10-Q 1 y86559e10vq.txt W. R. BERKLEY CORPORATION SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q (Mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended March 31, 2003 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 0-7849 W. R. BERKLEY CORPORATION ------------------------------------------------ (Exact name of registrant as specified in its charter) Delaware 22-1867895 ------------------------------- ---------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 475 Steamboat Road, Greenwich, Connecticut 06830 ------------------------------------------ ----- (Address of principal executive offices) (Zip Code)
(203) 629-3000 ---------------------------------------------------- (Registrant's telephone number, including area code) None ------------------------------------------------ Former name, former address and former fiscal year, if changed since last report. Indicate by check mark whether the registrant (1) 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 and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Number of shares of common stock, $.20 par value, outstanding as of May 7, 2003: 55,320,560 Part I - FINANCIAL INFORMATION ITEM 1. Financial Statements W. R. Berkley Corporation and Subsidiaries Consolidated Balance Sheets (dollars in thousands)
March 31, December 31, 2003 2002 ---- ---- (Unaudited) Assets Investments: Cash and cash equivalents ...................................... $ 722,884 $ 594,183 Fixed maturity securities ...................................... 3,773,655 3,511,522 Equity securities available for sale ........................... 260,815 205,372 Equity securities trading account .............................. 200,501 165,642 Other investments .............................................. 87,005 45,187 ----------- ----------- Total investments ............................................ 5,044,860 4,521,906 ----------- ----------- Premiums and fees receivable ..................................... 945,224 822,060 Due from reinsurers .............................................. 802,478 734,687 Accrued investment income ........................................ 44,975 46,334 Prepaid reinsurance premiums ..................................... 230,215 164,284 Deferred policy acquisition costs ................................ 352,666 308,200 Real estate, furniture & equipment at cost, less accumulated depreciation .................................. 136,085 135,488 Deferred federal and foreign income taxes ........................ 17,281 20,585 Goodwill ......................................................... 59,021 59,021 Trading account receivable from brokers and clearing organizations 185,678 177,309 Other assets ..................................................... 54,072 41,449 ----------- ----------- Total assets ................................................. $ 7,872,555 $ 7,031,323 =========== =========== Liabilities and Stockholders' Equity Liabilities: Reserves for losses and loss expenses .......................... $ 3,381,172 $ 3,167,925 Unearned premiums .............................................. 1,648,268 1,390,246 Due to reinsurers .............................................. 216,549 184,912 Trading securities sold but not yet purchased .................. 76,096 36,115 Policyholders' account balances ................................ 47,347 42,707 Due to brokers and clearing organizations ...................... 92,386 -- Other liabilities .............................................. 296,609 294,334 Debt ........................................................... 499,186 362,985 ----------- ----------- Total liabilities ............................................ 6,257,613 5,479,224 ----------- ----------- Trust preferred securities ....................................... 198,262 198,251 Minority interest ................................................ 19,372 18,649 Stockholders' equity: Preferred stock, par value $.10 per share: Authorized 5,000,000 shares; issued and outstanding - none ... -- -- Common stock, par value $.20 per share: Authorized 80,000,000 shares, issued and outstanding, net of treasury shares, 55,285,892 and 55,223,448 shares .... 13,934 13,934 Additional paid-in capital ..................................... 823,360 823,190 Retained earnings .............................................. 691,602 623,651 Accumulated other comprehensive income ......................... 97,339 104,603 Treasury stock, at cost, 14,383,658 and 14,446,102 shares ...... (228,927) (230,179) ----------- ----------- Total stockholders' equity ................................... 1,397,308 1,335,199 ----------- ----------- Total liabilities and stockholders' equity ................... $ 7,872,555 $ 7,031,323 =========== ===========
See accompanying notes to consolidated financial statements. 1 W. R. Berkley Corporation and Subsidiaries Consolidated Statements of Operations (Unaudited) (dollars in thousands except per share data)
For the Three Months Ended March 31, 2003 2002 Revenues: Net premiums written ............................. $ 892,059 $ 633,993 Change in unearned premiums ...................... (191,933) (155,527) --------- --------- Premiums earned ................................ 700,126 478,466 Net investment income ............................ 51,760 44,152 Service fees ..................................... 25,469 20,193 Realized investment gains ........................ 14,604 4,959 Foreign currency gains (losses) .................. (1,238) 4 Other income ..................................... 692 112 --------- --------- Total revenues ................................. 791,413 547,886 --------- --------- Expenses: Losses and loss expenses ......................... 443,886 310,601 Other operating expenses ......................... 230,853 175,443 Interest expense ................................. 12,095 11,135 --------- --------- Total expenses ................................. 686,834 497,179 --------- --------- Income before income taxes and minority interest 104,579 50,707 Income tax expense ................................. (32,986) (16,222) Minority interest .................................. 110 (89) --------- --------- Net income ..................................... $ 71,703 $ 34,396 ========= ========= Net income per share: Basic ............................................ $ 1.30 $ 0.69 ========= ========= Diluted .......................................... $ 1.25 $ 0.66 ========= ========= Average shares outstanding: Basic ............................................ 55,249 49,914 ========= ========= Diluted .......................................... 57,328 51,977 ========= =========
See accompanying notes to consolidated financial statements. 2 W. R. Berkley Corporation and Subsidiaries Consolidated Statements of Cash Flows (Unaudited) (dollars in thousands)
