replacing the indirect cash flow method as previously presented. Amounts
presented for the three and nine months ended September 30, 2003 were
reclassified to be consistent with the new presentation.
9
PXRE GROUP LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- -------------------------------------------------------------------------------
3. UNDERWRITING
Premiums written and earned for the three and nine months ended
September 30, 2004 and 2003 are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
% INCREASE % INCREASE
($000'S) 2004 2003 (DECREASE) 2004 2003 (DECREASE)
--------- --------- --------- --------- --------- ---------
Premiums written
Gross premiums written $ 125,529 $ 95,275 $ 285,847 $ 274,123
Ceded premiums written (12,938) (25,233) (32,320) (52,692)
--------- --------- --------- ---------
Net premiums written $ 112,591 $ 70,042 61 $ 253,527 $ 221,431 14
========= ========= ========= =========
Premiums earned
Gross premiums earned $ 101,623 $ 83,053 $ 263,856 $ 282,210
Ceded premiums earned (11,824) (13,971) (35,540) (44,340)
--------- --------- --------- ---------
Net premiums earned $ 89,799 $ 69,082 30 $ 228,316 $ 237,870 (4)
========= ========= ========= =========
PXRE from time to time purchases catastrophe retrocessional coverage
for its own protection, depending on market conditions. PXRE purchases
reinsurance primarily to reduce its exposure to severe losses related to any one
event or catastrophe. PXRE currently has reinsurance treaties in place with
several different coverages, territories, limits and retentions that serve to
reduce a large gross loss emanating from any one event. In addition, primarily
related to PXRE's exposure assumed on per-risk treaties, PXRE purchases clash
reinsurance protection which allows PXRE to recover losses ceded by more than
one reinsured related to any one particular property. In the event that
retrocessionaires are unable to meet their contractual obligations, PXRE would
remain liable for the underlying covered claims.
4. INVESTMENTS
The following table summarizes investments with unrealized losses at
fair value by length of continuous unrealized loss position as of September 30,
2004:
ONE YEAR OR LESS OVER ONE YEAR
-------------------- ---------------------
UNREALIZED UNREALIZED
($000'S) FAIR VALUE LOSS FAIR VALUE LOSS
---------- -------- ---------- --------
United States government securities $ 52,181 $ (35) $ -- $ --
United States government sponsored agency debentures 56,615 (484) -- --
United States government sponsored agency
mortgage-backed securities 46,881 (94) 6,771 (165)
Other mortgage and asset-backed securities 97,224 (1,487) 5,025 (198)
Obligations of states and political subdivisions 756 (1) -- --
Corporate securities 137,112 (2,114) 17,528 (420)
-------- -------- -------- --------
Total temporarily impaired securities $390,769 $ (4,215) $ 29,324 $ (783)
======== ======== ======== ========
10
PXRE GROUP LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- -------------------------------------------------------------------------------
5. EARNINGS PER SHARE
The table below presents the computation of basic and diluted earnings
per share:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
($000'S, EXCEPT PER SHARE DATA) 2004 2003 2004 2003
-------- -------- -------- --------
Net (loss) income available to common shareholders:
(Loss) income before cumulative effect of
accounting change and convertible preferred
share dividends $(73,174) $ 23,724 $ (8,854) $ 68,809
Cumulative effect of accounting change, net of tax -- -- (1,053) --
-------- -------- -------- --------
Net (loss) income before convertible preferred
share dividends (73,174) 23,724 (9,907) 68,809
Convertible preferred share dividends (3,583) (3,310) (10,540) (9,737)
-------- -------- -------- --------
Net (loss) income available to common shareholders $(76,757) $ 20,414 $(20,447) $ 59,072
======== ======== ======== ========
Weighted average common shares outstanding:
Weighted average common shares outstanding
(basic) 13,995 11,925 13,753 11,931
Equivalent shares of underlying options 284 162 398 239
Equivalent number of restricted shares 144 76 144 113
Equivalent number of convertible preferred shares 13,116 11,420 12,670 10,918
-------- -------- -------- --------
Weighted average common equivalent shares (diluted) 27,539 23,583 26,965 23,201
======== ======== ======== ========
Weighted average common equivalent shares when
anti-dilutive 13,995 -- 13,753 --
======== ======== ======== ========
Per share amounts:
Basic:
(Loss) income before cumulative effect
of accounting change and convertible
preferred share dividends $ (5.22) $ 1.99 $ (0.64) $ 5.77
Cumulative effect of accounting change -- -- (0.08) --
Convertible preferred share dividends (0.26) (0.28) (0.77) (0.82)
-------- -------- -------- --------
Net (loss) income available to common shareholders $ (5.48) $ 1.71 $ (1.49) $ 4.95
======== ======== ======== ========
Diluted:
Net (loss) income before cumulative effect of
accounting change $ (5.48) $ 1.01 $ (1.41) $ 2.97
Cumulative effect of accounting change -- -- (0.08) --
-------- -------- -------- --------
Net (loss) income $ (5.48) $ 1.01 $ (1.49) $ 2.97
======== ======== ======== ========
6. INCOME TAXES
The Company is incorporated under the laws of Bermuda and, under
current Bermuda law, is not obligated to pay any taxes in Bermuda based upon
income or capital gains. The Company has received an undertaking from the
Supervisor of Insurance in Bermuda pursuant to the provisions of the Exempted
Undertakings Tax Protection Act, 1966, which exempts the Company from any
Bermuda taxes computed on profits, income or any capital asset, gain or
appreciation, or any tax in the nature of estate duty or inheritance tax, at
least until the year 2016.
11
PXRE GROUP LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- -------------------------------------------------------------------------------
The Company does not consider itself to be engaged in a trade or
business in the United States and, accordingly, does not expect to be subject to
direct United States income taxation.
The United States subsidiaries of the Company file a consolidated U.S.
federal income tax return.
7. SHAREHOLDERS' EQUITY
On December 16, 2003, the Company completed a public offering of 2.2
million of its common shares at $21.75 per share, pursuant to a Shelf
Registration Statement on Form S-3 that was filed in 2003 for up to $150.0
million of various types of securities. Of the 2.2 million shares sold, 1.1
million were offered by PXRE and 1.1 million were offered by Phoenix Life
Insurance Company ("Phoenix"), one of the Company's common shareholders. The
underwriters were given an option to purchase up to an additional 0.3 million
common shares from the Company, which they exercised on January 22, 2004. As a
result of the offering and the exercise of the option, the Company received
total net proceeds of approximately $26.9 million. The Company did not receive
any of the proceeds from the sale of shares by Phoenix.
On April 4, 2002, the Company issued $150.0 million of additional
capital comprised of 15,000 convertible voting preferred shares in a private
placement not involving a public offering under Section 4(2) of the Securities
Act of 1933, as amended. The convertible preferred share investment occurred
pursuant to a share purchase agreement, dated as of December 10, 2001, between
the Company and certain investors. On February 12, 2002, the shareholders
approved the sale and issuance of three series of convertible preferred shares
pursuant to the share purchase agreement, including 7,500 Series A convertible
preferred shares, 5,000 Series B convertible preferred shares, and 2,500 Series
C convertible preferred shares. Proceeds of the offering of the convertible
preferred shares, net of offering expenses of $9.1 million, amounted to $140.9
million. As of September 30, 2004, 18,273 convertible preferred shares were
issued and outstanding.
The convertible preferred shares accrue cumulative dividends per share
at the rate per annum of 8% of the sum of the stated value of each share plus
any accrued and unpaid dividend thereon payable on a quarterly basis. The
shareholders also voted to approve the division of 20.0 million of PXRE's 50.0
million authorized common shares into three new classes of convertible common
shares including 10.0 million Class A convertible voting common shares, 6.7
million Class B convertible voting common shares, and 3.3 million Class C
convertible voting common shares. No convertible voting common shares of any
class are currently outstanding.
Convertible preferred shares are convertible into convertible common
shares at the option of the holder at any time at a conversion price equal to
the original conversion price, subject to adjustment if PXRE experiences adverse
development on losses incurred prior to September 30, 2001 in excess of a $7.0
million after-tax threshold. The number of convertible common shares issued upon
the conversion of each convertible preferred share would be equal to the sum of
the original purchase price ($10,000) of such convertible preferred share plus
accrued but unpaid dividends divided by the adjusted conversion price. Certain
adverse development, excluding that related to most of the adverse development
on loss reserves within the exited lines segment and all of the losses arising
from the events of September 11, 2001, is subject to a cap of $12.0 million
after-tax. Adverse development on the reserves excluded is not subject to any
cap or limit. As of September 30, 2004, after giving effect to the $12.0 million
cap referred to above, PXRE has incurred $32.9 million of net after-tax adverse
development above this $7.0 million threshold, resulting in an adjusted
conversion price of $13.48 as of September 30, 2004. Two-thirds of the
convertible preferred shares mandatorily convert by April 4, 2005, and the
balance by April 4, 2008. Convertible preferred shares vote on a fully converted
basis on all matters brought before the shareholders other than the election of
directors.
12
PXRE GROUP LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- -------------------------------------------------------------------------------
8. SEGMENT INFORMATION
PXRE operates in two reportable property and casualty segments - (i)
catastrophe and risk excess and (ii) exited lines - based on PXRE's approach to
managing the business. Commencing with the 2002 underwriting renewal season,
PXRE returned its focus to its core property catastrophe and risk excess
business. Businesses that were not renewed in 2002 are reported as exited lines.
Commencing with the 2004 underwriting renewal season, PXRE is reporting its
previously existing "other lines" segment, which in the past has consisted of a
single pro rata treaty, with its catastrophe and risk excess segment. In
addition, PXRE is reporting its previously existing "finite business" segment
with its exited lines segment to reflect its decision during the second quarter
to run-off the in-force finite business and not enter into any new finite
transactions subsequent to March 31, 2004. PXRE's segments for 2003 were
restated to be comparable to the two 2004 segments discussed above. As a result
of the above, the exited lines segment now includes business previously written
and classified by the Company as direct casualty, Lloyd's of London ("Lloyd's"),
international casualty and finite. In addition, PXRE operates in two geographic
segments - North American, representing North American based risks written by
North American based clients, and International (principally the United Kingdom,
Continental Europe, Latin America, the Caribbean, Australia and Asia),
representing all other premiums written.
There are no significant differences among the accounting policies of
the segments as compared to PXRE's consolidated financial statements.
PXRE does not maintain separate balance sheet data for each of its
operating segments, nor does it allocate net investment income, net realized
investment gains or losses, operating expenses, foreign exchange gains or losses
and financing costs to these segments. Accordingly, PXRE does not review and
evaluate the financial results of its operating segments based upon balance
sheet data and these other income statement items.
The following tables summarize the net premiums written, net premiums
earned and underwriting income (loss) by PXRE's business segments. The amounts
shown for the North American and International geographic segments are presented
net of proportional reinsurance but gross of corporate catastrophe excess of
loss reinsurance cessions, which are separately itemized where applicable.
