-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VtfuP2ZN5+mJIzeO2tTq2pvOQ+K7KPoa75hWJr04N8wriPsedsjoPa3x4u8b0013 2OPsD5gqYhLectSrmkjATQ== 0000950123-04-003258.txt : 20040312 0000950123-04-003258.hdr.sgml : 20040312 20040312164030 ACCESSION NUMBER: 0000950123-04-003258 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040312 FILER: COMPANY DATA: COMPANY CONFORMED NAME: BERKLEY W R CORP CENTRAL INDEX KEY: 0000011544 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 221867895 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-15202 FILM NUMBER: 04666567 BUSINESS ADDRESS: STREET 1: 475 STEAMBOAT ROAD STREET 2: . CITY: GREENWICH STATE: CT ZIP: 06830 BUSINESS PHONE: 2036293000 MAIL ADDRESS: STREET 1: 475 STEAMBOAT ROAD STREET 2: . CITY: GREENWICH STATE: CT ZIP: 06830 10-K 1 y95088e10vk.txt FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 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 1-15202 W. R. BERKLEY CORPORATION (Exact name of registrant as specified in its charter) Delaware 22-1867895 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number) 475 Steamboat Road, Greenwich, CT 06830 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (203) 629-3000 Securities registered pursuant to Section 12(b) of the Act: Common stock, par value $.20 per share Rights to purchase Series A Junior Participating Preferred Stock Securities registered pursuant to Section 12(g) of the Act: None 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 twelve 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities and Exchange Act of 1934). Yes [X] No [ ] The aggregate market value of the voting and non-voting common stock held by non-affiliates (computed by reference to the price at which the common stock was last sold) as of the last business day of the Registrant's most recently completed second fiscal quarter was $2,575,558,247. Number of shares of common stock, $.20 par value, outstanding as of March 5, 2004: 83,737,664. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Company's 2003 Annual Report to Stockholders for the year ended December 31, 2003 are incorporated herein by reference in Part II, and portions of the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2003, are incorporated herein by reference in Part III. W. R. BERKLEY CORPORATION ANNUAL REPORT ON FORM 10-K December 31, 2003
Page ---- SAFE HARBOR STATEMENT 3 PART I ITEM 1. BUSINESS 4 ITEM 2. PROPERTIES 25 ITEM 3. LEGAL PROCEEDINGS 25 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 26 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 27 ITEM 6. SELECTED FINANCIAL DATA FOR THE FIVE YEARS ENDED DECEMBER 31, 2003 28 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 29 ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 29 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 29 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 29 ITEM 9A. CONTROLS AND PROCEDURES 29 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 30 ITEM 11. EXECUTIVE COMPENSATION 32 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 32 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 32 PART IV ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES 32 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K 33
2 SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 This is a "Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995. This document may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Some of the forward-looking statements can be identified by the use of forward-looking words such as "believes", "expects", "potential", "continued", "may", "will", "should", "seeks", "approximately", "predicts", "intends", "plans", "estimates", "anticipates" or the negative version of those words or other comparable words. Any forward-looking statements contained herein including statements related to our outlook for the industry and for our performance for the year 2004 and beyond, are based upon our 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 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; - increases in the 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; - exposure as to coverage for terrorist acts; - the ability of our reinsurers to pay reinsurance recoverables owed to us; - investment results, including those of our portfolio of fixed income securities and investments in equity securities, including merger arbitrage investments; - exchange rate and political risks relating to our international operations; - legislative and regulatory developments; - changes in the ratings assigned to us by rating agencies; - availability of dividends from our insurance company subsidiaries; - our ability to successfully acquire and integrate companies and invest in new insurance ventures; - our ability to attract and retain qualified employees; and - other risks detailed from time to time in our filings with the Securities and Exchange Commission. We describe these risks and uncertainties in greater detail below under the caption "Certain Factors That May Affect Future Results." These risks and uncertainties could cause our actual results for the year 2004 and beyond to differ materially from those expressed in any forward-looking statement we make. Any projections of growth in our net premiums written and management fees would not necessarily result in commensurate levels of underwriting and operating profits. Our future financial performance is dependent upon factors discussed elsewhere in this Form 10-K and our other SEC filings. Forward-looking statements speak only as of the date on which they are made. 3 PART I ITEM 1. BUSINESS W. R. Berkley Corporation, a Delaware corporation, is an insurance holding company which, through its subsidiaries, operates in five segments of the property casualty insurance business: - Specialty lines of insurance, including excess and surplus lines and commercial transportation - Alternative markets, including workers compensation and the management of self-insurance programs - Reinsurance - Regional commercial property casualty insurance - International Our holding company structure provides us with the flexibility to respond to local or specific market conditions and to pursue specialty business niches. It also allows us to be closer to our customers in order to better understand their individual needs and risk characteristics. Our structure allows us to capitalize on the benefits of economies of scale through centralized capital, investment and reinsurance management and actuarial, financial and legal staff support. Unless otherwise indicated, all references in this Form 10-K to "W. R. Berkley," "we," "us," "our," the "Company" or similar terms refer to W. R. Berkley Corporation together with its subsidiaries. Our specialty insurance and reinsurance operations are conducted nationwide, as well as in the United Kingdom. Alternative markets operations are conducted throughout the U.S. Regional insurance operations are conducted primarily in the Midwest, New England, Southern (excluding Florida) and Mid Atlantic regions of the United States. International operations are conducted in Argentina and Asia. The Company discontinued its regional personal lines and alternative markets reinsurance business in 2001 in order to focus on lines of business with higher expected returns. These discontinued businesses, which were previously reported in the regional and reinsurance segments, are now reported as a separate discontinued business segment. Although the Company discontinued the alternative market division of its reinsurance segment, it continues to write insurance and reinsurance covering workers' compensation for self-insured entities within the alternative markets segment. Segment information for prior periods has been restated to reflect these changes and to conform to the presentations of the 2003 segment information. Net premiums written, as reported based on accounting principles generally accepted in the United States of America ("GAAP"), for each of the past five years were as follows:
Year Ended December 31, --------------------------------------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- (Amounts in thousands) Net premiums written: Specialty insurance $ 1,295,570 $ 939,929 $ 567,714 $ 300,885 $ 268,889 Alternative markets 482,389 305,357 151,942 98,001 73,089 Reinsurance 861,457 601,969 196,572 261,280 300,671 Regional 963,988 776,577 598,149 499,526 497,041 International 67,111 79,313 150,090 118,981 86,172 Discontinued business -- 7,345 193,629 227,571 201,857 ------------ ---------- ---------- ---------- ---------- Total $ 3,670,515 $2,710,490 $1,858,096 $1,506,244 $1,427,719 ============ ========== ========== ========== ========== Percentage of net premiums written: Specialty insurance 35.3% 34.6% 30.5% 20.1% 18.8% Alternative markets 13.1 11.3 8.2 6.5 5.1 Reinsurance 23.5 22.2 10.6 17.3 21.1 Regional 26.3 28.7 32.2 33.1 34.9 International 1.8 2.9 8.1 7.9 6.0 Discontinued business -- 0.3 10.4 15.1 14.1 ----- ----- ----- ----- ----- Total 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== =====
4 The following sections briefly describe our insurance segments. All of the domestic insurance subsidiaries except Admiral Insurance Company have an A.M. Best Company, Inc. ("A.M. Best") rating of "A (Excellent)" which is the third highest rating out of 15 possible ratings by A. M. Best. Admiral Insurance Company has a rating of "A+ (Superior)" which is A.M. Best's second highest rating. W. R. Berkley Insurance (Europe), Limited has a rating of "A- (Excellent)" which is A.M. Best's fourth highest rating. A.M. Best's ratings are based upon factors of concern to policyholders, insurance agents and brokers and are not directed toward the protection of investors. A.M. Best states: "Best's Ratings reflect [its] opinion based on a comprehensive quantitative and qualitative evaluation of a company's balance sheet strength, operating performance and business profile. Ratings may be changed, suspended or withdrawn at any time for any reason at the discretion of A.M. Best Company. These ratings are not a warranty of an insurer's current or future ability to meet its contractual obligations, nor are they a recommendation to buy, sell or hold any security." A.M. Best reviews its ratings on a periodic basis, and ratings of the Company's subsidiaries are therefore subject to change. SPECIALTY INSURANCE Our specialty segment underwrites complex and sophisticated third-party liability risks, principally within the excess and surplus lines, professional liability, commercial transportation, medical excess and surety markets. The specialty business is conducted through ten operating units. The companies within the segment are divided along the different customer bases and product lines which they serve. The specialty units deliver their products through a variety of distribution channels depending on the customer base and particular risks insured. The customers in this segment are highly diverse. Admiral Insurance Company ("Admiral") provides excess and surplus lines coverages, with average annual premium per policy of approximately $43,000, that generally involve moderate to high degrees of risk due to the nature of the class of coverage (e.g., products liability) or insured entity (e.g., fireworks distributors). Admiral concentrates on commercial casualty, professional liability and commercial property lines of business produced by wholesale brokers. Admiral Excess Underwriters ("Admiral Excess"), a division of Admiral, writes commercial general liability and products liability coverage in excess of primary insurance or self-insured retentions. Nautilus Insurance Company ("Nautilus") insures excess and surplus risks, with average annual premium per policy of approximately $3,300, which are less complex and involve a lower degree of expected severity than those covered by Admiral. A substantial portion of Nautilus' business is written on a binding authority basis, subject to certain contractual limitations. Carolina Casualty Insurance Company ("Carolina") specializes in transportation insurance for long-haul trucking and public automobile risks, operating as an admitted carrier in all states. Monitor Liability Managers, Inc. ("Monitor") specializes in professional liability insurance, including directors' and officers' liability, employment practices liability, lawyers' professional liability, management liability, and non-profit directors' and officers' liability coverages. Vela Insurance Services, LLC ("Vela") is an excess and surplus lines underwriting manager that specializes in providing general liability and product liability coverages to small and medium size accounts having an average annual premium per policy of approximately $32,800. W. R. Berkley Insurance (Europe), Limited ("Berkley U.K.") is a United Kingdom authorized insurance company that began operations in July 2003. Berkley U.K. writes primarily professional indemnity business in the U.K. Berkley Medical Excess Underwriters, LLC ("Medical Excess") was established at the end of 2001 to provide medical malpractice excess insurance and reinsurance coverage and services to hospitals and hospital associations. Clermont Specialty Managers, Ltd. ("Clermont") writes package insurance programs for luxury condominium, cooperative and rental apartment buildings and restaurants in the New York City metropolitan area. 5 Monitor Surety Managers, Inc. ("Surety") writes contract bonds, court and fiduciary bonds, license and permit bonds, and public official bonds, with a primary focus on providing surety bonds to mid-sized contractors. The following table sets forth the percentage of direct premiums written by each specialty unit:
Year Ended December 31, -------------------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- Admiral 32.3% 36.3% 37.9% 38.0% 35.8% Nautilus 17.8 17.1 16.6 23.8 24.1 Carolina 14.3 17.3 18.1 10.4 17.7 Monitor 12.7 14.8 15.2 17.1 13.9 Vela 9.7 8.6 7.1 3.9 2.2 Berkley UK 3.4 -- -- -- -- Medical Excess 3.3 0.8 -- -- -- Clermont 3.3 4.0 3.4 4.4 4.1 Admiral Excess 2.0 -- -- -- -- Surety 1.2 1.1 1.7 2.4 2.2 ----- ----- ----- ----- ----- Total 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== =====
The following table sets forth the percentages of direct premiums written, by line, by our specialty insurance operations:
Year Ended December 31, ---------------------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- General Liability 51.6% 44.8% 43.8% 42.8% 32.0% Automobile Liability 11.0 12.4 14.8 10.2 17.9 Professional Liability 12.2 14.6 11.1 14.0 16.2 Fire and Allied Lines 7.2 9.2 8.9 8.8 7.5 Directors' and Officers' Liability 5.8 6.4 6.4 6.8 6.3 Commercial Multi-Peril 1.9 3.1 4.3 4.4 3.3 Automobile Physical Damage 1.9 2.6 3.7 4.1 6.3 Medical Malpractice 5.3 3.6 2.9 3.6 5.9 Surety 1.2 1.1 1.6 2.4 2.1 Inland Marine 1.2 1.6 2.0 1.5 1.9 Workers' Compensation 0.5 0.5 0.5 0.7 0.6 Other 0.2 0.1 -- 0.7 -- ----- ----- ----- ----- ----- Total 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== =====
ALTERNATIVE MARKETS Our alternative markets operations specialize in developing, insuring, reinsuring and administering self-insurance programs and other alternative risk transfer mechanisms. Our clients include employers, employer groups, insurers, and alternative market funds seeking less costly, more efficient ways to manage exposure to risks. In addition to providing insurance, the alternative markets segment also provides a wide variety of fee-based services, including consulting and administrative services. Each of our alternative markets operating units is involved in risk management and is organized according to one of the following product areas: insuring excess workers' compensation risks; insuring primary workers' compensation risks; and providing non-risk bearing services. Midwest Employers Casualty Company ("MECC") provides excess workers' compensation coverage to self-insured employers and groups above their self-insured or retained limits. Preferred Employers Insurance Company ("Preferred Employers") offers primary workers' compensation insurance in California. Insurance coverage is provided primarily to owner-managed small employers. 6 Key Risk Insurance Company ("Key Risk") offers primary workers' compensation insurance principally in North Carolina. Insurance services are also provided through its affiliate, Key Risk Management Services. Berkley Risk Administrators Company, LLC ("BRAC") implements and manages alternative risk management programs and self-insurance pools for business, governments, educational institutions, tribal nations and non-profit entities. BRAC also provides administrative and claims services to insurance companies. BRAC's services include third-party administration, claims adjustment and management, employee benefit consulting, accounting services, insurance and reinsurance risk transfer, loss control and safety consulting, management information systems, regulatory compliance and relations, risk management consulting, alternative markets plan management, statistical analysis, underwriting and rating, and policy issuance. BRAC also writes property casualty insurance for self-insured entities. The following table sets forth the percentage gross premiums written by each alternative markets unit:
Year Ended December 31, --------------------------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- MECC 41.1% 51.6% 53.6% 63.4% 68.7% Preferred Employers 29.8 24.3 20.6 9.7 3.9 BRAC 15.1 4.5 1.5 0.5 -- Key Risk 14.0 19.6 24.3 26.4 27.4 ----- ----- ----- ----- ----- Total 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== =====
The following table sets forth services fees for insurance services business conducted by BRAC and Key Risk (amounts in thousands):
Year Ended December 31, -------------------------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- Services fees $101,715 $ 86,095 $ 74,913 $ 63,434 $ 65,941
REINSURANCE Our reinsurance operations consist of seven operating units, which specialize in underwriting property casualty reinsurance on both a treaty and a facultative basis on behalf of Berkley Insurance Company. Treaty reinsurance is the reinsurance of all or a specified portion or category of risks underwritten by the ceding company during the term of the agreement. Facultative reinsurance is the reinsurance of individual risks whereby a reinsurer has the opportunity to analyze and separately underwrite a risk prior to agreeing to be bound. Signet Star Re, LLC ("Signet Star") focuses on specialty lines of business, including professional liability, umbrella, workers' compensation, commercial automobile and trucking, where knowledge and expertise in a specific area is valued over the capital scale of the reinsurance provider. Signet Star emphasizes casualty excess of loss treaties and seeks significant participations in order to have greater influence over the terms and conditions of coverage. Signet Star is committed exclusively to the broker market segment of the treaty reinsurance industry; accordingly, its business is produced through reinsurance brokers or intermediaries as opposed to direct relationships with the ceding companies. This permits Signet Star to have wider market access. Facultative ReSources, Inc. ("Fac Re") specializes in individual certificate and program facultative business developed through brokers. Its experienced underwriters seek to offset the underwriting and pricing cycles in the underlying insurance business by working closely with ceding company clients to develop appropriate underwriting criteria and through superior risk selection. B F Re Underwriting, LLC. ("BF Re"), which commenced operations in 2002, writes facultative reinsurance on a direct basis. 7 Lloyd's reinsurance represents quota share reinsurance contracts with MAP Capital Limited, a Lloyd's corporate member, and two Lloyd's syndicates managed by Kiln plc. Map Capital Limited and the Lloyd's syndicates underwrite a broad range of mainly short-tail classes of business on a worldwide basis. Berkley Underwriting Partners, LLC ("Berkley Underwriting Partners") writes specialty insurance products through program administrators and managing general underwriters. Fidelity & Surety Reinsurance Managers, LLC ("Fidelity and Surety") offers reinsurance coverage to a limited number of regional fidelity and surety accounts. Berkley Risk Solutions ("Berkley Risk Solutions") was formed in 2003, and in 2004 began to provide insurance and reinsurance based financial solutions to insurance companies and self insured entities. The following table sets forth the percentages of gross premiums written by each reinsurance unit:
Year Ended December 31, ------------------------------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- Signet Star 34.0% 35.4% 56.3% 76.8% 79.6% Fac Re 28.0 24.3 26.9 15.2 12.6 Lloyds 23.9 27.8 -- -- -- Berkley Underwriting Partners 7.9 11.0 10.2 -- -- B F Re 5.7 -- -- -- -- Fidelity and Surety 0.5 1.5 6.6 8.0 7.8 ----- ----- ----- ----- ----- Total 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== =====
The following table sets forth the percentage of gross premiums written, by property versus casualty business, by our reinsurance operations:
Year Ended December 31, ------------------------------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- Property 23.4% 24.8% 8.4% 14.4% 20.6% Casualty 76.6 75.2 91.6 85.6 79.4 ----- ----- ----- ----- ----- Total 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== =====
REGIONAL Our regional subsidiaries provide commercial insurance products to customers primarily in 32 states. Key clients of this segment are small-to-mid-sized businesses and state and local governmental entities. The regional subsidiaries are organized geographically, which provides them with the flexibility to adapt to local market conditions, while enjoying the superior administrative capabilities and financial strength of W. R. Berkley. The regional operations are conducted through four geographic regions based on markets served: Continental Western Insurance Group ("Continental Western") in the Midwest, Acadia Insurance Company ("Acadia") in New England, Union Standard Insurance Group ("Union Standard") in the South (excluding Florida) and Berkley Mid Atlantic Group in the Mid Atlantic region. The regional subsidiaries primarily sell insurance products through a network of non-exclusive independent agents who are compensated on a commission basis. Our regional companies underwrite all major commercial lines. The following table sets forth the percentage of direct premiums written by each region:
Year Ended December 31, ------------------------------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- Continental Western 39.7% 39.8% 42.3% 42.9% 45.1% Acadia 29.6 28.7 26.7 24.7 21.5 Union Standard 16.6 16.7 15.8 16.4 14.4 Berkley Mid Atlantic 14.1 14.8 15.2 16.0 19.0 ----- ----- ---- ----- ----- Total 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== =====
8 The following table sets forth the percentages of direct premiums written, by line, by our regional insurance operations:
Year Ended December 31, ------------------------------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- Commercial Multi-Peril 37.6% 36.2% 29.9% 28.9% 28.1% Workers' Compensation 24.8 24.9 24.3 22.7 22.8 Auto Liability 17.8 17.4 17.9 18.9 18.7 Auto Physical Damage 8.1 7.9 8.3 9.0 9.0 General Liability 5.7 6.1 8.3 8.7 8.7 Fire and Allied Lines 1.3 2.2 4.3 4.3 4.9 Inland Marine 1.9 2.6 3.9 4.1 4.4 Surety 0.7 0.8 1.0 1.0 0.9 Ocean Marine 0.7 0.7 0.9 1.0 0.9 Other 1.4 1.2 1.2 1.4 1.6 ----- ----- ----- ----- ----- Total 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== =====
The following table sets forth the percentages of direct premiums written, by state, by our regional insurance operations:
Year Ended December 31, ------------------------------------------------------------ 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- State Kansas 7.9% 8.3% 7.9% 5.0% 4.8% Massachusetts 7.7 7.2 7.2 5.8 4.6 Texas 6.4 6.2 6.3 6.0 5.3 Maine 6.2 7.5 7.9 8.0 6.8 New Hampshire 6.2 6.9 7.8 7.2 6.5 Iowa 4.7 4.6 5.5 6.5 6.4 Nebraska 4.5 4.8 5.4 5.3 5.1 Pennsylvania 4.2 3.9 2.4 2.1 3.7 Tennessee 4.1 1.8 1.6 2.0 2.0 Minnesota 3.8 3.5 3.7 4.1 5.5 Vermont 3.8 4.1 3.7 3.2 3.0 South Dakota 3.6 3.6 3.4 2.9 3.0 Missouri 3.5 3.2 3.5 3.7 4.4 North Carolina 3.2 4.0 4.9 5.4 6.0 Colorado 3.0 3.3 3.6 4.4 3.7 Wisconsin 2.8 2.7 2.9 2.7 3.0 Virginia 2.7 2.7 3.4 3.5 3.6 Mississippi 2.1 2.1 2.5 3.1 3.1 Illinois 2.0 2.2 2.3 2.7 3.0 Arkansas 1.9 1.9 2.3 2.7 2.2 Oklahoma 1.5 1.5 1.5 1.3 1.0 Idaho 1.5 1.5 1.3 1.2 1.5 South Carolina 1.1 1.3 1.6 2.0 1.9 Other 11.6 11.2 7.4 9.2 9.9 ----- ----- ----- ----- ----- Total 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== =====
International The Company and Northwestern Mutual Life International, Inc. ("NML"), a wholly-owned subsidiary of The Northwestern Mutual Life Insurance Company, jointly own Berkley International, LLC ("Berkley International"). 9 Applying the same approach that we take for our domestic businesses, we believe that decentralized control is key to the success of our international effort. For example, we hire local insurance executives who have specialized knowledge of their customers, markets and products, and we link their compensation to meeting performance objectives. International operations are conducted in Argentina and Asia. In Argentina, we offer commercial and personal property casualty insurance. Our Argentina subsidiary ceased writing life insurance business in 2002. In the Philippines, we provide savings and life products to customers, and in Hong Kong we provide marketing and agency services to life insurers. The following table set forth the percentages of direct premiums for our international operations:
Year Ended December 31, ------------------------------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- Property casualty 91.7% 72.3% 77.9% 72.3% 72.3% Life 0.6 10.0 12.4 14.7 16.5 ----- ---- ----- ----- ----- Total Argentina 92.3 82.3 90.3 87.0 88.8 Asia - Life 7.7 17.7 9.7 13.0 11.2 ----- ---- ----- ----- ----- Total 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== =====
DISCONTINUED BUSINESS In the third quarter of 2001, the Company discontinued its personal lines business, both homeowners and private passenger automobile, and the alternative markets division of its reinsurance segment, by not renewing existing policies or treaties and ceasing to write new business. The following table set forth the percentages of premiums for our discontinued business:
Year Ended December 31, ------------------------------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- Personal lines -- 68.3% 61.8% 61.8% 74.3% Alternative markets reinsurance -- 31.7 38.2 38.2 25.7 ---- ----- ----- ----- ----- Total -- 100.0% 100.0% 100.0% 100.0% ==== ===== ===== ===== =====
OTHER BUSINESS The Company owns a majority interest in Peyton Street Independent Financial Services ("Peyton Street"), a unitary thrift holding company that owns the common stock of InsurBanc. InsurBanc provides banking services principally to independent insurance agencies and their employees. 10 Results by Industry Segment Summary financial information about our operating segments is presented on a GAAP basis in the following table:
Year Ended December 31, ----------------------------------------------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- (Amounts in thousands) Specialty Insurance Revenues $ 1,188,013 $ 826,558 $ 470,107 $ 336,621 $ 320,046 Income before income taxes 201,885 136,112 34,554 32,104 43,331 Alternative Markets Revenues 551,091 359,230 234,430 189,425 172,119 Income before income taxes 85,397 62,703 34,255 34,944 25,807 Reinsurance Revenues 813,180 442,199 250,850 335,935 337,401 Income (loss) before income taxes 59,984 14,981 (61,403) 26,026 16,461 Regional Revenues 923,965 749,750 608,682 560,748 542,422 Income (loss) before income taxes 153,292 104,085 37,203 4,182 (70,964) International Revenues 70,931 94,609 155,913 117,971 93,734 Income (loss) before income taxes 3,347 (1,757) 12,149 6,591 4,200 Discontinued business Revenues -- 55,774 232,403 232,392 213,816 Loss before income taxes -- (10,682) (133,480) (9,936) (25,646) Other (1) Revenues 82,928 37,964 (10,588) 8,195 (5,870) Loss before income taxes (14,601) (46,009) (74,672) (53,060) (72,437) Total Revenues $3,630,108 $2,566,084 $1,941,797 $1,781,287 $1,673,668 Income (loss) before income tax 489,304 259,433 (151,394) 40,851 (79,248)
(1) Represents corporate revenues and expenses, realized investment gains and losses, and foreign exchange gains and losses, which are not allocated to business segments. Also includes the operating results of Peyton Street. 11 The table below represents summary underwriting ratios, on a GAAP accounting basis for our insurance segments. The combined ratio represents a measure of underwriting profitability, excluding investment income. A number in excess of 100 indicates an underwriting loss; a number below 100 indicates an underwriting profit:
Year Ended December 31, --------------------------------------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- Specialty Insurance Loss ratio 63.3% 63.7% 71.0% 73.1% 68.1% Expense ratio 24.9 25.7 30.7 33.5 35.2 ---- ----- ----- ----- ----- Combined ratio 88.2% 89.4% 101.7% 106.6% 103.3% ==== ===== ===== ===== ===== Alternative Markets Loss ratio 68.6% 66.7% 76.5% 70.2% 65.8% Expense ratio 24.6 29.6 32.9 38.7 41.5 ---- ----- ----- ----- ----- Combined ratio 93.2% 96.3% 109.4% 108.9% 107.3% ==== ===== ===== ===== ===== Reinsurance Loss ratio 69.6% 75.0% 109.3% 73.3% 76.1% Expense ratio 29.5 31.7 38.3 33.3 33.3 ---- ----- ----- ----- ----- Combined ratio 99.1% 106.7% 147.6% 106.6% 109.4% ==== ===== ===== ===== ===== Regional Loss ratio 56.3% 59.1% 67.2% 75.5% 87.1% Expense ratio 31.2 32.4 35.0 35.1 37.5 ---- ----- ----- ----- ----- Combined ratio 87.5% 91.5% 102.2% 110.6% 124.6% ==== ===== ===== ===== ===== International Loss ratio 54.4% 54.2% 61.4% 62.1% 55.4% Expense ratio 42.3 51.3 40.6 41.7 47.5 ---- ----- ----- ----- ----- Combined ratio 96.7% 105.5% 102.0% 103.8% 102.9% ==== ===== ===== ===== ===== Discontinued Business Loss ratio -- 98.7% 131.4% 75.9% 77.0% Expense ratio -- 30.8 33.0 32.8 34.0 ---- ----- ----- ----- ----- Combined ratio -- 129.5% 164.4% 108.7% 111.0% ==== ===== ===== ===== ===== Total Loss ratio 63.4% 65.0% 82.1% 73.4% 76.8% Expense ratio 28.0 30.4 34.4 34.8 36.5 ---- ----- ----- ----- ----- Combined ratio 91.4% 95.4% 116.5% 108.2% 113.3% ==== ===== ===== ===== =====
12 Investments Investment results before income tax effects were as follows:
Year Ended December 31, ----------------------------------------------------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- (Amounts in thousands) Average investments, at cost $5,326,621 $3,881,121 $3,279,830 $3,046,364 $3,068,324 ========== ========== ========== ========== ========== Investment income, before expenses $ 244,347 $ 210,900 $ 206,656 $ 219,955 $ 198,556 ========== ========== ========== ========== ========== Percent earned on average investments 4.6% 5.4% 6.3% 7.2% 6.5% ========== ========== ========== ========== ========== Realized gains (losses) $ 82,531 $ 15,214 $ (12,252) $ 7,535 $ (5,683) ========== ========== ========== ========== ========== Change in unrealized investment gains (losses) (1) $ 21,613 $ 124,188 $ 31,277 $ 109,273 $ (167,020) ========== ========== ========== ========== ==========
(1) The change in unrealized investment gains (losses) represents the difference between fair value and cost of investments at the beginning and end of the calendar year, including investments carried at cost. For comparison, following are the yield components of selected bond and stock indices:
Year Ended December 31, -------------------------------------------------------------------------- 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- Lehman Brothers U.S. Aggregate Bond Index 5.3% 6.0% 6.5% 6.9% 6.3% === === === === === Lehman Brothers Municipal Bond Index 4.8% 5.1% 5.2% 5.5% 5.1% === === === === === S&P 500 Index 2.3% 1.3% 1.1% 1.0% 1.5% === === === === ===
The percentages of the fixed maturity portfolio categorized by contractual maturity, based on fair value, on the dates indicated, are set forth below. Actual maturities may differ from contractual maturities because certain issuers have the right to call or prepay obligations.