For the Three Months Ended March 31, --------------- 2003 2002 ---- ---- Cash flows provided by operating activities: Net income ................................................... $ 71,703 $ 34,396 Adjustments to reconcile net income to cash flows provided by operating activities: Minority interest .......................................... (110) 89 Change in reserves for losses and loss expenses, net ................................... 181,733 55,123 Depreciation and amortization .............................. 5,783 4,071 Change in unearned premiums and prepaid reinsurance premiums ............................. 192,091 147,417 Change in premiums and fees receivable ..................... (123,164) (120,608) Change in federal and foreign income taxes ................. 29,242 15,369 Change in deferred policy acquisition cost ................. (44,466) (24,224) Realized investment and foreign currency gains (losses) .... (13,366) (4,963) Other, net ................................................. (23,615) (12,520) --------- --------- Net cash flows provided by operating activities before trading account ............................. 275,831 94,150 Increase in trading account securities ....................... (3,247) (32,930) --------- --------- Net cash flows provided by operating activities .......... 272,584 61,220 --------- --------- Cash flows used in investing activities: Proceeds from sales, excluding trading account: Fixed maturity securities ................................. 278,714 104,468 Equity securities ......................................... 17,330 4,158 Maturities and prepayments of fixed maturity securities ... 145,561 72,051 Cost of purchases, excluding trading account: Fixed maturity securities ................................. (676,576) (329,185) Equity securities ......................................... (74,245) (3,971) Other invested securities ................................. (41,424) -- Change in balances due to/from security brokers .............. 84,024 37,253 Net additions to real estate, furniture and equipment ........ (5,612) (10,416) Other, net ................................................... -- 17 --------- --------- Net cash flows used in investing activities ............... (272,228) (125,625) --------- --------- Cash flows provided by (used in) financing activities: Net proceeds from issuance of debt ........................... 196,840 -- Repayment and repurchase of debt ............................. (60,793) (8,000) Cash dividends ............................................... (10,473) (4,299) Net proceeds from stock options exercised .................... 1,422 3,858 Other, net ................................................... 1,349 1,519 --------- --------- Net cash flows provided by (used in) financing activities .. 128,345 (6,922) --------- --------- Net increase in cash and invested cash ..................... 128,701 (71,327) Cash and invested cash at beginning of year .................... 594,183 534,087 --------- --------- Cash and invested cash at end of period .................... $ 722,884 $ 462,760 ========= ========= Supplemental disclosure of cash flow information: Interest paid ................................................ $ 6,866 $ 6,457 ========= ========= Federal income taxes paid, net ............................... $ 5,100 $ 883 ========= =========
See accompanying notes to consolidated financial statements. 3 W. R. Berkley Corporation and Subsidiaries Notes to Unaudited Consolidated Financial Statements March 31, 2003 1. GENERAL The accompanying consolidated financial statements should be read in conjunction with the following notes and with the Notes to Consolidated Financial Statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. Reclassifications have been made in the 2002 financial statements as originally reported to conform them to the presentation of the 2003 financial statements. In the fourth quarter of 2002, the Company modified the presentation of reinsurance assumed from Lloyd's syndicates to reflect the Company's share of the reinsurance and brokerage costs paid by the syndicates. Previously, these amounts were netted against assumed premiums. Premiums and expenses for the first three quarters of 2002 were reclassified to conform with this presentation. There was no effect from this change on net income or net income per share. The federal and foreign income tax provision has been computed based on the Company's estimated annual effective tax rate, which differs from the federal income tax rate of 35% principally because of tax-exempt investment income. Basic earnings per share data is based upon the weighted average number of shares outstanding during the period. Diluted earnings per share data reflects the potential dilution that would occur if options granted under employee stock-based compensation plans were exercised. In the opinion of management, the financial information reflects all adjustments which are necessary for a fair presentation of financial position and results of operations for the interim periods. Seasonal weather variations affect the severity and frequency of losses sustained by the insurance and reinsurance subsidiaries. Although the effect on the Company's business of such natural catastrophes as tornadoes, hurricanes, hailstorms and earthquakes is mitigated by reinsurance, they nevertheless can have a significant impact on the results of any one or more reporting periods. 2. COMPREHENSIVE INCOME The following is a reconciliation of comprehensive income (dollars in thousands):
For the Three Months Ended March 31, --------------- 2003 2002 -------- -------- Net income ........................................ $ 71,703 $ 34,396 Other comprehensive income: Change in unrealized foreign exchange losses ... (2,098) (28) Unrealized holding gains (losses) on investment securities arising during the period, net of taxes ................................. 3,701 (14,269) Reclassification adjustment for realized gains included in net income, net of taxes ......... (8,867) (3,266) -------- -------- Other comprehensive loss .......................... (7,264) (17,563) -------- -------- Comprehensive income .............................. $ 64,439 $ 16,833 ======== ========
4 W. R. Berkley Corporation and Subsidiaries Notes to Unaudited Consolidated Financial Statements (Continued) 3. STOCK-BASED COMPENSATION During the first quarter of 2003, the Company adopted the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, effective as of January 1, 2003. Under the prospective method of adoption selected by the Company, the fair value provisions of FASB 123 will be applied to all employee awards granted, modified or settled after January 1, 2003. The following table illustrates the effect on net income and earnings per share as if the fair value based method had been applied to all outstanding and unvested awards in each period (dollars in thousands, except per share data).