13
PXRE GROUP LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- -------------------------------------------------------------------------------
NET PREMIUMS WRITTEN
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
($000'S, EXCEPT PERCENTAGES) 2004 2003 2004 2003
---------------------- --------------------- --------------------- --------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
--------- --------- --------- --------- --------- --------- --------- ---------
Catastrophe and Risk Excess
North American $ 28,771 $ 20,762 $ 67,532 $ 56,151
International 94,655 70,700 208,495 189,713
Excess of Loss Cessions (10,360) (18,192) (25,638) (30,186)
--------- --------- --------- ---------
113,066 100% 73,270 105% 250,389 99% 215,678 97%
--------- --------- --------- ---------
Exited Lines
North American (350) (2,023) 3,201 4,288
International (125) (1,205) (63) 1,465
--------- --------- --------- ---------
(475) -- (3,228) (5) 3,138 1 5,753 3
--------- --------- --------- --------- --------- --------- --------- ---------
Total $ 112,591 100% $ 70,042 100% $ 253,527 100% $ 221,431 100%
========= ========= ========= ========= ========= ========= ========= =========
NET PREMIUMS EARNED
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
($000'S, EXCEPT PERCENTAGES) 2004 2003 2004 2003
---------------------- --------------------- --------------------- --------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
--------- --------- --------- --------- --------- --------- --------- ---------
Catastrophe and Risk Excess
North American $ 24,517 $ 17,785 $ 64,257 $ 53,978
International 75,139 55,382 186,257 164,830
Excess of Loss Cessions (9,741) (8,489) (28,218) (23,810)
--------- --------- --------- ---------
89,915 100% 64,678 94% 222,296 97% 194,998 82%
--------- --------- --------- ---------
Exited Lines
North American 15 5,609 6,087 41,353
International (131) (1,205) (67) 1,519
--------- --------- --------- ---------
(116) -- 4,404 6 6,020 3 42,872 18
--------- --------- --------- --------- --------- --------- --------- ---------
Total $ 89,799 100% $ 69,082 100% $ 228,316 100% $ 237,870 100%
========= ========= ========= ========= ========= ========= ========= =========
14
PXRE GROUP LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- -------------------------------------------------------------------------------
Underwriting income (loss) includes premiums earned, losses incurred
and commission and brokerage, net of fee income, but does not include investment
income, net realized investment gains or losses, interest expense, operating
expenses or foreign exchange gains or losses.
UNDERWRITING INCOME (LOSS)
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
($000'S, EXCEPT PERCENTAGES) 2004 2003 2004 2003
--------------------- --------------------- -------------------- ----------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
--------- ------- --------- ------- --------- ------- --------- -------
Catastrophe and Risk Excess
North American $ (11,405) $ 15,332 $ 19,589 $ 32,987
International (37,419) 39,233 35,984 115,352
Excess of Loss Cessions (6,259) (7,686) (25,391) (26,403)
--------- --------- --------- ---------
(55,083) 74% 46,879 148% 30,182 334% 121,936 134%
--------- --------- --------- ---------
Exited Lines
North American (19,694) (12,507) (25,995) (25,846)
International 36 (2,605) 4,848 (5,028)
--------- --------- --------- ---------
(19,658) 26 (15,112) (48) (21,147) (234) (30,874) (34)
--------- --- --------- --- --------- --- --------- ---
Total $ (74,741) 100% $ 31,767 100% $ 9,035 100% $ 91,062 100%
========= === ========= === ========= === ========= ===
15
PXRE GROUP LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- -------------------------------------------------------------------------------
The following table reconciles the net underwriting income (loss) for
the operating segments to income (loss) before income taxes and cumulative
effect of accounting change as reported in the Consolidated Statements of
Operations and Comprehensive Operations.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ---------------------
($000'S)
2004 2003 2004 2003
-------- -------- -------- --------
Net underwriting (loss) income $(74,741) $ 31,767 $ 9,035 $ 91,062
Net investment income 5,157 5,994 16,941 20,026
Net realized investment (losses) gains (40) 502 11 611
Other operating expenses (8,272) (9,788) (30,760) (29,451)
Foreign exchange gains (losses) 382 (927) 22 (676)
Interest expense (3,817) -- (10,947) (2,504)
Minority interest in consolidated
subsidiaries -- (2,817) -- (7,350)
Other -- -- -- (22)
-------- -------- -------- --------
(Loss) income before income taxes, cumulative
effect of accounting change and convertible
preferred share dividends $(81,331) $ 24,731 $(15,698) $ 71,696
======== ======== ======== ========
9. SUBORDINATED DEBT
Trust preferred securities were classified as minority interest in
consolidated subsidiaries prior to 2004. Trust preferred securities are
mandatorily redeemable subordinated debt securities issued to separate special
purpose trusts holding solely those securities. As discussed in Note 2,
following the implementation of SFAS 150 and FIN 46 during the quarter ended
March 31, 2004, these trusts are no longer consolidated and the securities
issued to these trusts by PXRE (rather than the securities issued by the trusts
as was done previously) are now classified as liabilities on PXRE's September
30, 2004 Consolidated Balance Sheet. The subordinated debt securities are as
follows:
SEPTEMBER 30, DECEMBER 31,
($000'S) 2004 2003
-------- --------
8.85% fixed rate due February 1, 2027 $102,638 $ 94,341
7.35% fixed/floating rate due May 15, 2033 18,042 17,500
9.75% fixed rate due May 23, 2033 15,464 15,000
7.70% fixed/floating rate due October 29, 2033 20,619 20,000
7.58% fixed/floating rate due September 30, 2033 10,310 10,000
-------- --------
$167,073 $156,841
======== ========
The 8.85% fixed rate capital trust pass-through securities pay interest
semi-annually and are redeemable by PXRE from February 1, 2007 at 104.180%
declining to 100.418% at February 1, 2016, and at par thereafter. The 7.35%
fixed/floating rate capital trust pass-through securities initially pay interest
quarterly at a fixed rate of 7.35% for 5 years and then at a floating rate of 3
month LIBOR plus 4.1% reset quarterly thereafter, and are redeemable by PXRE at
par on or after May 15, 2008. The 9.75% fixed rate capital trust pass-through
securities pay interest quarterly and are redeemable by PXRE from May 23, 2008
at 104.875% declining to 100.975% at May 23, 2013, and at par thereafter. The
7.70% fixed/floating rate capital trust pass-through securities initially pay
interest quarterly at a rate of 7.70% for 5 years and then at a floating rate of
3 month LIBOR plus 3.85% reset quarterly thereafter, and are redeemable by PXRE
at par on or after October 29, 2008. The 7.58% fixed/floating rate capital trust
pass-through securities initially pay interest quarterly at a rate of 7.58% for
5 years and then at a floating rate of 3 month LIBOR plus 3.90% reset quarterly
thereafter, and are redeemable by PXRE at par on or after September 30, 2008.
16
PXRE GROUP LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- -------------------------------------------------------------------------------
PXRE has the option to defer interest payments on the capital trust
pass-through securities and redeem them earlier than the due dates, subject to
limits and penalties as set out in the relevant indentures.
10. EMPLOYEE BENEFITS
The qualified and non-qualified defined benefit pension plans were
curtailed effective March 31, 2004.
The components of net pension expense for these company-sponsored plans
are as follows:
($000'S)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
2004 2003 2004 2003
------- ------- ------- -------
COMPONENTS OF NET PERIODIC COST:
Service cost $ -- $ 245 $ 303 $ 734
Interest cost 93 139 322 416
Expected return on assets (109) (110) (321) (323)
Amortization of prior service costs -- 50 68 151
Recognized net actuarial costs -- (11) -- (33)
Settlement 723 -- 723 --
Curtailment -- 152 (486) 449
------- ------- ------- -------
Net periodic benefit costs $ 707 $ 465 $ 609 $ 1,394
======= ======= ======= =======
During the nine months ended September 30, 2004, the Company made no
contributions to its pension plans and expects no significant contributions
during 2004.
11. CONTINGENCIES
In April 2000, PXRE Reinsurance entered into an aggregate excess of
loss retrocessional reinsurance agreement (the "XOL Retro Treaty") with
Lumbermens Mutual Casualty Company ("LMC"). In the XOL Retro Treaty, PXRE
Reinsurance reinsured a portfolio of treaties underwritten by a former business
unit of LMC, which had been divested. Pursuant to this XOL Retro Treaty, PXRE
Reinsurance agreed to indemnify LMC for losses in excess of a 75% paid loss
ratio on this underlying portfolio of treaties up to a 100% paid loss ratio,
subject to an aggregate limit of liability of $50.0 million. The latest loss
reports related to the XOL Retro Treaty provided by LMC forecast an ultimate net
loss ratio in excess of 100%, which could result in a full limit loss to PXRE.
17
PXRE GROUP LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- -------------------------------------------------------------------------------
In June 2003, PXRE Reinsurance performed an audit of this portfolio of
treaties reinsured under the XOL Retro Treaty. As a result of this audit,
management identified problems and believes that LMC defrauded PXRE, breached
its duty of utmost good faith, and breached its contractual obligations and
fiduciary duties under the agreement. PXRE Reinsurance therefore filed suit
against LMC on July 24, 2003 in a United Stated District Court seeking
rescission of the agreement and/or compensatory and punitive damages.
Recently, the court granted partial summary judgment to LMC and
dismissed PXRE Reinsurance's fraud claims and breach of the duty of utmost good
faith arising out of alleged misconduct by LMC prior to the binding of the XOL
Retro Treaty. PXRE Reinsurance disagrees with the court's decision. PXRE
Reinsurance is filing a motion for reconsideration based upon recent deposition
testimony by the former president of the subject former LMC business unit which
had not been considered by the court prior to its decision on LMC's motion. If
that motion is unsuccessful, PXRE Reinsurance intends to seek to appeal the
order to the United States Court of Appeals for the Seventh Circuit.
The court did not address PXRE Reinsurance's breach of contract claims
and allegations arising out of LMC's post-binding activity and such claims
remain pending.
Unless the court order is reconsidered or overturned on appeal,
rescission may no longer be available as a remedy in our suit against LMC. At
this stage of the lawsuit, it is difficult to estimate the scope and amount of
potential damages relating to PXRE Reinsurance's breach of contract claims. We
have therefore recorded additional loss reserves of $14.7 million relating to
the XOL Retro Treaty as of September 30, 2004, which is equal to the remaining
portion of the $50.0 million aggregate limit of liability under the XOL Retro
Treaty. Accordingly, PXRE Reinsurance will have no exposure to additional losses
relating to the contract. This results in a negative after tax impact of $9.6
million on earnings in the quarter ended September 30, 2004.
Although the ultimate outcome of the litigation cannot presently be
determined, management believes that PXRE Reinsurance's claims are meritorious
and intends to continue to prosecute its suit.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Unless the context otherwise requires, references in this Form 10-Q to
the "Company" refer to PXRE Group Ltd., a Bermuda holding company, while "PXRE",
"we", "us" and "our" include PXRE Group Ltd. and its subsidiaries, which
principally include PXRE Corporation ("PXRE Delaware"), PXRE Reinsurance Company
("PXRE Reinsurance"), PXRE Reinsurance Ltd. ("PXRE Bermuda"), PXRE Reinsurance
(Barbados) Ltd. ("PXRE Barbados"), PXRE Solutions Inc. ("PXRE Solutions"), PXRE
Solutions, S.A. ("PXRE Europe") and PXRE Limited. References to GAAP refer to
accounting principles generally accepted in the United States ("GAAP").
References to SAP refer to statutory accounting principles ("SAP") in either the
State of Connecticut, where PXRE Reinsurance is domiciled, or Bermuda, where
PXRE Bermuda is domiciled, as applicable.