2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- 1 year or less 1.6% 3.1% 3.2% 3.5% 3.0% Over 1 year through 5 years 21.1 16.9 20.5 22.1 16.4 Over 5 years through 10 years 19.0 25.4 23.2 21.8 26.0 Over 10 years 36.8 27.8 26.2 27.7 34.6 Mortgage-backed securities 21.5 26.8 26.9 24.9 20.0 ----- ----- ----- ----- ----- Total 100.0% 100.0% 100.0% 100.0% 100.0% ===== ===== ===== ===== =====
Loss and Loss Adjustment Expense Reserves In the property casualty insurance industry, it is not unusual for significant periods of time to elapse between the occurrence of an insured loss, the report of the loss to the insurer and the insurer's payment of that loss. To recognize liabilities for unpaid losses, insurers establish reserves, which is a balance sheet account representing estimates of future amounts needed to pay claims and related expenses with respect to insured events which have occurred. Our loss reserves reflect current estimates of the ultimate cost of closing outstanding claims. Other than our excess workers' compensation business and the workers' compensation portion of our reinsurance business, as discussed below, we do not discount our reserves for financial reporting purposes. In general, when a claim is reported, claims personnel establish a "case reserve" for the estimated amount of the ultimate payment. The estimate represents an informed judgment based on general reserving practices and reflects the experience and knowledge of the claims personnel regarding the nature and value of the specific type of claim. Reserves are also established on an aggregate basis which provide for losses incurred but not yet reported to the insurer, potential inadequacy of case reserves, the estimated expenses of settling claims, including legal and other fees and general expenses of administering the claims adjustment process ("LAE"), and a provision for potentially uncollectible reinsurance. 13 In examining reserve adequacy, several factors are considered, including historical data, legal developments, changes in social attitudes and economic conditions, including the effects of inflation. The actuarial process relies on the basic assumption that past experience, adjusted judgmentally for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events. Reserve amounts are necessarily based on management's informed estimates and judgments using data currently available. As additional experience and other data become available and are reviewed, these estimates and judgments are revised. This may result in increases or decreases to reserves for insured events of prior years. The reserving process implicitly recognizes the impact of inflation and other factors affecting loss costs by taking into account changes in historical claim patterns and perceived trends. There is no precise method to evaluate the impact of any specific factor on the adequacy of reserves, because the ultimate cost of closing claims is influenced by numerous factors. While the methods for establishing the reserves are well tested over time, some of the major assumptions about anticipated loss emergence patterns are subject to fluctuation. In particular, high levels of jury verdicts against insurers, as well as judicial decisions which "re-formulate" policies to expand coverage to include previously unforeseen theories of liability, e.g., those regarding pollution, other environmental exposures or man-made catastrophes, have produced unanticipated claims and increased the difficulty of estimating loss and loss adjustment expense reserves. We discount our liabilities for excess workers' compensation business and the workers' compensation portion of our reinsurance business because of the long period of time over which losses are paid. Discounting is intended to appropriately match losses and loss expenses to income earned on investment securities supporting the liabilities. The expected losses and loss expense payout pattern subject to discounting was derived from the Company's loss payout experience and is supplemented with data compiled from insurance companies writing similar business. The liabilities for losses and loss expenses have been discounted using risk-free discount rates determined by reference to the U.S. Treasury yield curve for non-proportional business, and at the statutory rate for proportional business. The discount rates range from 3.9% to 6.5% with a weighted average rate of 5.0%. The aggregate net discount, after reflecting the effects of ceded reinsurance, is $393,000,000, $293,000,000 and $243,000,000 at December 31, 2003, 2002 and 2001, respectively. The increase in the aggregate discount from 2002 to 2003 and from 2001 to 2002 resulted from the increase in workers' compensation reserves. To date, known asbestos and environmental claims at our insurance company subsidiaries have not had a material impact on our operations. Environmental claims have not materially impacted us because these subsidiaries generally did not insure the larger industrial companies which are subject to significant environmental exposures. Our net reserves for losses and loss adjustment expenses relating to asbestos and environmental claims were $31,866,000 and $28,509,000 at December 31, 2003 and 2002, respectively. The Company's gross reserves for losses and loss adjustment expenses relating to asbestos and environmental claims were $49,283,000 and $47,637,000 at December 31, 2003 and 2002, respectively. Net incurred losses and loss expenses (recoveries) for reported asbestos and environmental claims were approximately $4,749,000, $6,652,000 and ($4,503,000) in 2003, 2002 and 2001, respectively. Net paid losses and loss expenses (receivables) for reported asbestos and environmental claims were approximately $1,391,000, $2,938,000 and $125,000 in 2003, 2002 and 2001, respectively. The estimation of these liabilities is subject to significantly greater than normal variation and uncertainty because it is difficult to make a reasonable actuarial estimate of these liabilities due to the absence of a generally accepted actuarial methodology for these exposures and the potential affect of significant unresolved legal matters, including coverage issues as well as the cost of litigating the legal issues. Additionally, the determination of ultimate damages and the final allocation of such damages to financially responsible parties are highly uncertain. The following table sets forth the components of our net provision for losses and loss expense (amounts in thousands):
2003 2002 2001 ---- ---- ---- Net provision for losses and loss expense: Property casualty $ 2,049,656 $ 1,457,254 $ 1,360,683 Life 521 6,717 19,817 ----------- ----------- --------------- Total $ 2,050,177 $ 1,463,971 $ 1,380,500 =========== =========== ===============
14 The table below provides a reconciliation of the beginning and ending property casualty reserves, on a gross of reinsurance basis (amounts in thousands):
2003 2002 2001 ---- ---- ---- Net reserves at beginning of year $2,323,241 $2,033,293 $1,818,049 ---------- ---------- ---------- Net provision for losses and loss expenses: Claims occurring during the current year 1,780,905 1,288,071 1,140,622 Increase in estimates for claims occurring in prior years 272,850 173,732 211,344 Net decrease (increase) in discount for prior years (4,099) (4,549) 8,717 ---------- ---------- ---------- 2,049,656 1,457,254 1,360,683 ---------- ---------- ---------- Net payments for claims: Current year 268,170 373,541 443,802 Prior years 599,432 793,765 701,637 ---------- ---------- ---------- 867,602 1,167,306 1,145,439 ---------- ---------- ---------- Net reserves at end of year 3,505,295 2,323,241 2,033,293 Ceded reserves at end of year 686,796 844,684 730,557 ---------- ---------- ---------- Gross reserves at end of year $4,192,091 $3,167,925 $2,763,850 ========== ========== ==========
In the above table, claims occurring during the current year are net of discount of $96,356,000, $38,939,000 and $24,781,000 for the years ended December 31, 2003, 2002 and 2001, respectively. Net payments in 2003 are net of $331 million of cash received upon the commutation of the aggregate reinsurance agreement (see Note 10 of Notes to Consolidated Financial Statements). Also, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" for further information regarding the increase in estimates for claims occurring in prior years. A reconciliation between the reserves as of December 31, 2003 as reported in the accompanying consolidated GAAP financial statements and those reported on the basis of statutory accounting principles ("SAP") is as follows (amounts in thousands):
Net reserves reported on a SAP basis $ 3,495,274 Additions (deductions) to statutory reserves: International property & casualty reserves 26,735 Loss reserve discounting (1) (16,714) ----------- Net reserves reported on a GAAP basis 3,505,295 Ceded reserves reclassified as assets 686,796 ----------- Gross reserves reported on a GAAP basis $ 4,192,091 ===========
(1) For statutory purposes, we use a discount rate of 4.2% as permitted by the Department of Insurance of the State of Delaware. The following table presents the development of net reserves for 1993 through 2003. The top line of the table shows the estimated reserves for unpaid losses and loss expenses recorded at the balance sheet date for each of the indicated years. This represents the estimated amount of losses and loss expenses for claims arising in all prior years that are unpaid at the balance sheet date, including losses that had been incurred but not yet reported to us. The upper portion of the table shows the re-estimated amount of the previously recorded reserves based on experience as of the end of each succeeding year. The estimate changes as more information becomes known about the frequency and severity of claims for individual years. The "cumulative redundancy (deficiency)" represents the aggregate change in the estimates over all prior years. For example, the 1993 reserves have developed a $161 million redundancy over ten years. That amount has been reflected in income over the ten years. The impact on the results of operations of the past three years of changes in reserve estimates is shown in the reconciliation tables above. It should be noted that the table presents a "run off" of balance sheet reserves, rather than accident or policy year loss development. Therefore, each amount in the table includes the effects of changes in reserves for all prior years. For example, assume a claim that occurred in 1993 is reserved for $2,000 as of December 31, 1993. Assuming this claim estimate was changed in 2003 to $2,300, and was settled for $2,300 in 2003, the $300 deficiency would appear as a deficiency in each year from 1993 through 2002. 15
(Amounts in millions) Year Ended December 31, 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 - --------------------------- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- Discounted net reserves for losses and loss expenses $ 783 $ 895 $1,209 $1,333 $1,433 $1,583 $1,724 $1,818 $2,033 $2,323 $3,505 Reserve discounting -- -- 152 172 190 187 196 223 243 293 393 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Undiscounted net reserve 783 895 1,361 1,505 1,623 1,770 1,920 2,041 2,276 2,616 3,898 for loss and loss expenses 710 783 895 1,361 1,505 Net Re-estimated as of: One year later 776 885 1,346 1,481 1,580 1,798 1,934 2,252 2,450 2,889 Two years later 755 872 1,305 1,406 1,566 1,735 2,082 2,397 2,671 Three years later 744 833 1,236 1,356 1,446 1,805 2,203 2,520 Four years later 708 789 1,195 1,239 1,463 1,856 2,260 Five years later 672 764 1,112 1,248 1,494 1,859 Six years later 649 706 1,118 1,271 1,488 Seven years later 599 712 1,135 1,265 Eight years later 605 723 1,132 Nine years later 610 725 Ten years later 622 Cumulative redundancy (deficiency) undiscounted $ 161 $ 170 $ 229 $ 240 $ 135 $ (89) $ (340) $ (479) $ (395) $ (273) ====== ====== ====== ====== ====== ====== ====== ====== ====== ====== Cumulative amount of net liability paid through: One year later 186 221 265 332 365 496 584 702 794 599 Two years later 221 355 434 523 574 795 1,011 1,255 1,191 Three years later 291 445 550 635 737 1,032 1,426 1,501 Four years later 334 501 616 714 852 1,306 1,567 Five years later 363 528 655 782 1,033 1,387 Six years later 373 543 701 903 1,068 Seven years later 373 577 785 935 Eight years later 393 634 809 Nine years later 421 654 Ten years later 436 Discounted net reserves 783 895 1,209 1,333 1,433 1,583 1,724 1,818 2,033 2,323 3,505 Ceded Reserves 1,233 1,176 451 450 477 538 617 658 731 845 687 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ----- Discounted gross reserves 2,016 2,071 1,660 1,783 1,910 2,121 2,341 2,476 2,764 3,168 4,192 Reserve discounting -- -- 192 216 241 248 250 286 324 384 462 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ----- Gross reserve $2,016 $2,071 $1,852 $1,999 $2,151 $2,369 $2,591 $2,762 $3,088 $3,552 $4,654 ====== ====== ====== ====== ====== ====== ====== ====== ====== ====== ====== Gross Re-estimated as of: One year later 2,010 2,043 1,827 1,965 2,132 2,390 2,653 2,827 3,153 3,957 Two years later 1,966 2,026 1,789 1,959 2,096 2,389 2,556 2,730 3,461 Three years later 1,955 1,983 1,754 1,909 2,010 2,218 2,385 2,900 Four years later 1,913 1,951 1,733 1,823 1,871 2,079 2,465 Five years later 1,855 1,928 1,681 1,739 1,787 2,102 Six years later 1,815 1,899 1,630 1,688 1,795 Seven years later 1,788 1,858 1,589 1,692 Eight years later 1,757 1,827 1,593 Nine years later 1,737 1,834 Ten Years later 1,754 Gross cumulative redundancy (deficiency) $ 262 $ 237 $ 259 $ 307 $ 356 $ 267 $ 126 $ (138) $ (373) $ (405) ====== ====== ====== ====== ====== ====== ====== ====== ====== ======
16 Reinsurance We follow the customary industry practice of reinsuring a portion of our exposures and paying to reinsurers a part of the premiums received on the policies that we write. Reinsurance is purchased principally to reduce net liability on individual risks and to protect against catastrophic losses. Although reinsurance does not legally discharge an insurer from its primary liability for the full amount of the policies, it does make the assuming reinsurer liable to the insurer to the extent of the reinsurance coverage. We monitor the financial condition of our reinsurers and attempt to place our coverages only with substantial, financially sound carriers. As a result, generally the reinsurers who reinsure our casualty insurance must have an A.M. Best rating of "A (Excellent)" or better with $500 million in policyholder surplus and the reinsurers who cover our property insurance must have an A.M. Best rating of "A-(Excellent)" or better with $250 million in policyholder surplus. As a result of the attacks of September 11, 2001, many reinsurers have significantly changed their underwriting guidelines, and limit or no longer provide terrorism coverage. See "Management's Discussion and Analysis of Financial Condition and Result of Operations" and Note 10 of "Notes to Consolidated Financial Statements." Regulation Our insurance subsidiaries are subject to varying degrees of regulation and supervision in the jurisdictions in which they do business, and the Company believes that it is in compliance in all material respects with such regulations. They are subject to statutes which delegate regulatory, supervisory and administrative powers to state insurance commissioners. This regulation relates to such matters as the standards of solvency which must be met and maintained; the licensing of insurers and their agents; the nature of and limitations on investments; deposits of securities for the benefit of policyholders; approval of policy forms and premium rates; periodic examination of the affairs of insurance companies; annual and other reports required to be filed on the financial condition of insurers or for other purposes; establishment and maintenance of reserves for unearned premiums and losses; and requirements regarding numerous other matters. Our property casualty subsidiaries, other than E&S and reinsurance subsidiaries, must generally file all rates with the insurance department of each state in which they operate. Our excess and surplus and reinsurance subsidiaries generally operate free of rate and form regulation. In addition to regulatory supervision of our insurance subsidiaries, we are subject to state statutes governing insurance holding company systems. Typically, such statutes require that we periodically file information with the state insurance commissioner, including information concerning our capital structure, ownership, financial condition and general business operations. Under the terms of applicable state statutes, any person or entity desiring to purchase more than a specified percentage (commonly 10%) of our outstanding voting securities would be required to obtain regulatory approval of the purchase. Under Florida law, which is applicable to us due to our ownership of Carolina Casualty Insurance Company, a Florida domiciled insurer, the acquisition of more than 5% of our capital stock must receive regulatory approval. Further, state insurance statutes typically place limitations on the amount of dividends or other distributions payable by insurance companies in order to protect their solvency. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources." Various state and federal organizations, including Congressional committees and the National Association of Insurance Commissioners ("NAIC"), have been conducting reviews into various aspects of the insurance business. The NAIC codified statutory accounting practices for certain insurance enterprises effective January 1, 2001. No assurance can be given that future legislative or regulatory changes resulting from such activity will not adversely affect our insurance subsidiaries. The NAIC utilizes a Risk Based Capital (RBC) formula which is designed to measure the adequacy of an insurer's statutory surplus in relation to the risks inherent in its business. The RBC formula develops a risk adjusted target level of adjusted statutory capital by applying certain factors to various asset, premium and reserve items. The RBC Model Law provides for four incremental levels of regulatory attention for insurers whose surplus is below the calculated RBC target. These levels of attention range in severity from requiring the insurer to submit a plan for corrective action to actually placing the insurer under regulatory control. The RBC of each of our domestic insurance subsidiaries was above the authorized RBC control level as of December 31, 2003. The Gramm-Leach-Bliley Act, or Financial Services Modernization Act of 1999 (the "Act"), was enacted in 1999 and significantly affects the financial services industry, including insurance companies, banks and securities firms. The Act modifies federal law to permit the creation of financial holding companies, which, as regulated by the Act, can maintain cross-holdings in insurance companies, banks and securities firms to an extent not previously allowed. The Act also permits or facilitates certain types of combinations or affiliations for financial 17 holding companies. The Act establishes a functional regulatory scheme under which state insurance departments will maintain primary regulation over insurance activities, subject to provisions for certain federal preemptions. Our insurance subsidiaries are also subject to assessment by state guaranty funds when an insurer in that jurisdiction has been judicially declared insolvent and insufficient funds are available from the liquidated company to pay policyholders and claimants. The protection afforded under a state's guaranty fund to policyholders of the insolvent insurer varies from state to state. Generally, all licensed property casualty insurers are considered to be members of the fund, and assessments are based upon their pro rata share of direct written premiums. The NAIC Model Post-Assessment Guaranty Fund Act, which many states have adopted, limits assessments to an insurer to 2% of its subject premium and permits recoupment of assessments through rate setting. Likewise, several states (or underwriting organizations of which our insurance subsidiaries are required to be members) have limited assessment authority with regard to deficits in certain lines of business. We receive funds from our insurance subsidiaries in the form of dividends and management fees for certain management services. Annual dividends in excess of maximum amounts prescribed by state statutes may not be paid without the approval of the insurance commissioner of the state in which an insurance subsidiary is domiciled. The Terrorism Risk Insurance Act of 2002 ("TRIA") became effective November 26, 2002. TRIA establishes a temporary Federal program that provides for a system of shared public and private compensation for insured losses resulting from acts of terrorism. The program terminates on December 31, 2005. TRIA is applicable to almost all commercial lines of property and casualty insurance. Insurers with direct commercial property and casualty insurance exposure in the United States are required to participate in the program and make available coverage for certified acts of terrorism. Federal participation will be triggered under TRIA when the Secretary of Treasury certifies an act of terrorism. Under the program the federal government will pay 90% of an insurer's losses in excess of the insurer's applicable deductible. The insurer's deductible is based on a percent of earned premium for covered lines of commercial property and casualty insurance: for 2003 the deductible is 7% of 2002 premium, for 2004 it is 10% of 2003 premium and for 2005 it is 15% of 2004 premium. Based on our 2003 earned premiums, our deductible under TRIA during 2004 will be $277 million. Based on our estimated earned premiums for 2004, our deductible under TRIA during 2005 will increase to approximately $500 million. TRIA limits the federal governments share of losses at $100 billion for a program year. In addition, an insurer that has satisfied its deductible is not liable for the payment of losses in excess of the $100 billion cap. Competition The property casualty insurance and reinsurance businesses are competitive, with over 2,000 insurance companies transacting business in the United States. We compete directly with a large number of these companies. Our strategy in this highly fragmented industry is to seek specialized areas or geographic regions where our insurance subsidiaries can gain a competitive advantage by responding quickly to changing market conditions. Each of our subsidiaries establishes its own pricing practices. Such practices are based upon a Company-wide philosophy to price products with the general intent of making an underwriting profit. Competition in the industry generally changes with profitability. Competition for specialty and alternative markets business comes from other specialty insurers, regional carriers, large national multi-line companies and reinsurers. Under certain market conditions, standard carriers also compete for excess and surplus business. Competition for the reinsurance business comes from domestic and foreign reinsurers, which produce their business either on a direct basis or through the broker market. These competitors include Berkshire Hathaway, Employers Reinsurance, Transatlantic Reinsurance and Everest Reinsurance, which collectively comprise a majority of the property casualty reinsurance market in the United States. The regional property casualty subsidiaries compete with mutual and other regional stock companies as well as national carriers. Direct writers of property casualty insurance compete with the regional subsidiaries by writing insurance through their salaried employees, generally at a lower cost than through independent agents such as those used by the Company. The international operations compete with native insurance operations both large and small, which may be related to government entities, as well as with branch or local subsidiaries of multinational companies. 18 Employees As of March 5, 2004, we employed 4,669 persons. Of this number, our subsidiaries employed 4,611 persons, of whom 2,459 were executive and administrative personnel and 2,152 were clerical personnel. We employed the remaining 58 persons at the parent company and in investment operations, of whom 43 were executive and administrative personnel and 15 were clerical personnel. Other Information about the Company's business We maintain an interest in the acquisition or start up of complementary businesses and continue to evaluate possible acquisitions and new ventures on an ongoing basis. In addition, the insurance subsidiaries develop new coverages or lines of business to meet the needs of insureds. Seasonal weather variations and other events affect the severity and frequency of losses sustained by the insurance and reinsurance subsidiaries. Although the effect on our business of such catastrophes as tornadoes, hurricanes, hailstorms, earthquakes and terrorist acts may be mitigated by reinsurance, they nevertheless can have a significant impact on the results of any one or more reporting periods. We have no customer which accounts for 10 percent or more of our consolidated revenues. Compliance by W. R. Berkley and its subsidiaries with federal, state and local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to protection of the environment has not had a material effect upon our capital expenditures, earnings or competitive position. The Company's internet address is www.wrberkley.com. The information on our website is not incorporated by reference in this annual report on Form 10-K. The Corporation's annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act are accessible free of charge through this website as soon as reasonably practicable after they have been electronically filed with or furnished to the Securities and Exchange Commission. 19 CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS Our business faces significant risks. If any of the events or circumstances described as risks below actually occurs, our business, results of operations or financial condition could be materially and adversely affected. RISKS RELATING TO OUR INDUSTRY OUR RESULTS MAY FLUCTUATE AS A RESULT OF MANY FACTORS, INCLUDING CYCLICAL CHANGES IN THE INSURANCE AND REINSURANCE INDUSTRY. The results of companies in the property casualty insurance industry historically have been subject to significant fluctuations and uncertainties. The demand for insurance is influenced primarily by general economic conditions, while the supply of insurance is directly related to available capacity. The adequacy of premium rates is affected mainly by the severity and frequency of claims, which are influenced by many factors, including natural disasters, regulatory measures and court decisions that define and expand the extent of coverage and the effects of economic inflation on the amount of compensation due for injuries or losses. In addition, investment rates of return may impact policy rates. These factors can have a significant impact on ultimate profitability because a property casualty insurance policy is priced before its costs are known, as premiums usually are determined long before claims are reported. These factors could produce results that would have a negative impact on our results of operations and financial condition. OUR ACTUAL CLAIMS LOSSES MAY EXCEED OUR RESERVES FOR CLAIMS, WHICH MAY REQUIRE US TO ESTABLISH ADDITIONAL RESERVES. Our gross reserves for losses and loss expenses were approximately $4.2 billion as of December 31, 2003. Our loss reserves reflect our best estimates of the cost of settling all claims and related expenses with respect to insured events that have occurred. Reserves do not represent an exact calculation of liability. Rather, reserves represent an estimate of what management expects the ultimate settlement and claims administration will cost for claims that have occurred, whether known or unknown. The major assumptions about anticipated loss emergence patterns are subject to unanticipated fluctuation. 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, inflation, judicial theories of liability, reinsurance coverage, legislative changes and other factors, including the actions of third parties which are beyond our control. The inherent uncertainties of estimating reserves are greater for certain types of liabilities, where long periods of time elapse before a definitive determination of liability is made and settlement is reached. In periods with increased economic volatility, it becomes more difficult to accurately predict claim costs. 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, we cannot assure you that our current reserves will prove adequate in light of subsequent events. Should we need to increase our reserves, our pre-tax income for the period would decrease by a corresponding amount. We increased our estimates for claims occurring in prior years by $273 million 2003, $174 million in 2002 and $211 million in 2001. We, along with the property casualty insurance industry in general, have experienced higher than expected losses for certain types of business written from 1998 to 2001. Although our reserves reflect our best estimate of the costs of settling claims, we cannot assure you that our claim estimates will not need to be increased in the future. We discount our reserves for excess and assumed workers' compensation business because of the long period of time over which losses are paid. Discounting is intended to appropriately match losses and loss expenses to income earned on investment securities supporting liabilities. The expected loss and loss expense payout pattern subject to discounting is derived from our loss payout experience and is supplemented with data compiled from insurance companies writing similar business. Changes in the loss and loss expense payout pattern are recorded in the period they are determined. If the actual loss payout pattern is shorter than anticipated, the discount will be reduced and pre-tax income will decrease by a corresponding amount. 20 AS A PROPERTY CASUALTY INSURER, WE FACE LOSSES FROM NATURAL AND MAN-MADE CATASTROPHES. Property casualty insurers are subject to claims arising out of catastrophes that may have a significant effect on their results of operations, liquidity and financial condition. Catastrophe losses have had a significant impact on our results. For example, weather-related losses for our regional business were $55 million in 2001, $29 million in 2002 and $38 million in 2003. In addition, through our recent quota share arrangements with certain Lloyd's syndicates, we have additional exposure to catastrophic losses. Catastrophes can be caused by various events, including hurricanes, windstorms, earthquakes, hailstorms, explosions, severe winter weather and fires, as well as terrorist activities. The incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Some catastrophes are restricted to small geographic areas; however, hurricanes and earthquakes may produce significant damage in large, heavily populated areas. Catastrophes can cause losses in a variety of our property casualty lines, and most of our past catastrophe-related claims have resulted from severe storms. Seasonal weather variations may affect the severity and frequency of our losses. Insurance companies are not permitted to reserve for a catastrophe until it has occurred. It is therefore possible that a catastrophic event or multiple catastrophic events could produce significant losses and have a material adverse effect on our results of operations and financial condition. WE FACE SIGNIFICANT COMPETITIVE PRESSURES IN OUR BUSINESSES, WHICH MAY REDUCE PREMIUM RATES AND PREVENT US FROM PRICING OUR PRODUCTS AT ATTRACTIVE RATES. We compete with a large number of other companies in our selected lines of business. We compete, and will continue to compete, with major U.S. and non-U.S. insurers and reinsurers, other regional companies, as well as mutual companies, specialty insurance companies, underwriting agencies and diversified financial services companies. Competition in our businesses is based on many factors, including the perceived financial strength of the company, premium charges, other terms and conditions offered, services provided, ratings assigned by independent rating agencies, speed of claims payment and reputation and experience in the lines to be written. Some of our competitors, particularly in the reinsurance business, have greater financial and marketing resources than we do. These competitors within the reinsurance segment include Berkshire Hathaway, Employers Reinsurance, Transatlantic Reinsurance and Everest Reinsurance Company, which collectively comprise a majority of the U.S. property casualty reinsurance market. We expect that perceived financial strength, in particular, will become more important as customers seek high quality reinsurers. New competition could cause the supply and/or demand for insurance or reinsurance to change, which could affect our ability to price our products at attractive rates. WE, AS A PRIMARY INSURER, MAY HAVE SIGNIFICANT EXPOSURE FOR TERRORIST ACTS. To the extent that reinsurers have excluded coverage for terrorist acts or have priced such coverage at rates that we believe are not practical, we, in our capacity as a primary insurer, do not have reinsurance protection and are exposed for potential losses as a result of any terrorist acts. For example, our losses from the World Trade Center attack in 2001 were $35 million. To the extent an act of terrorism is certified by the Secretary of Treasury, we may be covered under The Terrorism Risk Insurance Act of 2002 ("TRIA") for up to 90% of our losses. However, any such coverage would be subject to a mandatory deductible based on a percent of earned premium for the covered lines of commercial property and casualty insurance. Based on our 2003 earned premiums, our deductible under TRIA during 2004 will be $277 million. Based on our estimated earned premiums for 2004, our deductible under TRIA during 2005 will increase to approximately $500 million. If TRIA is not extended beyond its stated termination date of December 31, 2005 or replaced by a similar program, our liability for terrorist acts could be a material amount. In addition, even this coverage provided under TRIA does not apply to reinsurance that we write. 