For the Three Months Ended March 31, --------------- 2003 2002 ---------- ---------- Net income, as reported .................. $ 71,703 $ 34,396 Add: Stock-based compensation expense included in reported net income, net of tax ................................... 3 -- Deduct: Total stock-based employee compensation expense under fair value based method for all awards, net of tax .. (1,194) (1,133) ---------- ---------- Pro forma net income ..................... $ 70,512 $ 33,263 ========== ========== Earnings per share: Basic - as reported .................... $ 1.30 $ .69 Basic - pro forma ...................... $ 1.28 $ .67 Diluted - as reported .................. $ 1.25 $ .66 Diluted - pro forma .................... $ 1.23 $ .64
4. CHANGES IN STOCKHOLDERS' EQUITY Changes in stockholder's equity were as follows (dollars in thousands):
For the Three Months Ended March 31, --------------- 2003 2002 ----------- ----------- Beginning of period ......... $ 1,335,199 $ 931,595 Net income .................. 71,703 34,396 Other comprehensive loss .... (7,264) (17,563) Direct credit (1) ........... 1,775 -- Dividends ................... (5,527) (4,333) Purchase of treasury stock .. 1,422 3,858 ----------- ----------- End of period ............... $ 1,397,308 $ 947,953 =========== ===========
(1) From its inception in 1995 and through the fourth quarter of 2002, the international segment's results were reported on a one-quarter lag to facilitate the timely completion of the consolidated financial statements. Improvements in reporting procedures now allow this segment to be reported without a one-quarter lag. Beginning in the first quarter of 2003, the international segment's results are reported in the consolidated statement of operations without a one-quarter lag. In order to eliminate the one-quarter lag, net income of the international segment for the fourth quarter of 2002 was reported as a direct credit to consolidated retained earnings during the first quarter of 2003. 5 W. R. Berkley Corporation and Subsidiaries Notes to Unaudited Consolidated Financial Statements (Continued) 5. INVESTMENTS The cost, fair value and carrying value of fixed maturity securities, equity securities and trading account securities sold but not yet purchased are as follows (dollars in thousands):
March 31, 2003 December 31, 2002 -------------- ----------------- Amortized Fair Carrying Amortized Fair Carrying Cost Value Value Cost Value Value ---------- ---------- ---------- ---------- ---------- ---------- Fixed maturity: Held to maturity ............ $ 190,676 $ 212,222 $ 190,676 $ 205,856 $ 227,610 $ 205,856 Available for sale .......... 3,415,551 3,582,979 3,582,979 3,129,993 3,305,666 3,305,666 ---------- ---------- ---------- ---------- ---------- ---------- Total ................... $3,606,227 $3,795,201 $3,773,655 $3,335,849 $3,533,276 $3,511,522 ========== ========== ========== ========== ========== ========== Equity securities available for sale .................... $ 260,212 $ 260,815 $ 260,815 $ 203,388 $ 205,372 $ 205,372 Equity securities trading account ..................... 202,586 200,501 200,501 168,125 165,642 165,642 Trading account securities sold but not yet purchased .. 78,069 76,096 76,096 38,347 36,115 36,115
Realized gains from the sale of fixed maturity securities during the three months ended March 31, 2003 were $15,113,000. The amortized cost of fixed maturity securities sold were $409,162,000. 6. REINSURANCE CEDED The Company reinsures a portion of its exposures principally to reduce its net liability on individual risks and to protect against catastrophic losses. The following amounts arising under reinsurance ceded contracts have been deducted in arriving at the amounts reflected in the statement of operations (dollars in thousands):
For the Three Months Ended March 31, --------------- 2003 2002 ---- ---- Ceded premiums earned: Aggregate reinsurance agreement: Individual losses ................ $ 28,407 $ 15,676 Aggregate losses ................. 5,000 6,250 -------- -------- Total ............................ 33,407 21,926 Other reinsurance contracts ........ 97,641 73,633 -------- -------- Total ........................... $131,048 $ 95,559 ======== ======== Ceded losses incurred: Aggregate reinsurance agreement: Individual losses ................ $ 20,401 $ 8,354 Aggregate losses ................. 9,000 11,250 -------- -------- Total ............................ 29,401 19,604 Other reinsurance contracts ........ 50,974 41,966 -------- -------- Total ............................ $ 80,375 $ 61,570 ======== ========
6 W. R. Berkley Corporation and Subsidiaries Notes to Unaudited Consolidated Financial Statements (Continued) 6. REINSURANCE CEDED (Continued) Effective January 1, 2001, the Company entered into a multi-year aggregate reinsurance agreement that provides two types of reinsurance coverage. The first type of coverage provides protection for individual losses on an excess of loss or quota share basis, as specified for each class of business covered by the agreement. The second type of coverage provides aggregate accident year protection for the Company's reinsurance segment for loss and loss adjustment expenses incurred above a certain level. Loss recoveries are subject to annual limits and an aggregate limit over the contract period. The agreement contains a profit sharing provision under which the Company can recover a portion of premiums paid to the reinsurer if certain profit conditions are met. Based on its estimate of expected profits under the contract, the Company accrued return premiums of $5.0 million for the three months ended March 31, 2003, none for the same period in 2002. As of March 31, 2003 and December 31, 2002, funds held by the Company under the aggregate reinsurance agreement exceeded the amount recoverable from the reinsurer for losses and loss adjustment expenses. Certain of the Company's reinsurance agreements, including the aggregate reinsurance agreement, are structured on a funds held basis, whereby the Company retains some or all of the ceded premiums in a separate account that is used to fund ceded losses as they become due from the reinsurance company. Interest is credited to reinsurers for funds held on their behalf at rates ranging from 7.0% to 8.9% of the account balances, as defined under the agreements. Interest credited to reinsurers, which is reported as a reduction of net investment income, was $7.3 million for the three months ended March 31, 2003 and $3.9 million for the corresponding 2002 period. 