The following is a discussion and analysis of PXRE's results of
operations for the three and nine months ended September 30, 2004 compared with
the three and nine months ended September 30, 2003, and also a discussion of our
financial condition as of September 30, 2004. This discussion and analysis
should be read in conjunction with the attached unaudited consolidated financial
statements and notes thereto and PXRE's Annual Report on Form 10-K for the year
ended December 31, 2003 (the "10-K"), including the audited consolidated
financial statements and notes thereto, the discussion of Certain Risks and
Uncertainties and the discussion of Critical Accounting Policy Disclosures
contained in the 10-K.
OVERVIEW
PXRE Group Ltd. is an insurance holding company organized in Bermuda.
We provide reinsurance products and services to a worldwide marketplace through
our wholly owned subsidiary operations located in Bermuda, Barbados, Europe and
the United States. Our primary business is catastrophe and risk excess
reinsurance, which accounted for 100% of net premiums written for the three
months ended September 30, 2004. Our catastrophe and risk excess business
includes property catastrophe excess of loss, property catastrophe
retrocessional, property risk excess, marine excess and aerospace excess and pro
rata reinsurance products.
As a result of catastrophe losses during the quarter, namely,
hurricanes Charley, Frances, Ivan and Jeanne, we generated a net loss before
convertible preferred share dividends of $73.2 million in the quarter ended
September 30, 2004 compared to the net income before convertible preferred share
dividends of $23.7 million generated in the third quarter of 2003.
Our ability and willingness to generate significant premium growth are
highly dependent upon the premium pricing levels in the reinsurance market.
Pricing in our catastrophe and risk excess business was healthy during the third
quarter of 2004 following the significant rate increases experienced in 2002 and
2003. During 2004, pricing has been generally flat to up slightly in our North
America property catastrophe and world-wide retrocessional businesses. We
experienced single-digit rate decreases in our international property
catastrophe business.
19
In 2005, we believe the occurrence and the resulting losses of the four
significant hurricanes as well as typhoons in Japan will drive moderate rate
increases in our worldwide retrocessional business, increase or stabilize
pricing in our North American property catastrophe business and moderate rate
decreases in our international property catastrophe business.
COMPARISON OF THIRD QUARTER RESULTS FOR 2004 WITH 2003
For the quarter ended September 30, 2004, net loss before convertible
preferred share dividends was $73.2 million compared to net income before
convertible preferred share dividends of $23.7 million for the comparable period
of 2003. Net loss per diluted common share was $5.48 for the third quarter of
2004 compared to net income per diluted common share of $1.01 for the third
quarter of 2003, based on diluted average shares outstanding of approximately
14.0 million in the third quarter of 2004 and 23.6 million in the third quarter
of 2003. As the Company incurred a loss from continuing operations, in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings Per Share," it did not include 13.5 million of average shares in its
calculation of net loss per diluted common shares that are anti-dilutive, as
shown in Note 5 to the Consolidated Financial Statements, which is the primary
reason for the decrease in the number of diluted average shares outstanding in
the third quarter of 2004 compared to the third quarter of 2003.
PREMIUMS
Gross and net premiums written for the third quarter of 2004 and 2003
were as follows:
($000'S) THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------- % INCREASE
2004 2003 (DECREASE)
-------------- -------------- ------------
Gross premiums written $ 125,529 $ 95,275 32
Ceded premiums written (12,938) (25,233) (49)
-------------- --------------
Net premiums written $ 112,591 $ 70,042 61
============== ==============
Gross premiums written for the third quarter of 2004 increased $30.3
million, or 32%, to $125.5 million from $95.3 million in the third quarter of
2003. Gross premiums written in our core catastrophe and risk excess segment
increased $27.0 million, or 27%, compared to the corresponding period of 2003
due to increased business written and reinstatement premiums associated with
catastrophe losses that occurred during the third quarter of 2004, namely,
hurricanes Charley, Frances, Ivan and Jeanne. Gross reinstatement premiums
written related to the catastrophe and risk excess business increased by $24.0
million to $24.6 million in the third quarter of 2004 from $0.6 million in the
corresponding period of 2003.
Ceded premiums written decreased $12.3 million, or 49%, to $12.9
million for the third quarter of 2004 from $25.2 million for the third quarter
of 2003, as a result of a decrease in ceded premiums written related to excess
of loss retrocessional catastrophe treaties of $7.8 million compared to the year
earlier period and to $6.8 million of ceded premiums written to Select
Reinsurance Ltd. ("Select Re") under a quota share retrocessional contract that
was in place in 2003 but was not renewed at January 1, 2004.
20
Net premiums written for the third quarter of 2004 increased $42.5
million, or 61%, to $112.6 million from $70.0 million in the third quarter of
2003. Net premiums written in our catastrophe and risk excess segment increased
$39.8 million, or 54%, during the third quarter of 2004 compared to the
comparable prior year period. The increase in this segment is due to the same
factors that caused the increase in gross premiums written and decrease in ceded
premiums written as explained above.
Gross and net premiums earned for the third quarter of 2004 and 2003
were as follows:
($000'S) THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------- % INCREASE
2004 2003 (DECREASE)
-------------- -------------- ------------
Gross premiums earned $ 101,623 $ 83,053 22
Ceded premiums earned (11,824) (13,971) (15)
-------------- --------------
Net premiums earned $ 89,799 $ 69,082 30
============== ==============
Gross premiums earned for the third quarter of 2004 increased $18.6
million, or 22%, to $101.6 million from $83.1 million in the third quarter of
2003. Gross premiums earned in our catastrophe and risk excess segment increased
$22.5 million, or 28%, to $101.7 million in the third quarter of 2004 compared
to $79.2 million in the corresponding period of 2003. Gross reinstatement
premiums earned related to the catastrophe and risk excess business increased by
$24.0 million compared to $24.6 million in the third quarter of 2004 from $0.6
million in the corresponding period of 2003. The change in this segment is due
to similar factors as those discussed above in gross premiums written.
Offsetting this increase, in part, was a planned decrease in our exited lines
segment of $4.0 million compared to the year earlier period.
Ceded premiums earned decreased $2.1 million, or 15%, to $11.8 million
for the third quarter of 2004 from $14.0 million for the third quarter of 2003,
primarily as a result of a decrease of $5.2 million of ceded earned premiums to
Select Re under the quota share retrocessional contract discussed above that was
not renewed at January 1, 2004. Offsetting this decrease, in part, was an
increase in ceded premiums earned related to excess of loss catastrophe
retrocessional treaties.
Net premiums earned for the third quarter of 2004 increased $20.7
million, or 30%, to $89.8 million from $69.1 million for the corresponding
period of 2003. Net premiums earned in the catastrophe and risk excess segment
increased $25.2 million, or 39%, for the third quarter of 2004 as compared to
the corresponding prior-year period. The change in this segment is due to
similar factors as those discussed above in gross and net premiums written.
Offsetting this increase, in part, was a planned decrease in our exited lines
segment of $4.5 million compared to the year earlier period.
As part of our efforts to return to our core catastrophe and risk
business, we have ceased underwriting finite business, and during the quarter
ended June 30, 2004 we began to include the results of this business in our
exited lines segment. During the year ended December 31, 2003 and the quarter
ended March 31, 2004, this business was focused on a limited group of cedents
and on policies that did not contain significant risk transfer. Finite contracts
that do not contain sufficient risk transfer are not recorded as reinsurance
arrangements but are treated as deposits for accounting purposes. As such, the
income related to these transactions is recorded as fee income, and liabilities,
if any, are recorded as deposit liabilities. There will be an insignificant
amount of finite premiums earned in future periods.
21
A summary of our net premiums written and earned by business segment
for the three months ended September 30, 2004 and 2003 is included in Note 8 to
the Consolidated Financial Statements.
RATIOS
The underwriting results of a property and casualty insurer are
discussed frequently by reference to its loss ratio, expense ratio (including
the commission and brokerage ratio, net of fee income, if any, and the operating
expense ratio) and combined ratio. The loss ratio is the result of dividing
losses and loss expenses incurred by net premiums earned. The expense ratio is
the result of dividing underwriting expenses (including commission and
brokerage, net of fee income, if any, and the operating expenses) by net
premiums earned. The combined ratio is the sum of the loss ratio and the expense
ratio. A combined ratio less than 100% indicates underwriting profits and a
combined ratio greater than 100% indicates underwriting losses. The combined
ratio does not reflect the effect of investment income on underwriting results.
The ratios discussed below have been calculated on a GAAP basis.
The following table summarizes the loss ratio, expense ratio and
combined ratio for the quarters ended September 30, 2004 and 2003, respectively:
(%) THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2004 2003
-------------- -----------
Loss ratio 174.1 51.0
Expense ratio 18.3 17.2
-------------- -----------
Combined ratio 192.4 68.2
============== ===========
Catastrophe and risk excess loss ratio 151.4 17.5
============== ===========
LOSSES AND LOSS EXPENSES
Losses and loss expenses incurred amounted to $156.3 million in the
third quarter of 2004 compared to $35.2 million in the third quarter of 2003.
The loss ratio was 174.1% for the third quarter of 2004 compared to 51.0% for
the comparable prior-year period largely due to $135.7 million in incurred
losses, net of reinsurance, primarily from hurricanes Charley, Frances, Ivan and
Jeanne that occurred during the third quarter of 2004. As noted above in the
discussion of Premiums, the hurricanes triggered $24.0 million of reinstatement
premiums earned during the third quarter of 2004, which somewhat offset the
impact of the hurricane losses on net income.
Also during the third quarter of 2004, we experienced net adverse
development of $12.2 million for prior-year losses and loss expenses, comprised
of $7.8 million cat and risk excess net favorable development and $20.0 million
exited lines net adverse development. The favorable development in the cat and
risk excess business was primarily related to case reserve takedowns from past
significant catastrophes, such as the 2002 European floods. The $20.0 million
net adverse development related to exited lines is due primarily to recording
additional loss reserves of $14.7 million relating to an excess of loss
retrocessional reinsurance agreement (the "XOL Retro Treaty") with Lumbermens
Mutual Casualty Company ("LMC") (See "Commitments, Contingencies and Contractual
Obligations") and several treaties with a ceding company for which we wrote
general liability business within our direct casualty operations. These treaties
were commuted in the third quarter of 2004.
22
During the third quarter of 2003, we experienced net adverse
development of $9.8 million for prior-year loss and loss expenses, $10.1 million
of which was due to adverse loss development on our exited direct casualty
reinsurance operations.
UNDERWRITING EXPENSES
The expense ratio was 18.3% for the third quarter of 2004 compared to
17.2% during the comparable year-earlier period. The commission and brokerage
ratio, net of fee income, was 9.1% for the third quarter of 2004 compared with
3.0% for the third quarter of 2003, with the prior-year ratio affected by a
large negative commission on a finite contract. The catastrophe and risk excess
commission and brokerage ratio, net of fee income, was 9.9% for the third
quarter of 2004 compared to 10.0% for the third quarter of 2003.
PXRE is not a party to any so-called Market Service Agreements or
Placement Service Agreements, nor does PXRE engage in any of the contingent
commission or other practices that we understand to be the focus of the ongoing
investigations by the New York State Attorney General's Office, as reported in
the press.
