10-Q 1 y91281e10vq.txt ALLEGHANY CORP. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR QUARTER ENDED SEPTEMBER 30, 2003 COMMISSION FILE NUMBER 1-9371 ALLEGHANY CORPORATION -------------------------------------------------------------------------------- EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER DELAWARE -------------------------------------------------------------------------------- STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION 51-0283071 -------------------------------------------------------------------------------- INTERNAL REVENUE SERVICE EMPLOYER IDENTIFICATION NUMBER 375 PARK AVENUE, NEW YORK NY 10152 -------------------------------------------------------------------------------- ADDRESS OF PRINCIPAL EXECUTIVE OFFICE, INCLUDING ZIP CODE 212-752-1356 -------------------------------------------------------------------------------- REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE NOT APPLICABLE -------------------------------------------------------------------------------- FORMER NAME, FORMER ADDRESS, AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE) AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES [X] NO [ ] INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS DEFINED IN RULE 12B-2 OF THE EXCHANGE ACT). YES [X] NO [ ] INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF COMMON STOCK, AS OF THE LAST PRACTICABLE DATE. 7,492,354 SHARES AS OF NOVEMBER 7, 2003 -------------------------------------------------------------------------------- ITEM 1. FINANCIAL STATEMENTS ALLEGHANY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS FOR THE THREE MONTHS ENDED SEPTEMBER 3O, 2003 AND 2002 (dollars in thousands, except share and per share amounts) (unaudited)
2003 2002 ----------- ----------- REVENUES Net fastener sales $ 30,559 $ 28,150 Interest, dividend and other income 11,096 12,947 Net premiums earned 167,819 32,700 Net mineral and filtration sales 67,502 65,017 Net gain on investment transactions 77,874 4,617 ----------- ----------- Total revenues 354,850 143,431 ----------- ----------- COSTS AND EXPENSES Underwriting expenses 40,097 12,145 Salaries, administrative and other operating expenses 22,914 18,659 Loss and loss adjustment expenses 100,609 30,192 Cost of goods sold - fasteners 23,614 21,084 Cost of mineral and filtration sales 50,174 47,467 Interest expense 1,381 1,845 Corporate administration 8,218 6,940 ----------- ----------- Total costs and expenses 247,007 138,332 ----------- ----------- Earnings before income taxes 107,843 5,099 Income taxes 32,973 (16,621) ----------- ----------- Net earnings $ 74,870 $ 21,720 =========== =========== Basic earnings per share of common stock ** $ 10.02 $ 2.93 =========== =========== Diluted earnings per share of common stock ** $ 9.99 $ 2.91 =========== =========== Dividends per share of common stock * * =========== =========== Average number of outstanding shares of common stock ** 7,468,549 7,409,912 =========== ===========
* In March 2002 and 2003, Alleghany declared a stock dividend consisting of one share of Alleghany common stock for every fifty shares outstanding. ** Adjusted to reflect the common stock dividend declared in March 2003. See Notes to Consolidated Financial Statements. ALLEGHANY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 (dollars in thousands, except share and per share amounts) (unaudited)
2003 2002 ---------- ---------- REVENUES Net fastener sales $ 85,804 $ 85,035 Interest, dividend and other income 36,187 32,924 Net premiums earned 234,759 92,370 Net mineral and filtration sales 198,410 189,309 Net gain on investment transactions 82,716 43,564 ---------- ---------- Total revenues 637,876 443,202 ---------- ---------- COSTS AND EXPENSES Underwriting expenses 68,380 32,505 Salaries, administrative and other operating expenses 60,498 54,370 Loss and loss adjustment expenses 140,277 73,419 Cost of goods sold - fasteners 65,182 64,171 Cost of mineral and filtration sales 150,295 139,849 Interest expense 4,127 5,141 Corporate administration 21,001 15,954 ---------- ---------- Total costs and expenses 509,760 385,409 ---------- ---------- Earnings before income taxes 128,116 57,793 Income taxes 39,526 1,369 ---------- ---------- Net earnings $ 88,590 $ 56,424 ========== ========== Basic earnings per share of common stock ** $ 11.91 $ 7.56 ========== ========== Diluted earnings per share of common stock ** $ 11.87 $ 7.51 ========== ========== Dividends per share of common stock * * ========== ========== Average number of outstanding shares of common stock ** 7,437,907 7,459,691 ========== ==========