21 WE ARE SUBJECT TO EXTENSIVE GOVERNMENTAL REGULATION, WHICH INCREASES OUR COSTS AND COULD RESTRICT THE CONDUCT OF OUR BUSINESS. We are subject to extensive governmental regulation and supervision. Most insurance regulations are designed to protect the interests of policyholders rather than stockholders and other investors. This system of regulation, generally administered by a department of insurance in each state in which we do business, relates to, among other things: - standards of solvency, including risk-based capital measurements; - restrictions on the nature, quality and concentration of investments; - requiring certain methods of accounting; - rate and form regulation pertaining to certain of our insurance businesses; and - potential assessments for the provision of funds necessary for the settlement of covered claims under certain policies provided by impaired, insolvent or failed insurance companies. State insurance departments conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to the financial condition of insurance companies, holding company issues and other matters. Recently adopted federal financial services modernization legislation may lead to additional federal regulation of the insurance industry in the coming years. Also, foreign governments regulate our international operations. We may be unable to maintain all required licenses and approvals and our business may not fully comply with the wide variety of applicable laws and regulations or the relevant authority's interpretation of the laws and regulations. Also, some regulatory authorities have relatively broad discretion to grant, renew or revoke licenses and approvals. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, the insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or monetarily penalize us. Also, changes in the level of regulation of the insurance industry, whether federal, state or foreign, or changes in laws or regulations themselves or interpretations by regulatory authorities, restrict the conduct of our business. In certain of our insurance businesses, the rates we charge our policyholders are subject to regulatory approval. Certain lines of business are subject to a greater degree of regulatory scrutiny then others. For example, the workers' compensation business is highly regulated. During 2003, approximately 12% of our net premiums written represented primary workers' compensation business. Of our net premiums written, approximately 4% represented primary workers' compensation business written in the State of California, which is undergoing workers' compensation reform that may adversely affect our ability to adjust rates. RISKS RELATING TO OUR BUSINESS OUR EARNINGS COULD BE MORE VOLATILE, ESPECIALLY SINCE WE HAVE INCREASED, AND EXPECT TO FURTHER SUBSTANTIALLY INCREASE, OUR LEVEL OF RETENTION IN OUR BUSINESS. We have increased our retention levels due to changes in market conditions and the pricing environment. We plan to purchase less reinsurance, the process by which we transfer, or cede, part of the risk we have assumed to a reinsurance company, thereby retaining more risk. As a result, our earnings could be more volatile and increased severities are more likely to have a material adverse effect on our results of operations and financial condition. A significant change in our retention levels could also cause our historical financial results, including compound annual growth rates, to be inaccurate indicators of our future performance on a segment or consolidated basis. WE CANNOT GUARANTEE THAT OUR REINSURERS WILL PAY IN A TIMELY FASHION, IF AT ALL, AND, AS A RESULT, WE COULD EXPERIENCE LOSSES. We purchase reinsurance by transferring part of the risk that we have assumed, known as ceding, to a reinsurance company in exchange for part of the premium we receive in connection with the risk. Although reinsurance makes the reinsurer liable to us to the extent the risk is transferred or ceded to the reinsurer, it does not relieve us, the reinsured, of our liability to our policyholders or, in cases where we are a reinsurer, to our reinsureds. Our reinsurers may not pay the reinsurance recoverables that they owe to us or they may not pay such recoverables on a timely basis. As of December 31, 2003, the amount due from our reinsurers was $805 million, 22 including amounts due from state funds and industry pools. Certain of these amounts due from reinsurers are secured by letters of credit or held in trust on our behalf. Accordingly, we bear credit risk with respect to our reinsurers, and if our reinsurers fail to pay us, our financial results would be adversely affected. Underwriting results and investment returns of some of our reinsurers may affect their future ability to pay claims. WE ARE RATED BY A.M. BEST AND STANDARD & POOR'S, AND A DECLINE IN THESE RATINGS COULD AFFECT OUR STANDING IN THE INSURANCE INDUSTRY AND CAUSE OUR SALES AND EARNINGS TO DECREASE. Ratings have become an increasingly important factor in establishing the competitive position of insurance companies. Certain of our insurance company subsidiaries are rated by A.M. Best, Standard & Poor's and Moody's Investors Services. A.M. Best, Standard & Poor's and Moody's ratings reflect their opinions of an insurance company's financial strength, operating performance, strategic position and ability to meet its obligations to policyholders, are not evaluations directed to investors and are not recommendations to buy, sell or hold our securities. Our ratings are subject to periodic review, and we cannot assure you that we will be able to retain those ratings. All of the domestic insurance subsidiaries except Admiral Insurance Company have an A.M. Best Company, Inc. ("A.M. Best") rating of "A (Excellent)" which is the third highest rating out of 15 possible ratings by A. M. Best. Admiral Insurance Company has a rating of "A+ (Superior)" which is A.M. Best's second highest rating. W. R. Berkley Insurance (Europe), Limited has a rating of "A- (Excellent)" which is A.M. Best's fourth highest rating. The Standard & Poor's financial strength rating for our insurance subsidiaries is A+/negative (the seventh highest rating out of twenty-seven possible ratings). Our Moody's rating is A2 for Berkley Insurance Company (the sixth highest rating out of twenty-one possible ratings). If our ratings are reduced from their current levels by A.M. Best, Standard & Poor's and/or Moody's, our competitive position in the insurance industry could suffer and it would be more difficult for us to market our products. A significant downgrade could result in a substantial loss of business as policyholders move to other companies with higher claims-paying and financial strength ratings. IF MARKET CONDITIONS CAUSE REINSURANCE TO BE MORE COSTLY OR UNAVAILABLE, WE MAY BE REQUIRED TO BEAR INCREASED RISKS OR REDUCE THE LEVEL OF OUR UNDERWRITING COMMITMENTS. As part of our overall risk and capacity management strategy, we purchase reinsurance for certain amounts of risk underwritten by our insurance company subsidiaries, especially catastrophe risks. We also purchase reinsurance on risks underwritten by others which we reinsure. Market conditions beyond our control determine the availability and cost of the reinsurance protection we purchase, which may affect the level of our business and profitability. Our reinsurance facilities are generally subject to annual renewal. We may be unable to maintain our current reinsurance facilities or to obtain other reinsurance facilities in adequate amounts and at favorable rates. If we are unable to renew our expiring facilities or to obtain new reinsurance facilities, either our net exposures would increase or, if we are unwilling to bear an increase in net exposures, we would have to reduce the level of our underwriting commitments, especially catastrophe exposed risks. OUR INTERNATIONAL OPERATIONS EXPOSE US TO INVESTMENT, POLITICAL AND ECONOMIC RISKS. Our international operations, including our recent UK-based operations, expose us to investment, political and economic risks, including foreign currency and credit risk. Changes in the value of the U.S. dollar relative to other currencies could have an adverse effect on our results of operations and financial condition. For example, Argentina has recently experienced substantial political and economic problems, including the devaluation of the Argentinean peso. As a result, we recorded a charge of $18 million in 2001 and $10 million in 2002 to recognize other than temporary impairment of our investment in Argentine bonds. WE MAY NOT FIND SUITABLE ACQUISITION CANDIDATES OR NEW INSURANCE VENTURES AND EVEN IF WE DO, WE MAY NOT SUCCESSFULLY INTEGRATE ANY SUCH ACQUIRED COMPANIES OR SUCCESSFULLY INVEST IN SUCH VENTURES. As part of our present strategy, we continue to evaluate possible acquisition transactions and the start-up of complementary businesses on an ongoing basis, and at any given time, we may be engaged in discussions with respect to possible acquisitions and new ventures. We cannot assure you that we will be able to identify suitable acquisition transactions or insurance ventures, that such transactions will be financed and completed on acceptable terms or that our future acquisitions or ventures will be successful. The process of integrating any companies we do acquire or investing in new ventures may have a material adverse effect on our results of operations and financial condition. 23 WE MAY BE UNABLE TO ATTRACT AND RETAIN QUALIFIED EMPLOYEES. We depend on our ability to attract and retain experienced underwriting talent and other skilled employees who are knowledgeable about our business. If the quality of our underwriting team and other personnel decreases, we may be unable to maintain our current competitive position in the specialized markets in which we operate, and be unable to expand our operations into new markets. RISKS RELATING TO OUR INVESTMENTS A SIGNIFICANT AMOUNT OF OUR ASSETS IS INVESTED IN FIXED INCOME SECURITIES AND IS SUBJECT TO MARKET FLUCTUATIONS. Our investment portfolio consists substantially of fixed income securities. As of December 31, 2003, our investment in fixed income securities was approximately $4.3 billion, or 66% of our total investment portfolio. The fair market value of these assets and the investment income from these assets fluctuate depending on general economic and market conditions. The fair market value of fixed income securities generally decreases as interest rates rise. Conversely, if interest rates decline, investment income earned from future investments in fixed income securities will be lower. In addition, some fixed income securities, such as mortgage-backed and other asset-backed securities, carry prepayment risk as a result of interest rate fluctuations. Based upon the composition and duration of our investment portfolio at December 31, 2003, a 100 basis point increase in interest rates would result in a decrease in the fair value of our investments of approximately $203 million. The value of investments in fixed income securities, and particularly our investments in high-yield securities, is subject to impairment as a result of deterioration in the credit worthiness of the issuer. Although we attempt to manage this risk by diversifying our portfolio and emphasizing preservation of principal, our investments are subject to losses as a result of a general decrease in commercial and economic activity for an industry sector in which we invest, as well as risks inherent in particular securities. For example, we reported provisions for other than temporary impairments in the value of our fixed income investments of $27 million in 2001, $16 million in 2002 and $430,000 in 2003. WE INVEST SOME OF OUR ASSETS IN EQUITY SECURITIES, INCLUDING MERGER ARBITRAGE INVESTMENTS AND REAL ESTATE SECURITIES, WHICH MAY DECLINE IN VALUE. We invest a portion of our investment portfolio in equity securities, including merger arbitrage investments. At December 31, 2003, our investments in equity securities was approximately $759 million, or 12% of our investment portfolio. Although we did not report any provisions for "other than temporary impairments" in the value of our equity securities in 2000 or in 2003, we reported such provisions in the amounts of $0.1 million in 2001 and $2.7 million in 2002. Nearly half our equity securities are invested in merger and convertible arbitrage trading. Merger arbitrage is the business of investing in the securities of publicly held companies that are the targets in announced tender offers and mergers. Merger arbitrage differs from other types of investments in its focus on transactions and events believed likely to bring about a change in value over a relatively short time period, usually four months or less. While our merger arbitrage positions are generally hedged against market declines, these equity investments are exposed primarily to the risk associated with the completion of announced deals, which are subject to regulatory as well as political and other risks. As a result of the reduced activity in the merger and acquisitions area, we may not be able achieve the returns that we have enjoyed in the past. Included in our equity security portfolio are investments in publicly traded real estate investment trusts ("REITs") and private real estate investment funds and limited partnerships. At December 31, 2003, our investments in these securities was approximately $254 million, or 4% of our investment portfolio. The values of our real estate investments are subject to fluctuations based on changes in the economy in general and real estate valuations in particular. In addition, the real estate investment funds and limited partnerships in which we invest are less liquid than our other investments. 24 RISKS RELATING TO PURCHASING OUR SECURITIES WE ARE AN INSURANCE HOLDING COMPANY AND, THEREFORE, MAY NOT BE ABLE TO RECEIVE DIVIDENDS IN NEEDED AMOUNTS. Our principal assets are the shares of capital stock of our insurance company subsidiaries. We have to rely on dividends from our insurance company subsidiaries to meet our obligations for paying principal and interest on outstanding debt obligations and for paying dividends to stockholders and corporate expenses. For example, during 2000 and 2001, we received approximately $44.5 million and $7.2 million of dividends, respectively, from our insurance subsidiaries. We elected not to take any dividends from our insurance subsidiaries in 2002 and 2003. The payment of dividends by our insurance company subsidiaries is subject to regulatory restrictions and will depend on the surplus and future earnings of these subsidiaries, as well as the regulatory restrictions. During 2004, the maximum amount of dividends which can be paid without regulatory approval is approximately $197 million. As a result, in the future we may not be able to receive dividends from these subsidiaries at times and in amounts necessary to meet our obligations or pay dividends. WE ARE SUBJECT TO CERTAIN PROVISIONS THAT MAY HAVE THE EFFECT OF HINDERING, DELAYING OR PREVENTING THIRD PARTY TAKEOVERS, WHICH MAY PREVENT OUR SHAREHOLDERS FROM RECEIVING PREMIUM PRICES FOR THEIR SHARES IN AN UNSOLICITED TAKEOVER AND MAKE IT MORE DIFFICULT FOR THIRD PARTIES TO REPLACE OUR CURRENT MANAGEMENT. Provisions of our certificate of incorporation and by-laws, as well as our rights agreement and state insurance statutes, may hinder, delay or prevent unsolicited acquisitions or changes of our control. These provisions may also have the effect of making it more difficult for third parties to cause the replacement of our current management without the concurrence of our board of directors. These provisions include: - our classified board of directors and the ability of our board to increase its size and to appoint directors to fill newly created directorships; - the requirement that 80% of our stockholders must approve mergers and other transactions between us and the holder of 5% or more of our shares, unless the transaction was approved by our board of directors prior to such holder's acquisition of 5% of our shares; - the need for advance notice in order to raise business or make nominations at stockholders' meetings; - our rights agreement which subject persons (other than William R. Berkley) who acquire beneficial ownership of 15% or more of our common stock without board approval to substantial dilution; and - state insurance statutes that restrict the acquisition of control (generally defined as 5 - 10% of the outstanding shares) of an insurance company without regulatory approval. ITEM 2. PROPERTIES W. R. Berkley and its subsidiaries own or lease office buildings or office space suitable to conduct their operations. At December 31, 2003, the Company had aggregate office space of 1,155,539 square feet, of which 350,589 were owned and 804,950 were leased. Rental expense was approximately $18,773,000, $17,586,000 and $18,021,000 for 2003, 2002 and 2001, respectively. Future minimum lease payments (without provision for sublease income) are $14,583,000 in 2004; $12,503,000 in 2005; $10,103,000 in 2006; and $26,525,000 thereafter. ITEM 3. LEGAL PROCEEDINGS The Company's subsidiaries are subject to disputes, including litigation and arbitration, arising in the ordinary course of their insurance and reinsurance businesses. The Company's estimates of the costs of settling such matters are reflected in its aggregate reserves for losses and loss expenses, and the Company does not believe that the ultimate outcome of such matters, individually or in the aggregate, will have a material adverse effect on its financial condition or results of operations. 25 During 2003, two arbitration hearings in which subsidiaries of the Company were involved were completed. The Company recorded an increase in reserves for loss and loss expenses during the third quarter of 2003 of $15 million, which represents the excess of the Company's estimate of the ultimate cost of the disposition of these matters over amounts that were previously accrued. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted during the fourth quarter of 2003 to a vote of holders of the Company's Common Stock. 26 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our Common Stock is traded on the New York Stock Exchange under the symbol "BER". All amounts have been adjusted to reflect the 3-for-2 common stock splits effected on August 27, 2003 and July 2, 2002.
Common Price Range Dividends Paid ------------------- -------------- High Low Per Share -------- -------- -------------- 2003: Fourth Quarter $ 36.93 $ 31.55 $ .07 cash Third Quarter 36.01 31.27 $ .07 cash Second Quarter 35.73 27.83 $ .07 cash First Quarter 28.80 24.39 $ .07 cash 2002: Fourth Quarter $ 26.85 $ 20.76 $ .06 cash Third Quarter 24.93 19.93 $ .06 cash Second Quarter 27.20 23.98 $ .06 cash First Quarter 25.80 21.36 $ .06 cash
The closing price of the Common Stock on March 5, 2004, as reported on the New York Stock Exchange, was $42.46 per share. The approximate number of record holders of the Common Stock on March 5, 2004 was 585. 27 ITEM 6. SELECTED FINANCIAL DATA FOR THE FIVE YEARS ENDED DECEMBER 31, 2003
Year Ended December 31, ---------------------------------------------------------------------------- 2003 2002 2001 2000 1999 ------------ ------------ ------------ ------------ ------------ (Amounts in thousands, except per share data) Net premiums written $ 3,670,515 $ 2,710,490 $ 1,858,096 $ 1,506,244 $ 1,427,719 Premiums earned 3,234,610 2,252,527 1,680,469 1,491,014 1,414,384 Net investment income 210,056 187,875 195,021 210,448 190,316 Service fees 101,715 86,095 75,771 68,049 72,344 Realized investment gains (losses) 82,531 15,214 (12,252) 7,535 (5,683) Foreign currency gains (losses) (839) 21,856 758 829 (381) Total revenues 3,630,108 2,566,084 1,941,797 1,781,287 1,673,668 Interest expense 54,733 45,475 45,719 47,596 50,801 Income (loss) before income taxes 489,304 259,433 (151,394) 40,851 (79,248) Income tax (expense) benefit (150,626) (84,139) 56,661 (2,451) 45,766 Minority interest (1,458) (249) 3,187 (2,162) (566) Preferred dividends -- -- -- -- (497) Net income (loss) before change in accounting and extraordinary gain 337,220 175,045 (91,546) 36,238 (34,545) Cumulative effect of change in accounting -- -- -- -- (3,250) Extraordinary gain -- -- -- -- 735 Net income (loss) attributable to common stockholders 337,220 175,045 (91,546) 36,238 (37,060) Data per common share (1): Net income (loss) per basic share 4.06 2.29 (1.39) .63 (.64) Net income (loss) per diluted share 3.87 2.21 (1.39) .62 (.64) Stockholders' equity 20.14 16.12 12.45 11.79 10.27 Cash dividends declared $ .28 $ .24 $ .24 $ .24 $ .24 Weighted average shares outstanding: Basic 83,124 76,328 65,562 57,672 58,103 Diluted 87,063 79,385 68,750 58,481 58,337 Investments (2) $ 6,480,713 $ 4,663,100 $ 3,607,586 $ 3,112,540 $ 2,995,980 Total assets 9,334,685 7,031,323 5,633,509 5,022,070 4,784,791 Reserves for losses and loss expenses 4,192,091 3,167,925 2,763,850 2,475,805 2,340,890 Debt 659,208 362,985 370,554 370,158 394,792 Trust preferred securities 193,336 198,251 198,210 198,169 198,126 Stockholders' equity $ 1,682,562 $ 1,335,199 $ 931,595 $ 680,896 $ 591,778
(1) Adjusted to reflect the 3-for-2 common stock splits effected on August 27, 2003 and July 2, 2002. (2) Including trading account receivable from brokers and clearing organizations and trading account securities sold but not yet purchased. 28 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Reference is made to the information under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in the registrant's 2003 Annual Report to Stockholders, which information is incorporated herein by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Reference is made to the information under "Market Risk" under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in the registrant's 2003 Annual Report to Stockholders, which information is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements of the registrant are contained in the registrant's 2003 Annual Report to Stockholders and are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. 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 Exchange Act Rule 13a-14 as of the end of the period covered by this annual 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 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. 29 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The following information is provided as to the directors and executive officers of the Company as of March 10, 2004:
Name Age Position ---- --- -------- William R. Berkley 58 Chairman of the Board, Chief Executive Officer, President and Chief Operating Officer Eugene G. Ballard 51 Senior Vice President - Chief Financial Officer and Treasurer William R. Berkley, Jr. 31 Senior Vice President - Specialty Operations, Director Robert P. Cole 53 Senior Vice President - Regional Operations Paul J. Hancock 42 Senior Vice President - Chief Corporate Actuary Robert C. Hewitt 43 Senior Vice President - Alternative Markets Operations Robert W. Gosselink 50 Senior Vice President - Insurance Risk Management Ira S. Lederman 50 Senior Vice President - General Counsel and Secretary James W. McCleary 57 Senior Vice President - Reinsurance Operations James G. Shiel 44 Senior Vice President - Investments Clement P. Patafio 39 Vice President - Corporate Controller Philip J. Ablove 63 Director Ronald E. Blaylock 44 Director Mark E. Brockbank 51 Director George G. Daly 63 Director Richard G. Merrill 73 Director Jack H. Nusbaum 63 Director Mark L. Shapiro 59 Director
As permitted by Delaware law, the Board of Directors of the Company is divided into three classes, the classes being divided as equally as possible and each class having a term of three years. Directors generally serve until their respective successors are elected at the annual meeting of stockholders which ends their term. None of the Company's directors has any family relationship with any other director or executive officer, except William R. Berkley, Jr. is the son of William R. Berkley. Each year the term of office of one class expires. In May 2003, the term of a class consisting of three directors expired. William R. Berkley, George G. Daly and Philip J. Ablove were elected as directors to hold office for a term of three years until the Annual Meeting of Stockholders in 2006 and until their successors are duly elected and qualify. William R. Berkley has been Chairman of the Board and Chief Executive Officer of the Company since its formation in 1967. He also currently serves as President and Chief Operating Officer, a position which he has held since March 1, 2000 and has held at various times from 1967 to 1995. Mr. Berkley also serves as Chairman of the Board or director of a number of public and private companies. These include Associated Community Bancorp, Inc. and its Connecticut Community Bank, N.A. subsidiary, FLOORgraphics, Inc.; Interlaken Capital, Inc.; Strategic Distribution, Inc.; The First Marblehead Corporation and W. R. Berkley Corporation Charitable Foundation. Mr. Berkley's current term as a director expires in 2006. Eugene G. Ballard has been Senior Vice President - Chief Financial Officer and Treasurer of the Company since June 1, 1999. Before joining the Company, Mr. Ballard was Executive Vice President and Chief Financial Officer of GRE Insurance Group, New York, New York since 1995. William R. Berkley, Jr. has been a Director of the Company since 2001, Senior Vice President - Specialty Operations since January 2003 and Vice Chairman of Berkley International, LLC since May 2002. He was Senior Vice President of the Company from January 2002 to January 2003 and Vice President from May 2000 to January 2002. Mr. Berkley joined the Company in September 1997. Mr. Berkley was President of Berkley International, LLC from January 2001 to May 2002, and was its Executive Vice President from March 2000 to January 2001. From July 1995 to August 1997, he served in the Corporate Finance Department of Merrill Lynch Investment Company. Mr. Berkley is also a director of Associated Community Bancorp, Inc. and its Connecticut Community Bank, N.A. subsidiary; Interlaken Capital, Inc.; LD Realty Advisors LLC; Strategic Distribution, Inc.; and W. R. Berkley Corporation Charitable Foundation. Mr. Berkley's current term as director expires in 2004. 30 Robert P. Cole has been Senior Vice President of the Company since January 1998. Prior thereto, he was Vice President since October 1996. Before joining the Company, Mr. Cole was, since 1992, a senior Officer of Christania General Insurance Corp. of New York, which was purchased by Folksamerica Reinsurance Company in 1996. He has been in the insurance/reinsurance business for more than 25 years. Paul J. Hancock has been Senior Vice President - Chief Corporate Actuary of the Company since January 2002. He joined the Company in 1997 and most recently served as a Vice President in the actuarial department. Mr. Hancock came to the Company from Berkley Insurance Company, a subsidiary of the Company, where he was Vice President - Actuarial Manager. Robert C. Hewitt has been Senior Vice President - Alternative Markets of the Company since January 2004. Prior thereto, Mr. Hewitt was Senior Vice President-Risk Management from January 2002. Before joining the Company, Mr. Hewitt was a Senior Vice President for Benfield Blanch Inc. (and its predecessor, E. W. Blanch Co., Inc.), where he served from 1986 - 2002 and managed its New York City office since 1995. Mr. Hewitt has over 20 years of experience in the reinsurance and insurance industries. Robert W. Gosselink has been Senior Vice President - Insurance Risk Management of the Company since October 2003. Before joining the Company, Mr. Gosselink was Senior Vice President and Manager, Ceded Reinsurance and Portfolio Management for XL Global Services since 2001; and Senior Vice President XL America from 1999 to 2001, both subsidiaries of XL Capital Ltd. Mr. Gosselink held various positions in treaty underwriting and risk management since 1990 when he joined NAC Reinsurance Corporation, which was acquired by XL Capital Ltd. in 1999. Ira S. Lederman has been Senior Vice President - since January 1997 and General Counsel and Corporate Secretary of the Company since November 2001. Additionally, he has been General Counsel of Berkley International, LLC since January 1998. Previously, Mr. Lederman was General Counsel - Insurance Operations from August 2000, Assistant Secretary from May 1986, Assistant General Counsel from July 1989 until August 2000 and Vice President from May 1986 until January 1997. Prior thereto, Mr. Lederman was Insurance Counsel of the Company since May 1986 and Associate Counsel from April 1983. James W. McCleary has been Senior Vice President - Reinsurance Operations of the Company since August 2001. Mr. McCleary has served as President of Facultative ReSources, Inc., a Berkley subsidiary, since 1990 and chief underwriting officer since its inception. Mr. McCleary has over 30 years of experience in the reinsurance sector. James G. Shiel has been Senior Vice President - Investments of the Company since January 1997. Prior thereto, he was Vice President - Investments of the Company since January 1992. Since February 1994, Mr. Shiel has been President of Berkley Dean & Company, Inc., a subsidiary of the Company, which he joined in 1987. Clement P. Patafio has been Vice President - Corporate Controller of the Company since January 1997. Prior thereto, he was Assistant Vice President - Corporate Controller since July 1994 and Assistant Controller since May 1993. Before joining the Company, Mr. Patafio was with KPMG LLP from 1986 to 1993. Philip J. Ablove has been a director of the Company since August 2002. Mr. Ablove was Executive Vice President and Chief Financial Officer of Pioneer Companies, Inc. from March 1996 to December 2002 when he retired. He was Senior Vice President and Chief Financial Officer of W. R. Berkley Corporation from July 1973 until April 1983. Mr. Ablove's current term as a director expires in 2006. Ronald E. Blaylock has been a director of the Company since 2001. Mr. Blaylock is the Founder, Chairman and Chief Executive Officer of Blaylock & Partners, L.P., an investment banking firm. He held senior management positions with PaineWebber Group and Citicorp before launching Blaylock & Partners in 1993. Mr. Blaylock is also a director of Radio One, Inc. Mr. Blaylock's current term as director expires in 2004. Mark E. Brockbank retired, has been a director of the Company since 2001. Mr. Brockbank served from 1995 to 2000 as Chief Executive of XL Brockbank LTD, an underwriting management agency at Lloyd's of London. He was a founder of the predecessor firm of XL Brockbank LTD and was a director of XL Brockbank LTD from 1983 to 2000. Mr. Brockbank's current term as a director expires in 2004. George G. Daly has been a director of the Company since 1998. Dr. Daly is Fingerhut Professor and Dean Emeritus Stern School of Business, New York University since August 2002. Previously, he was Dean of Stern School of Business, and Dean Richard R. West Professor of Business, New York University for more than five years. In addition to his academic career, Dr. Daly served as Chief Economist at the U.S. Office of Energy Research and Development in 1974. Dr. Daly also serves as a director of The First Marblehead Corporation. Dr. Daly's current term as a director expires in 2006. 31 Richard G. Merrill has been a director of the Company since 1994. Mr. Merrill was Executive Vice President of Prudential Insurance Company of America from August 1987 to March 1991 when he retired. Prior thereto, he served as Chairman and President of Prudential Asset Management Company since 1985. Mr. Merrill is also a director of Sysco Corporation. Mr. Merrill's current term as a director expires in 2005. Jack H. Nusbaum has been a director of the Company since 1967. Mr. Nusbaum is the Chairman of the New York law firm of Willkie Farr & Gallagher LLP where he has been a partner for more than the last five years. He is also a director of Strategic Distribution, Inc. and The Topps Company, Inc. Mr. Nusbaum's current term as a director expires in 2005. Mark L. Shapiro has been a director of the Company since 1974. Since September 1998, Mr. Shapiro has been a private investor. From July 1997 through August 1998, Mr. Shapiro was a Senior Consultant to the Export-Import Bank of the United States. Previously, he was a Managing Director in the investment banking firm of Schroder & Co. Inc. for more than the past five years. Mr. Shapiro's current term as a director expires in 2005. ITEM 11. EXECUTIVE COMPENSATION Reference is made to the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2003, and which is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (a) Security ownership of certain beneficial owners Reference is made to the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2003, and which is incorporated herein by reference. (b) Security ownership of management Reference is made to the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2003, and which is incorporated herein by reference. (c) Changes in control Reference is made to the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2003, and which is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Reference is made to the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2003, and which is incorporated herein by reference. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES Reference is made to the registrant's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 2003, and which is incorporated herein by reference. 32 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Index to Financial Statements The Management's Discussion and Analysis of Financial Condition and Results of Operations, and the Company's financial statements, together with the report thereon of KPMG LLP, appear in the Company's 2003 Annual Report to Stockholders and are incorporated by reference in this Annual Report on Form 10-K. With the exception of the aforementioned information, the 2003 Annual Report to Stockholders is not deemed to be filed as part of this report. The schedules to the financial statements listed below should be read in conjunction with the financial statements in such 2003 Annual Report to Stockholders. Financial statement schedules not included in this Annual Report on Form 10-K have been omitted because they are not applicable or required information is shown in the financial statements or notes thereto.