7. INDUSTRY SEGMENTS The Company's operations are presently conducted through five segments of the insurance business: specialty lines of insurance (including excess and surplus lines and commercial transportation); alternative markets (including the management of alternative insurance market mechanisms); reinsurance; regional property casualty insurance; and international. The specialty segment's business is principally within the excess and surplus lines, professional liability, commercial transportation and surety markets. The Company's alternative markets segment offers workers' compensation insurance on an excess and primary basis and provides fee-based services to help clients develop and administer self-insurance programs. The Company's reinsurance segment specializes in underwriting property, casualty and surety reinsurance on both a treaty and facultative basis. The regional property casualty insurance segment provides commercial property casualty insurance products. The international segment offers personal and commercial property casualty insurance Argentina and savings and life products in the Philippines. During 2001, the Company discontinued its regional personal lines business and the alternative markets division of its reinsurance segment. These discontinued businesses are reported collectively as a separate business segment. The accounting policies of the segments are the same as those described in the summary of significant accounting policies included in the Company's Annual Report on Form 10-K for the year ended December 31, 2002, except as described below. Realized investment and foreign currency gains and losses are not allocated to segments. Income tax expense and benefits are calculated based upon the Company's overall effective tax rate. Summary financial information about the Company's operating segments is presented in the following table. Income (loss) before income taxes by segment consists of revenues less expenses related to the respective segment's operations, including allocated investment income. Identifiable assets by segment are those assets used in or allocated to the operation of each segment. 7 W. R. Berkley Corporation and Subsidiaries Notes to Unaudited Consolidated Financial Statements (Continued) 7. INDUSTRY SEGMENTS (Continued)
Revenues -------- Earned Investment Pre-Tax Net (dollars in thousands) Premiums Income Other Total Income Income --------- --------- --------- --------- --------- --------- For the three months ended March 31, 2003: Specialty .............. $ 241,627 $ 16,194 $ -- $ 257,821 $ 48,541 $ 31,455 Alternative Markets .... 82,974 9,527 25,469 117,970 21,949 14,745 Reinsurance ............ 162,477 13,474 -- 175,951 9,669 6,724 Regional ............... 198,205 11,279 -- 209,484 32,195 21,463 International .......... 14,843 1,419 -- 16,262 1,235 351 Discontinued Business .. -- -- -- -- -- -- Corporate and eliminations ......... -- (133) 692 559 (22,376) (11,902) Realized gains ......... -- -- 13,366 13,366 13,366 8,867 --------- --------- --------- --------- --------- --------- Consolidated ........... $ 700,126 $ 51,760 $ 39,527 $ 791,413 $ 104,579 $ 71,703 ========= ========= ========= ========= ========= ========= For the three months ended March 31, 2002: Specialty (1) .......... $ 150,422 $ 12,110 $ -- $ 162,532 $ 20,379 $ 13,713 Alternative Markets .... 45,337 8,754 20,026 74,117 14,232 9,485 Reinsurance (1) ........ 64,579 10,182 (2) 74,759 8,191 6,242 Regional ............... 156,581 10,021 -- 166,602 22,435 15,156 International .......... 39,184 1,452 4 40,640 266 (95) Discontinued Business .. 22,363 1,869 -- 24,232 (54) (35) Corporate and eliminations ......... -- (236) 277 41 (19,705) (13,296) Realized gains ........ -- -- 4,963 4,963 4,963 3,226 --------- --------- --------- --------- --------- --------- Consolidated ........... $ 478,466 $ 44,152 $ 25,268 $ 547,886 $ 50,707 $ 34,396 ========= ========= ========= ========= ========= =========
(1) During the first quarter of 2003, management responsibility and financial reporting for Vela Insurance Services, Inc., an excess and surplus lines underwriting manager, were transferred from the reinsurance segment to the specialty segment. Segment results for the prior period were restated to reflect this change. Interest expense for the reinsurance and alternative market segments was $45,000 and $586,000 for the three months ended March 31, 2003 and 2002, respectively. Corporate interest expense (net of intercompany amounts) was $12,050,000 and $10,549,000 for the corresponding periods. Identifiable assets by segment are as follows (dollars in thousands):
March 31, December 31, 2003 2002 (1) ----------- ----------- Specialty ..................... $ 2,473,483 $ 2,271,105 Alternative Markets ............... 1,424,746 1,197,977 Reinsurance ................... 2,771,596 2,431,429 Regional .......................... 1,660,108 1,590,913 International ..................... 142,171 126,528 Discontinued Business ............. 140,277 162,754 Corporate other and eliminations .. (739,826) (749,383) ----------- ----------- Consolidated ...................... $ 7,872,555 $ 7,031,323 =========== ===========
8. DEBT In February 2003, the Company issued $200 million aggregate principal amount of 5.875% senior notes due February 2013. The notes were issued at 99.07% of their face value amount and the net proceeds after expenses were $196,840,000. During the first quarter of 2003, the Company repaid $35,793,000 of 6.5% senior subordinated notes and $25,000,000 of 6.71% senior notes upon their respective maturities. 8 W. R. Berkley Corporation and Subsidiaries Notes to Unaudited Consolidated Financial Statements (Continued) 9. COMMITMENTS, LITIGATION AND CONTINGENT LIABILITIES The Company's subsidiaries are regularly engaged in the defense of claims arising out of the conduct of the insurance business. The Company does not believe that such litigation, individually or in the aggregate, will have a material effect on its financial condition or results of operations. A subsidiary of the Company has a pending arbitration proceeding pertaining to the interpretation of the contract terms in two reinsurance agreements. As of March 31, 2003, the reinsurer's interpretation of the contract terms would reduce the recoverable from the reinsurer by approximately $4 million for paid losses and approximately $46 million for unpaid losses. Although the ultimate outcome of this matter cannot be determined, management believes that the Company's interpretation of these agreements is correct and intends to vigorously pursue this matter in arbitration. There are two pending arbitrations pertaining to reinsurance contract coverage issues where a subsidiary of the Company is the assuming reinsurer. The