The operating expense ratio was 9.2% for the three months ended
September 30, 2004 compared with 14.2% for the comparable period of 2003. The
decrease is the result of increased net premiums earned and a decrease in
incentive compensation expense associated with catastrophe activity during the
quarter. Other operating expenses decreased 15% to $8.3 million for the three
months ended September 30, 2004 from $9.8 million in the comparable period of
2003. This decrease in operating expenses is primarily a result of a decrease in
incentive compensation costs partially offset by increased costs in the third
quarter of 2004 associated with consulting costs from Sarbanes-Oxley Section 404
compliance.
INTEREST EXPENSE AND MINORITY INTEREST IN CONSOLIDATED SUBSIDIARIES
Interest expense, including minority interest in consolidated
subsidiaries, increased to $3.8 million for the three months ended September 30,
2004 from $2.8 million in the comparable period of 2003. This increase is
primarily due to $0.6 million of additional interest on $30.9 million of trust
preferred securities issued subsequent to September 30, 2003. As discussed in
Note 2 to the Consolidated Financial Statements, following the implementation of
SFAS 150 and FIN 46 during the quarter ended March 31, 2004, the interest on
trust preferred securities is now shown as interest expense, whereas it was
previously recorded as minority interest in consolidated subsidiaries.
NET INVESTMENT INCOME
Net investment income for the third quarter of 2004 decreased 14% to
$5.2 million from $6.0 million in the third quarter of 2003, primarily as a
result of a $1.5 million decrease in income from our hedge fund portfolio,
offset by $0.9 million additional income from the other invested asset
portfolio. Investment income related to our hedge fund portfolio decreased to
$0.9 million in the third quarter of 2004 from $2.4 million in the third quarter
of 2003 as investments in hedge funds produced a return of 0.7% for the third
quarter of 2004 compared with 2.1% in the comparable prior-year period.
Offsetting this decrease was an increase in the balance of our fixed maturities
and short-term investment portfolios partially offset by a decrease in the book
yield to 3.1% during the third quarter of 2004 from 3.5% during the comparable
prior-year period.
23
Investment income for the quarter was also affected by various finite
and other reinsurance contracts where premiums payable under such contracts were
retained on a funds withheld basis. In order to reduce credit risk or to comply
with regulatory credit for reinsurance requirements, a portion of premiums paid
under such reinsurance contracts is retained by the cedent pending payment of
losses or commutation of the contract. Investment income on such withheld funds
is typically for the benefit of the reinsurer and the cedent may provide a
minimum investment return on such funds. We have both ceded and assumed
reinsurance contracts that involve the withholding of premiums by the cedent. On
assumed reinsurance contracts, cedents held premiums and accrued investment
income due to us of $0.0 million and $26.0 million as of September 30, 2004 and
2003, respectively, for which we have recognized $0.0 million and $0.4 million
of investment income for the third quarter of 2004 and 2003, respectively. On
ceded reinsurance contracts, we held premiums and accrued investment income of
$84.7 million and $123.0 million due to reinsurers as of September 30, 2004 and
2003, respectively, for which we recognized a charge to investment income of
$1.8 million and $2.2 million for the third quarter of 2004 and 2003,
respectively. On a net basis, this reduction to investment income was $1.0
million and $0.8 million for the quarters ended September 30, 2004 and 2003,
respectively, representing the difference between the stated investment return
under such contracts and the overall yield achieved on our total investment
portfolio for the quarter. The weighted average contractual investment return on
the funds held by PXRE is 8.0% and 6.8% for the quarters ended September 30,
2004 and 2003, respectively, and we expect to be obligated for this contractual
investment return for the life of the underlying liabilities, which is expected
to be two years as of September 30, 2004 on a weighted average basis.
INCOME TAXES
PXRE recognized a tax benefit of $8.2 million in the third quarter of
2004 compared to a tax expense of $1.0 million in the comparable prior-year
period. The tax benefit in the third quarter of 2004 differed from the U.S.
statutory rate primarily due to the reinsurance business written in our Bermuda
reinsurance subsidiary.
COMPARISON OF YEAR-TO-DATE RESULTS FOR 2004 WITH 2003
For the nine months ended September 30, 2004, net loss before
convertible preferred share dividends was $9.9 million compared to net income
before convertible preferred share dividends of $68.8 million for the comparable
period of 2003. Net loss per diluted common share was $1.49 for the first nine
months of 2004 compared to net income per diluted common share of $2.97 for the
first nine months of 2003, based on diluted average shares outstanding of
approximately 13.8 million in the first nine months of 2004 and 23.2 million in
the first nine months of 2003. As the Company incurred a loss from continuing
operations, in accordance with SFAS No. 128, "Earnings Per Share," it did not
include 13.2 million of average shares in its calculation of net loss per
diluted common shares that are anti-dilutive, as shown in Note 5 to the
Consolidated Financial Statements, which is the primary reason for the decrease
in the number of diluted average shares outstanding in the nine months ended
September 30, 2004 compared to the corresponding period of 2003.
24
PREMIUMS
Gross and net premiums written for the nine months ended September 30,
2004 and 2003 were as follows:
($000'S) NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- % INCREASE
2004 2003 (DECREASE)
-------------- -------------- ------------
Gross premiums written $ 285,847 $ 274,123 4
Ceded premiums written (32,320) (52,692) (39)
-------------- --------------
Net premiums written $ 253,527 $ 221,431 14
============== ==============
Gross premiums written for the nine-month period ended September 30,
2004 increased $11.7 million, or 4% to $285.8 million from $274.1 million in the
corresponding prior-year period. Gross premiums written in our core catastrophe
and risk excess segment increased $14.3 million, or 5%, compared to the
corresponding period of 2003. This increase was caused primarily by $29.7
million of reinstatement premiums, $24.6 million of which were from the
hurricanes Charley, Frances, Ivan and Jeanne. Reinstatement premiums in the
nine-month period ended September 30, 2003 were $5.0 million. This increase was
offset, in part, by rate decreases in our international property catastrophe
business and the non-renewal of several programs due to decreases in market
pricing. In addition, there was a planned decrease in our exited lines segment
of $2.6 million, or 44%, compared to the year earlier period.
Ceded premiums written decreased by $20.4 million, or 39%, to $32.3
million for the nine-month period ended September 30, 2004 from $52.7 million
for the corresponding prior-year period, as a result of a decrease of $16.0
million of ceded premiums written to Select Re in 2003 under a quota share
retrocessional contract that was in place in 2003 but was not renewed at January
1, 2004 and a $4.6 million decrease in ceded premiums written related to excess
of loss retrocessional catastrophe treaties.
Net premiums written for the nine-month period ended September 30, 2004
increased $32.1 million, or 14%, to $253.5 million from $221.4 million in the
corresponding prior-year period. Net premiums written in our catastrophe and
risk excess segment increased $34.7 million, or 16%, to $250.4 million in the
first nine months of 2004 from $215.7 million in the first nine months of 2003.
Net premiums written in the exited lines segment decreased $2.6 million, or 45%,
during the nine-month period ended September 30, 2004 versus the prior-year
comparable period. The changes in these segments are due to similar factors that
caused the increase in gross premiums written and decrease in ceded premiums
written as explained above.
25
Gross and net premiums earned for the nine-month period ended September
30, 2004 and 2003 were as follows:
($000'S) NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- % INCREASE
2004 2003 (DECREASE)
-------------- -------------- ------------
Gross premiums earned $ 263,856 $ 282,210 (7)
Ceded premiums earned (35,540) (44,340) (20)
-------------- --------------
Net premiums earned $ 228,316 $ 237,870 (4)
============== ==============
Gross premiums earned for the first nine months of 2004 decreased $18.4
million, or 7%, to $263.9 million from $282.2 million in the first nine months
of 2003. This decrease is primarily due to a planned decrease in our exited
lines segment of $36.8 million as compared to the corresponding period of 2003.
Gross premiums earned in our catastrophe and risk excess segment increased $18.5
million, or 8%, to $257.7 million in the first nine months of 2004 from $239.2
million in the corresponding period of 2003. The changes in these segments are
due to similar factors as those discussed above in gross premium written.
Ceded premiums earned decreased $8.8 million, or 20%, to $35.5 million
for the nine-month period ended September 30, 2004 from $44.3 million for the
corresponding prior-year period, primarily as a result of a decrease of $12.5
million of ceded earned premiums to Select Re under the quota share
retrocessional contract discussed above that was not renewed at January 1, 2004.
Offsetting this decrease, in part, was an increase in ceded premiums earned
related to excess of loss catastrophe retrocessional treaties.
Net premiums earned for the first nine months of 2004 decreased $9.6
million, or 4% to $228.3 million from $237.9 million for the corresponding
period of 2003. Net premiums earned in the exited lines segment decreased $36.9
million, or 86%, for the first nine months of 2004 as compared to the first nine
months of 2003. Net premiums earned in the catastrophe and risk excess segment
increased $27.3 million, or 14%, to $222.3 million for the nine months ended
September 30, 2004 from $195.0 million in the corresponding prior-year period.
The changes in these segments are due to the same factors as those discussed
above in gross and net premiums written.
As part of our efforts to return to our core catastrophe and risk
business, we have ceased underwriting finite business, and during
the quarter ended June 30, 2004 we began to include the results of this business
in our exited lines segment. During the year ended December 31, 2003 and the
quarter ended March 31, 2004, this business was focused on a limited group of
cedents and on policies that did not contain significant risk transfer. Finite
contracts that do not contain sufficient risk transfer are not recorded as
reinsurance arrangements but are treated as deposits for accounting purposes. As
such, the income related to these transactions is recorded as fee income, and
liabilities, if any, are recorded as deposit liabilities. There will be an
insignificant amount of finite premiums earned in future periods.
A summary of our net premiums written and earned by business segment
for the nine months ended September 30, 2004 and 2003 is included in Note 8 to
the Consolidated Financial Statements.
26
RATIOS
The following table summarizes the loss ratio, expense ratio and
combined ratio for the nine months ended September 30, 2004 and 2003,
respectively:
(%) NINE MONTHS ENDED
SEPTEMBER 30,
--------------
2004 2003
----- ----
Loss ratio 84.3 47.3
Expense ratio 25.2 26.8
----- ----
Combined ratio 109.5 74.1
===== ====
Catastrophe and risk excess loss ratio 75.2 25.3
===== ====
LOSSES AND LOSS EXPENSES
Losses and loss expenses incurred amounted to $192.6 million for the
nine months ended September 30, 2004 compared to $112.5 million in the
corresponding prior year period. The loss ratio was 84.3% for the first nine
months of 2004 compared to 47.3% for the comparable prior-year period largely
due to $135.7 million in incurred losses, net of reinsurance, primarily from
hurricanes Charley, Frances, Ivan and Jeanne that occurred during the third
quarter of 2004. As noted above in the discussion of Premiums, the hurricanes
triggered $24.0 million of reinstatement premiums earned during the third
quarter of 2004, which somewhat offset the impact of the hurricane losses on net
income.