Page Index to Financial Statement Schedules Independent Auditors' Report on Schedules and Consent 39 Schedule II - Condensed Financial Information of Registrant 40 Schedule III - Supplementary Insurance Information 44 Schedule IV - Reinsurance 45 Schedule VI - Supplementary Information concerning Property & Casualty Insurance Operations 46
(b) Reports on Form 8-K None (c) Exhibits The exhibits filed as part of this report are listed on pages 36 and 37 hereof. 33 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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 /s/ William R. Berkley By _______________________________ William R. Berkley, Chairman of the Board and Chief Executive Officer March 12, 2004 34 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date --------- ----- ---- /s/ William R. Berkley Chairman of the Board and - ----------------------------------------- Chief Executive Officer March 12, 2004 William R. Berkley Principal executive officer /s/ William R. Berkley, Jr. Director March 12, 2004 - ----------------------------------------- William R. Berkley, Jr. /s/ Philip J. Ablove Director March 12, 2004 - ----------------------------------------- Philip J. Ablove /s/ Ronald E. Blaylock Director March 12, 2004 - ----------------------------------------- Ronald E. Blaylock /s/ Mark E. Brockbank Director March 12, 2004 - ----------------------------------------- Mark E. Brockbank /s/ George G. Daly Director March 12, 2004 - ----------------------------------------- George G. Daly /s/ Richard G. Merrill Director March 12, 2004 - ----------------------------------------- Richard G. Merrill /s/ Jack H. Nusbaum Director March 12, 2004 - ----------------------------------------- Jack H. Nusbaum /s/ Mark L. Shapiro Director March 12, 2004 - ----------------------------------------- Mark L. Shapiro /s/ Eugene G. Ballard Senior Vice President, March 12, 2004 - ----------------------------------------- Chief Financial Officer and Eugene G. Ballard Treasurer Principal accounting officer /s/ Clement P. Patafio Vice President, March 12, 2004 - ----------------------------------------- Corporate Controller Clement P. Patafio
35 ITEM 14. (c) EXHIBITS Number (2.1) Agreement and Plan of Merger between the Company, Berkley Newco Corp. and MECC, Inc. (incorporated by reference to Exhibit 2.1 of the Company's Current Report on Form 8-K (File No. 0-7849) filed with the Commission on September 28, 1995.) (2.2) Agreement and Plan of Restructuring, dated July 20, 1995, by and among the Company, Signet Star Holdings, Inc., Signet Star Reinsurance Company, Signet Reinsurance Company and General Re Corporation (incorporated by reference to Exhibit 2.2 of the Company's Current Report on Form 8-K (File No. 0-7849) filed with the Commission on September 28, 1995). (3.1) Restated Certificate of Incorporation, as amended through May 19, 2003 (incorporated by reference to Exhibit 3.1 of the Company's Quarterly Report on Form 10-Q (File No. 1-15202) filed with the Commission on August 6, 2003). (3.2) Amendment, dated May 20, 2003, to the Company's Restated Certificate of Incorporation, as amended (incorporated by reference to Exhibit 3.2 of the Company's Quarterly Report on Form 10-K (File No. 1-15202) filed with the Commission on August 6, 2003). (3.3) Amended and Restated By-Laws (incorporated by reference to Exhibit 3(ii) of the Company's Current Report on Form 8-K (File No. 0-7849) filed with the Commission on May 11, 1999). (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 principal amount of the Company's 5.875% Senior Notes due 2013 (incorporated by reference to Exhibit 4.1 of the Company's Annual Report on Form 10-K (File No. 1-15202) filed with the Commission of March 31, 2003). (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 principal amount of the Company's 5.875% Senior Notes due 2013, including form of the Notes as Exhibit A (incorporated by reference to Exhibit 4.1 of the Company's Annual Report on Form 10-K (File No. 1-15202) filed with the Commission of March 31, 2003). (4.3) Second Supplemental Indenture, dated as of September 12, 2003, between the Company and The Bank of New York, as Trustee, relating to $150,000,000 principal amount of the Company's 5.125% Senior Notes due 2010, including form of the Notes as Exhibit A. (incorporated by reference to Exhibit 4.2 of the Company's Quarterly Report on Form 10-Q (File No. 1-15202) filed with the Commission on November 14, 2003). (4.4) The instruments defining the rights of holders of the other long term debt securities of the Company are omitted pursuant to Section (b)(4)(iii)(A) of Item 601 of Regulation S-K. The Company agrees to furnish supplementally copies of these instruments to the Commission upon request. (10.1) W. R. Berkley Corporation 2003 Stock Incentive Plan (incorporated by reference to Annex A of the Company's 2003 Proxy Statement (File No. 1-15202) filed with the Commission on April 14, 2003). (10.2) Form of Restricted Stock Unit Agreement (incorporated by reference to Exhibit 10.2 of the Company's Quarterly Report on Form 10-Q (File No. 1-15202) filed with the Commission on August 6, 2003). (10.3) The Company's lease dated June 3, 1983 with the Ahneman, Devaul and Devaul Partnership (incorporated by reference to Exhibit 10.3 of the Company's Registration Statement on Form S-1 (File No. 2-98396) filed with the Commission on June 14, 1985). (10.4) W. R. Berkley Corporation Deferred Compensation Plan for Officers as amended January 1, 1991 (incorporated by reference to Exhibit 10.4 of the Company's Annual Report on Form 10-K (File No. 0-7849) filed with the Commission on March 26, 1996). 36 (10.5) W. R. Berkley Corporation Deferred Compensation Plan for Directors as adopted March 7, 1996 (incorporated by reference to Exhibit 10.5 of the Company's Annual Report on Form 10-K (File No. 0-7849) filed with the Commission on March 26, 1996). (10.6) W. R. Berkley Corporation Annual Incentive Compensation Plan (incorporated by reference to Annex A of the Company's 2002 Proxy Statement (File No. 1-15202) filed with the Commission on April 5, 2002). (10.7) W. R. Berkley Corporation Long Term Incentive Compensation Plan (incorporated by reference to Exhibit 10.8 of the Company's Annual Report on Form 10-K (File No. 0-7849) filed with the Commission on March 27, 1998). (10.8) 1997 Directors Stock Plan, as Amended and Restated as of May 11, 1999 (incorporated by reference to Exhibit 10.2 of the Company's Quarterly Report on Form 10-Q (File No. 0-7849) filed with the Commission on August 11, 1999). (13) Portions of the 2003 Annual Report to Stockholders of W. R. Berkley Corporation that are incorporated by reference in this Report on Form 10-K (filed herewith). 37 (21) Following is a list of the Company's significant subsidiaries and other operating entities. Subsidiaries of subsidiaries are indented and the parent of each such corporation owns 100% of the outstanding voting securities of such corporation except as noted below.
Percentage Jurisdiction of owned Incorporation by the Company(1) ---------------- ----------------- Berkley International, LLC(2) New York 65% Carolina Casualty Insurance Company Florida 100% Clermont Specialty Managers, Ltd. New Jersey 100% J/I Holding Corporation: Delaware 100% Admiral Insurance Company: Delaware 100% Admiral Indemnity Company Delaware 100% Berkley London Holdings, Inc.(3) Delaware 100% W. R. Berkley London Finance, Limited United Kingdom 80% W. R. Berkley London Holdings, Limited United Kingdom 80% W. R. Berkley Insurance (Europe), Limited United Kingdom 80% Berkley Risk Administrators Company, LLC Minnesota 100% Nautilus Insurance Company: Arizona 100% Great Divide Insurance Company North Dakota 100% Key Risk Management Services, Inc. North Carolina 100% Monitor Liability Managers, Inc. Delaware 100% Monitor Surety Managers, Inc. Delaware 100% Signet Star Holdings, Inc.: Delaware 100% Berkley Insurance Company Delaware 100% Berkley Regional Insurance Company Delaware 100% Acadia Insurance Company Maine 100% Chesapeake Bay Property and Casualty Insurance Company Maine 100% Berkley Insurance Company of the Carolinas North Carolina 100% Continental Western Insurance Company Iowa 100% Firemen's Insurance Company of Washington, D.C. Delaware 100% Great River Insurance Company Mississippi 100% Tri-State Insurance Company of Minnesota Minnesota 100% Union Insurance Company Nebraska 100% Union Standard Insurance Company Oklahoma 100% Key Risk Insurance Company North Carolina 100% Midwest Employers Casualty Company: Delaware 100% Preferred Employers Insurance Company California 100% Facultative ReSources, Inc. Connecticut 100% Gemini Insurance Company Delaware 100% Nonprofits Insurance Company Minnesota 100% Riverport Insurance Company of California California 100% StarNet Insurance Company Delaware 100%
1) W. R. Berkley Corporation is the ultimate parent. The subsidiary of a direct parent in indicated by an indentation, and its percentage ownership is as indicated in this column. 2) Owned by W. R. Berkley Corporation and its subsidiaries as follows: W. R. Berkley Corporation (1%), Admiral Insurance Company (25%), Berkley Regional Insurance Company (10%), Nautilus Insurance Company (5%) and Berkley Insurance Company (24%). 3) Owned by Admiral Insurance Company (66.67%) and Berkley Insurance Company (33.33%) (23) Independent Auditors' Report on Schedules and Consent (31.1) Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/ 15d-14(a). (31.2) Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/ 15d-14(a). (32.1)Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 38 INDEPENDENT AUDITORS' REPORT ON SCHEDULES AND CONSENT Board of Directors and Stockholders W. R. Berkley Corporation The audits referred to in our report dated February 11, 2004, incorporated by reference in the Form 10-K, included the related financial statement schedules as of December 31, 2003, and for each of the years in the three-year period ended December 31, 2003. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein. As discussed in Note 1 to the consolidated financial statements, the Company has changed its method of accounting for goodwill in 2002. We consent to the use of our reports incorporated by reference in the Registration Statements, (No. 333-109621) and (No. 333-00459)on Form S-3 and (No. 333-33935), (No. 33-88640) and (No. 33-55726) on Form S-8 of W. R. Berkley Corporation. KPMG LLP New York, New York March 12, 2004 39 Schedule II W. R. Berkley Corporation Condensed Financial Information of Registrant Balance Sheets (Parent Company) (Amounts in thousands)
December 31, --------------------------- 2003 2002 ------------ ------------ Assets Cash and cash equivalents $ 69,864 $ 30,349 Fixed maturity securities: Available for sale at fair value (cost $64 and $24,232) 64 26,016 Equity securities, at fair value: Available for sale (cost $493 and $691) 513 763 Trading account (cost $920 and $909) 920 909 Investments in subsidiaries 2,420,911 1,810,572 Due from subsidiaries 43,203 690 Deferred Federal income taxes 39,278 28,557 Real estate, furniture & equipment at cost, less accumulated depreciation 8,466 7,979 Other assets 2,586 2,080 ------------ ------------ $ 2,585,805 $ 1,907,915 ============ ============ Liabilities, Debt and Stockholders' Equity Liabilities: Other liabilities 62,446 47,273 Debt 647,461 327,192 Trust preferred securities 193,336 198,251 ------------ ------------ 903,243 572,716 ------------ ------------ Stockholders' equity: Preferred stock -- -- Common stock 20,901 20,901 Additional paid-in capital 820,388 816,223 Retained earnings (including accumulated undistributed net income of subsidiaries of $968,965 and $574,717 in 2003 and 2002, respectively) 939,911 623,651 Accumulated other comprehensive income 119,977 104,603 Treasury stock, at cost (218,615) (230,179) ------------ ------------ 1,682,562 1,335,199 ------------ ------------ $ 2,585,805 $ 1,907,915 ============ ============
See note to condensed financial statements. 40 Schedule II, Continued W. R. Berkley Corporation Condensed Financial Information of Registrant, Continued Statements of Operations (Parent Company) (Amounts in thousands)
Years ended December 31, -------------------------------------- 2003 2002 2001 ---------- ---------- ---------- Management fees and investment income from affiliates, including dividends of $7,210, for 2001 $ 5,885 $ 5,470 $ 12,550 Realized investment gains (losses) 1,540 (867) (221) Other income 2,359 2,924 4,678 ---------- ---------- ---------- Total revenues 9,784 7,527 17,007 Expenses, other than interest expense 44,476 39,349 21,607 Interest expense 56,009 44,546 44,690 ---------- ---------- ---------- Loss before Federal income taxes (90,701) (76,368) (49,290) ---------- ---------- ---------- Federal income taxes: Federal income taxes (benefit) expense by subsidiaries on a separate return basis 185,342 106,145 (42,357) Federal income tax benefit (expense) on a consolidated return basis (151,669) (77,438) 58,884 ---------- ---------- ---------- Net benefit 33,673 28,707 16,527 ---------- ---------- ---------- Loss before undistributed equity in net income (loss) of subsidiaries (57,028) (47,661) (32,763) Equity in undistributed net income (loss) of subsidiaries 394,248 222,706 (58,783) ---------- ---------- ---------- Net income (loss) attributable to common stockholders $ 337,220 $ 175,045 $ (91,546) ========== ========== ==========
See note to condensed financial statements. 41 Schedule II, Continued W. R. Berkley Corporation Condensed Financial Information of Registrant, Continued Statement of Cash Flows (Parent Company) (Amounts in thousands)
Years ended December 31, -------------------------------------- 2003 2002 2001 ---------- ---------- ---------- Cash flows from operating activities: Net income (loss) $ 337,220 $ 175,045 $ (91,546) Adjustments to reconcile net income to net cash flows provided by operating activities: Equity in undistributed net income of subsidiaries (394,248) (222,706) 58,783 Tax payments received from (paid) to subsidiaries 204,768 33,085 (9,668) Federal income taxes provided by subsidiaries on a separate return basis (185,341) (106,145) 42,357 Change in Federal income taxes (15,709) 59,082 (71,459) Realized investment losses (gains) (1,540) 867 221 Employee stock benefit plan 2,328 -- -- Other, net 20,391 28,415 (9,960) Increase in trading account securities (11) (6) (39) ---------- ---------- ---------- Net cash used in operating activities (32,142) (32,363) (81,311) ---------- ---------- ---------- Cash flow used in investing activities: Proceeds from sales, excluding trading account: Fixed maturity securities available for sale 26,246 32,695 11,221 Equity securities 198 -- -- Proceeds from maturities and prepayments of fixed maturity securities -- 3,473 4,114 Cost of purchases, excluding trading account: Fixed maturity securities (544) (28,811) (42,744) Equity securities -- (621) -- Cost of companies acquired -- (3,730) -- Investments in and advances to subsidiaries, net (251,255) (206,277) (112,805) Net additions to real estate, furniture & equipment (1,446) (6,597) (1,469) Other, net -- 628 (1) ---------- ---------- ---------- Net cash used in investing activities (226,801) (209,240) (141,684) ---------- ---------- ---------- Cash flows provided by financing activities: Net proceeds from stock offering -- 166,960 315,840 Net change in short-term debt -- -- (10,000) Purchase of treasury shares -- (72) (1,002) Cash dividends to common stockholders (27,681) (17,872) (14,707) Net proceeds from issuance of long-term debt 344,435 -- -- Retirement of debt (29,957) -- -- Net proceeds from stock options exercised 13,401 12,986 25,052 Other, net (1,740) -- 1,143 ---------- ---------- ---------- Net cash provided by financing activities 298,458 162,002 316,326 ---------- ---------- ---------- Net increase (decrease) in cash and cash equivalents 39,515 (79,601) 93,331 Cash and cash equivalents at beginning of year 30,349 109,950 16,619 ---------- ---------- ---------- Cash and cash equivalents at end of year $ 69,864 $ 30,349 $ 109,950 ========== ========== ==========
See note to condensed financial statements. 42 Schedule II, Continued W. R. Berkley Corporation Condensed Financial Information of Registrant, Continued December 31, 2003 Note to Condensed Financial Statements (Parent Company) The accompanying condensed financial statements should be read in conjunction with the notes to consolidated financial statements included elsewhere herein. Reclassifications have been made in the 2002 and 2001 financial statements as originally reported to conform them to the presentation of the 2003 financial statements. The Company files a consolidated federal tax return with the results of its domestic insurance subsidiaries included on a statutory basis. Under present Company policy, Federal income taxes payable by (or refundable to) subsidiary companies on a separate-return basis are paid to (or refunded by) W. R. Berkley Corporation, and the Company pays the tax due on a consolidated return basis. 43 Schedule III W. R. Berkley Corporation and Subsidiaries Supplementary Insurance Information December 31, 2003, 2002 and 2001 (Amounts in thousands)
Reserve for Deferred policy losses and Net acquisition loss Unearned Premiums investment cost expenses premiums earned income --------------- ------------ ------------ ------------ ------------ December 31, 2003 Specialty $ 141,442 $ 1,372,110 $ 667,106 $ 1,117,781 $ 70,232 Alternative markets 31,843 808,886 225,051 410,926 38,450 Reinsurance 87,602 1,112,276 440,759 760,558 52,622 Regional 119,961 775,166 517,451 880,597 43,368 International 24,476 29,544 7,528 64,748 6,173 Discontinued -- 94,109 -- -- -- Corporate and adjustments -- -- -- -- (789) ------------ ------------ ------------ ------------ ------------ Total $ 405,324 $ 4,192,091 $ 1,857,895 $ 3,234,610 $ 210,056 ============ ============ ============ ============ ============ December 31, 2002 Specialty $ 104,676 $ 988,761 $ 486,363 $ 772,696 $ 53,862 Alternative markets 24,720 634,620 184,800 235,558 37,641 Reinsurance 63,470 766,740 312,764 398,287 43,912 Regional 100,422 610,329 401,703 705,385 44,365 International 14,912 21,907 4,359 89,284 5,325 Discontinued -- 145,568 257 51,317 4,457 Corporate and adjustments -- -- -- -- (1,687) ------------ ------------ ------------ ------------ ------------ Total $ 308,200 $ 3,167,925 $ 1,390,246 $ 2,252,527 $ 187,875 ============ ============ ============ ============ ============ December 31, 2001 Specialty $ 73,731 $ 810,865 $ 312,242 $ 428,058 $ 41,021 Alternative markets 9,763 448,762 61,146 123,173 37,765 Reinsurance 17,379 624,981 93,691 209,938 40,905 Regional 78,708 613,805 327,006 555,750 51,640 International 29,477 35,667 23,765 140,909 13,993 Discontinued 15,052 229,770 61,790 222,641 9,762 Corporate and adjustments -- -- -- -- (65) ------------ ------------ ------------ ------------ ------------ Total $ 224,110 $ 2,763,850 $ 879,640 $ 1,680,469 $ 195,021 ============ ============ ============ ============ ============ Amortization of Loss and deferred policy Other Loss acquisition operating cost Net premiums expenses costs and expenses written ------------ --------------- --------------- ------------ December 31, 2003 Specialty $ 707,711 $ 236,654 $ 41,763 $ 1,295,570 Alternative markets 281,967 90,815 92,912 482,389 Reinsurance 529,092 201,694 22,410 861,457 Regional 496,156 233,339 41,177 963,988 International 35,251 24,665 7,668 67,111 Discontinued -- -- -- -- Corporate and adjustments -- -- 42,797 -- ------------ ------------ ------------ ------------ Total $ 2,050,177 $ 787,167 $ 248,727 $ 3,670,515 ============ ============ ============ ============ December 31, 2002 Specialty $ 492,160 $ 156,441 $ 41,845 $ 939,929 Alternative markets 157,186 57,668 81,737 305,357 Reinsurance 298,719 125,549 623 601,969 Regional 416,815 201,382 27,469 776,577 International 48,419 41,220 6,727 79,313 Discontinued 50,672 7,733 8,051 7,345 Corporate and adjustments -- -- 40,760 -- ------------ ------------ ------------ ------------ Total $ 1,463,971 $ 589,993 $ 207,212 $ 2,710,490 ============ ============ ============ ============ December 31, 2001 Specialty $ 304,056 $ 93,372 $ 38,125 $ 567,714 Alternative markets 94,258 30,653 74,785 151,942 Reinsurance 229,515 79,896 516 196,572 Regional 373,647 167,681 26,955 598,149 International 86,582 52,853 4,328 150,090 Discontinued 292,442 67,610 5,831 193,629 Corporate and adjustments -- -- 21,171 -- ------------ ------------ ------------ ------------ Total $ 1,380,500 $ 492,065 $ 171,711 $ 1,858,096 ============ ============ ============ ============
44 Schedule IV W. R. Berkley Corporation and Subsidiaries Reinsurance Years ended December 31, 2003, 2002 and 2001 (Amounts in thousands)
Assumed Percentage Ceded from of amount Direct to other other Net assumed to amount companies companies amount net ---------- ---------- ---------- ---------- ---------- Premiums written: Year ended December 31, 2003: Specialty $1,396,825 $ 132,647 $ 31,392 $1,295,570 2.4% Alternative markets 517,095 74,649 39,943 482,389 8.3 Reinsurance 86,629 169,697 944,525 861,457 109.6 Regional 1,122,630 190,785 32,143 963,988 3.3 International 72,232 5,121 -- 67,111 -- Discontinued -- -- -- -- -- ---------- ---------- ---------- ---------- Total $3,195,411 $ 572,899 $1,048,003 $3,670,515 28.6% ========== ========== ========== ========== Year ended December 31, 2002: Specialty $1,003,739 $ 87,747 $ 23,937 $ 939,929 2.5 Alternative markets 309,437 43,597 39,517 305,357 12.9 Reinsurance 97,040 167,859 672,788 601,969 111.8 Regional 939,927 178,573 15,223 776,577 2.0 International 87,265 7,952 -- 79,313 -- Discontinued 13,229 12,010 6,126 7,345 83.4 ---------- ---------- ---------- ---------- Total $2,450,637 $ 497,738 $ 757,591 $2,710,490 28.0% ========== ========== ========== ========== Year ended December 31, 2001: Specialty $ 645,060 $ 90,485 $ 13,139 $ 567,714 2.3 Alternative markets 144,687 17,497 24,752 151,942 16.3 Reinsurance 41,348 88,975 244,199 196,572 124.2 Regional 698,114 106,852 6,887 598,149 1.2 International 170,600 20,510 -- 150,090 -- Discontinued 135,702 26,051 83,978 193,629 43.4 ---------- ---------- ---------- ---------- Total $1,835,511 $ 350,370 $ 372,955 $1,858,096 20.1% ========== ========== ========== ==========
45 Schedule VI W. R. Berkley Corporation and Subsidiaries Supplementary Information Concerning Property-Casualty Insurance Operations December 31, 2003, 2002 and 2001 (Amounts in thousands)
2003 2002 2001 Deferred policy acquisition costs $ 405,324 $ 308,200 $ 224,110 Reserves for losses and loss expenses 4,192,091 3,167,925 2,763,850 Unearned premium 1,857,895 1,390,246 879,640 Premiums earned 3,234,610 2,252,527 1,680,469 Net investment income 210,056 187,875 195,021 Losses and loss expenses incurred: Current Year 1,780,905 1,288,071 1,140,622 Prior Years 272,850 173,732 211,344 Net decrease (increase) in discount from prior years (4,099) (4,549) 8,717 Amortization of deferred policy acquisition costs 787,167 589,993 492,065 Paid losses and loss expenses 867,602 1,167,306 1,145,439 Net premiums written 3,670,515 2,710,490 1,858,096
46 EX-13 3 y95088exv13.txt MD&A MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW W. R. Berkley Corporation is an insurance holding company that provides, through its subsidiaries, commercial property casualty insurance products and services. The Company's primary sources of revenues and earnings are insurance and investments. The profitability of the Company's insurance business is affected primarily by the adequacy of premium rates. The ultimate adequacy of premium rates is not known at the time a property casualty insurance policy is issued because premiums are usually determined long before claims are reported. The ultimate adequacy of premium rates is affected mainly by the severity and frequency of claims, which are influenced by many factors, including natural and other disasters, regulatory measures and court decisions that define and expand the extent of coverage and the effects of economic inflation on the amount of compensation due for injuries or losses. General insurance prices are also influenced by the available insurance capacity, i.e., the level of policyholders' surplus employed in the industry and the industry's willingness to deploy that capital. The Company's invested assets, which are derived from its own capital and cash flow from insurance business, are invested principally in fixed income securities. The return on invested assets is affected primarily by general interest rates and the credit quality and duration of the investment portfolio. CRITICAL ACCOUNTING POLICIES Management considers policies relating to reserves for losses and loss expenses 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. In the property casualty insurance industry, significant periods of time may elapse between the occurrence of an insured loss, the report of the loss to the insurer and the insurer's payment of that loss. To recognize liabilities for unpaid losses, either known or unknown, insurers establish reserves, which is a balance sheet account representing estimates of future amounts needed to pay claims and related expenses with respect to insured events which have occurred. Our loss reserves reflect our best estimates of the cost of settling all such claims. In general, when a claim is reported, claims personnel establish a "case reserve" for the estimated amount of the ultimate payment. The estimate represents an informed judgment based on general reserving practices and reflects the experience and knowledge of the claims personnel regarding the nature and value of the specific type of claim. Reserves are also established on an aggregate basis which provide for losses incurred but not yet reported to the insurer, potential inadequacy of case reserves, the estimated expenses of settling claims, including legal and other fees and general expenses of administering the claims adjustment process, and a provision for potentially uncollectible reinsurance. Reserves are established based upon the then current legal interpretation of coverage provided. In examining reserve adequacy, several factors are considered in addition to the economic value of losses. These factors include historical data, legal developments, changes in social attitudes and economic conditions, including the effects of inflation. The actuarial process relies on the basic assumption that past experience, adjusted judgmentally for the effects of current developments and anticipated trends, is an appropriate basis for predicting future outcomes. Reserve amounts are necessarily based on management's informed estimates and judgments using data currently available. As additional experience and other data become available and are reviewed, these estimates and judgments are revised. This may result in increases or decreases to reserves for insured events of prior years. The reserving process implicitly recognizes the impact of inflation and other factors affecting loss costs by taking into account historical claim patterns and perceived trends. Reserves do not represent an exact calculation of liability. Rather, reserves represent an estimate of what management expects the ultimate settlement and claim administration will cost. While the methods for establishing the reserves are well tested over time, some of the major assumptions about anticipated loss emergence patterns are subject to unanticipated fluctuation. 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 inflation, judicial and litigation trends, reinsurance coverage and legislative changes. 1 The inherent uncertainties of estimating reserves are greater for certain types of liabilities, where long periods of time elapse before a definitive determination of liability is made. In periods with increased economic volatility, it becomes more difficult to accurately predict claim costs. 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 that its current reserves will prove adequate in light of subsequent events. Should the Company need to increase its reserves, its pre-tax income for the period would decrease by a corresponding amount. Each of the Company's major operating units has an actuarial staff that has primary responsibility for assessing loss reserves. The Company's corporate actuaries review the analyses prepared by its subsidiaries' actuaries and also perform their own loss reserve reviews for most units. In addition, for certain operating units, the Company engages independent actuaries to perform an annual review and evaluation of loss reserves. The actuaries use a variety of actuarial techniques and methods in estimating its ultimate liability for losses and loss expenses. These methods include paid loss development, incurred loss development, paid and incurred Bornhuetter-Ferguson methods and frequency and severity methods. This actuarial data is analyzed by line of business, coverage, and accident or policy year, as appropriate, for each operating unit. Industry loss experience is also used to supplement the Company's own data in selecting "tail factors" and in areas where the Company's own data is limited. For those operating units where the actuarial analysis has been substantially completed at the time the financial statements are prepared, the loss reserves included in the financial statements are based upon that analysis. For those operating units where the actuarial analysis requires additional time to complete, the Company accrues loss reserves based upon the most recent actuarially indicated loss ratios, adjusted as necessary to reflect known events or unusual claim activity since those indications were made. Management determines the loss reserves included in the Company's financial statements based on the actuarial estimates contained in the actuarial analyses. However, to the extent not already reflected in the actuarial analyses, management also considers qualitative factors that may affect the ultimate loss reserves, to determine its best estimate of the loss reserves. These qualitative considerations include, among others, the impact of re-underwriting initiatives, changes in the mix of business, changes in distribution sources and changes in terms and conditions. Examples of changes in terms and conditions that can have a significant impact on reserve levels are the use of aggregate policy limits, the expansion of coverage exclusions, whether or not defense costs are within policy limits and changes in deductibles and attachment points. Net losses and loss expenses for the years ended December 31, 2003, 2002 and 2001 included increases in estimates for claims occurring in prior years of $273,000,000, $174,000,000 and $211,000,000, respectively. The Company, along with the property casualty insurance industry in general, has experienced higher than expected loss costs for certain business written from 1998 to 2001. Following is a summary of increases in estimates for claims occurring in prior years for the indicated periods (dollars in thousands):