Company's estimates of the cost of settling its insurance and reinsurance claims, including claims in arbitrations and litigation, are reflected in its aggregate reserves for losses and loss expenses. Accordingly, based on currently available information, the Company believes that the resolution of the two pending arbitrations will not have a material effect on its financial condition or results of operations. However, if these two arbitrations are decided adversely to the Company, the Company's potential exposure, in excess of the amounts reserved, is up to $16 million, after tax. 10. SAFE HARBOR STATEMENT This is a "Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995. Any forward-looking statements contained herein, including statements related to our outlook for the industry and for our performance for the year 2003 and beyond, are based upon the Company's historical performance and on current plans, estimates and expectations. The inclusion of this forward-looking information should not be regarded as a representation by us or any other person that the future plans, estimates or expectations contemplated by us will be achieved. They are subject to various risks and uncertainties, including but not limited to, the cyclical nature of the property casualty industry, the long-tail and potentially volatile nature of the reinsurance business, product demand and pricing, claims development and the process of estimating reserves, the uncertain nature of damage theories and loss amounts, the ultimate results of the various pending legal and arbitration proceedings, the increased level of our retention, natural and man-made catastrophic losses, including as a result of terrorist activities, the impact of competition, the availability of reinsurance, the ability of our reinsurers to pay reinsurance recoverables owed to us, investment results and potential impairment of invested assets, exchange rate and political risks, legislative and regulatory developments, changes in the ratings assigned to us by ratings agencies, our exposure for terrorist acts, the availability of dividends from our insurance company subsidiaries, our successful integration of acquired companies or investment in new insurance ventures, our ability to attract and retain qualified employees, and other risks detailed from time to time in the Company's filings with the Securities and Exchange Commission. These risks could cause actual results of the industry or our actual results for the year 2003 and beyond to differ materially from those expressed in any forward-looking statement made by or on behalf of the Company. Forward-looking statements speak only as of the date on which they are made, and the Company undertakes no obligation to update publicly or revise any forward-looking statement, whether as a result of new information, future developments or otherwise. 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations CRITICAL ACCOUNTING POLICIES The notes to the Company's financial statements, included in the Company's Annual Report on Form 10-K for the year ended December 31, 2002, discuss its significant accounting policies. Management considers certain of these policies to be critical to the portrayal of the Company's financial condition and results since they require management to establish estimates based on complex and subjective judgments, often including the interplay of specific uncertainties with related accounting measurements. RESERVES FOR LOSSES AND LOSS EXPENSES The Company maintains reserves for losses and loss expenses to cover its estimated liability for unpaid claims, including legal and other fees, as well as a portion of its general expenses, for reported and unreported claims incurred as of the end of each accounting period. Reserves do not represent an exact calculation of liability. Rather, reserves represent an estimate of what management expects the ultimate settlement and administration of claims will cost. These estimates, which generally involve actuarial projections, are based on management's assessment of facts and circumstances then known, as well as estimates of future trends in claims severity and frequency, judicial theories of liability and other factors, including the actions of third parties which are beyond the Company's control. The variables described above are affected by both internal and external events, such as changes in claims handling procedures, inflation, judicial and litigation trends and legislative changes. Additionally, there may be a significant delay between the occurrence of the insured event and the time it is reported to the Company. The inherent uncertainties of estimating reserves are greater for certain types of liabilities, where the various considerations affecting these types of claims are subject to change and long periods of time may elapse before a definitive determination of liability is made. Reserve estimates are continually refined in an ongoing process as experience develops and further claims are reported and settled. Adjustments to reserves are reflected in the results of the periods in which such estimates are changed. Because setting reserves is inherently uncertain, the Company cannot assure you that its current reserves will prove adequate in light of subsequent events. Should the Company need to increase its reserves, its net income for the period will decrease by a corresponding amount. RESULTS OF OPERATIONS The Company reported net income of $71.7 million, or $1.25 per share, for the three months ended March 31, 2003 compared with $34.4 million, or $.66 per share, for the corresponding 2002 period. Following are the components of net income for the three months ended March 31, 2003 and 2002 (dollars in thousands):
2003 2002 ---- ---- Underwriting income (1) ......................... $ 57,078 $ 18,641 Insurance services .............................. 5,652 3,450 Net investment income ........................... 51,760 44,152 Interest and other expenses ..................... (23,277) (20,499) Realized investment and foreign currency gains .. 13,366 4,963 Income taxes and minority interest .............. (32,876) (16,311) -------- -------- Net income .................................... $ 71,703 $ 34,396 ======== ========
(1) Represents premiums earned less loss, loss expenses and underwriting expenses incurred 10 UNDERWRITING Following is a summary of underwriting results for the three months ended March 31, 2003 and 2002 (dollars in thousands):