Also during the first nine months of 2004, we experienced net adverse
development of $11.6 million for prior-year losses and loss expenses, comprised
of $7.8 million cat and risk excess net favorable development and $19.4
million exited lines net adverse development. The favorable development in the
cat and risk excess business was primarily related to case reserve takedowns
from past significant catastrophes, such as the 2002 European floods. The $19.4
million net adverse development related to exited lines is due primarily to
recording additional loss reserves of $14.7 million relating to the XOL Retro
Treaty with LMC (See "Commitments, Contingencies and Contractual Obligations")
and several treaties with a ceding company for which we wrote general liability
business within our direct casualty operations. These treaties were commuted in
the third quarter of 2004.
During the first nine months of 2003, we experienced net adverse
development of $40.7 million for prior-year loss and loss expenses, primarily
due to $19.7 million on our exited direct casualty reinsurance operations, $9.1
million adverse loss development from aerospace claims primarily arising from
our first receipt of notice that the increase in industry losses related to a
1998 air crash had resulted in the exhaustion of deductibles under three
aerospace contracts between the Company and Reliance Insurance Company and $6.0
million of loss development from finite contracts.
UNDERWRITING EXPENSES
The expense ratio was 25.2% for the first nine months of 2004 compared
to 26.8% during the comparable year-earlier period. The commission and brokerage
ratio, net of fee income, was 11.7% for the first nine months of 2004 compared
with 14.4% for the comparable prior-year period, with the prior-year ratio
affected by the higher proportion of exited lines premium. The catastrophe and
risk excess commission and brokerage ratio, net of fee income, was 11.2% for the
first nine months of 2004 compared with 12.2% for the first nine months of 2003,
primarily due to $4.0 million of structuring fees related to a reinsurance
agreement with P-1 Re Ltd. and the subsequent commutation thereof in the first
nine months of 2003. The exited lines commission and brokerage ratio, net of fee
income, was 30.5% for the first nine months of 2004 compared with 24.7% during
the first nine months of 2003.
27
The operating expense ratio was 13.5% for the first nine months of 2004
compared with 12.4% for the comparable period of 2003. The increase is the
result of the decrease in net premiums earned, offset, in part, by a decrease in
incentive compensation expense associated with catastrophe activity during the
quarter. Other operating expenses increased 4% to $30.8 million for the nine
months ended September 30, 2004 from $29.5 million in the comparable period of
2003. This increase is primarily due to severance expenses during the nine
months ended September 30, 2004 related to a 10.0% reduction in personnel and
increased costs associated with consulting costs from Sarbanes-Oxley Section 404
compliance.
INTEREST EXPENSE AND MINORITY INTEREST IN CONSOLIDATED SUBSIDIARIES
Interest expense, including minority interest in consolidated
subsidiaries, increased to $10.9 million for the nine months ended September 30,
2004 from $9.9 million in the comparable period of 2003. This increase is due to
$2.8 million of additional interest on $64.4 million of trust preferred
securities which replaced $30.0 million of bank debt in 2003, offset by the
non-recurrence of $1.5 million of expense reflected in 2003 from an interest
rate swap that became ineffective as a hedging instrument during the quarter
ended March 31, 2003. As discussed in Note 2 to the Consolidated Financial
Statements, following the implementation of SFAS 150 and FIN 46 during the
quarter ended March 31, 2004, the interest on trust preferred securities is now
shown as interest expense, whereas it was previously recorded as minority
interest in consolidated subsidiaries.
NET INVESTMENT INCOME
Net investment income for the first nine months of 2004 decreased 15%
to $16.9 million from $20.0 million in the comparable prior-year period
primarily as a result of a $4.7 million decrease in income from our hedge fund
portfolio, offset by a $2.4 million increase in income from our fixed maturity
and short-term investment portfolios. Investment income related to our hedge
fund portfolio decreased to $5.2 million in the first nine months ended
September 30, 2004 from $9.9 million in the comparable prior-year period as
investments in hedge funds produced a return of 4.2% for the first nine months
of 2004 compared with 8.8% in the comparable prior-year period. Offsetting this
decrease was an increase in the balance of our fixed maturity and short-term
investment portfolios partially offset by a decrease in the book yield to 3.2%
during the first nine months of 2004 from 3.7% during the comparable prior-year
period.
28
Investment income for the first nine months of 2004 was also affected
by various finite and other reinsurance contracts where premiums payable under
such contracts were retained on a funds withheld basis. In order to reduce
credit risk or to comply with regulatory credit for reinsurance requirements, a
portion of premiums paid under such reinsurance contracts is retained by the
cedent pending payment of losses or commutation of the contract. Investment
income on such withheld funds is typically for the benefit of the reinsurer and
the cedent may provide a minimum investment return on such funds. We have both
ceded and assumed reinsurance contracts that involve the withholding of premiums
by the cedent. On assumed reinsurance contracts, cedents held premiums and
accrued investment income due to us of $0.0 million and $26.0 million as of
September 30, 2004 and 2003, respectively, for which we have recognized $0.9
million and $1.3 million of investment income for the first nine months of 2004
and 2003, respectively. On ceded reinsurance contracts, we held premiums and
accrued investment income of $84.7 million and $123.0 million due to reinsurers
as of September 30, 2004 and 2003, respectively, for which we recognized a
charge to investment income of $6.2 million and $6.9 million for the first nine
months of 2004 and 2003, respectively. On a net basis, this reduction to
investment income was $2.7 million and $1.8 million for the nine months ended
September 30, 2004 and 2003, respectively, representing the difference between
the stated investment return under such contracts and the overall yield achieved
on our total investment portfolio for the nine month period. The weighted
average contractual investment return on the funds held by PXRE is 7.4% and 7.0%
for the nine months ended September 30, 2004 and 2003, respectively, and we
expect to be obligated for this contractual investment return for the life of
the underlying liabilities, which is expected to be two years as of September
30, 2004 on a weighted average basis.
INCOME TAXES
PXRE recognized a tax benefit of $6.8 million in the first nine months
of 2004 compared to a tax expense of $2.9 million in the comparable prior-year
period. The tax benefit in the first nine months of 2004 differed from the U.S.
statutory rate primarily due to the reinsurance business written in our Bermuda
reinsurance subsidiary.
CUMULATIVE ADJUSTMENT
The Company adopted the provisions of FIN 46 during the first quarter
of 2004. The cumulative effect of this accounting pronouncement reduced net
income for the nine months ended September 30, 2004 by $1.1 million but did not
materially impact shareholders' equity.
FINANCIAL CONDITION
CAPITAL RESOURCES
The Company relies primarily on dividend payments from its
subsidiaries, including PXRE Reinsurance and PXRE Bermuda, to pay its operating
expenses, to meet its debt service obligations and to pay dividends. During the
nine months ended September 30, 2004, PXRE Reinsurance paid $42.5 million in
dividends. In addition, PXRE Reinsurance distributed capital of $57.5 million in
the third quarter of 2004 as approved by the Insurance Department of the State
of Connecticut. PXRE Bermuda did not pay any dividends during the same period.
Based on the statutory surplus as of December 31, 2003, the aggregate dividends
that remain available to be paid during 2004, without prior regulatory approval,
by PXRE Reinsurance and PXRE Bermuda are $155.1 million. We anticipate that this
available dividend capacity will be sufficient to fund our liquidity needs
during 2004.
29
LIQUIDITY
The primary sources of liquidity for PXRE Reinsurance and PXRE Bermuda,
our principal operating subsidiaries, are net cash flow from operating
activities (including interest income from investments), the maturity or sale of
investments, borrowings, capital contributions and advances. Funds are applied
primarily to the payment of claims, operating expenses, income taxes, the
purchase of investments and payment of capital costs. Premiums are typically
received in advance of related claim payments.
Financings
As of September 30, 2004, PXRE had $167.1 million in subordinated debt
securities outstanding as follows:
SEPTEMBER 30,
($000'S) 2004
----------
8.85% fixed rate due February 1, 2027 $ 102,638
7.35% fixed/floating rate due May 15, 2033 18,042
9.75% fixed rate due May 23, 2033 15,464
7.70% fixed/floating rate due October 29, 2033 20,619
7.58% fixed/floating rate due September 30, 2033 10,310
----------
$ 167,073
==========
Share Dividends and Book Value
Dividends to common shareholders declared in the third quarter of 2004
and 2003 were $0.9 million and $0.7 million, respectively. The expected annual
dividend based on common shares outstanding at September 30, 2004 is
approximately $3.4 million. Book value per common share was $20.34 at September
30, 2004 after considering convertible preferred shares.
The convertible preferred shares accrue cumulative dividends per share
at the rate per annum of 8% of the sum of the stated value of each share plus
any accrued and unpaid dividend thereon payable on a quarterly basis. As of
September 30, 2004, 18,273 convertible preferred shares were issued and
outstanding. Dividends to preferred shareholders, paid in kind, during the third
quarter of 2004 and 2003 amounted to $3.6 million and $3.3 million,
respectively.
On December 16, 2003, the Company completed an offering of 2.2 million
of its common shares at $21.75 per share, pursuant to a Shelf Registration on
Form S-3, filed in 2003 for $150.0 million. Of the 2.2 million shares sold, 1.1
million were offered by PXRE and 1.1 million were offered by Phoenix Life
Insurance Company ("Phoenix"), one of the Company's common shareholders. The
Company did not receive any of the proceeds from the sale of shares by Phoenix.
On January 22, 2004, the underwriters of the above mentioned share offering
exercised in-full the over-allotment option to purchase 0.3 million additional
common shares at $21.75 per share. As a result of the exercise of the option,
the Company received additional proceeds, net of offering costs, of $6.5
million. We used the net proceeds for general corporate purposes, including
contributions to the capital of PXRE Bermuda. After giving effect to the sale of
the over-allotment shares, a total of 2.5 million shares were sold in the
offering.
30
Cash Flows
Net cash flows provided by operations were $33.6 million in the third
quarter of 2004 compared to $11.7 million in the third quarter of 2003 due to
the timing of losses paid, the sale of trading investment portfolio assets in
the third quarter of 2004 without any similar disposals in the third quarter of
2003 and the payment of funds under deposit contracts during the third quarter
of 2004 as opposed to the receipt of funds associated with deposit contracts in
the third quarter of 2003. Because of the nature of the coverages we provide,
which typically can produce infrequent losses of high severity, it is not
possible to predict accurately our future cash flows from operating activities.
As a consequence, cash flows from operating activities may fluctuate, perhaps
significantly, between individual quarters and years.
Net cash used by investing activities were $34.1 million in the third
quarter of 2004 compared to $72.1 million in the third quarter of 2003 due
primarily to purchases of securities for investment partially offset by proceeds
received on sale or maturity of investments.
The Company is subject to large losses, including natural perils such
as hurricanes and earthquakes. Since the timing and amount of losses from such
exposures is unknown, the Company invests its assets so that should an event
occur, it would have sufficient liquidity to pay claims on the underlying
contracts. A portion of the invested assets is notionally allocated to a Primary
Capital Portfolio. The guidelines of this portfolio are designed in such a
manner that securities are available to pay claims from a potential loss. For
example, the securities, which are of high credit quality, have a duration that
approximates the duration of the cash outflows of past large losses incurred by
PXRE. The purpose of the Primary Capital Portfolio is to maintain a pool of
assets whose underlying durations and maturities approximate that of the
potential future cash outflows. Should an event actually occur, the Company may
dedicate assets, including cash equivalents and other short-term investments, in
such a manner that cash is always on hand to pay claims.