2003 2002 2001 ----------- ----------- ----------- Gross reserves for losses and loss expenses at beginning of year $ 3,168,000 $ 2,764,000 $ 2,476,000 Increase in estimates for claims occurring in prior years, net of ceded reinsurance: Reinsurance: Casualty lines $ 74,000 $ 47,000 $ 53,000 Property lines -- -- 15,000 Fidelity and surety 15,000 14,000 -- Specialty: Excess and surplus lines 62,000 30,000 24,000 Professional liability 35,000 31,000 12,000 Other 4,000 4,000 5,000 Alternative markets workers' compensation 41,000 34,000 (2,000) Regional 40,000 10,000 (4,000) International 2,000 4,000 5,000 Discontinued -- -- 103,000 ----------- ----------- ----------- Total $ 273,000 $ 174,000 $ 211,000 =========== =========== ===========
2 Reinsurance. In 2003 and 2002, the Company increased its estimates of the ultimate loss costs for casualty reinsurance risks written between 1998 and 2001 primarily as a result of higher than expected claims reported by ceding companies. A significant portion of the increase in estimates for claims occurring in prior years that was recognized in 2003 related to certain large accounts. The Company sets its initial loss estimates based principally upon information obtained during the underwriting process and adjusts these estimates as additional information becomes available. As certain large contracts have matured, the Company has adjusted its loss estimates upward to reflect the known loss experience and has revised its expectations regarding the level of ultimate losses to reflect a higher level of known losses as well as a pattern of delayed loss reporting by some ceding companies. The Company analyzes its treaty reinsurance business and sets reinsurance reserves each quarter on a treaty-by-treaty basis, rather than in the aggregate for the entire reinsurance business. The Company believes this method provides a better estimate of required reserves, as the Company is able to promptly identify changes in underlying trends experienced by individual ceding companies and adjusts its reserves as necessary. The increase in estimated ultimate loss costs for fidelity and surety reinsurance reflects the settlement of several large surety claims during 2003 and 2002, including arbitration resolutions. In addition, the Company has reserved for certain claims relating to financial guarantee exposures that were not intended to be covered under the Company's reinsurance policies. Specialty. The Company increased its estimates of ultimate costs for excess and surplus lines casualty business written in prior years to recognize certain recently identified trends in the development of losses and loss expenses. These trends include a substantial increase in legal expenses incurred in the defense of claims, in particular for claims with multiple claimants in multiple states. For some policies, the obligation to defend has caused the Company to incur aggregate legal expenses in excess of policy limits, which was unanticipated in both pricing and reserving these exposures. In addition, the Company identified certain recent changes in the claims reporting pattern that suggest that claim costs are emerging over a longer period of time and at a higher level than in the past. Prior year ultimate loss ratios were adjusted upwards to recognize the estimated impact of such trends. The increase in prior year reserves for the excess and surplus lines also reflects the cost of the disposition of a reinsurance arbitration. The increase in estimated ultimate loss costs for professional liability business written in prior years relates primarily to lawyers professional liability, liability coverage for senior living centers and employment practices liability. These lines have experienced a higher level of claim frequency and severity and a longer reporting pattern than anticipated when initial loss reserves were established. These lines also have a high incidence of litigated claims, and the reporting patterns have lengthened due to a more protracted and complex litigation environment. Alternative Markets. Ultimate loss costs for workers' compensation business written in prior years were impacted by a substantial increase in medical cost inflation. This resulted principally from increased utilization of the health care system by injured workers and more expensive and higher usage of prescription drugs. The impact of the increased medical cost trends is especially significant to the excess workers' compensation business because of the higher severity of claims and longer time period over which claims are paid. Regional. The increase in prior year reserves for the regional segment was primarily related to workers' compensation business, which experienced similar trends to those described under alternative markets. Environmental and asbestos. To date, known environmental and asbestos claims have not had a material impact on the Company's operations. These claims have not materially impacted the Company because its subsidiaries generally did not insure large industrial companies that are subject to significant environmental and asbestos exposures. The Company's net reserves for losses and loss adjustment expenses relating to asbestos and environmental claims were $31,866,000 and $28,509,000 at December 31, 2003 and 2002, respectively. The Company's gross reserves for losses and loss adjustment expenses relating to asbestos and environmental claims were $49,283,000 and $47,637,000 at December 31, 2003 and 2002, respectively. Net incurred losses and loss expenses (recoveries) for reported asbestos and environmental claims were approximately $4,749,000, $6,652,000 and $(4,503,000) in 2003, 2002 and 2001, respectively. Net paid losses and loss expenses were approximately $1,391,000, $2,938,000, and $125,000 in 2003, 2002 and 2001, respectively. The estimation of these liabilities is subject to significantly greater than normal variation and uncertainty because it is difficult to make an actuarial estimate of these liabilities due to the absence of a generally accepted actuarial methodology for these exposures and the potential effect of significant unresolved legal matters, including coverage issues as well as the cost of litigating the legal issues. Additionally, the determination of ultimate damages and the final allocation of such damages to financially responsible parties are highly uncertain. 3 Discounting. The Company discounts its liabilities for excess and assumed workers' compensation business because of the long period of time over which losses are paid. Discounting is intended to appropriately match losses and loss expenses to income earned on investment securities supporting the liabilities. The expected losses and loss expense payout pattern subject to discounting was derived from the Company's loss payout experience and is supplemented with data compiled from insurance companies writing similar business. The liabilities for losses and loss expenses have been discounted using risk-free discount rates determined by reference to the U.S. Treasury yield curve for non-proportional business, and at the statutory rate for proportional business. The discount rates range from 3.9% to 6.5% with a weighted average discount rate of 5.0%. For statutory purposes, the Company uses a discount rate of 4.2% as permitted by the Department of Insurance of the State of Delaware. The aggregate net discount, after reflecting the effects of ceded reinsurance, is $393,000,000, $293,000,000 and $243,000,000 at December 31, 2003, 2002 and 2001, respectively. The increase in the aggregate discount from 2002 to 2003 and from 2001 to 2002 resulted from the increase in workers' compensation reserves. 4 BUSINESS SEGMENT RESULTS Following is a summary of net premiums written, premiums earned, loss ratios (losses and loss expenses incurred expressed as a percentage of premiums earned), expense ratios (underwriting expenses expressed as a percentage of premiums earned) and combined ratios (sum of loss ratio and expense ratio) for each of our business segments for the years ended December 31, 2003, 2002 and 2001. The combined ratio represents a measure of underwriting profitability, excluding investment income. A combined ratio in excess of 100 indicates an underwriting loss; a number below 100 indicates an underwriting profit.
(DOLLARS IN THOUSANDS) 2003 2002 2001 ------------ ------------ ------------ SPECIALTY Net premiums written $ 1,295,570 $ 939,929 $ 567,714 Premiums earned 1,117,781 772,696 428,058 Loss ratio 63.3% 63.7% 71.0% Expense ratio 24.9% 25.7% 30.7% Combined ratio 88.2% 89.4% 101.7% ALTERNATIVE MARKETS Net premiums written $ 482,389 $ 305,357 $ 151,942 Premiums earned 410,926 235,558 123,173 Loss ratio 68.6% 66.7% 76.5% Expense ratio 24.6% 29.6% 32.9% Combined ratio 93.2% 96.3% 109.4% REINSURANCE Net premiums written $ 861,457 $ 601,969 $ 196,572 Premiums earned 760,558 398,287 209,938 Loss ratio 69.6% 75.0% 109.3% Expense ratio 29.5% 31.7% 38.3% Combined ratio 99.1% 106.7% 147.6% REGIONAL Net premiums written $ 963,988 $ 776,577 $ 598,149 Premiums earned 880,597 705,385 555,750 Loss ratio 56.3% 59.1% 67.2% Expense ratio 31.2% 32.4% 35.0% Combined ratio 87.5% 91.5% 102.2% INTERNATIONAL Net premiums written $ 67,111 $ 79,313 150,090 Premiums earned 64,748 89,284 140,909 Loss ratio 54.4% 54.2% 61.4% Expense ratio 42.3% 51.3% 40.6% Combined ratio 96.7% 105.5% 102.0% DISCONTINUED Net premiums written -- $ 7,345 $ 193,629 Premiums earned -- 51,317 222,641 Loss ratio -- 98.7% 131.4% Expense ratio -- 30.8% 33.0% Combined ratio -- 129.5% 164.4% CONSOLIDATED Net premiums written $ 3,670,515 $ 2,710,490 $ 1,858,096 Premiums earned 3,234,610 2,252,527 1,680,469 Loss ratio 63.4% 65.0% 82.1% Expense ratio 28.0% 30.4% 34.4% Combined ratio 91.4% 95.4% 116.5%
5 RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 The following table presents the Company's net income (loss) and net income (loss) per share for the years ended December 31, 2003, 2002 and 2001 (amounts in thousands, except per share data).
2003 2002 2001 -------- -------- --------- Net income (loss) $337,220 $175,045 $ (91,546) Weighted average diluted shares 87,063 79,385 68,750 Net income (loss) per diluted share $ 3.87 $ 2.21 $ (1.39)
The increase in net income in 2003 compared with 2002 reflects higher profits from underwriting activity as well as higher investment income and realized investment gains. The improvement in underwriting results reflects higher insurance prices, improved terms and conditions and growth in more profitable lines of business. The underwriting improvements were partially offset by additions to prior year loss reserves of $273 million in 2003 compared with additions to prior year loss reserves of $174 million in 2002 (see Critical Accounting Policies). The results for 2001 were impacted by additions to prior year loss reserves of $211 million, including $103 million for discontinued businesses, losses related to the World Trade Center attack of $35 million and surety losses related to the Enron bankruptcy of $18 million. NET PREMIUMS WRITTEN. Net premiums written were $3.7 billion in 2003, up 35% from 2002. In 2002, net premiums written were $2.7 billion, an increase of 46 % over 2001. The increases in net premiums written in 2003 and 2002 were a result of higher prices as well as new business. A summary of net premiums written in 2003 compared with 2002 by business segment follows: - Specialty premiums increased 38% to $1.3 billion in 2003 compared with $940 million in 2002 due to higher prices and new business. The increase in premiums included a 37% increase for the Company's three excess and surplus lines companies, a 16% increase for commercial transportation business and a 26% increase for Monitor Liability Managers, Inc., which specializes in directors and officers and lawyers professional liability business. Net premiums written in 2003 also include $23 million from the Company's medical excess underwriting unit, Berkley Medical Excess Underwriters, LLC, and $43 million from the Company's new London-based unit, W. R. Berkley Insurance (Europe), Limited. - Alternative markets premiums increased by 58% to $482 million in 2003 compared with $305 million in 2002. The increase included a 42% increase in excess workers' compensation business, a 95% increase in primary workers' compensation in California and a 34% increase in primary workers' compensation in other states. The increases generally reflect higher prices as well as new business. - Reinsurance premiums increased by 43% to $861 million in 2003 compared with $602 million in 2002. Net premiums written increased 104% to $286 million for facultative reinsurance, 27% to $218 million for reinsurance of certain Lloyd's syndicates, and 23% to $357 million for other treaty business. The increase in facultative net premiums written in 2003 includes $56 million from the Company's direct facultative underwriting unit, B F Re Underwriters, LLC. - Regional premiums increased by 24% to $964 million in 2003 compared with $777 million in 2002. The increase generally reflects higher prices across all four regional units. - International premiums decreased by 15% to $67 million in 2003 compared with $79 million in 2002. The decrease was a result of a lower exchanges rate for the Argentine peso and of lower life insurance premiums. NET PREMIUMS EARNED. Insurance premiums are earned ratably over the term of the policy. Net premiums earned increased 44% in 2003 compared with 2002 as a result of substantial growth in premiums written in 2003 and 2002. NET INVESTMENT INCOME. Net investment income increased 12% in 2003 compared with 2002. Average invested assets increased 37% compared with 2002 as a result of cash flow from operations and proceeds from a secondary stock offering in November 2002 and two debt offerings in 2003. The average yield on investments was 4.6% 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 cash equivalents and tax-exempt securities. REALIZED INVESTMENT GAINS AND LOSSES. Realized investment gains and losses result from sales of securities and from provisions for other than temporary impairment in securities. Realized investment gains of $83 million in 2003 and $15 million in 2002 resulted primarily from the sale of fixed income securities in order to decrease the duration of the portfolio and to increase the portion of the portfolio invested in municipal securities. Charges for the permanent impairment of investments were $0.4 million, $18.8 million and $26.6 million in 2003, 2002 and 2001, respectively. The charges in 2002 and 2001 included charges of $10.0 million and $18.0 million, respectively, related to the impairment of investments in Argentine sovereign bonds. 6 FOREIGN CURRENCY GAINS AND LOSSES. The Company reported a foreign currency loss of $0.8 million in 2003 and foreign currency gains of $21.9 million in 2002 and $0.8 million in 2001. The 2002 foreign currency gain related to the Company's operations in Argentina. This gain represented the net increase in the local currency value of assets and liabilities denominated in U.S. dollars following the devaluation of the Argentine peso. It also includes the gain from the negotiated settlement of certain U.S. dollar life insurance contracts for less than their local currency value following the devaluation of the Argentine peso. SERVICE FEES. The alternative markets segment offers fee-based services to help clients develop and administer self-insurance programs, primarily for workers compensation coverages. Service fees increased 18% in 2003 compared with 2002 primarily as a result of an increase in service fees for managing assigned risk plans in ten states. LOSSES AND LOSS EXPENSES. Losses and loss expenses increased 40% in 2003 compared with 2002 as a result of the increased premium volume. The consolidated loss ratio decreased to 91.4% in 2003 from 95.4% in 2002 primarily as a result of higher prices and improved terms and conditions. A summary of loss ratios in 2003 compared with 2002 by business segment follows: - Specialty's loss ratio was 63.3% in 2003 compared with 63.7% in 2002 as higher prices, more favorable terms and conditions and lower reinsurance costs were offset by an increase in prior year reserves, including the cost of the disposition of a reinsurance arbitration. - Alternative market's loss ratio was 68.6% in 2003 compared with 66.7% in 2002. The Company discounts its liabilities for excess workers' compensation business because of the long period of time over which losses are paid. The increase in the loss ratio in 2003 reflects a lower discount rate for current year business and an increase in prior year reserves. - The reinsurance loss ratio was 69.6% in 2003 compared with 75.0% in 2002. The decrease reflects the improved results for the current accident year as a result of higher prices for both treaty and facultative risks, which was partially offset by the impact of adverse reserve development on prior years. The 2003 and 2002 underwriting results also reflect loss recoveries under the Company's aggregate reinsurance agreement, which the Company terminated as of December 31, 2003. (See Note 10 of "Notes to Consolidated Financial Statements".) - The regional loss ratio decreased to 56.3% in 2003 from 59.1% in 2002 primarily as a result of higher prices in 2002 and 2003. Weather-related losses for the regional segment were $37.9 million in 2003 compared with $29.2 million in 2002. - The international loss ratio was 54.4% in 2003, nearly unchanged from 54.2% in 2002. - The discontinued segment consists of regional personal lines and alternative markets assumed reinsurance, both of which were discontinued in the fourth quarter of 2001. The discontinued segment reported a loss ratio of 131.4% in 2001, primarily as a result of reserve strengthening of $103 million. In 2002, the loss ratio was 98.7%, which represented the run-off of the remaining unearned premiums. There were no losses reported in 2003. OTHER OPERATING COSTS AND EXPENSES. Following is a summary of other operating costs and expenses for the years ended December 31, 2003, 2002 and 2001 (dollars in thousands):
2003 2002 2001 ---------- ---------- ---------- Underwriting expenses $ 905,349 $ 684,583 $ 577,658 Service company expenses 82,821 69,715 64,949 Other costs and expenses 47,724 42,907 21,169 ---------- ---------- ---------- Total $1,035,894 $ 797,205 $ 663,776 ========== ========== ==========
Underwriting expenses increased 32% in 2003 compared with 2002 as a result of higher premium volume. The consolidated expense ratio decreased to 28.0% in 2003 from 30.4% in 2002. The decrease is due to a 43.6% increase in earned premiums with no significant increase in underwriting expenses other than commissions and premium taxes. Service company expenses represent the costs associated with the alternative market's fee-based business. The increase in service expenses of 19% compared with 2002 was commensurate with the increase in service fee revenues of 18%. Other costs and expenses represent primarily general and administrative expenses for the corporate office. Other costs and expenses increased 11% to $48 million due to higher compensation costs and to start-up costs for new business ventures. INTEREST EXPENSE. Interest expense increased 20% to $55 million as a result of the issuance of $200 million of 5.875% senior notes in February 2003 and $150 million of 5.125% senior notes in September 2003. 7 RESTRUCTURING CHARGE. In 2001, the Company reported a restructuring charge of $3,196,000 in connection with its withdrawal from regional personal lines business and the reorganization of certain other operations. The Company reduced its permanent workforce by approximately 304 employees in connection with the plan. The charge consisted mainly of severance payments of $2,462,000 and contractual lease payments related to abandoned facilities. The activities under the plan were substantially completed in 2001. INCOME TAXES. The effective income tax rate was 31% in 2003, 32% in 2002 and 37% in 2001. The effective tax rate differs from the federal income tax rate of 35% primarily because of tax-exempt investment income. The decrease in the effective rate in 2003 compared with 2002 reflects a higher level of tax-exempt securities. LIQUIDITY AND CAPITAL RESOURCES CASH FLOW. Cash flow provided from operating activities was $1,398 million in 2003, $953 million in 2002 and $153 million in 2001. The increase in cash flow in 2003 was primarily due to a higher level of premium collections and a lower paid loss ratio (paid losses expressed as a percentage of premium earned). As a holding company, the Company derives cash from its subsidiaries in the form of dividends, tax payments and management fees. The Company uses cash to pay debt service, Federal income taxes, operating expenses and dividends. The Company also provides capital to its subsidiaries. Tax payments and management fees from the insurance subsidiaries are made under agreements that generally are subject to approval by state insurance departments. Maximum amounts of dividends that can be paid without regulatory approval are prescribed by statute. (See Note 14 of "Notes to Consolidated Financial Statements.") The Company's subsidiaries are highly liquid, receiving substantial cash from premiums, investment income, service fees and proceeds from sales and maturities of portfolio investments. The principal outflows of cash are payments of claims, taxes, operating expenses and dividends. FINANCING ACTIVITY. In February 2003, the Company issued $200 million aggregate principal amount of 5.875% senior notes due February 2013. In September 2003, the Company issued $150 million aggregate principal amount of 5.125% senior notes due September 2010. In July 2003, a subsidiary of the Company issued $12 million aggregate principal amount of 7.65% notes due June 2023. During the first quarter of 2003, the Company repaid $35.8 million of 6.5% senior subordinated notes and $25 million of 6.71% senior notes upon their respective maturities. During the second quarter of 2003, the Company purchased $5.0 million (carrying value) of its trust preferred securities. At December 31, 2003, the Company's outstanding debt was $667 million (face amount). The maturities of the debt are $40 million in 2005, $100 million in 2006, $89 million in 2008, $150 million in 2010, $200 million in 2013, $76 million in 2022 and $12 million in 2023. The Company also has $195 million (face amount) of trust preferred securities that mature in 2045. At December 31, 2003, stockholders' equity was $1,683 million and total capitalization (stockholders' equity, debt and trust preferred securities) was $2,535 million. The percentage of the Company's capital attributable to debt and trust preferred securities was 34% at December 31, 2003, compared with 30% at December 31, 2002. INVESTMENTS. As part of its investment strategy, the Company establishes a level of cash and highly liquid short-term and intermediate-term securities that, combined with expected cash flow, is believed adequate to meet foreseeable payment obligations. The Company also attempts to maintain 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 carrying value of the Company's investment portfolio as of December 31, 2003 and 2002 is as follows (dollars in thousands):
2003 2002 ----------- ----------- Cash and cash equivalents $ 1,431,466 $ 594,183 Fixed maturity securities 4,293,302 3,511,522 Equity securities available for sale 316,629 204,372 Equity securities trading account(a) 315,124 306,836 Investments in affiliates 126,772 46,187 Unsettled trades (2,580) -- ----------- ----------- Total $ 6,480,713 $ 4,663,100 =========== ===========