* In March 2002 and 2003, Alleghany declared a stock dividend consisting of one share of Alleghany common stock for every fifty shares outstanding. ** Adjusted to reflect the common stock dividend declared in March 2003. See Notes to Consolidated Financial Statements. ALLEGHANY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2003 AND DECEMBER 31, 2002 (dollars in thousands, except share amounts)
(UNAUDITED) SEPTEMBER 30, DECEMBER 31, 2003 2002 ---------- ---------- ASSETS Available for sale securities: 9/30/2003 12/31/2002 --------- ---------- Equity securities (cost: $402,191 $239,669) $ 623,667 $ 486,353 Debt securities (cost: $766,585 $570,973) 774,783 580,606 Short-term investments 117,693 237,698 ---------- ---------- 1,516,143 1,304,657 Cash 194,962 27,423 Notes receivable 92,101 92,358 Insurance and accounts receivable 186,991 85,710 Reinsurance receivables 147,622 147,479 Deferred acquisition costs 54,648 22,547 Property and equipment - at cost, net of accumulated depreciation and amortization 176,322 173,539 Inventory 86,744 81,978 Goodwill and other intangibles, net of amortization 228,663 112,858 Other assets 141,801 85,833 ---------- ---------- $2,825,997 $2,134,382 ========== ========== LIABILITIES AND COMMON STOCKHOLDERS' EQUITY Current taxes payable $ 34,086 $ 28,372 Losses and loss adjustment expenses 338,432 258,471 Other liabilities 240,820 147,411 Unearned premiums 452,046 64,115 Parent company debt 25,000 -- Subsidiaries' debt 158,947 152,507 Net deferred tax liability 111,986 104,164 ---------- ---------- Total liabilities 1,361,317 755,040 Common stockholders' equity 1,464,680 1,379,342 ---------- ---------- $2,825,997 $2,134,382 ========== ========== Shares of common stock outstanding * 7,487,885 7,409,282 ========== ==========
* Adjusted to reflect the common stock dividend declared in March 2003. See Notes to Consolidated Financial Statements. ALLEGHANY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002 (dollars in thousands) (unaudited)
2003 2002 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 88,590 $ 34,704 Adjustments to reconcile net earnings to cash provided by (used in) operations: Depreciation and amortization 15,979 10,065 Net gain on investment transactions (82,716) (38,947) Tax benefit on stock options exercised 3,388 1,176 Other charges, net 11,222 9,997 Increase in insurance and accounts receivable (101,281) (37,049) Decrease (increase) in deferred acquisition costs (32,101) (4,833) Decrease (increase) in other assets including goodwill (176,539) 29,430 Decrease (increase) in other liabilities and current taxes payable 99,123 (44,493) (Decrease) increase in unearned premiums 387,931 7,838 Increase in losses and loss adjustment expenses 79,961 (20,542) Decrease (increase) in reinsurance receivables (143) 26,357 --------- --------- Net adjustments 204,824 (61,001) --------- --------- Cash provided by (used in) operations 293,414 (26,297) --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of investments (687,270) (561,331) Sales of investments 437,580 325,661 Purchases of property and equipment (15,709) (5,579) Net change in short-term investments 120,005 544,167 Other, net 114,837 (16,489) Acquisition of insurance companies, net of cash acquired (131,389) (221,056) --------- --------- Net cash (used in) provided by investing activities (161,946) 65,373 --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Principal payments on debt (82,931) (90,641) Proceeds of debt 114,371 82,316 Treasury stock acquisitions 0 (18,360) Other, net 4,631 4,168 --------- --------- Net cash provided by financing activities 36,071 (22,517) --------- --------- Net increase in cash 167,539 16,559 Cash at beginning of period 27,423 15,717 --------- --------- Cash at end of period $ 194,962 $ 32,276 ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the period for: Interest $ 2,977 $ 2,876 Income taxes $ 9,019 $ 48,873