This asset/liability matching strategy is evidenced by the Company's
overall 2.2 year duration of its fixed income and short-term investments. Due to
this relatively short duration portfolio, the company does not believe selling
securities before anticipated will have a material adverse impact on its
financial position.
The Company has $200 million in letter of credit (LOC) facilities that
allow it to provide LOCs to its ceding companies if such LOC is required under
the terms of the contract. The Company must transfer eligible assets to a
collateral account prior to the banks issuing the LOC. Since eligible assets
include fixed income investments, such securities need not be sold in order to
qualify as eligible collateral.
31
Commitments, Contingencies and Contractual Obligations
We do not have any material off-balance sheet arrangements. We are
updating the contractual obligations disclosed in the Company's Annual Report on
Form 10-K for the year ended December 31, 2003, to include additional disclosure
on the Company's loss and loss expense reserves. Other contractual obligations
disclosed in the Form 10-K for the year ended December 31, 2003 are not
presented herein as they have not materially changed.
Loss and loss expense reserves represent management's best estimate of
the ultimate cost of settling the underlying reinsurance claims. As more fully
discussed in Update on Critical Accounting Policies - Estimation of Loss and
Loss Expenses, the estimation of loss and loss expense reserves is based on
various complex and subjective judgments. Actual losses and loss expenses paid
may deviate, perhaps substantially, from the reserve estimates reflected in our
financial statements. Similarly, the timing for payment of our estimated losses
is not fixed and is not determinable on an individual or aggregate basis. The
assumptions used in estimating the likely payments due by periods are based on
the Company's historical claims payment experience, but due to the inherent
uncertainty in the process of estimating the timing of such payments, there is a
risk that the amounts paid in any such period can be significantly different
than the amounts disclosed below.
PAYMENT DUE BY PERIOD
($000'S) LESS THAN 1 - 3 3 - 5 MORE THAN 5
TOTAL 1 YEAR YEARS YEARS YEARS
--------- ---------- --------- -------- --------
Losses and loss expenses $ 517,501 $ 252,680 $ 143,819 $ 50,497 $ 70,505
As of September 30, 2004, other commitments and pledged assets include
(a) LOCs of $8.1 million which are secured by cash and securities amounting to
$9.2 million, (b) securities with a par value of $9.1 million on deposit with
various state insurance departments in order to comply with insurance laws, (c)
securities with a fair value of $67.7 million deposited in a trust for the
benefit of a cedent in connection with certain finite reinsurance transactions,
(d) funding commitments to certain limited partnerships of $0.3 million, (e) a
commitment to lend a further $0.1 million to finance the completion of the
construction of an office building that we currently use as our headquarters in
Bermuda, (f) a contingent liability amounting to $1.2 million under the Restated
Employee Annual Incentive Bonus Plan, (g) commitments under the capital trust
pass-through securities discussed above, and (h) commitment fees of $0.2 million
per annum under a Letter of Credit Facility Agreement, dated June 25, 2004,
between PXRE Bermuda and Barclays Bank PLC.
In connection with the capitalization of PXRE Lloyd's Syndicate 1224,
PXRE Reinsurance has on deposit a $22.5 million par value U.S. Treasury security
as collateral for Lloyd's. Cash and invested assets held by PXRE Lloyd's
Syndicate 1224, amounting to $12.5 million at September 30, 2004, are restricted
from being paid as a dividend until the run-off of our exited Lloyd's business
has been completed.
32
We entered into a joint venture agreement, dated June 2001 (the "JV
Agreement"), with BF&M Properties Limited to form a Bermuda corporation, Barr's
Bay Properties Limited ("Barr's Bay"). Barr's Bay was formed to construct an
office building in Hamilton, Bermuda, in which we will have the option to lease
office space for three consecutive five-year terms. We own 40% of the
outstanding shares of Barr's Bay. Pursuant to the JV Agreement, we agreed to
lend up to $7.0 million to Barr's Bay to finance the construction of the subject
office building, $6.9 million of which has been advanced as of September 30,
2004. The loans are secured by a first mortgage on the property.
In April 2000, PXRE Reinsurance entered into the XOL Retro Treaty with
LMC. In the XOL Retro Treaty, PXRE Reinsurance reinsured a portfolio of treaties
underwritten by a former business unit of LMC, which had been divested. Pursuant
to this XOL Retro Treaty, PXRE Reinsurance agreed to indemnify LMC for losses in
excess of a 75% paid loss ratio on this underlying portfolio of treaties up to a
100% paid loss ratio, subject to an aggregate limit of liability of $50.0
million. The latest loss reports related to the XOL Retro Treaty provided by LMC
forecast an ultimate net loss ratio in excess of 100%, which could result in a
full limit loss to PXRE.
In June 2003, PXRE Reinsurance performed an audit of this portfolio of
treaties reinsured under the XOL Retro Treaty. As a result of this audit,
management identified problems and believes that LMC defrauded PXRE, breached
its duty of utmost good faith, and breached its contractual obligations and
fiduciary duties under the agreement. PXRE Reinsurance therefore filed suit
against LMC on July 24, 2003 in a United Stated District Court seeking
rescission of the agreement and/or compensatory and punitive damages.
Recently, the court granted partial summary judgment to LMC and
dismissed PXRE Reinsurance's fraud claims and breach of the duty of utmost good
faith arising out of alleged misconduct by LMC prior to the binding of the XOL
Retro Treaty. PXRE Reinsurance disagrees with the court's decision. PXRE
Reinsurance is filing a motion for reconsideration based upon recent deposition
testimony by the former president of the subject former LMC business unit which
had not been considered by the court prior to its decision on LMC's motion. If
that motion is unsuccessful, PXRE Reinsurance intends to seek to appeal the
order to the United States Court of Appeals for the Seventh Circuit.
The court did not address PXRE Reinsurance's breach of contract claims
and allegations arising out of LMC's post-binding activity and such claims
remain pending.
Unless the court order is reconsidered or overturned on appeal,
rescission may no longer be available as a remedy in our suit against LMC. At
this stage of the lawsuit, it is difficult to estimate the scope and amount of
potential damages relating to PXRE Reinsurance's breach of contract claims. We
have therefore recorded additional loss reserves of $14.7 million relating to
the XOL Retro Treaty as of September 30, 2004, which is equal to the remaining
portion of the $50.0 million aggregate limit of liability under the XOL Retro
Treaty. Accordingly, PXRE Reinsurance will have no exposure to additional losses
relating to the contract. This results in a negative after tax impact of $9.6
million on earnings in the quarter ended September 30, 2004.
33
Although the ultimate outcome of the litigation cannot presently be
determined, management believes that PXRE Reinsurance's claims are meritorious
and intends to continue to prosecute its suit.
INVESTMENTS
As of September 30, 2004, our investment portfolio, at fair value, was
allocated 63.7% in fixed maturities, 23.6% in short-term investments, 12.1% in
hedge funds and 0.6% in other investments.
The following table summarizes our investments at September 30, 2004
and December 31, 2003 at fair value:
ANALYSIS OF INVESTMENTS
--------------------------------------------------
SEPTEMBER 30, 2004 DECEMBER 31, 2003
----------------------- -----------------------
($000'S, EXCEPT PERCENTAGES) AMOUNT PERCENT AMOUNT PERCENT
------------- ----- ------------ -----
Fixed maturities:
United States treasury securities $ 70,611 6.6% $ 40,237 4.2%
Foreign denominated securities 14,160 1.3 21,451 2.3
United States government sponsored agency debentures 99,047 9.2 115,440 12.2
United States government sponsored agency
mortgage-backed securities 105,304 9.8 134,323 14.2
Other mortgage and asset-backed securities 178,639 16.7 146,196 15.4
Municipal securities 1,578 0.2 18,584 2.0
Corporate securities 213,522 19.9 162,878 17.2
------------- ----- ------------ -----
Total fixed maturities 682,861 63.7 639,109 67.5
Short-term investments 252,893 23.6 175,771 18.6
------------- ----- ------------ -----
Total fixed maturities and short-term investments 935,754 87.3 814,880 86.1
Hedge funds 129,601 12.1 121,466 12.8
Other investments 6,931 0.6 10,173 1.1
------------- ----- ------------ -----
Total investment portfolio $ 1,072,286 100.0% $ 946,519 100.0%
============= ===== ============ =====
At September 30, 2004, 98.3% of the fair value of our fixed maturities
and short-term investments portfolio was in obligations rated "A" (strong) or
better by Moody's or S&P. Mortgage and asset-backed securities accounted for
30.3% of fixed maturities and short-term investments or 26.5% of our total
investment portfolio based on fair value at September 30, 2004.
Fixed maturity investments, other than trading securities, are reported
at fair value, with the net unrealized gain or loss, net of tax, reported as a
separate component of shareholders' equity. Fixed maturity investments
classified as trading securities are reported at fair value, with the net
unrealized gain or loss reported as investment income. At September 30, 2004, an
after-tax unrealized loss of $1.1 million was included in shareholders' equity.
Short-term investments are carried at amortized cost, which
approximates fair value. Our short-term investments, principally short-term
agencies and United States treasuries, amounted to $252.9 million at September
30, 2004, compared to $175.8 million at December 31, 2003.
34
A significant component of our investment strategy is investing a
portion of our invested assets in a diversified portfolio of hedge funds. At
September 30, 2004, total hedge fund investments amounted to $129.6 million,
representing 12.1% of the total investment portfolio. At December 31, 2003,
total hedge fund investments amounted to $121.5 million, representing 12.8% of
the total investment portfolio. For the nine months ended September 30, 2004,
our hedge funds yielded a return of 4.2% compared to 8.8% in the nine months
ended September 30, 2003. At September 30, 2004, hedge fund investments with
fair values ranging from $1.0 million to $16.9 million were administered by
eighteen managers.
As of September 30, 2004, our investment portfolio also included $6.9
million of other invested assets of which 99% is in two mezzanine bond funds.
The remaining aggregate cash call commitments in respect of such investments are
$0.3 million.
Hedge funds and other limited partnership investments are accounted for
under the equity method. Total investment income for the nine months ended
September 30, 2004, included $6.0 million attributable to hedge funds and other
investments.
Our hedge fund and other privately held securities program should be
viewed as exposing us to the risk of substantial losses, which we seek to reduce
through our diversified investment strategies and managers. There can be no
assurance, however, that this approach will prove to be successful.
TAXES
PXRE Delaware files U.S. income tax returns for itself and all of its
direct or indirect U.S. subsidiaries that satisfy the stock ownership
requirements for consolidation. PXRE Delaware is party to a tax allocation
agreement concerning filing of consolidated federal income tax returns pursuant
to which each of these U.S. subsidiaries makes tax payments to PXRE Delaware in
an amount equal to the federal income tax payment that would have been payable
by the relevant U.S. subsidiary for the year if it had filed a separate income
tax return for that year. PXRE Delaware is required to provide payment of the
consolidated federal income tax liability for the entire group. If the aggregate
amount of tax payments made in any tax year by one of these U.S. subsidiaries is
less than (or greater than) the annual tax liability for that U.S. subsidiary on
a stand-alone basis for that year, the U.S. subsidiary will be required to make
up the deficiency to PXRE Delaware (or will be entitled to receive a credit if
payments exceed the separate return tax liability of that U.S. subsidiary).