(a) Represents trading account equity securities plus trading account receivables from brokers and clearing organizations less trading account securities sold but not yet purchased. 8 FIXED MATURITIES. The Company's investment policy with respect to fixed maturity securities is generally to purchase instruments with the expectation of holding them to their maturity. However, active management of a portion of the portfolio is considered necessary to maintain an approximate matching of assets and liabilities as well as to adjust the portfolio as a result of changes in financial market conditions and tax considerations. At December 31, 2003, the fixed maturities portfolio mix was as follows: U.S. Government securities were 14% (20% in 2002); state and municipal securities were 46% (29% in 2002); corporate securities were 14% (19% in 2002); mortgage-backed securities were 21% (27% in 2002); and foreign bonds were 5% in 2003 and 2002. EQUITY SECURITIES AVAILABLE FOR SALE. Equity securities available for sale represent primarily investments in common and preferred stocks of publicly traded real estate investment trusts (REITs). EQUITY SECURITIES TRADING ACCOUNT. The trading account is comprised of direct investments in arbitrage securities and investments in arbitrage-related limited partnerships that specialize in merger arbitrage and convertible arbitrage strategies. Merger arbitrage is the business of investing in the securities of publicly held companies which are the targets in announced tender offers and mergers. Convertible arbitrage, is the business of investing in convertible securities with the goal of capitalizing on price differentials between these securities and their underlying equities. INVESTMENTS IN AFFILIATES. Investments in affiliates represent principally the Company's 20.1% interest in Kiln plc ($40.5 million in 2003 and $31.5 million in 2002) and the Company's interest in real estate partnerships ($57.6 million in 2003 and $10.8 million in 2002). SECURITIES IN AN UNREALIZED LOSS POSITION. The following table summarizes, for all securities in an unrealized loss position at December 31, 2003, the aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position (dollars in thousands):
GROSS UNREALIZED FAIR VALUE LOSS ---------- ---------- Fixed maturities: 0 - 6 months $578,934 $ 4,541 7- 12 months 21,124 437 Over 12 months 14,137 603 -------- -------- Total $614,195 $ 5,581 ======== ======== Equities securities available for sale: 0 - 6 months $ 3,215 $ 88 7- 12 months 9,345 401 Over 12 months 13,971 664 -------- -------- Total $ 26,531 $ 1,153 ======== ========
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 and interest rates. In addition, the Company's international businesses and securities are subject to currency exchange rate risk. As discussed above, 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 principal market risk for the Company's fixed maturity securities is interest rate risk. The Company uses various models and stress test scenarios to monitor and manage interest rate risk. The following table outlines the groups of fixed maturity securities and the components of the interest rate risk at December 31, 2003:
MARKET EFFECTIVE FAIR VALUE YIELD DURATION (000s) ------ --------- ---------- Cash and cash equivalents 1.13% .02 $1,431,466 U. S. Government securities 2.95 4.53 605,126 State and municipal 3.64 7.49 1,966,596 Corporate 4.10 4.33 592,262 Foreign 4.91 3.97 222,545 Mortgage-backed securities 4.54 2.81 925,574 ---- ---- ---------- Total 3.18% 4.10 $5,743,569 ==== ==== ==========
9 Duration is a common gauge of the price sensitivity of a fixed income portfolio to a change in interest rates. Based upon a pricing model, the Company determines the estimated change in fair value of the fixed maturity securities, assuming immediate parallel shifts in the treasury yield curve while keeping spreads between individual securities and treasury securities static. The fair value at specified levels at December 31, 2003 would be as follows:
ESTIMATED FAIR ESTIMATED VALUE OF FINANCIAL CHANGE IN INSTRUMENTS FAIR VALUE CHANGE IN INTEREST RATES (000s) (000s) ------------------------ ------------------- ------------ 300 basis point rise $ 5,109,479 $ (634,090) 200 basis point rise 5,318,545 (425,024) 100 basis point rise 5,540,247 (203,322) Base scenario 5,743,569 -- 100 basis point decline 5,969,866 226,297 200 basis point decline 6,230,624 487,055 300 basis point decline 6,515,505 771,936
The estimated changes in fair value, based upon the above table, would be partially offset by the Company's liabilities if they were marked to market. Arbitrage investing differs from other types of investments in its focus on transactions and events believed likely to bring about a change in value over a relatively short time period (usually four months or less). The Company believes that this makes arbitrage investments less vulnerable to changes in general stock market conditions. Potential changes in market conditions are also mitigated by the implementation of hedging strategies, including short sales. Additionally, the arbitrage positions are generally hedged against market declines by purchasing put options, selling call options or entering into swap contracts. The Company's merger arbitrage securities are primarily exposed to the completion of announced deals, which are subject to regulatory as well as political and other risks. FEDERAL AND FOREIGN INCOME TAXES The Company files a consolidated income tax return in the U. S. and foreign tax returns in the countries of its overseas operations. At December 31, 2003, the Company had a deferred tax asset, net of valuation allowance, of $273 million (which primarily relates to loss and loss expense reserves and unearned premium reserves) and a deferred tax liability of $237 million (which primarily relates to deferred policy acquisition costs, unrealized investment gains and intangible assets). The realization of the deferred tax asset is dependent upon the Company's ability to generate sufficient taxable income in future periods. Based on historical results and the prospects for future operations, management anticipates that it is more likely than not that future taxable income will be sufficient for the realization of this asset. REINSURANCE The Company follows the customary industry practice of reinsuring a portion of its exposures, paying to reinsurers a part of the premiums received on the policies it writes. Reinsurance is purchased by the Company principally to reduce its net liability on individual risks and to protect it against catastrophic losses. Although reinsurance does not legally discharge an insurer from its primary liability for the full amount of the policies, it does make the assuming reinsurer liable to the insurer to the extent of the reinsurance coverage. The Company monitors the financial condition of its reinsurers and attempts to place its coverages only with substantial, financially sound carriers. The largest net amounts retained by the Company for any one risk are: $5 million for Monitor Liability and Berkley Medical; $6 million for surety business; statutory limits for workers' compensation business; and up to $2 million for other lines of business. The Company also purchases facultative coverage, where appropriate, for exposures or limits falling outside its treaty protection. In addition, the Company's U. S. property catastrophe reinsurance provides protection for losses above $7.5 million up to $60 million. The Company's principal reinsurers for its 2004 reinsurance program are: Chubb Group, XL Capital, PartnerRe, Converium Group, Hannover Re and Allied World Assurance Company. From January 1, 2001 through December 31, 2003, the Company was reinsured under an aggregate reinsurance agreement that provided individual loss protection for certain lines of business and aggregate accident year protection for its reinsurance segment. The agreement contained annual and aggregate limits over loss recoveries as well as profit sharing provisions that enabled the Company to recover a portion of the reinsurance costs if certain profit conditions were met. The aggregate reinsurance agreement was commuted and settled on December 31, 2003. (See Note 10 of "Notes to Consolidated Financial Statements".) 10 CONTRACTUAL OBLIGATIONS Following is a summary of the Company's contractual obligations as of December 31, 2003 (amounts in thousands):
Payments Due By Period 2004 2005 2006 2007 2008 Thereafter - --------------------------------------------- -------- -------- -------- -------- -------- ---------- Long-term debt and trust preferred securities $ -- $ 40,000 $100,000 $ -- $ 88,800 $633,250 Operating lease obligations 14,583 12,503 10,103 7,331 5,537 13,657 Purchase obligations 15,346 18,597 2,475 19,980 18,122 800 Other long-term liabilities reflected on our consolidated balance sheet 1,850 2,975 4,325 2,075 3,250 1,425 -------- -------- -------- -------- -------- -------- Total $ 31,779 $ 74,075 $116,903 $ 29,386 $115,709 $649,132 ======== ======== ======== ======== ======== ========
As of December 31, 2003, the Company has non-cancelable operating lease obligations of approximately $63.7 million and contractual purchase commitments of approximately $75.3 million. The Company utilizes letters of credit to back certain payments and obligations. Outstanding letters of credit were $22.0 million as of December 31, 2003. The Company has made guarantees to state regulators that the statutory capital of certain subsidiaries will be maintained above certain minimum levels. In addition, the Company has commitments to invest up to $136.0 million in certain investment funds. The contractual obligations set forth in the above table do not include policyholder account balances of $53 million and liabilities for bank deposits of $31 million. OFF-BALANCE SHEET ARRANGEMENTS An off-balance sheet arrangement is any transaction, agreement or other contractual arrangement involving an unconsolidated entity under which a company has (1) made guarantees, (2) a retained or contingent interest in transferred assets, (3) an obligation under derivative instruments classified as equity or (4) any obligation arising out of a material variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the Company, or that engages in leasing, hedging or research and development arrangements with the Company. We have no arrangements of these types that we believe may have a material current or future effect on our financial condition, liquidity or results of operations. 11 CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except per share data)
YEARS ENDED DECEMBER 31, 2003 2002 2001 ----------- ----------- ----------- Revenues: Net premiums written $ 3,670,515 $ 2,710,490 $ 1,858,096 Change in net unearned premiums (435,905) (457,963) (177,627) ----------- ----------- ----------- Premiums earned 3,234,610 2,252,527 1,680,469 Net investment income 210,056 187,875 195,021 Service fees 101,715 86,095 75,771 Realized investment gains (losses) 82,531 15,214 (12,252) Foreign currency gains (losses) (839) 21,856 758 Other income 2,035 2,517 2,030 ----------- ----------- ----------- Total revenues 3,630,108 2,566,084 1,941,797 Operating costs and expenses: Losses and loss expenses 2,050,177 1,463,971 1,380,500 Other operating costs and expenses 1,035,894 797,205 663,776 Interest expense 54,733 45,475 45,719 Restructuring charge -- -- 3,196 ----------- ----------- ----------- Total expenses 3,140,804 2,306,651 2,093,191 Income (loss) before income taxes 489,304 259,433 (151,394) Income tax (expense) benefit (150,626) (84,139) 56,661 Minority interest (1,458) (249) 3,187 ----------- ----------- ----------- Net income (loss) $ 337,220 $ 175,045 $ (91,546) =========== =========== =========== Earnings (loss) per share: Basic $ 4.06 $ 2.29 $ (1.39) =========== =========== =========== Diluted $ 3.87 $ 2.21 $ (1.39) =========== =========== ===========
See accompanying notes to consolidated financial statements. 12 CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except per share data)
DECEMBER 31, 2003 2002 ----------- ----------- ASSETS Investments: Cash and cash equivalents $ 1,431,466 $ 594,183 Fixed maturity securities 4,293,302 3,511,522 Equity securities available for sale 316,629 204,372 Equity securities trading account 331,967 165,642 Investments in affiliates 126,772 46,187 ----------- ----------- Total Investments 6,500,136 4,521,906 ----------- ----------- Premiums and fees receivable 950,551 822,060 Due from reinsurers 804,962 734,687 Accrued investment income 54,313 46,334 Prepaid reinsurance premiums 193,693 164,284 Deferred policy acquisition costs 405,324 308,200 Real estate, furniture and equipment 143,792 135,488 Deferred Federal and foreign income taxes 35,813 20,585 Goodwill 59,021 59,021 Trading account receivable from brokers and clearing organizations 102,257 177,309 Other assets 84,823 41,449 ----------- ----------- Total Assets $ 9,334,685 $ 7,031,323 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Reserves for losses and loss expenses $ 4,192,091 $ 3,167,925 Unearned premiums 1,857,895 1,390,246 Due to reinsurers 123,226 184,912 Trading account securities sold but not yet purchased 119,100 36,115 Policyholders' account balances 53,405 42,707 Other liabilities 415,714 294,334 Debt 659,208 362,985 Trust preferred securities 193,336 198,251 ----------- ----------- Total Liabilities 7,613,975 5,677,475 ----------- ----------- Minority interest 38,148 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 150,000,000 shares, issued and outstanding, net of treasury shares, 83,537,740 and 82,835,172 shares 20,901 20,901 Additional paid-in capital 820,388 816,223 Retained earnings 939,911 623,651 Accumulated other comprehensive income 119,977 104,603 Treasury stock, at cost, 20,964,520 and 21,669,153 shares (218,615) (230,179) ----------- ----------- Total Stockholders' Equity 1,682,562 1,335,199 ----------- ----------- Total Liabilities and Stockholders' Equity $ 9,334,685 $ 7,031,323 =========== ===========
See accompanying notes to consolidated financial statements. 13 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Dollars in thousands, except per share data)
2003 2002 2001 --------- --------- --------- Years ended December 31, COMMON STOCK: Beginning of period $ 20,901 $ 19,487 $ 16,382 Issuance of common stock -- 1,414 3,105 --------- --------- --------- End of period 20,901 20,901 19,487 ========= ========= ========= ADDITIONAL PAID IN CAPITAL: Beginning of period $ 816,223 $ 648,440 $ 324,960 Issuance of common stock -- 165,546 312,735 Stock options exercised 2,015 2,237 10,745 Restricted stock units earned 1,927 -- -- Other 223 -- -- --------- --------- --------- End of period 820,388 816,223 648,440 ========= ========= ========= RETAINED EARNINGS: Beginning of period $ 623,651 $ 467,185 $ 574,345 Net income (loss) 337,220 175,045 (91,546) Eliminations of international reporting lag 1,776 -- -- Dividends to stockholders (22,736) (18,579) (15,614) --------- --------- --------- End of period 939,911 623,651 467,185 ========= ========= ========= ACCUMULATED OTHER COMPREHENSIVE INCOME: Unrealized investment gains: Beginning of period $ 114,664 $ 41,731 $ 23,545 Net change in period 6,143 72,933 18,186 --------- --------- --------- End of period 120,807 114,664 41,731 ========= ========= ========= Currency translation adjustments: Beginning of period $ (10,061) $ (4,391) $ (4,174) Net change in period 9,231 (5,670) (217) --------- --------- --------- End of period (830) (10,061) (4,391) ========= ========= ========= Total accumulated other comprehensive income 119,977 104,603 37,340 ========= ========= ========= TREASURY STOCK: Beginning of period $(230,179) $(240,857) $(254,162) Stock issued under stock option plan 11,386 10,749 14,307 Other 178 -- -- Purchase of common stock -- (71) (1,002) --------- --------- --------- End of period (218,615) (230,179) (240,857) ========= ========= =========
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Dollars in thousands)
2003 2002 2001 --------- --------- --------- Years ended December 31, Net income (loss) attributable to common stockholders $ 337,220 $ 175,045 $ (91,546) --------- --------- --------- Other comprehensive income (loss) Unrealized holding gains on investment securities arising during the period, net of income tax expense of $36,544, $37,964, and $7,328 59,477 94,266 15,299 Reclassification adjustment for realized (gains) losses included in net income (loss) (53,334) (21,333) 2,887 Change in unrealized foreign exchange gains (losses) 9,231 (5,670) (217) --------- --------- --------- Other comprehensive income 15,374 67,263 17,969 --------- --------- --------- Comprehensive income (loss) $ 352,594 $ 242,308 $ (73,577) ========= ========= =========
See accompanying notes to consolidated financial statements. 14 CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)
YEARS ENDED DECEMBER 31, 2003 2002 2001 ----------- ----------- ----------- Cash flows provided by operating activities: Net income (loss) $ 337,220 $ 175,045 $ (91,546) Adjustments to reconcile net income (loss) to net cash flows provided by operating activities: Realized investment and foreign currency (gains) losses (81,692) (37,070) 11,494 Depreciation and amortization 20,324 17,944 17,493 Minority interest 1,458 249 (3,187) Equity in undistributed earnings of affiliates (6,508) (690) 16 Employee stock benefit plan 2,328 -- -- Change in: Equity securities trading account (166,326) 45,649 135,980 Premiums and fees receivable (128,491) (278,372) (153,175) Due from reinsurers (70,275) (19,273) (1,656) Accrued investment income (7,979) (10,233) 53 Prepaid reinsurance premiums (29,409) (60,530) (4,223) Deferred policy acquisition cost (97,124) (84,090) (40,882) Deferred federal and foreign income taxes (38,769) 41,298 (61,360) Trading account receivable from brokers and clearing organizations 75,052 174,398 (82,263) Other assets (41,804) 5,884 (17,470) Reserves for losses and loss expenses 1,024,166 395,420 335,276 Unearned premiums 467,649 508,751 182,728 Due to reinsurers (61,686) 45,590 6,801 Trading account securities sold but not yet purchased 82,985 (20,875) (112,030) Other liabilities 117,064 54,019 31,220 ----------- ----------- ----------- Net cash flows provided by operating activities 1,398,183 953,114 153,269 ----------- ----------- ----------- Cash flows used in investing activities: Proceeds from sales, excluding trading account: Fixed maturity securities 1,084,957 662,144 532,861 Equity securities 117,006 69,438 64,038 Investment in affiliates -- 2,250 -- Proceeds from maturities and prepayments of fixed maturity securities 696,176 291,031 189,961 Cost of purchases, excluding trading account: Fixed maturity securities (2,495,088) (1,837,114) (933,084) Equity securities (195,857) (205,780) (81,331) Other invested securities (69,138) (458) (1,178) Proceeds (cost) of sold/acquired companies, net of acquired cash and invested cash 5,257 (2,053) 3,215 Net additions to real estate, furniture and equipment (28,315) (36,570) (22,076) Other, net (5,353) 26,722 11,303 ----------- ----------- ----------- Net cash used in investing activities (890,355) (1,030,390) (236,291) ----------- ----------- ----------- Cash flows provided by financing activities: Net proceeds from issuance of debt 356,181 -- -- Policyholders' account balances 10,698 (11,125) (4,280) Bank deposits 12,051 15,871 2,955 Advances from federal home loan bank 14,650 1,250 -- Net proceeds from stock offerings -- 166,960 315,840 Net proceeds from stock options exercised 13,401 12,986 25,052 Repayment of debt (65,750) (8,000) -- Net change in short-term debt -- -- (10,000) Cash dividends to common stockholders (27,681) (17,872) (14,707) Purchase of common treasury shares -- (71) (1,002) Proceeds from minority shareholders 15,337 -- -- Other, net 568 (22,627) (5,880) ----------- ----------- ----------- Net cash provided by financing activities 329,455 137,372 307,978 ----------- ----------- ----------- Net increase in cash and cash equivalents 837,283 60,096 224,956 Cash and cash equivalents at beginning of year 594,183 534,087 309,131 ----------- ----------- ----------- Cash and cash equivalents at end of year $ 1,431,466 $ 594,183 $ 534,087 =========== =========== =========== Supplemental disclosure of cash flow information: Interest paid on debt $ 47,714 $ 45,447 $ 45,241 =========== =========== =========== Federal income taxes paid $ 170,418 $ 19,381 $ 10,644 =========== =========== ===========
See accompanying notes to consolidated financial statements. 15 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the years ended December 31, 2003, 2002 and 2001 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (A) Principles of consolidation and basis of presentation The consolidated financial statements, which include the accounts of W. R. Berkley Corporation and its subsidiaries (the "Company"), have been prepared on the basis of accounting principles generally accepted in the United States of America ("GAAP"). All significant intercompany transactions and balances have been eliminated. Reclassifications have been made in the 2002 and 2001 financial statements to conform them to the presentation of the 2003 financial statements. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the revenues and expenses reflected during the reporting period. Actual results could differ from those estimates. (B) Revenue recognition Property Casualty - Premiums written are recorded at the inception of the policy. Reinsurance premiums written are estimated based upon information received from ceding companies and subsequent differences arising on such estimates are recorded in the period they are determined. Insurance premiums are earned ratably over the term of the policy. Fees for service are earned over the contract period. Life - For investment contracts, premiums collected from policyholders are not reported as revenues but are included in the liability for policyholders' account balances. Policy charges for policy administration, cost of insurance and surrender charges are assessed against policyholders' account balances and are recognized as premium income in the period in which services are provided. (C) Cash and cash equivalents Cash equivalents consist of funds invested in money market accounts and investments with an effective maturity of three months or less when purchased. (D) Investments The Company classifies its investments into four categories. Securities that the Company has the positive intent and ability to hold to maturity are classified as "held to maturity" and reported at amortized cost. Securities that the Company purchased with the intent to sell in the near-term are classified as "trading" and are reported at estimated fair value, with unrealized gains and losses reflected in the statement of operations. Investments in affiliates are carried under the "equity method of accounting", whereby the Company reports its share of the income or loss from such investments as net investment income. The remaining securities are classified as "available for sale" and carried at estimated fair value, with unrealized gains and losses, net of applicable income taxes, excluded from earnings and reported as a component of comprehensive income (loss) and a separate component of stockholders' equity. Fair value is generally determined using published market values. Realized gains or losses represent the difference between the cost of securities sold and the proceeds realized upon sale. The cost of securities is adjusted where appropriate to include a provision for significant decline in value which is considered to be other than temporary. An other than temporary decline is considered to occur in investments where there has been a sustained reduction in market value and there are no mitigating circumstances. The Company uses the specific identification method where possible, and the first-in, first-out method in other instances, to determine the cost of securities sold. Realized gains or losses, including any provision for decline in value, are included in the statement of operations. (E) Trading account Assets and liabilities related to direct investments in arbitrage securities and investments in arbitrage-related limited partnerships are classified as trading account securities. Long portfolio positions and partnership interests are presented in the balance sheet as equity securities trading account. Short sales and short call options are presented as trading securities sold but not yet purchased. Unsettled trades and the net margin balances held by the clearing broker are presented as trading account receivable from brokers and clearing organizations. The Company's trading account portfolio is recorded at fair value. Realized and unrealized gains and losses from trading activity are reported as net investment income. (F) Per share data All share data have been retroactively adjusted to reflect the three-for-two common stock splits that were effected on August 27, 2003 and on July 2, 2002. Basic per share data is based upon the weighted average number of shares outstanding during the year. Diluted per share data reflects the potential dilution that would occur if employee stock-based compensation plans were exercised. 16 (G) Deferred policy acquisition costs Acquisition costs (primarily commissions and premium taxes) incurred in writing insurance and reinsurance business are deferred and amortized ratably over the terms of the related contracts. Deferred policy acquisition costs are limited to the amounts estimated to be recoverable from the applicable unearned premiums and the related anticipated investment income by giving effect to anticipated losses, loss adjustment expenses and expenses necessary to maintain the contracts in force. (H) Reserves for losses and loss expenses Reserves for losses and loss expenses are an accumulation of amounts determined on the basis of (1) evaluation of claims for business written directly by the Company; (2) estimates received from other companies for reinsurance assumed; and (3) estimates for losses incurred but not reported (based on Company and industry experience). These estimates are periodically reviewed and, as experience develops and new information becomes known, the reserves are adjusted as necessary. Such adjustments are reflected in results of operations in the period in which they are determined. The Company discounts its reserves for excess and assumed workers' compensation claims using a risk-free or statutory rate. (See Note 9 of Notes to Consolidated Financial Statements.) (I) Reinsurance ceded Ceded unearned premiums are reported as prepaid reinsurance premiums and estimated amounts of reinsurance recoverable on unpaid losses are reported as due from reinsurers. To the extent any reinsurer does not meet its obligations under reinsurance agreements, the Company must discharge the liability. Amounts due from reinsurers are reflected net of funds held where the right of offset is present. The Company has provided reserves for estimated uncollectible reinsurance. (J) Federal and foreign income taxes The Company files a consolidated income tax return in the U.S. and foreign tax returns in each of the countries in which it has its overseas operations. The Company's method of accounting for income taxes is the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are measured using tax rates currently in effect or expected to apply in the years in which those temporary differences are expected to reverse. (K) Stock options Effective January 1, 2003, the Company adopted the fair value recognition provisions of FAS 123 "Accounting for Stock-Based Compensation". The fair value provisions of FAS 123 were applied prospectively to all employee awards granted, modified, or settled on or 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).