2003 2002 % Change ---- ---- -------- Gross premiums written ... $1,066,473 $ 776,208 37% Net premiums written ..... 892,059 633,933 41% Premiums earned .......... 700,126 478,466 46% Underwriting income ...... 57,078 18,641 Loss ratio (1) ........... 63.4% 64.9% Expense ratio (2) ........ 28.4% 31.2% Combined ratio ........... 91.8% 96.1%
(1) Represents losses and loss expenses incurred expressed as a percentage of premiums earned. (2) Represents underwriting expenses expressed as a percentage of premiums earned. The Company's operations are presently conducted through five segments: specialty lines of insurance, alternative markets, reinsurance, regional property casualty insurance, and international. In addition, the Company reports the run-off of its discontinued personal lines and alternative markets reinsurance business as a separate business segment. During the first quarter of 2003, management responsibility and financial reporting for Vela Insurance Services, Inc., an excess and surplus lines underwriting manager, were transferred from the reinsurance segment to the specialty segment. Segment result for the prior period were restated to reflect this change. Additional information for the business segments follows. SPECIALTY The specialty segment provides insurance products and services principally to the excess and surplus lines, professional liability, commercial transportation and surety markets. Following is a summary of underwriting results for the specialty segment for the three months ended March 31, 2003 and 2002 (dollars in thousands):
2003 2002 % Change ---- ---- -------- Gross premiums written .. $321,306 $217,936 47% Net premiums written .... 286,701 192,429 49% Premiums earned ......... 241,627 150,422 61% Underwriting income ..... 32,347 8,267 Loss ratio .............. 61.7% 66.2% Expense ratio ........... 24.9% 28.3% Combined ratio .......... 86.6% 94.5%
Net premiums written in 2003 increased by 49% compared with 2002 as a result of higher prices and new business. Net premiums written increased 44% for the Company's three excess and surplus lines companies, 57% for commercial transportation business and 43% for Monitor Liability Managers, Inc., which specializes in directors and officers and lawyers professional liability business. Net premiums written in 2003 also included $8 million from the Company's new underwriting unit, Berkley Medical Excess Underwriters, LLC. The 2003 loss ratio decreased by 4.5 percentage points to 61.7%. The improvement was primarily a result of higher prices and more favorable terms and conditions for current business, partially offset by prior year reserve development. The reserve development was principally for casualty business written in 1998 and 1999. The 2003 expense ratio decreased by 3.4 percentage points to 24.9% as a result of a 61% increase in earned premiums with no significant increase in expenses other than commissions and premium taxes. 11 ALTERNATIVE MARKETS The alternative markets segment offers workers' compensation insurance on an excess and primary basis and provides fee-based services to help clients develop and administer self-insurance programs. Following is a summary of underwriting results for the alternative markets segment for the three months ended March 31, 2003 and 2002 (dollars in thousands):
2003 2002 % Change ---- ---- -------- Gross premiums written .. $170,181 $ 98,173 73% Net premiums written .... 137,182 84,580 62% Premiums earned ......... 82,974 45,337 83% Underwriting income ..... 6,770 2,032 Loss ratio .............. 67.3% 66.8% Expense ratio ........... 24.6% 28.7% Combined ratio .......... 91.9% 95.5%
Net premiums written in 2003 increased by 62% compared with 2002. The increase reflects higher prices as well as an increase in policies-in-force for both primary and excess workers' compensation business. The expense ratio decreased by 4.1 percentage points to 24.6% due to an 83% increase in premiums earned with no significant increase in expenses other than commissions and premium taxes. Following is a summary of insurance services results for the alternative markets segment for the three months ended March 31, 2003 and 2002 (dollars in thousands):
2003 2002 % Change ---- ---- -------- Service revenues ............. $ 25,469 $ 20,026 27% Service expenses ............. (19,817) (16,576) 20% Service income before taxes .. 5,652 3,450 64%
Service revenues in 2003 increased 27% compared with 2002 primarily as a result of an increase in service fees for managing assigned risk plans in nine states. Service income before taxes increased 64% compared with 2002 due to revenues increasing at a greater rate than expenses. REINSURANCE The Company's reinsurance segment specializes in underwriting property, casualty and surety reinsurance on both a treaty and facultative basis. Following is a summary of underwriting results for the reinsurance segment for the three months ended March 31, 2003 and 2002 (dollars in thousands):
2003 2002 % Change ---- ---- -------- Gross premiums written .. $ 262,392 $ 166,943 57% Net premiums written .... 214,799 129,289 66% Premiums earned ......... 162,477 64,579 152% Underwriting loss ....... (3,760) (1,407) Loss ratio .............. 71.9% 69.5% Expense ratio ........... 30.4% 32.7% Combined ratio .......... 102.3% 102.2%
Net premiums written in 2003 increased by 66% compared with 2002 as a result of higher prices and new business. Net premiums written increased 118% to $63 million for facultative reinsurance, 35% to $62 million for Lloyd's reinsurance, 34% to $60 million for standard treaty business and 195% to $30 million for the other reinsurance units, Berkley Capital Underwriters, LLC and Berkley Underwriting Partners, LLC. The 2003 loss ratio increased 2.4 percentage points to 71.9%. The increase reflects the impact of reserve development on prior years, which was partially offset by improved results for the current accident year as a result of higher prices for both treaty and facultative risks. The prior year reserve development related primarily to business written in underwriting years 1998 through 2000. The 2003 and 2002 underwriting results also reflect loss recoveries under the Company's aggregate reinsurance agreement. (See Note 7 of "Notes to Consolidated Financial Statements".) The 2003 expense ratio decreased 2.3 percentage points to 30.4% primarily as a result of a shift in the mix of business and increased volume. 12 REGIONAL The regional property casualty insurance segment principally provides commercial property casualty insurance products. Following is a summary of underwriting results for the regional segment for the three months ended March 31, 2003 and 2002 (dollars in thousands):