CERTAIN RELATED PARTY TRANSACTIONS
Since 1997, PXRE has entered into various reinsurance agreements with
Select Re, a privately held Bermuda reinsurance company. The primary reinsurance
agreement between PXRE and Select Re was a quota share retrocessional agreement
("Obligatory Quota Share Treaty"), pursuant to which we have ceded varying
proportional shares of our non-casualty reinsurance business ranging from a high
of 16.5% in 2001 to a low of 2.62% in 1997. These cessions satisfied an
undertaking we entered into with Select Re to use commercially reasonable
efforts to present Select Re with aggregate annual premiums equal to a minimum
of 20% of Select Re's shareholders' equity (as defined in the undertaking). This
undertaking was amended in November 2002 and extended until 2005. In return,
Select Re was obligated to pay us a management fee of 15% based on the gross
premiums ceded to them under the Obligatory Quota Share Treaty, which resulted
in fee income of $0.5 million for the nine months ended September 30, 2004. The
cession percentage under the Obligatory Quota Share Treaty was reduced to 0% on
January 1, 2004.
35
Select Re has decided to explore a different strategic direction.
Accordingly, as of September 30, 2004, Select Re and PXRE have mutually agreed
to terminate the Obligatory Quota Share Treaty and the related 20% undertaking.
We further agreed to commute all outstanding liabilities under the Obligatory
Quota Share Treaty and a number of other reinsurance agreements between PXRE and
Select Re. As a result, Select Re paid PXRE a commutation payment of $23.1
million as consideration for the commutation, which was effected pursuant to a
commutation agreement, dated as of September 30, 2004 (the "Select Commutation
Agreement"). The commutation resulted in underwriting income of $1.9 million
during the quarter ended September 30, 2004.
Following the commutation, only one in-force excess of loss treaty and
two expired excess of loss treaties remain in effect between PXRE and Select Re
(the "Non-Commuted Contracts"). As of September 30, 2004, net assets of $28.5
million were due to us in the aggregate from Select Re with respect to the
Non-Commuted Contracts. Select Re has deposited $38.5 million in various
reinsurance trusts to secure its obligations under the Non-Commuted Contracts.
Mr. William Michaelcheck is a member of the Board of Select Re and also
one of its founding shareholders. Mr. Michaelcheck is also the President and a
major shareholder of Mariner Investment Group, Inc. ("Mariner"), which acts as
the investment manager for our hedge fund and alternative investment portfolio.
During the nine months ended September 30, 2004 and 2003, we incurred investment
management fees of $0.7 million and $0.6 million, respectively, relating to
services provided by Mariner.
The Company's Board of Directors reviews the various transactions with
Select Re at each of its meetings. In addition, the Board of Directors requires
the prior approval of the Company's Chief Financial Officer for any transaction
entered into with Select Re.
UPDATE ON CRITICAL ACCOUNTING POLICY DISCLOSURES
The Company's Annual Report on Form 10-K for the year ended December
31, 2003 contains a discussion concerning critical accounting policy disclosures
(See Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations -Critical Accounting Policy Disclosures contained in the
Company's Annual Report on Form 10-K for the year ended December 31, 2003). We
disclose our significant accounting policies in the notes to the Consolidated
Financial Statements which should be read in conjunction with the notes to the
interim Consolidated Financial Statements and the 2003 audited Consolidated
Financial Statements and notes. Several of these policies are critical to the
portrayal of our financial condition and results since they require management
to establish estimates based on complex and subjective judgments. This included
disclosure concerning our estimation of losses and loss expenses.
36
Estimation of Loss and Loss Expenses
As a property catastrophe reinsurer, incurred losses are inherently
more volatile than those of primary insurers and reinsurers of risks that have
an established historical pattern of losses. Because of the uncertainty in the
process of estimating our loss from insured events, there is a risk that our
reserves for loss and loss expenses could prove to be inadequate, with a
consequent adverse impact on our future earnings and shareholders' equity. In
reserving for catastrophe losses, our estimates are influenced by underwriting
information provided by our clients, industry catastrophe models and our
internal analyses of this information. This reserving approach can cause
significant development for an accident year when events occur late in the
reporting period, as happened in 1999. As an event matures, we rely more and
more on our own development patterns by type of event as well as contract
information to project ultimate losses for the event. This process can cause our
ultimate estimates to differ significantly from initial projections. The French
Storm Martin that occurred on December 27, 1999 presents an extreme example of
these potential uncertainties. We based our reserves to a significant degree on
industry estimates, which were approximately $1.0 billion. In 2001, the cost was
estimated to be $2.5 billion by SIGMA, a widely used industry publication. Our
gross loss estimate at December 31, 1999 for this event was $31.3 million. Our
gross loss estimate at September 30, 2004 for this event was $67.5 million.
Thus, the original industry loss estimate increased by 150%, and our loss
estimate increased by 116%.
Excluding the extraordinary development of 1999 French storms Martin
and Lothar in 2000, during the last 10 years, reserve development in any single
year from prior year losses, expressed as a percentage of shareholders' equity,
ranged from 15% adverse development in 1993 (primarily arising from Hurricane
Andrew) to 4% favorable development in 1996.
In reserving for non-catastrophe losses for recent periods, we are
required to make assumptions concerning the expected loss ratio usually for
broad lines of business, but sometimes on an individual contract basis. We
consider historical loss ratios for each line of business and utilize
information provided by our clients and estimates provided by underwriters and
actuaries concerning the impact of pricing and coverage changes. As experience
emerges, we will revise our prior estimates concerning pricing adequacy and
non-catastrophe loss potential for our coverages and we will eventually rely
solely on our indicated loss development patterns to estimate ultimate losses.
In addition, the risk for recent underwriting years includes the
increased casualty exposures assumed by us through our casualty and finite
businesses. Unlike property losses that tend to be reported more promptly and
usually are settled within a shorter time period, casualty losses are frequently
slower to be reported and may be determined only through the lengthy,
unpredictable process of litigation. Moreover, given our limited experience in
the casualty and finite businesses, we do not have established historical loss
development patterns that can be used to establish these loss liabilities. We
must therefore rely on the inherently less reliable historical loss development
patterns reported by our clients and industry loss development data in
calculating our liabilities. PXRE's loss reserve estimation process takes into
consideration the facts and circumstances related to reported losses; however,
for immature accident years, reported casualty losses are relatively
insignificant when compared to ultimate losses. As such, it is difficult to
determine how facts and circumstances related to early-notified claims will
impact future reported losses. When reported losses grow to a magnitude at which
they suggest a trend, PXRE can, and does, re-estimate loss reserves.
37
The Company has historically been involved in very few disputes with
ceding companies, especially those that enter into contracts that the Company
includes in its catastrophe and risk excess segment.
There is an additional risk of uncertainty in the Company's
estimation of loss due to the fact that the Company writes only reinsurance
business and no insurance business. As a result, losses, unearned premiums and
premiums written are all recorded based on reports received from the ceding
companies. PXRE does not receive loss information from the underlying insureds;
however, since the Company's primary reinsurance business focuses on short-tail
lines such as property catastrophe, retrocessional property catastrophe,
risk-excess and aerospace, the delay from the time of the underlying loss to the
report date to PXRE is not as significant a risk as it would be if the Company
underwrote a significant amount of casualty business; however, with respect to
insured events that occur near the end of a reporting period, as well as with
respect to our retrocessional book of business, a delay in losses being reported
to insurance carriers, reinsurers and finally retrocessionaires may require us
to make estimates of losses based on limited information from our clients,
industry loss estimates and our own underwriting data.
The Company derives almost all of its business from reinsurance
intermediaries. As a result, the ceding company reports claims to the
intermediary and the intermediary in turn reports the data to all the reinsurers
included in the underlying program. Controls in place require that certain
claims must be approved by the underwriter or a member of senior management. The
underwriter, based on his knowledge and judgment, may question the broker or
ceding company if he did not expect a loss of a certain magnitude to impact a
certain layer. Since many of PXRE's losses are from events that are well known,
such as large hurricanes and earthquakes, the underwriter may in fact expect
losses to certain layers and therefore would not question the accuracy of such
loss reports. If the underwriter does question the loss data, PXRE will perform
audits at the underlying ceding company in order to determine the accuracy of
the amounts ceded. The Company's risk management and underwriting systems
provide a list of impacted or potentially impacted contracts by peril and by
geographic zone. This assists PXRE in determining the completeness of losses, as
the Company will contact intermediaries and the ceding companies for which it
believes underlying contracts are impacted subsequent to an event to request
information.
Currently, the Company does not have any backlog related to the
processing of assumed reinsurance information. When a large loss occurs, the
Company shifts personnel from various functions to assist the claims personnel
in the processing and evaluation of claims data.
Finally, the Company records reserves for losses that have been
incurred but not yet reported to PXRE, which are generally referred to as IBNR
reserves. The IBNR includes both losses from events which PXRE is not aware of
and losses from events which PXRE is aware of but has not yet received reports
from ceding companies.
38
During the third quarter of 2004, we experienced net adverse
development of $12.2 million for prior-year losses and loss expenses, comprised
of $7.8 million cat and risk excess net favorable development and $20.0 million
exited lines net adverse development. The favorable development in the cat and
risk excess business was primarily related to case reserve takedowns from past
significant catastrophes, such as the 2002 European floods. The $20.0 million
net adverse development related to exited lines is due primarily to recording
additional loss reserves of $14.7 million relating to the XOL Retro Treaty with
LMC (See "Commitments, Contingencies and Contractual Obligations") and several
treaties with a ceding company for which we wrote general liability business
within our direct casualty operations. These treaties were commuted in the third
quarter of 2004.
Loss and loss expense liabilities as estimated by PXRE's actuaries and
recorded by management in the statement of financial position as of September
30, 2004 were as follows:
($000'S) GROSS NET
---------- ---------
Catastrophe and Risk Excess $ 315,200 $ 260,938
Exited Lines 202,301 193,957
---------- ---------
Total $ 517,501 $ 454,895
========== =========
On an overall basis, the low and high ends of a range of reasonable net
loss reserves are $31.0 million below and $33.2 million above the $454.9 million
best estimate displayed above. Note that the range around the overall estimate
is not the sum of the ranges about the component segments due to the impact of
diversification when the reserve levels are considered in total. The low and
high ends of a range of reasonable net loss reserves around the best estimate
displayed in the table above with respect to each segment are as follows:
($000'S) LOW END BEST ESTIMATE HIGH END
--------- ------------- --------
Catastrophe and Risk Excess $ 232,561 $ 260,938 $291,429
Exited Lines 181,541 193,957 207,261
Estimation and Recognition of Assumed and Ceded Premiums
Our premiums on reinsurance business assumed are recorded as earned on
a pro rata basis over the contract period based upon estimated subject premiums.
The Company's assumed premium is comprised of both minimum and deposit premium
and an estimate of premium. Minimum and deposit premium is billed and collected
in accordance with the provisions of the contracts and is usually billed
quarterly or semi-annually. A premium estimate is also recorded if the estimate
of the ultimate premium is greater than the minimum and deposit premium. The
final or ultimate premium for most contracts is the product of the provisional
rate and the ceding company's subject net earned premium income (SNEPI). Since
this portion of the premium is reasonably estimable, the Company records and
recognizes it as revenue over the period of the contract in the same manner as
the minimum and deposit premium. The key assumption related to the premium
estimate is the estimate of the amount of the ceding company's SNEPI, which is a
significant element of PXRE's overall underwriting process. Because of the
inherent uncertainty in this process, there is the risk that premiums and
related receivable balances may turn out to be higher or lower than reported.