2003 2002 2001 --------- --------- --------- Net income (loss), as reported $ 337,230 $ 175,045 $ (91,546) Add: Stock-based employee compensation expense Included in reported net income, net of tax 48 -- -- Deduct: Total stock-based employee compensation expense under fair value based method for all awards, net of tax (4,803) (4,534) (3,008) --------- --------- --------- Pro forma net income (loss) $ 332,475 $ 170,511 $ (94,554) ========= ========= ========= Earnings per share: Basic-as reported $ 4.06 $ 2.29 $ (1.39) Basic-pro forma 4.00 2.23 (1.44) Diluted-as reported 3.87 2.21 (1.39) Diluted-pro forma 3.82 2.15 (1.44)
The fair value of the options granted is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for 2003 and 2002, respectively: (a) dividend yield of 1%, (b) expected volatility of 26%, (c) risk-free interest rates of 3.9% and 4.9% and (d) expected life of 7 years. 17 (L) Foreign currency Gains and losses resulting from foreign currency transactions (transactions denominated in a currency other than the entity's functional currency) are included in the statement of operations. Unrealized gains or resulting from translating the results of non-U.S. dollar denominated operations and investment securities are reported as accumulated other comprehensive income. Revenues and expenses denominated in currencies other than U.S. dollars are translated at the weighted average exchange rate during the year. Assets and liabilities are translated at the rate of exchange in effect at the balance sheet date. (M) Real estate, furniture and equipment Real estate, furniture and equipment are carried at cost less accumulated depreciation. Depreciation is calculated using the estimated useful lives of the respective assets. Depreciation expense was $20,160,000, $19,426,000 and $16,349,000 for 2003, 2002 and 2001, respectively. (N) Comprehensive income (loss) Comprehensive income (loss) encompasses all changes in stockholders' equity (except those arising from transactions with stockholders) and includes net income, net unrealized capital gains or losses on available-for-sale securities and unrealized foreign currency translation adjustments. (O) Goodwill and other intangible assets The Company adopted FAS 142, "Goodwill and Other Intangible Assets," effective January 1, 2002. Under FAS 142, goodwill is no longer amortized and is evaluated periodically for other than temporary declines in value. A reconciliation of the reported net loss to adjusted net loss for the year ended December 31, 2001 had FAS 142 been applied as of January 1, 2001 follows (amounts in thousands, except per share data):
NET LOSS PER YEAR ENDED DECEMBER 31, 2001 NET LOSS SHARE -------- ------------ Net loss, as reported $(91,546) $ (1.39) Add back goodwill amortization (net of tax) 3,686 .05 -------- -------- Adjusted net loss $(87,860) $ (1.34) ======== ========
(P) Recent accounting pronouncements In May 2003, the FASB issued FAS 150, "Accounting for Certain Financial Instruments with Characteristics of both Liability and Equity." FAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. One requirement under FAS 150 is that certain trust preferred securities are to be presented as liabilities. The Company elected to adopt FAS 150 in the second quarter of 2003, and accordingly, its trust preferred securities have been reclassified to liabilities in the accompanying consolidated balance sheet. The adoption of FAS 150 did not have an effect on the Company's results of operations. In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"), which was replaced in December 2003 by FIN 46R. FIN 46R addresses consolidation issues surrounding special purpose entities and certain other entities, collectively termed variable interest entities ("VIE"). A VIE is an entity in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46R requires VIEs to be consolidated by their primary beneficiaries. FIN 46R was effective immediately for new VIEs formed subsequent to January 31, 2003. For VIEs, that are not special purpose entities, formed prior to February 1, 2003, the effective date is the end of the first interim or annual period ending after March 15, 2004. The Company adopted FIN 46R 2003, except for the consolidation provisions which are required to be adopted during the first quarter of 2004. The adoption of FIN46R did not have an effect on the Company's financial statements. The Company does not expect the adoption of the consolidation provisions of FIN 46R to have a material effect on the Company's financial condition or results of operations. (2) ACQUISITIONS AND ASSET SALES During 2002 and 2001, business acquisitions were completed for an aggregate consideration of approximately $3,730,000 and $3,780,000, respectively. The acquisitions were accounted for as purchases and, accordingly, the results of operations of the companies have been included from the respective dates of acquisition. Pro forma results of operations have been omitted as such effects are not significant. 18 (3) INVESTMENTS IN FIXED MATURITY SECURITIES At December 31, 2003 and 2002, investments in fixed maturity securities were as follows:
(DOLLARS IN THOUSANDS) GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR CARRYING TYPE OF INVESTMENT COST GAINS LOSSES VALUE VALUE ---------- ----------- ---------- ---------- ---------- December 31, 2003 Held to maturity: State and municipal $ 81,966 $ 9,133 $ (80) $ 91,019 $ 81,966 Corporate 6,371 700 -- 7,071 6,371 Mortgage-backed securities 115,554 9,048 -- 124,602 115,554 ---------- ---------- ---------- ---------- ---------- Total held to maturity 203,891 18,881 (80) 222,692 203,891 ---------- ---------- ---------- ---------- ---------- Available for sale: United States Government and government agency 572,142 33,635 (651) 605,126 605,126 State and municipal 1,810,133 66,844 (1,400) 1,875,577 1,875,577 Corporate 558,247 27,844 (900) 585,191 585,191 Mortgage-backed securities 779,365 22,484 (877) 800,972 800,972 Foreign 203,269 20,949 (1,673) 222,545 222,545 ---------- ---------- ---------- ---------- ---------- Total available for sale 3,923,156 171,756 (5,501) 4,089,411 4,089,411 ---------- ---------- ---------- ---------- ---------- Total investment in fixed maturity securities $4,127,047 $ 190,637 $ (5,581) $4,312,103 $4,293,302 ========== ========== ========== ========== ========== December 31, 2002 Held to maturity: State and municipal $ 54,600 $ 9,018 $ (101) $ 63,517 $ 54,600 Corporate 6,384 875 -- 7,259 6,384 Mortgage-backed securities 144,872 11,968 (6) 156,834 144,872 ---------- ---------- ---------- ---------- ---------- Total held to maturity 205,856 21,861 (107) 227,610 205,856 ---------- ---------- ---------- ---------- ---------- Available for sale: United States Government and government agency 679,323 46,330 -- 725,653 725,653 State and municipal 918,534 44,498 (731) 962,301 962,301 Corporate 629,639 43,804 (5,798) 667,645 667,645 Mortgage-backed securities 752,148 40,240 (2,167) 790,221 790,221 Foreign 150,349 9,879 (382) 159,846 159,846 ---------- ---------- ---------- ---------- ---------- Total available for sale 3,129,993 184,751 (9,078) 3,305,666 3,305,666 ---------- ---------- ---------- ---------- ---------- Total investment in fixed maturity securities $3,335,849 $ 206,612 $ (9,185) $3,533,276 $3,511,522 ========== ========== ========== ========== ==========
The amortized cost and fair value of fixed maturity securities at December 31, 2003, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because certain issuers may have the right to call or prepay obligations:
(DOLLARS IN THOUSANDS) 2003 --------------------------- AMORTIZED COST FAIR VALUE ------------ ------------ Due in one year or less $ 67,449 $ 69,333 Due after one year through five years 878,918 910,618 Due after five years through ten years 768,743 820,051 Due after ten years 1,517,018 1,586,527 Mortgage-backed securities 894,919 925,574 ------------ ------------ Total $ 4,127,047 $ 4,312,103 ============ ============
At December 31, 2003 and 2002, there were no investments, other than investments in United States government and government agency securities, which exceeded 10% of stockholders' equity. At December 31, 2003, investments with a carrying value of $382 million were on deposit with state insurance departments as required by state laws; investments with a carrying value of $30 million were held in trust for policyholders; and investments with a carrying value of $36 million were deposited at Lloyd's in support of underwriting activities. The Company had contingent liabilities regarding irrevocable undrawn letters of credit supporting reinsurance business of $22 million at December 31, 2003. The Company has pledged investments with a carrying value of $54 million as collateral to support this commitment. 19 (4) INVESTMENTS IN EQUITY SECURITIES AVAILABLE FOR SALE At December 31, 2003 and 2002, investments in equity securities were as follows:
(DOLLARS IN THOUSANDS) GROSS GROSS UNREALIZED UNREALIZED FAIR CARRYING TYPE OF INVESTMENT COST GAINS LOSSES VALUE VALUE --------- ---------- ---------- --------- --------- December 31, 2003 Common stocks $ 145,893 $ 25,980 $ (698) $ 171,175 $ 171,175 Preferred stocks 134,768 11,141 (455) 145,454 145,454 --------- --------- --------- --------- --------- Total $ 280,661 $ 37,121 $ (1,153) $ 316,629 $ 316,629 ========= ========= ========= ========= ========= December 31, 2002 Common stocks $ 102,576 $ 3,606 $ (5,570) $ 100,612 $ 100,612 Preferred stocks 99,812 4,626 (678) 103,760 103,760 --------- --------- --------- --------- --------- Total $ 202,388 $ 8,232 $ (6,248) $ 204,372 $ 204,372 ========= ========= ========= ========= =========
(5) TRADING ACCOUNT At December 31, 2003 and 2002, the arbitrage trading account was as follows:
(DOLLARS IN THOUSANDS) GROSS GROSS UNREALIZED UNREALIZED FAIR CARRYING TYPE OF INVESTMENT COST GAINS LOSSES VALUE VALUE --------- ---------- ---------- --------- --------- December 31, 2003 Direct equity securities $ 220,791 $ 11,378 $ (1,098) $ 231,071 $ 231,071 Arbitrage-related partnerships 100,896 -- -- 100,896 100,896 --------- --------- --------- --------- --------- Total equity securities trading account 321,687 11,378 (1,098) 331,967 331,967 --------- --------- --------- --------- --------- Receivables from brokers 102,257 -- -- 102,257 102,257 Securities sold but not yet purchased (110,782) 280 (8,598) (119,100) (119,100) --------- --------- --------- --------- --------- Total trading account $ 313,162 $ 11,658 $ (9,696) $ 315,124 $ 315,124 ========= ========= ========= ========= ========= December 31, 2002 Direct equity securities $ 72,217 $ 890 $ (3,373) $ 69,734 $ 69,734 Arbitrage-related partnerships 95,908 -- -- 95,908 95,908 --------- --------- --------- --------- --------- Total equity securities trading account 168,125 890 (3,373) 165,642 165,642 --------- --------- --------- --------- --------- Receivables from brokers 177,309 -- -- 177,309 177,309 Securities sold but not yet purchased (38,347) 2,870 (638) (36,115) (36,115) --------- --------- --------- --------- --------- Total trading account $ 307,087 $ 3,760 $ (4,011) $ 306,836 $ 306,836 ========= ========= ========= ========= =========
The primary focus of the trading account is merger and convertible arbitrage. Merger arbitrage is the business of investing in the securities of publicly held companies which are the targets in announced tender offers and mergers. Convertible arbitrage is the business of investing in convertible securities with the goal of capitalizing on price differences between their securities and their underlying equities. Arbitrage investing differs from other types of investments in its focus on transactions and events believed likely to bring about a change in value over a relatively short time period (usually four months or less). The Company believes that this makes arbitrage investments less vulnerable to changes in general financial market conditions. Potential changes in market conditions are also mitigated by the implementation of hedging strategies, including short sales. The arbitrage positions are generally hedged against market declines by purchasing put options, selling call options or entering into swap contracts. Therefore, just as long portfolio positions may incur losses during market declines, hedge positions may also incur losses during market advances. As of December 31, 2003, the notional amount of long option contracts outstanding was $31,292,000 and the notional amount of short option contracts outstanding was $46,346,000. 20 (6) INVESTMENTS IN AFFILIATES Investments in affiliates include the following:
EQUITY (LOSS) CARRYING VALUE EARNINGS (LOSS) -------------------------------- ---------------------------------- (DOLLARS IN THOUSANDS) 2003 2002 2001 2003 2002 2001 -------- -------- -------- -------- -------- -------- Kiln plc $ 40,488 $ 31,498 $ -- $ 4,565 $ 687 $ -- Real estate partnerships 57,560 10,808 2,878 6,112 190 -- Structured finance partnership 17,846 -- -- (112) -- -- Other 10,878 3,881 2,587 (3,540) (187) (16) -------- -------- -------- -------- -------- -------- Total $126,772 $ 46,187 $ 5,465 $ 7,025 $ 690 $ (16) ======== ======== ======== ======== ======== ========
The Company's investments in affiliates are reported under the equity method of accounting. The Company's share of the earnings of affiliates is generally reported on a one-quarter lag in order to facilitate the timely completion of the consolidated financial statements. The Company's acquired a 20.1% interest in Kiln plc in 2002 for approximately $29 million. Kiln plc is based in the U.K. and conducts international insurance and reinsurance underwriting through Lloyd's syndicates. The Company also entered into qualifying quota share reinsurance agreements with two Lloyd's syndicates managed by Kiln plc. Net premiums written under these quota share agreements were $122 million in 2003 and $121 million in 2002. (7) INVESTMENT INCOME Investment income consists of the following:
(DOLLARS IN THOUSANDS) 2003 2002 2001 --------- --------- --------- Investment income earned on: Fixed maturity securities $ 197,963 $ 182,762 $ 162,751 Equity securities available for sale 18,906 12,552 6,754 Equity securities trading account(a) 8,110 7,144 19,572 Investment in affiliates 7,025 690 (16) Cash and cash equivalents 11,516 5,899 14,715 Other 827 1,853 2,880 --------- --------- --------- Gross investment income 244,347 210,900 206,656 Interest on funds held under reinsurance treaties and investment expense (34,291) (23,025) (11,635) --------- --------- --------- Net investment income $ 210,056 $ 187,875 $ 195,021 ========= ========= =========
(a) Investment income earned from net trading account activity includes unrealized trading gains of $2,174,000 in 2003 and unrealized trading losses of $1,155,000 in 2002. 21 (8) REALIZED GAINS AND LOSSES Realized gains (losses) and the change in difference between fair value and cost of investments, before applicable income taxes, are as follows:
(DOLLARS IN THOUSANDS) 2003 2002 2001 --------- --------- --------- Realized gains (losses): Fixed maturity securities(a) $ 73,000 $ 27,446 $ 6,706 Equity securities available for sale 10,506 6,603 7,755 Provision for other than temporary impairment (b): Fixed maturity securities (430) (16,155) (26,511) Equity securities available for sale -- (2,680) (109) Other (545) -- (93) --------- --------- --------- 82,531 15,214 (12,252) --------- --------- --------- Change in difference between fair value and cost of investments, not including trading securities: Fixed maturity securities (12,371) 128,327 32,452 Equity securities available for sale 33,984 (4,139) (1,175) --------- --------- --------- 21,613 124,188 31,277 --------- --------- --------- Total $ 104,144 $ 139,402 $ 19,025 ========= ========= =========
(a) During 2003, 2002 and 2001, gross gains of $76,019,000, $39,494,000 and, $13,033,000, respectively, and gross losses of $3,019,000, $12,048,000 and $6,327,000, respectively, were realized. (b) The 2003 provision for other than temporary impairment reflected the write-down of 2 bond holdings. The 2002 provision for other than temporary impairment reflected a second quarter charge of $10 million for Argentine sovereign bonds (see Note 22 of Notes to Consolidated Financial Statements) and a fourth quarter charge of $9 million for other investments, including $6 million of securities issued by Dynegy Inc. The 2001 provision for other then temporary impairment reflected the write-down of Argentine sovereign bonds and other securities. For fixed maturity securities and equity securities available for sale, gross unrealized gains were $227,758,000 and gross unrealized losses were $6,734,000 as of December 31, 2003. The gross unrealized losses of $6,734,000 include unrealized losses of $1,267,000 for securities that have been continuously in an unrealized loss position for more than twelve months. (9) RESERVES FOR LOSSES AND LOSS EXPENSES (INCREASES) The table below provides a reconciliation of the beginning and ending reserve balances on a gross of reinsurance basis:
(DOLLARS IN THOUSANDS) 2003 2002 2001 ----------- ----------- ----------- Net reserves at beginning of year $ 2,323,241 $ 2,033,293 $ 1,818,049 ----------- ----------- ----------- Net provision for losses and loss expenses: Claims occurring during the current year 1,780,905 1,288,071 1,140,622 Increase (decrease) in estimates for claims occurring in prior years 272,850 173,732 211,344 Net (increase) decrease in discount for prior years (4,099) (4,549) 8,717 ----------- ----------- ----------- 2,049,656 1,457,254 1,360,683 ----------- ----------- ----------- Net payments for claims Current year 268,170 373,541 443,802 Prior years 599,432 793,765 701,637 ----------- ----------- ----------- 867,602 1,167,306 1,145,439 ----------- ----------- ----------- Net reserves at end of year 3,505,295 2,323,241 2,033,293 Ceded reserves at end of year 686,796 844,684 730,557 ----------- ----------- ----------- Gross reserves at end of year $ 4,192,091 $ 3,167,925 $ 2,763,850 =========== =========== ===========
The statement of operations includes $521,000, $6,717,000 and $19,817,000 for the years ended December 31, 2003, 2002 and 2001, respectively, relating to the policyholder benefits incurred on life insurance which are not included in the above table. Net payments in 2003 are net of $331 million of cash received upon the commutation of the aggregate reinsurance agreement (see Note 10 of Notes to Consolidated Financial Statements). 22 Net losses and loss expenses for the years ended December 31, 2003, 2002 and 2001 included increases in estimates for claims occurring in prior years. The Company, along with the property casualty insurance industry in general, has experienced higher than expected loss costs for certain business written from 1998 to 2001. Following is a summary of the increases in estimates for claims occurring in prior years for the indicated periods (dollars in thousands):
2003 2002 2001 ----------- ----------- ----------- Gross reserves for losses and loss expenses at beginning of year $ 3,168,000 $ 2,764,000 $ 2,476,000 Increase in estimates for claims occurring in prior years, net of reinsurance: Reinsurance: Casualty lines $ 74,000 $ 47,000 $ 53,000 Property lines -- -- 15,000 Fidelity and surety 15,000 14,000 -- Specialty: Excess and surplus lines 62,000 30,000 24,000 Professional liability 35,000 31,000 12,000 Other 4,000 4,000 5,000 Alternative markets workers' compensation 41,000 34,000 (2,000) Regional 40,000 10,000 (4,000) International 2,000 4,000 5,000 Discontinued -- -- 103,000 ----------- ----------- ----------- Total $ 273,000 $ 174,000 $ 211,000 =========== =========== ===========
Reinsurance - In 2002 and 2003, the Company increased its estimates of the ultimate loss costs for casualty reinsurance risks written between 1998 and 2001 primarily as a result of higher than expected claims reported by ceding companies. A significant portion of the increase in estimates for claims occurring in prior years that was recognized in 2003 related to certain large accounts. The Company sets its initial loss estimates based principally upon information obtained during the underwriting process and adjusts these estimates as additional information becomes available. As certain large contracts have matured, the Company has adjusted its loss estimates upward to reflect the known loss experience and has revised its expectations regarding the level of ultimate losses to reflect a higher level of known losses as well as a pattern of delayed loss reporting by some ceding companies. The Company analyzes its treaty reinsurance business and sets reinsurance reserves each quarter on a treaty-by-treaty basis, rather than in the aggregate for the entire reinsurance business. The Company believes this method provides a better estimate of required reserves, as the Company is able to promptly identify changes in underlying trends experienced by individual ceding companies and adjust its reserves as necessary. The increase in estimated ultimate loss costs for fidelity and surety reinsurance reflects the settlement of several large surety claims during 2002 and 2003, including arbitration resolutions. In addition, the Company has reserved for certain claims relating to financial guarantee exposures that were not intended to be covered under the Company's reinsurance policies. Specialty - The Company increased its estimates of ultimate costs for excess and surplus lines casualty business written in prior years to recognize certain recently identified trends in the development of losses and loss expenses. These trends include a substantial increase in legal expenses incurred in the defense of claims, in particular for claims with multiple claimants in multiple states. For some policies, the obligation to defend has caused the Company to incur aggregate legal expenses in excess of policy limits, which was unanticipated in both pricing and reserving these exposures. In addition, the Company identified certain recent changes in the claims reporting pattern that suggest that claim costs are emerging over a longer period of time and at a higher level than in the past. Prior year ultimate loss ratios were adjusted upwards to recognize the estimated impact of such trends. The increase in prior year reserves for the excess and surplus lines also reflects the cost of the disposition of reinsurance arbitration. The increase in estimated ultimate loss costs for professional liability business written in prior years relates primarily to lawyers professional liability, liability coverage for senior living centers and employment practices liability. These lines have experienced a higher level of claim frequency and severity and a longer reporting pattern than anticipated when initial loss reserves were established. These lines also have a high incidence of litigated claims, and the reporting patterns have lengthened due to a more protracted and complex litigation environment. Alternative Markets - Ultimate loss costs for workers' compensation business written in prior years were impacted by a substantial increase in medical cost inflation. This resulted principally from increased utilization of the health care system by injured workers and more expensive and higher usage of prescription drugs. The impact of the increased medical cost trends is especially significant to the 23 excess workers' compensation business because of the higher severity of claims and longer time period over which claims are paid. Regional - The increase in prior year reserves for the regional segment was primarily related to workers' compensation business, which experienced similar trends to those described under alternative markets. Environmental and asbestos - To date, known environmental and asbestos claims have not had a material impact on the Company's operations. These claims have not materially impacted the Company because its subsidiaries generally did not insure large industrial companies that are subject to significant environmental and asbestos exposures. The Company's net reserves for losses and loss adjustment expenses relating to asbestos and environmental claims were $31,866,000 and $28,509,000 at December 31, 2003 and 2002, respectively. The Company's gross reserves for losses and loss adjustment expenses relating to asbestos and environmental claims were $49,283,000 and $47,637,000 at December 31, 2003 and 2002, respectively. Net incurred losses and loss expenses (recoveries) for reported asbestos and environmental claims were approximately $4,749,000, $6,652,000 and $(4,503,000) in 2003, 2002 and 2001, respectively. Net paid losses and loss expenses were approximately $1,391,000, $2,938,000, and $125,000 in 2003, 2002 and 2001, respectively. The estimation of these liabilities is subject to significantly greater than normal variation and uncertainty because it is difficult to make an actuarial estimate of these liabilities due to the absence of a generally accepted actuarial methodology for these exposures and the potential effect of significant unresolved legal matters, including coverage issues as well as the cost of litigating the legal issues. Additionally, the determination of ultimate damages and the final allocation of such damages to financially responsible parties are highly uncertain. Discounting - The Company discounts its liabilities for excess and assumed workers' compensation business because of the long period of time over which losses are paid. Discounting is intended to appropriately match losses and loss expenses to income earned on investment securities supporting the liabilities. The expected losses and loss expense payout pattern subject to discounting was derived from the Company's loss payout experience and is supplemented with data compiled from insurance companies writing similar business. The liabilities for losses and loss expenses have been discounted using risk-free discount rates determined by reference to the U.S. Treasury yield curve for non-proportional business, and at the statutory rate for proportional business. The discount rates range from 3.9% to 6.5% with a weighted average discount rate of 5.0%. For statutory purposes, the Company uses a discount rate of 4.2% as permitted by the Department of Insurance of the State of Delaware. The aggregate net discount, after reflecting the effects of ceded reinsurance, is $393,000,000, $293,000,000 and $243,000,000 at December 31, 2003, 2002 and 2001, respectively. The increase in the aggregate discount from 2002 to 2003 and from 2001 to 2002 resulted from the increase in workers' compensation reserves. (10) REINSURANCE CEDED The Company reinsures a portion of its exposures principally to reduce 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) 2003 2002 2001 -------- -------- -------- Ceded premiums earned: Aggregate reinsurance agreement 152,632 109,238 46,585 Other reinsurance contracts 403,992 346,023 299,574 -------- -------- -------- Total $556,624 $455,261 $346,159 ======== ======== ======== Ceded losses incurred: Aggregate reinsurance agreement 156,519 94,164 59,441 Other reinsurance contracts 291,014 241,162 274,470 -------- -------- -------- Total $447,533 $335,326 $333,911 ======== ======== ========
The Company had a multi-year aggregate reinsurance agreement that provided two types of reinsurance coverage. The first type of coverage provided 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 provided aggregate accident year protection for our reinsurance segment for loss and loss adjustment expenses incurred above a certain level. Loss recoveries were subject to annual limits and an aggregate limit over the contract period. The agreement contained a profit sharing provision under which the Company could recover a portion of premiums paid to the reinsurer if certain profit conditions were met. The Company accrued return premiums of $51 million in 2003 and $20 million in 2002 (none in 2001). As of December 31, 2003, the Company commuted the aggregate reinsurance agreement. Upon commutation, the reinsurer released funds held in an amount equal to the commuted loss reserves and unearned premium reserves and, accordingly there was no gain or loss as a result of the commutation. 24 Certain of the Company's reinsurance agreements 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 $32 million in 2003, $21 million in 2002 and $12 million in 2001. (11) DEBT Debt consists of the following:
(dollars in thousands) 2003 2002 ----------------------------- -------------- DESCRIPTION RATE MATURITY FACE VALUE CARRYING VALUE CARRYING VALUE ----------------------- ------ ------------------- ------------ -------------- -------------- Senior Subsidiary Notes 6.50% January 1, 2003 $ -- $ -- $ 35,793 Senior Notes 6.71% March 4, 2003 -- -- 24,997 ___________ ___________ ____________ Current installment due -- -- $ 60,790 ___________ ___________ ____________ Senior Notes 6.375% April 15, 2005 40,000 39,954 39,919 Senior Notes 6.25% January 15, 2006 100,000 99,699 99,566 Senior Notes 9.875% May 15, 2008 88,800 87,272 87,010 Senior Notes 5.125% September 30, 2010 150,000 147,845 -- Senior Notes 5.875% February 15, 2013 200,000 196,973 -- Senior Debentures 8.70% January 1, 2022 76,503 75,718 75,700 Subsidiary Debt 7.65% June 30, 2023 11,747 11,747 -- ------------ ----------- ----------- $ 667,050 $ 659,208 $ 362,985 ============ =========== ===========