2003 2002 % Change ---- ---- -------- Gross premiums written .. $295,858 $238,319 24% Net premiums written .... 237,754 183,703 29% Premiums earned ......... 198,205 156,581 27% Underwriting income ..... 20,916 12,416 Loss ratio .............. 57.9% 60.5% Expense ratio ........... 31.5% 31.6% Combined ratio .......... 89.4% 92.1%
Net premiums written in 2003 increased by 29% compared with 2002. The increase reflects higher prices across all four regional units. The 2003 loss ratio decreased by 2.6 percentage points to 57.9% primarily as a result of higher prices in 2002 and 2003. Weather-related losses for the regional segment were $4.3 million in 2003 compared with $3.9 million in 2002. INTERNATIONAL The international segment offers personal and commercial property casualty insurance in Argentina and savings and life products in the Philippines. Following is a summary of underwriting results for the international segment for the three months ended March 31, 2003 and 2002 (dollars in thousands):
2003 2002 % Change ---- ---- -------- Gross premiums written ...... $ 16,736 $ 46,218 (64)% Net premiums written ........ 15,623 40,550 (61)% Premiums earned ............. 14,843 39,184 (62)% Underwriting income (loss) .. 805 (744) Loss ratio .................. 49.2% 60.1% Expense ratio ............... 45.4% 41.8% Combined ratio .............. 94.6% 101.9%
Net premiums written in 2003 decreased by 61% compared with 2002. The decrease was the result of the withdrawal from life insurance business in Argentina and of lower exchange rates for the Argentine peso in 2003. The combined ratio increased 7.3 percentage points to 94.6% as a result of a reduction in costs relating to the withdrawal from life insurance business in Argentina and of improvement in underwriting results for the Argentine property casualty business. DISCONTINUED The discontinued segment consists of regional personal lines and the alternative markets reinsurance, which were discontinued in 2001. Following is a summary of underwriting results for the regional segment for the three months ended March 31, 2003 and 2002 (dollars in thousands):
2003 2002 ---- ---- Gross premiums written .. $ -- $ 8,619 Net premiums written .... -- 3,442 Premiums earned ......... -- 22,363 Underwriting loss ....... -- (1,923)
13 NET INVESTMENT INCOME Following is a summary of investment activity for the three months ended March 31, 2003 and 2002 (dollars in thousands):
2003 2002 % Change ---- ---- -------- Net investment income ........... $ 51,760 $ 44,152 17% Average invested assets ......... 4,670,404 3,593,257 30% Annualized effective yield (1) 5.1% 5.4% Realized gains .................. 14,604 4,959 Change in unrealized gains ...... (9,814) (27,137)
(1) Represents net investment income (before interest in funds held) expressed as a percentage of average invested assets. Net investment income in 2003 increased 17% compared with 2002. Average invested assets increased 30% compared with 2002 as a result of cash flow from operations and of the proceeds from a secondary stock offering in 2002 and a $200 million debt offering in 2003. The average yield on investments was 5.1% in 2003 compared with 5.4% in 2002. The lower yield in 2003 reflects the decrease in general interest rate levels as well as an increase in the portion of the portfolio invested in municipal securities. The carrying value of the Company's investment portfolio as of March 31, 2003 and December 31, 2002 is as follows (dollars in thousands):
March 31, December 31, 2003 2002 ---- ---- Cash and cash equivalents ............. $ 722,884 $ 594,183 Fixed maturities ...................... 3,773,655 3,511,522 Equity securities available for sale .. 260,815 205,372 Trading account(a) .................... 310,083 306,836 Other investments ..................... 87,005 45,187 Due to brokers and clearing organizations ....................... (92,386) -- ----------- ----------- Total ........................... $ 5,062,056 $ 4,663,100 =========== ===========
(a) Represents trading account equity securities plus trading account receivables from brokers and clearing organizations less trading account equity securities sold but not yet purchased. At March 31, 2003, as compared with December 31, 2002, the fixed maturity portfolio mix was as follows: U.S. Government securities were 19% (20% in 2002); state and municipal securities were 35% (29% in 2002); corporate securities were 13% (19% in 2002); mortgage-backed securities were 27% (27% in 2002); and foreign bonds were 6% (5% in 2002). INTEREST AND OTHER EXPENSES Interest and other expenses represents interest expense, corporate expenses and other miscellaneous income and expenses. Interest and other expenses were $23 million in 2003 compared with $20 million in 2002. The increase reflects higher general and administrative expenses and an increase in interest expense of $1 million as a result of a $200 million debt offering in 2003. REALIZED INVESTMENT GAINS Realized investment gains were $14.6 million, primarily as a result of the sale of fixed income securities in order to increase the portion of the portfolio invested in municipal securities. INCOME TAXES AND MINORITY INTEREST The effective income tax rate was 32% in 2003 and 2002. The effective tax rate differs from the federal income tax rate of 35% primarily because of tax-exempt investment income. Minority interest represents the portion of the Company's international operations held by outside investors. 14 FINANCING ACTIVITY In February 2003, the Company issued $200 million aggregate principal amount of 5.875% senior notes due February 2013. The notes were issued at 99.07% of their face value amount and the net proceeds after expenses were $196,840,000. During the first quarter of 2003, the Company repaid $35,793,000 of 6.5% senior subordinated notes and $25,000,000 of 6.71% senior notes upon their respective maturities. At March 31, 2003, the Company's outstanding debt was $505 million (face amount). The maturities of the debt are $40 million in 2005, $100 million in 2006, $89 million in 2008, $200 million in 2013 and $76 million in 2022. The Company also has $200 million (face amount) of trust preferred securities that mature in 2045. At March 31, 2003, stockholders' equity was $1,397 million and total capitalization (stockholders' equity, debt and trust preferred securities) was $2,095 million. The percentage of the Company's capital attributable to debt was 24% at March 31, 2003 compared with 19% at December 31, 2002. For background information concerning the Company's Liquidity and Capital Resources, see the Company's Annual Report on Form 10-K for the year ended December 31, 2002. 