39
For the first nine months of 2004, the catastrophe and risk excess
assumed premium estimate is $8.3 million, which is 3.7% of the total gross
current underwriting year premium written, excluding reinstatement premiums, of
$226.9 million. The estimated premium receivable included in premiums receivable
was $18.7 million at September 30, 2004.
The company records an allowance for doubtful accounts that we believe
approximates the exposure for all potential uncollectible assets.
The premiums on reinsurance business ceded are recorded as incurred on
a pro rata basis over the contract period. Certain ceded reinsurance contracts
contain provisions requiring us to pay additional premiums or reinstatement
premiums in the event that losses of a significant magnitude are ceded under
such contracts. Under GAAP, we are not permitted to establish reserves for
potential additional premiums or record such amounts until a loss occurs that
would trigger the obligation to pay such additional or reinstatement premiums.
As a result, the net amount recoverable from our reinsurers in the event of a
loss may be reduced by the payment of additional premiums and reinstatement
premiums. Frequently, the impact of such premiums will be offset by additional
premiums and reinstatement premiums payable to us by our clients on our assumed
reinsurance business. No assurance can be given, however, that assumed
reinstatement and additional premiums will offset ceded reinstatement and
additional premiums. For example, in the case of the September 11, 2001
terrorist attacks, our net premiums earned during 2001 were reduced by $26.3
million as a result of net additional premiums and reinstatement premiums due to
that loss.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This report contains various forward-looking statements and includes
assumptions concerning our operations, future results and prospects. Statements
included herein, as well as statements made by or on our behalf in press
releases, written statements or other documents filed with the Securities and
Exchange Commission (the "SEC"), or in our communications and discussions with
investors and analysts in the normal course of business through meetings, phone
calls and conference calls, which are not historical in nature are intended to
be, and are hereby identified as, "forward-looking statements" for purposes of
the safe harbor provided by Section 21E of the Securities Exchange Act of 1934
as amended. These forward-looking statements, identified by words such as
"intend," "believe," "anticipate," or "expects" or variations of such words or
similar expressions are based on current expectations, speak only as of the date
hereof, and are subject to risk and uncertainties. In light of the risks and
uncertainties inherent in all future projections, these forward-looking
statements in this report should not be considered as a representation by us or
any other person that our objectives or plans will be achieved. We caution
investors and analysts that actual results or events could differ materially
from those set forth or implied by the forward-looking statements and related
assumptions, depending on the outcome of certain important factors including,
but not limited to, the following:
(i) because of exposure to catastrophes, our financial results may
vary significantly from period to period;
40
(ii) we may be overexposed to losses in certain geographic areas
for certain types of catastrophe events;
(iii) we operate in a highly competitive environment;
(iv) reinsurance prices may decline, which could affect our
profitability;
(v) underwriting reinsurance includes the application of judgment,
the assessment of probabilities and outcomes, and assumption
of correlations, which are subject to inherent uncertainties;
(vi) reserving for losses includes significant estimates which are
also subject to inherent uncertainties;
(vii) a decline in the credit rating assigned to our claim-paying
ability may impact our potential to write new or renewal
business;
(viii) a decline in our ratings may require us to transfer premiums
retained by us into a beneficiary trust or may allow clients
to terminate their contract with us;
(ix) our investment portfolio is subject to market and credit risks
which could result in a material adverse impact on our
financial position or results;
(x) because we depend on a few reinsurance brokers for a large
portion of revenue, loss of business provided by them could
adversely affect us; and our reliance on reinsurance brokers
exposes us to their credit risk;
(xi) we may be adversely affected by foreign currency fluctuations;
(xii) retrocessional reinsurance subjects us to credit risk and may
become unavailable on acceptable terms;
(xiii) the impairment of our ability to provide collateral to cedents
could affect our ability to offer reinsurance in certain
markets;
(xiv) the reinsurance business is historically cyclical, and we may
experience periods with excess underwriting capacity and
unfavorable premium rates; conversely, we may have a shortage
of underwriting capacity when premium rates are strong;
(xv) regulatory constraints may restrict our ability to operate our
business;
(xvi) contention by the United States Internal Revenue Service that
we or our offshore subsidiaries are subject to U.S. taxation
could result in a material adverse impact on our financial
position or results; and
(xvii) changes in tax laws, tax treaties, tax rules and
interpretations could result in a material adverse impact on
our financial position or results.
41
In addition to the factors outlined above that are directly related to
our business, we are also subject to general business risks, including, but not
limited to, adverse state, federal or foreign legislation and regulation,
adverse publicity or news coverage, changes in general economic factors and the
loss of key employees. The factors listed above should not be construed as
exhaustive.
We undertake no obligation to release publicly the results of any
future revisions we may make to forward-looking statements to reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We have reviewed our exposure to market risks at September 30, 2004 and
the changes in exposure since December 31, 2003. The principal market risks
which we are exposed to, continue to be interest rate and credit risk.
The composition of our fixed maturity portfolio did not change
materially during the third quarter of 2004. There were no material changes in
our exposure to market risks or our risk management strategy during the third
quarter of 2004.
ITEM 4. CONTROLS AND PROCEDURES
An evaluation of the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rule 13a-15(e) of the
Securities Exchange Act of 1934, as amended) was carried out under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer. Based on that evaluation, our
Chief Executive Officer and Chief Financial Officer concluded that the
disclosure controls and procedures were effective as of the end of the period
covered by this report.
No change in our internal control over financial reporting (as defined
in Rule 13a-15(f) of the Securities Exchange Act of 1934, as amended) occurred
during the period covered by this report that materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
We are subject to litigation and arbitration in the ordinary course of
business. Except as disclosed below, management does not believe that the
eventual outcome of any such pending litigation or arbitration is likely to have
a material effect on our financial condition or business. Pursuant to our
insurance and reinsurance arrangements, disputes are generally required to be
finally settled by binding arbitration.
In April 2000, PXRE Reinsurance entered into the XOL Retro Treaty with
LMC. In the XOL Retro Treaty, PXRE Reinsurance reinsured a portfolio of treaties
underwritten by a former business unit of LMC, which had been divested. Pursuant
to this XOL Retro Treaty, PXRE Reinsurance agreed to indemnify LMC for losses in
excess of a 75% paid loss ratio on this underlying portfolio of treaties up to a
100% paid loss ratio, subject to an aggregate limit of liability of $50.0
million. The latest loss reports related to the XOL Retro Treaty provided by LMC
forecast an ultimate net loss ratio in excess of 100%, which could result in a
full limit loss to PXRE.
42
In June 2003, PXRE Reinsurance performed an audit of this portfolio of
treaties reinsured under the XOL Retro Treaty. As a result of this audit,
management identified problems and believes that LMC defrauded PXRE, breached
its duty of utmost good faith, and breached its contractual obligations and
fiduciary duties under the agreement. PXRE Reinsurance therefore filed suit
against LMC on July 24, 2003 in a United Stated District Court seeking
rescission of the agreement and/or compensatory and punitive damages.
Recently, the court granted partial summary judgment to LMC and
dismissed PXRE Reinsurance's fraud claims and breach of the duty of utmost good
faith arising out of alleged misconduct by LMC prior to the binding of the XOL
Retro Treaty. PXRE Reinsurance disagrees with the court's decision. PXRE
Reinsurance is filing a motion for reconsideration based upon recent deposition
testimony by the former president of the subject former LMC business unit which
had not been considered by the court prior to its decision on LMC's motion. If
that motion is unsuccessful, PXRE Reinsurance intends to seek to appeal the
order to the United States Court of Appeals for the Seventh Circuit.
The court did not address PXRE Reinsurance's breach of contract claims
and allegations arising out of LMC's post-binding activity and such claims
remain pending.
Unless the court order is reconsidered or overturned on appeal,
rescission may no longer be available as a remedy in our suit against LMC. At
this stage of the lawsuit, it is difficult to estimate the scope and amount of
potential damages relating to PXRE Reinsurance's breach of contract claims. We
have therefore recorded additional loss reserves of $14.7 million relating to
the XOL Retro Treaty as of September 30, 2004, which is equal to the remaining
portion of the $50.0 million aggregate limit of liability under the XOL Retro
Treaty. Accordingly, PXRE Reinsurance will have no exposure to additional losses
relating to the contract. This results in a negative after tax impact of $9.6
million on earnings in the quarter ended September 30, 2004.
Although the ultimate outcome of the litigation cannot presently be
determined, management believes that PXRE Reinsurance's claims are meritorious
and intends to continue to prosecute its suit.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
During the quarter ended September 30, 2004, the Company issued the
following equity securities in transactions that were not registered under the
Securities Act of 1933, as amended (the "Act"):
(a) Securities sold. On September 30, 2004, the Company issued
358.293 Convertible Voting Preferred Shares to the existing
holders of the Company's Convertible Preferred Shares in
payment of its dividend obligation thereon. The 358.293
Convertible Voting Preferred Shares issued were allocated
among Series as follows:
43
i. 179.147 shares of Series A convertible voting
preferred shares, allocated to two sub-series of
shares, 119.431 shares allocated to sub-series Al and
59.716 shares allocated to sub-series A2;
ii. 119.431 shares of Series B convertible voting
preferred shares, allocated to two sub-series of
shares, 79.621 shares allocated to Series B1 and
39.810 shares allocated to Series B2; and
iii. 59.715 shares of Series C convertible voting
preferred shares, allocated to two sub-series of
shares, 39.810 shares allocated to Series Cl and
19.905 shares allocated to Series C2.
(b) Underwriters and other purchasers. No underwriter
participated.
(c) Consideration. The convertible voting preferred shares were
issued in satisfaction of the Company's obligation to pay a
quarterly dividend of $3.6 million to the holders of the
outstanding convertible voting preferred shares.
(d) Exemption from registration claimed. Exemption from
registration under the Act was claimed based upon Section 4(2)
of the Act as a sale by an issuer not involving a public
offering.
(e) Terms of conversion and exercise. The description of the terms
of the Preferred Shares contained in Part II, Item 5 of the
Company's Annual Report on Form 10-K for the year ended
December 31, 2003 is incorporated herein by reference.
(f) Use of proceeds. Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS.
A list of exhibits required to be filed as part of this report is set
forth in the Exhibit Index of this Form 10-Q, which immediately precedes such
exhibits, and is incorporated herein by reference.
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EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.1 Commutation Agreement, effective September 30, 2004, between PXRE
Reinsurance Company, PXRE Reinsurance Ltd., PXRE Group Ltd. and Select
Reinsurance Ltd. *
31.1 Certification by the Chief Executive Officer Relating to a Periodic
Report Containing Financial Statements pursuant to Section 302 of the
Sarbanes-Oxley Act of 2003.*
31.2 Certification by the Chief Financial Officer Relating to a Periodic
Report Containing Financial Statements Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2003.*
32.1 Certification of Periodic Report Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2003.*
* Filed Herewith
45
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report or amendment thereto to be signed on
its behalf by the undersigned thereunto duly authorized.
PXRE GROUP LTD.
November 5, 2004 By: /s/ John M. Modin
-----------------
John M. Modin
Executive Vice President
and Chief Financial Officer
46