The difference between the face value of long-term debt and the carrying value is unamortized discount. All outstanding debt is not redeemable until maturity. (12) TRUST PREFERRED SECURITIES The Company-obligated mandatorily redeemable preferred securities of a subsidiary trust holding solely junior subordinated debentures ("Trust Preferred Securities") were issued by the W. R. Berkley Capital Trust ("the Trust") in 1996. All of the common securities of the Trust are owned by the Company. The sole assets of the Trust are $210,000,000 aggregate principal amount of 8.197% Junior Subordinated Debentures due December 15, 2045, issued by the Company (the "Junior Subordinated Debentures"). The Company's guarantee of payments of cash distributions and payments on liquidation of the Trust and redemption of the Trust Preferred Securities, when taken together with the Company's obligations under the Trust Agreement under which the Trust Preferred Securities were issued, the Junior Subordinated Debentures and the Indenture under which the Junior Subordinated Debentures were issued, including its obligations to pay costs, expenses, debts and liabilities of the Trust (other than with respect to the Trust Preferred Securities), provide a full and unconditional guarantee of the Trust's obligations under the Trust Preferred Securities. The Company records the preferential cumulative cash dividends arising from the payments of interest on the Junior Subordinated Debentures as interest expense in its consolidated statement of operations. The Trust Preferred Securities are subject to mandatory redemption in a like amount (i) in whole but not in part, on the stated maturity date, upon repayment of the Junior Subordinated Debentures, (ii) in whole but not in part, at any time contemporaneously with the optional prepayment of the Junior Subordinated Debentures by the Company upon the occurrence and continuation of a certain event and (iii) in whole or in part, on or after December 15, 2006, contemporaneously with the optional prepayment by the Company of Junior Subordinated Debentures. The liability for Trust Preferred Securities is reported net of $15 million (face amount) of Trust Preferred Securities repurchased by the Company. (13) FEDERAL AND FOREIGN INCOME TAXES Federal and foreign income tax expense (benefit) consists of:
(DOLLARS IN THOUSANDS) 2003 2002 2001 --------- --------- --------- Current expense $ 173,613 $ 44,694 $ 2,068 --------- --------- --------- Deferred expense (benefit) (22,987) 39,445 (58,729) --------- --------- --------- Total expense (benefit) $ 150,626 $ 84,139 $ (56,661) ========= ========= =========
25 A reconciliation of Federal and foreign income tax (expense) benefit and the amounts computed by applying the Federal and foreign income tax rate of 35% to pre-tax income are as follows:
(DOLLARS IN THOUSANDS) 2003 2002 2001 --------- --------- --------- Computed "expected" tax expense (benefit) $ 171,975 $ 90,802 $ (52,988) Tax-exempt investment income (21,838) (9,051) (8,045) Change in valuation allowance (980) (3,275) 3,100 Other, net 1,469 5,663 1,272 --------- --------- --------- Total expense (benefit) $ 150,626 $ 84,139 $ (56,661) ========= ========= =========
At December 31, 2003 and 2002, the tax effects of differences that give rise to significant portions of the deferred tax asset and deferred tax liability are as follows:
(DOLLARS IN THOUSANDS) 2003 2002 --------- --------- DEFERRED TAX ASSET Loss reserve discounting $ 137,165 $ 94,159 Life reserve 7,538 9,900 Unearned premiums 113,705 85,541 Net operating loss carry forward 2,355 1,143 Alternative minimum tax credit carryforward -- 12,113 Other 16,741 20,656 --------- --------- Gross deferred tax asset 277,504 223,512 Less valuation allowance (4,223) (6,825) --------- --------- Deferred tax asset 273,281 216,687 ========= ========= DEFERRED TAX LIABILITY Amortization of intangibles 7,323 7,844 Deferred policy acquisition costs 137,153 109,582 Deferred taxes on unrealized investment gains 72,609 64,043 Other 20,383 14,633 --------- --------- Deferred tax liability 237,468 196,102 --------- --------- Net deferred tax asset $ 35,813 $ 20,585 ========= =========
Federal income tax expense (benefit) applicable to realized investment gains (losses) was $28,090,000, $13,817,000 and $(2,478,000) in 2003, 2002 and 2001, respectively. The Company had a current income tax payable of $8,654,000 and $8,314,000 at December 31, 2003 and 2002, respectively. At December 31, 2003, the Company had foreign net operating loss carryforwards of $2,935,000, which expire from 2004 and 2008. The net change in the valuation allowance is primarily related to the foreign net operating loss carryforwards. The Company's tax returns through December 31, 2000 have been reviewed by the Internal Revenue Service. The realization of the deferred tax asset is dependent upon the Company's ability to generate sufficient taxable income in future periods. Based on historical results and the prospects for future current operations, management anticipates that it is more likely than not that future taxable income will be sufficient for the realization of this gross asset. (14) DIVIDENDS FROM SUBSIDIARIES AND STATUTORY FINANCIAL INFORMATION The Company's insurance subsidiaries are restricted by law as to the amount of dividends they may pay without the approval of regulatory authorities. During 2004, the maximum amount of dividends which can be paid without such approval is approximately $197 million. Combined net income (loss) and policyholders' surplus of the Company's consolidated insurance subsidiaries, as determined in accordance with statutory accounting practices, are as follows:
(DOLLARS IN THOUSANDS) 2003 2002 2001 ----------- ----------- ----------- Net income (loss) $ 293,455 $ 192,845 $ (130,630) =========== =========== =========== Policyholders' surplus $ 1,886,013 $ 1,275,302 $ 928,367 =========== =========== ===========
The significant variances between statutory accounting practices and GAAP are that for statutory purposes bonds are carried at amortized cost, acquisition costs are charged to operations as incurred, deferred Federal income taxes are subject to limitations, excess and assumed workers' compensation reserves are discounted at different discount rates and certain assets designated as "non-admitted assets" are charged against surplus. 26 The NAIC has risk-based capital ("RBC") requirements that require insurance companies to calculate and report information under a risk-based formula which measures statutory capital and surplus needs based on a regulatory definition of risk in a company's mix of products and its balance sheet. All of the Company's insurance subsidiaries have an RBC amount above the authorized control level RBC, as defined by the NAIC. The Company has guaranteed that RBC levels of certain subsidiaries will remain above their authorized control levels. (15) STOCKHOLDERS' EQUITY COMMON EQUITY The weighted average number of shares used in the computation of basic earnings per share was 83,124,000, 76,328,000, and 65,562,000 for 2003, 2002 and 2001, respectively. The weighted average number of shares used in the computations of diluted earnings per share was 87,063,000, 79,385,000 and 68,750,000, for 2003, 2002 and 2001, respectively. Treasury shares have been excluded from average outstanding shares from the date of acquisition. The difference in calculating basic and diluted earnings per share is attributable entirely to the dilutive effect of stock-based compensation plans. Changes in shares of common stock outstanding, net of treasury shares, are as follows:
(IN THOUSANDS) 2003 2002 2001 ------ ------ ------ Balance, beginning of year 82,835 74,792 57,726 Shares issued 705 8,048 17,106 Shares repurchased (2) (5) (40) ------ ------ ------ Balance, end of year 83,538 82,835 74,792 ====== ====== ======
On May 11, 1999, the Company declared a dividend distribution of one Right for each outstanding share of common stock. Each Right entitles the holder to purchase a unit consisting of one one-thousandth of a share of Series A Junior Participating Preferred Stock at a purchase price of $120 per unit (subject to adjustment) upon the occurrence of certain events relating to potential changes in control of the Company. The Rights expire on May 11, 2009, unless earlier redeemed by the Company as provided in the Rights Agreement. (16) INVESTMENT IN PEYTON STREET The consolidated financial statements include the accounts of Peyton Street Independent Financial Services ("Peyton Street"), a unitary thrift holding company that owns the common stock of InsurBanc. InsurBanc provides banking services principally to independent insurance agencies and their employees. Following is a summary of assets and liabilities related to Peyton Street that were included on the Company's consolidated balance sheets as of December 31, 2002 and 2003:
(AMOUNTS IN THOUSANDS) 2003 2002 --------- --------- Cash and cash equivalents $ 6,218 $ 4,596 Fixed maturity securities 24,674 12,985 Real estate, furniture and equipment 308 410 Other assets: Loans receivable 24,960 11,937 Other 350 555 --------- --------- Total $ 56,510 $ 30,483 ========= ========= Other Liabilities: Deposits $ 30,876 $ 18,826 Advances from Federal Home Loan Bank 15,900 1,250 Other 2,411 1,619 --------- --------- Total Liabilities $ 49,187 $ 21,695 ========= =========
The Company's share of Peyton Street's net loss was $1,422,000 in 2003, $1,782,000 in 2002 and $1,235,000 in 2001. In the ordinary course of business, Peyton Street is a party to financial instruments with off-balance-sheet risk. At December 31, 2003, these financial instruments include contractual commitments of $10,675,000 to extend credit under future loan agreements and unused lines of credit. The advances from FHLB is secured by investments with an aggregate market value $20 million. 27 (17) FAIR VALUE OF FINANCIAL INSTRUMENTS The following table presents the carrying amounts and estimated fair values of the Company's financial instruments as of December 31, 2003 and 2002:
(DOLLARS IN THOUSANDS) 2003 2002 ----------------------------- ------------------------------ CARRYING CARRYING AMOUNT FAIR VALUE AMOUNT FAIR VALUE ------------- ------------ ------------- ------------ Investments $ 6,480,713 $ 6,507,831 $ 4,663,100 $ 4,684,854 Debt 659,208 718,787 362,985 397,849 Trust preferred securities 193,336 208,553 198,251 187,036
The estimated fair value of investments is based on quoted market prices as of the respective reporting dates. The fair value of the debt and the trust preferred securities are based on rates available for borrowings similar to the Company's outstanding debt as of the respective reporting dates. (18) LEASE OBLIGATIONS The Company and its subsidiaries use office space and equipment under leases expiring at various dates. These leases are considered operating leases for financial reporting purposes. Some of these leases have options to extend the length of the leases and contain clauses for cost of living, operating expense and real estate tax adjustments. Rental expense was approximately: $18,773,000, $17,586,000 and $18,021,000 for 2003, 2002 and 2001, respectively. Future minimum lease payments (without provision for sublease income) are $14,583,000 in 2004; $12,503,000 in 2005; $10,103,000 in 2006; and $26,525,000 thereafter. (19) COMMITMENTS, LITIGATION AND CONTINGENT LIABILITIES The Company's subsidiaries are subject to disputes, including litigation and arbitration, arising in the ordinary course of their insurance and reinsurance businesses. The Company's estimates of the costs of settling such matters are reflected in its aggregate reserves for losses and loss expenses, and the Company does not believe that the ultimate outcome of such matters, individually or in the aggregate, will have a material adverse effect on its financial condition or results of operations. During 2003, two arbitration hearings in which subsidiaries of the Company were involved were completed. The Company recorded an increase in reserves for loss and loss expenses during the third quarter of 2003 of $15 million, which represents the excess of the Company's estimate of the ultimate cost of the disposition of these matters over amounts that were previously accrued. (20) STOCK INCENTIVE PLAN The Company has a stock incentive plan (the "Stock Incentive Plan") under which 16,031,250 shares of Common Stock were reserved for issuance. Pursuant to the Stock Incentive Plan, stock incentives may be granted at prices determined by the Board of Directors but not less than fair market value on the date of grant. The following table summarizes option information:
2003 2002 2001 ----------------------- ----------------------- ----------------------- SHARES PRICE(a) SHARES PRICE(a) SHARES PRICE(a) --------- ---------- --------- ---------- --------- ---------- Outstanding at beginning of year 9,206,468 $ 17.15 8,187,929 $ 15.21 8,968,679 $ 14.03 Granted 73,000 30.96 1,897,013 24.41 1,217,138 20.92 Exercised 694,989 14.33 581,550 13.41 1,559,025 13.23 Canceled 112,658 15.66 296,924 17.17 438,863 14.55 --------- ---------- --------- ---------- --------- ---------- Outstanding at end of year 8,471,821 $ 17.52 9,206,468 $ 17.15 8,187,929 $ 15.21 --------- ---------- --------- ---------- --------- ---------- Options exercisable at year end 3,727,375 $ 15.55 3,609,791 $ 15.61 3,719,069 $ 14.73 --------- ---------- --------- ---------- --------- ---------- Stock available for future grant 3,611,946 3,578,751 5,179,931 --------- ---------- --------- ---------- --------- ----------
(a) Weighted average exercise price. 28 The following table summarizes information about stock options outstanding at December 31, 2003 and 2002:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ---------------------------------------- -------------------------- WEIGHTED WEIGHTED RANGE OF REMAINING WEIGHTED AVERAGE EXERCISE NUMBER CONTRACTUAL AVERAGE NUMBER EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE -------- ----------- ----------- -------- ----------- -------- December 31, 2003 $6 to $10 1,444,013 6.3 $ 8.25 262,817 $ 8.24 10 to 20 2,826,005 3.3 14.56 2,652,918 14.59 20 to 35 4,201,803 7.0 22.69 811,640 21.05 --------- ----- -------- --------- ------- Total 8,471,821 5.6 $ 17.52 3,727,375 $ 15.55 ========= ===== ======== ========= ======= December 31, 2002 $6 to $10 1,634,098 7.0 $ 8.30 -- $ -- 10 to 20 3,186,783 4.2 14.37 2,958,048 14.41 20 to 35 4,385,587 7.7 22.47 651,743 21.05 --------- ----- -------- --------- ------- Total 9,206,468 6.3 $ 17.15 3,609,791 $ 15.61 ========= ===== ======== ========= =======
(21) COMPENSATION PLAN The Company and its subsidiaries have profit sharing retirement plans in which substantially all employees participate. The plans provide for minimum annual contributions of 5% of eligible compensation; contributions above the minimum are discretionary and vary with each participating subsidiary's profitability. Employees become eligible to participate in the Retirement Plans on the first day of the month following the first full three months in which they are employed. Profit sharing expense amounted to $17,135,000 $12,821,000, and $9,287,000 for 2003, 2002 and 2001, respectively. The Company has a Long-Term Incentive Compensation Plan ("LTIP") that provides for incentive compensation to key executives based on the Company's earnings, as defined under the LTIP. Key employees are awarded participation units ("Units"), which vest and become exercisable over a maximum term of five years from the date of their award. In 2001, the Company granted 178,875 Units, with an aggregate maximum value of $19,875,000, to key executives. Based on the Company's earnings, these Units achieved their maximum value in 2003. The participants received the maximum value for their Units in cash in February 2004. Thereafter, no remaining units were outstanding. Compensation expense related to the LTIP was $11,475,000 in 2003 and $8,400,000 in 2002. During 2003, 456,000 Restricted Stock Units (RSU) were awarded to officers of the Company and its subsidiaries. Each RSU represents the right to receive one share of common stock, conditioned on the employee's satisfying certain requirements outlined in the award agreement. The RSUs vest after five years of continuous employment. The Company determines the cost of the RSUs awarded based on the market value of the stock at the time of the award. The cost is recognized as compensation expense as the units are earned over the vesting period. Compensation expense related to RSUs was $1,927,000 for 2003. The remaining unearned compensation for outstanding RSUs was $11,060,000 as of December 31, 2003. (22) INTERNATIONAL OPERATIONS 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 were 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. During 2001 and 2002, Argentina experienced substantial economic disruption, including default on its sovereign bonds, severe currency devaluation, high unemployment and inflation, increasing fiscal deficits and declining central bank reserves. As a result of these events, The Company ceased writing life insurance business in Argentina in 2002 and has since liquidated substantially all of its life insurance policies. The Company also wrote down the carrying value of its Argentine sovereign bonds by $18 million in 2001 and $10 million in 2002. In addition, the Company's Argentine subsidiary reported net gains of $21.7 million in 2002 as a result of foreign currency transactions and the related settlement of life insurance contracts. The foreign currency transaction gain represents the net increase in the local currency value of assets and liabilities denominated in US dollars following the devaluation of the Argentine peso. The gain on surrender of life insurance contracts represents the gain from the negotiated settlement of certain US dollar life insurance contracts for less than their local currency value following the devaluation of the Argentine peso. 29 (23) SUPPLEMENTAL FINANCIAL STATEMENT DATA Other operating costs and expenses consist of the following:
(DOLLARS IN THOUSANDS) 2003 2002 2001 ----------- ---------- ---------- Amortization of deferred policy acquisition costs $ 787,167 $ 589,993 $ 492,065 Other underwriting expenses 118,182 94,590 85,593 Service company expenses 82,821 69,715 64,949 Other costs and expenses 47,724 42,907 21,169 ----------- ---------- ---------- Total $ 1,035,894 $ 797,205 $ 663,776 =========== ========== ==========
(24) RESTRUCTURING PLAN In 2001, the Company reported a restructuring charge of $3,196,000 in connection with its withdrawal from regional personal lines business and the reorganization of certain other operations. The Company reduced its permanent workforce by approximately 304 employees in connection with the plan. The charge consisted mainly of severance payments of $2,462,000 and contractual lease payments related to abandoned facilities. The activities under the plan were substantially completed in 2001. (25) INDUSTRY SEGMENTS The Company's operations are presently conducted through five segments of the insurance business: specialty lines of insurance; alternative markets; reinsurance; regional property casualty insurance; and international. Our specialty segment underwrites complex and sophisticated third-party liability risks, principally within the excess and surplus lines, professional liability, commercial transportation and surety markets. The specialty business is conducted through seven operating units. The companies within the segment are divided along the different customer bases and product lines which they serve. The specialty units deliver their products through a variety of distribution channels depending on the customer base and particular risks insured. The customers in this segment are highly diverse. Our alternative markets operations specialize in developing, insuring, reinsuring and administering self-insurance programs and other alternative risk transfer mechanisms. Our clients include employers, employer groups, insurers, and alternative market funds seeking less costly, more efficient ways to manage exposure to risks. In addition to providing primary and excess workers' compensation insurance, the alternative markets segment also provides a wide variety of fee-based services, including consulting and administrative services. Our reinsurance operations specialize in underwriting property casualty reinsurance on both a treaty and a facultative basis. The principal reinsurance units are facultative reinsurance, which writes individual certificates and program facultative business, treaty reinsurance, which functions as a traditional reinsurer in specialty and standard reinsurance lines, and Lloyd's reinsurance, which writes quota share reinsurance with certain Lloyd's syndicates. Our regional subsidiaries provide commercial insurance products to customers primarily in 32 states. Key clients of this segment are small-to-mid-sized businesses and governmental entities. The regional subsidiaries are organized geographically, which provides them with the flexibility to adapt to local market conditions, while enjoying the superior administrative capabilities and financial strength of the Company. The regional operations are conducted through four geographic regions based on markets served: Midwest, New England, Southern (excluding Florida) and Mid Atlantic. International operations are conducted in Argentina and Asia. In Argentina, we currently offer commercial and personal property casualty insurance. In Asia, we provide savings and life products to customers, including endowment policies to pre-fund education costs and retirement income. During 2001, the Company discontinued its regional personal lines business and the alternative markets division of its reinsurance segment. These discontinued businesses are now being managed and reported collectively as a separate Discontinued Business Segment. Prior period segment information has been restated to reflect these changes. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. 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. Reclassifications have been made in the 2002 and 2001 segment information in order to conform with the presentation of the 2003 segment information. 30
REVENUES ---------------------------------------------- PRE-TAX NET EARNED INVESTMENT INCOME INCOME (DOLLARS IN THOUSANDS) PREMIUMS INCOME OTHER TOTAL (LOSS) (LOSS) ---------- ---------- -------- ---------- --------- -------- December 31, 2003: Specialty $1,117,781 $ 70,232 $ -- $1,188,013 $ 201,885 $136,725 Alternative Markets 410,926 38,450 101,715 551,091 85,397 59,066 Reinsurance 760,558 52,622 -- 813,180 59,984 43,610 Regional 880,597 43,368 -- 923,965 153,292 105,468 International 64,748 6,173 10 70,931 3,347 3,716 Discontinued Business -- -- -- -- -- -- Corporate, other and eliminations -- (789) 2,025 1,236 (96,293) (64,699) Realized investment and foreign currency gains (losses) -- -- 81,692 81,692 81,692 53,334 ---------- ---------- -------- ---------- --------- -------- Consolidated $3,234,610 $ 210,056 $185,442 $3,630,108 $ 489,304 $337,220 ========== ========== ======== ========== ========= ======== December 31, 2002: Specialty $ 772,696 $ 53,862 $ -- $ 826,558 $ 136,112 $ 90,498 Alternative Markets 235,558 37,641 86,031 359,230 62,703 42,376 Reinsurance 398,287 43,912 -- 442,199 14,981 11,626 Regional 705,385 44,365 -- 749,750 104,085 69,429 International 89,284 5,325 -- 94,609 (1,757) (2,631) Discontinued Business 51,317 4,457 -- 55,774 (10,682) (6,943) Corporate, other and eliminations -- (1,687) 2,581 894 (83,079) (50,643) Realized investment and foreign currency gains (losses) -- -- 37,070 37,070 37,070 21,333 ---------- ---------- -------- ---------- --------- -------- Consolidated $2,252,527 $ 187,875 $125,682 $2,566,084 $ 259,433 $175,045 ========== ========== ======== ========== ========= ======== December 31, 2001: Specialty $ 428,058 $ 41,021 $ 1,028 $ 470,107 $ 34,554 $ 24,617 Alternative Markets 123,173 37,765 73,492 234,430 34,255 23,723 Reinsurance 209,938 40,905 7 250,850 (61,403) (43,715) Regional 555,750 51,640 1,292 608,682 37,203 26,763 International 140,909 13,993 1,011 155,913 12,149 9,293 Discontinued Business 222,641 9,762 232,403 (133,480) (88,839) Corporate, other and eliminations -- (65) 971 906 (63,178) (40,501) Realized investment and foreign currency gains (losses) -- -- (11,494) (11,494) (11,494) (2,887) ---------- ---------- -------- ---------- --------- -------- Consolidated $1,680,469 $ 195,021 $ 66,307 $1,941,797 $(151,394) $(91,546) ========== ========== ======== ========== ========= ========
Interest expense for the alternative markets and reinsurance segments was $2,327,000 and $2,806,000 for the years ended December 31, 2002 and 2001, respectively. Additionally, corporate interest expense (net of intercompany amounts) was $54,733,000, $43,148,000 and $42,913,000 for the corresponding periods. Identifiable assets by segment are as follows (dollars in thousands):
DECEMBER 31, 2003 2002 2001 ------------ ------------ ------------ Specialty $ 3,127,810 $ 2,271,105 $ 1,580,155 Alternative Markets 1,504,535 1,197,977 859,502 Reinsurance 3,415,191 2,431,429 1,751,428 Regional 1,992,660 1,590,913 1,462,861 International 152,571 126,528 209,473 Discontinued Business 94,109 162,754 289,313 Corporate, other and eliminations (952,191) (749,383) (519,223) ------------ ------------ ------------ Consolidated $ 9,334,685 $ 7,031,323 $ 5,633,509 ============ ============ ============
(26) QUARTERLY FINANCIAL INFORMATION (UNAUDITED) The following is a summary of quarterly financial data (in thousands except per share data):
THREE MONTHS ENDED -------------------------------------------------------------------------------------------- MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, 2003 2002 2003 2002 2003 2002 2003 2002 -------- -------- -------- -------- -------- -------- -------- -------- Revenues $791,413 $547,886 $926,957 $569,935 $916,382 $640,071 $995,356 $808,192 Net income 71,703 34,396 95,840 27,374 76,469 40,544 93,208 72,731 ======== ======== ======== ======== ======== ======== ======== ======== Net income per share: Basic (a) .87 .46 1.15 .36 .92 .54 1.12 .91 ======== ======== ======== ======== ======== ======== ======== ======== Diluted (a) .83 .44 1.10 .34 .87 .52 1.07 .88 ======== ======== ======== ======== ======== ======== ======== ========
(a) Earnings per share (EPS) in each quarter is computed using the weighted-average number of shares outstanding during that quarter while EPS for the full year is computed using the weighted-average number of shares outstanding during the year. Thus, the sum of the four quarters EPS does not necessarily equal the full-year EPS. 31 INDEPENDENT AUDITORS' REPORT Board of Directors and Stockholders W. R. Berkley Corporation We have audited the consolidated balance sheets of W. R. Berkley Corporation and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, stockholders' equity, comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of W. R. Berkley Corporation and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 1 to the consolidated financial statements, the Company has changed its method of accounting for goodwill in 2002. New York, New York KPMG LLP February 11, 2004 32 EX-31.1 4 y95088exv31w1.txt CERTIFICATION EXHIBIT 31.1 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 annual report on Form 10-K of the registrant; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 12, 2004 /s/ William R. Berkley _______________________________ William R. Berkley Chairman of the Board and Chief Executive Officer EX-31.2 5 y95088exv31w2.txt CERTIFICATION EXHIBIT 31.2 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 annual report on Form 10-K of the registrant; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 12, 2004 /s/ Eugene G. Ballard ______________________________ Eugene G. Ballard Senior Vice President, Chief Financial Officer and Treasurer EX-32.1 6 y95088exv32w1.txt CERTIFICATIONS EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of W. R. Berkley Corporation (the "Company") on Form 10-K for the fiscal year ended December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), we, William R. Berkley, Chairman of the Board and Chief Executive Officer of the Company, and Eugene G. Ballard, Senior Vice President, Chief Financial Officer and Treasurer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ William R. Berkley ___________________________ William R. Berkley Chairman of the Board and Chief Executive Officer /s/ Eugene G. Ballard ___________________________ Eugene G. Ballard Senior Vice President - Chief Financial Officer and Treasurer March 12, 2004 A signed original of this written statement required by Section 906 has been provided to W. R. Berkley Corporation (the "Company") and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----