15 Item 3. Quantitative and Qualitative Disclosure About Market Risk The Company's market risk generally represents the risk of gain or loss that may result from the potential change in the fair value of the Company's investment portfolio as a result of fluctuations in prices, interest rates and currency exchange rates. The Company attempts to manage its interest rate risk by maintaining an appropriate relationship between the average duration of the investment portfolio and the approximate duration of its liabilities, i.e., policy claims and debt obligations. The Company has maintained approximately the same duration of its investment portfolio to its liabilities from December 31, 2002 to March 31, 2003, and the overall market risk relating to the Company's portfolio has remained similar to the risk at December 31, 2002. Item 4. Controls and Procedures The Company's management, including its Chief Executive Officer and Chief Financial Officer, have conducted an evaluation of the effectiveness of the Company's disclosure controls and procedures pursuant to Securities Exchange Act Rule 13a-14 within the 90 days prior to the date of the filing of this quarterly report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company has in place appropriate controls and procedures designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Securities Exchange Act and the rules thereunder, is recorded, processed, summarized and reported within the time periods specified in the Commission's rules and forms. There have been no significant changes in internal controls, or in factors that could significantly affect internal controls, subsequent to the date the Chief Executive Officer and Chief Financial Officer completed their evaluation. PART II - OTHER INFORMATION Item 1. Legal Proceedings The Company's subsidiaries are regularly engaged in the defense of claims arising out of the conduct of the insurance business. The Company does not believe that such litigation, individually or in the aggregate, will have a material effect on its financial condition or results of operations. A subsidiary of the Company has a pending arbitration proceeding pertaining to the interpretation of the contract terms in two reinsurance agreements. As of March 31, 2003, the reinsurer's interpretation of the contract terms would reduce the recoverable from the reinsurer by approximately $4 million for paid losses and approximately $46 million for unpaid losses. Although the ultimate outcome of this matter cannot be determined, management believes that the Company's interpretation of these agreements is correct and intends to vigorously pursue this matter in arbitration. There are two pending arbitrations pertaining to reinsurance contract coverage issues where a subsidiary of the Company is the assuming reinsurer. The Company's estimates of the cost of settling its insurance and reinsurance claims, including claims in arbitrations and litigation, are reflected in its aggregate reserves for losses and loss expenses. Accordingly, based on currently available information, the Company believes that the resolution of the two pending arbitrations will not have a material effect on its financial condition or results of operations. However, if these two arbitrations are decided adversely to the Company, the Company's potential exposure, in excess of the amounts reserved, is up to $16 million, after tax. 16 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits
Number ------ (4.1) Indenture, dated as of February 14, 2003, between the Company and The Bank of New York, as trustee, relating to $200,000,000 principle amount of the Company's 5.875% Senior Notes due 2013 (incorporated by reference from the Company's Annual Report on Form 10-K for the year ended December 31, 2002). (4.2) First Supplemental Indenture, dated February 14, 2003, between the Company and The Bank of New York, as trustees, relating to $200,000,000 principle amount of the Company's 5.875% Senior Notes due 2013, including form of the Notes as Exhibit A (incorporated by reference from the Company's Annual Report on Form 10-K for the year ended December 31, 2002). (99.1) Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (99.2) Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K During the quarter ended March 31, 2003, the Company filed the following Reports on Form 8-K: Report dated February 10, 2003 with respect to the press release relating to the announcement of the Company's results of operations for the fourth quarter of 2002 and the year then ended (under item 5 of Form 8-K). Report dated February 11, 2003 with respect certain exhibits filed in connection with the Prospectus Supplement dated February 11, 2003 to the Prospectus dated June 7, 2002, filed as part of the Registration Statement on Form S-3 (Registration No. 333-88920; declared effective on June 7, 2002) filed by the Company with the Securities and Exchange Commission covering Debt Securities issuable under an Indenture relating to Senior Debt Securities, to be dated as of February 14, 2003, between the Company and The Bank of New York, as trustee (the "Trustee") (under Item 5 of Form 8-K). Report dated March 4, 2003 with respect to the press release relating to the announcement of the Company's intention to form a United Kingdom authorized insurance company, the engagement of Stuart Wright as the to-be-formed company's chief executive officer, and the Company's discussions with Kiln plc about Kiln holding a minority interest in the new company (under Item 5 of Form 8-K). 17 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. W. R. BERKLEY CORPORATION Date: May 15, 2003 /s/ WILLIAM R. BERKLEY ------------------------------ William R. Berkley Chairman of the Board and Chief Executive Officer Date: May 15, 2003 /s/ EUGENE G. BALLARD ------------------------------ Eugene G. Ballard Senior Vice President, Chief Financial Officer and Treasurer
18 CERTIFICATIONS I, William R. Berkley, Chairman of the Board and Chief Executive Officer of W. R. Berkley Corporation (the "registrant"), certify that: 1. I have reviewed this quarterly report on Form 10-Q of the registrant; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 15, 2003 /s/ WILLIAM R. BERKLEY ------------------------------ William R. Berkley Chairman of the Board and Chief Executive Officer 19 CERTIFICATIONS I, Eugene G. Ballard, Senior Vice President, Chief Financial Officer and Treasurer of W. R. Berkley Corporation (the "registrant"), certify that: 1. I have reviewed this quarterly report on Form 10-Q of the registrant; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 15, 2003 /s/ EUGENE G. BALLARD -------------------------- Eugene G. Ballard Senior Vice President, Chief Financial Officer and Treasurer 20