See Notes to Consolidated Financial Statements. Notes to the Consolidated Financial Statements This report should be read in conjunction with the Annual Report on Form 10-K for the year ended December 31, 2002 (the "2002 Form 10-K"), the Quarterly Report on Form 10-Q for the quarter ended March 31, 2003 (the "2003 First Quarter Form 10-Q") and the Quarterly Report on Form 10-Q for the quarter ended June 30, 2003 (the "2003 Second Quarter Form 10-Q") of Alleghany Corporation (the "Company"). The information included in this report is unaudited but reflects all adjustments which, in the opinion of management, are necessary to a fair statement of the results of the interim periods covered thereby. All adjustments are of a normal and recurring nature except as described herein. Stock-Based Compensation Accounting The Company sponsors fixed option plans and a performance-based stock plan, where awards are granted to eligible employees of the Company in the form of non-qualified stock options or other stock-based awards. Prior to 2003, the Company accounted for those plans under the recognition and measurement provisions of APB Opinion No. 25, "Accounting for Stock Issued to Employees." No compensation cost for the Company's fixed option plans is reflected in three and nine months ended September 30, 2002 net income, as all options granted under the plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Effective January 1, 2003, the Company adopted the fair value recognition provisions of FAS Statement No. 123, "Accounting for Stock-Based Compensation," prospectively for all employee awards granted after January 1, 2003. Therefore, the costs related to the Company's fixed option plans and performance-based stock plan included in the determination of net income for the three and nine months ended September 30, 2003 is less than that which would have been recognized if the fair value based method had been applied to all awards prior to January 1, 2003. The following table illustrates the effect on net earnings and earnings per share if the fair value based method had been applied to all outstanding and unvested awards under all of the Company plans in each period. 6
For the three months ended For the nine months ended (in thousands, except per share September 30, September 30, September 30, September 30, amounts) 2003 2002 2003 2002 ---------- ---------- ---------- ---------- Net earnings, as reported $ 74,870 $ 21,720 $ 88,590 $ 56,424 Add: stock-based employee compensation expense included in reported net earnings, net of related tax 1,167 491 2,504 (254) Less: stock-based compensation expense determined under fair value method for all stock options, net of related tax 1,288 462 3,543 1,385 ---------- ---------- ---------- ---------- Pro forma net earnings $ 74,749 $ 21,749 $ 87,551 $ 54,785 ========== ========== ========== ========== Earnings per share Basic - as reported $ 10.02 $ 2.93 $ 11.91 $ 7.56 Basic - pro forma $ 10.01 $ 2.94 $ 11.77 $ 7.34 Diluted - as reported $ 9.99 $ 2.91 $ 11.87 $ 7.51 Diluted - pro forma $ 9.97 $ 2.91 $ 11.73 $ 7.29
Acquisition of Royal Specialty Underwriting, Inc. On July 1, 2003, Alleghany Insurance Holdings LLC ("AIHL") completed the acquisition of Royal Specialty Underwriting, Inc. ("RSUI"), a wholesale underwriting agency, from Royal Group, Inc., a subsidiary of Royal & Sun Alliance Insurance Group plc ("R&SA"), for cash consideration, including capitalized expenditures, of approximately $108.1 million. The acquisition also included renewal rights to the ongoing business underwritten by RSUI for the insurance affiliates of R&SA and the related net unearned premium reserve portfolio of approximately $320.0 million. The transaction did not include loss reserves associated with business underwritten by RSUI for insurance affiliates of R&SA prior to the date of the transaction. 7 In connection with the acquisition of RSUI, on June 30, 2003, AIHL acquired Underwriters Reinsurance Company ("URC") from Swiss Re America Holding Corporation for consideration of approximately $19.7 million. On August 13, 2003, URC's name was changed to RSUI Indemnity Company ("RIC"). On September 2, 2003, RIC purchased Landmark American Insurance Company ("Landmark"), a non-admitted insurance company domiciled in Oklahoma, to write non-admitted business underwritten by RSUI, from R&SA for cash consideration of $33.9 million, $30.3 of which represented consideration for Landmark's investment portfolio and approximately $3.5 million of which represented consideration for licenses. Change in Accounting In April 2003, the Financial Accounting Standards Board ("FASB") issued FAS Statement No. 149, "Amendment to Statement No. 133 on Derivative Instruments and Hedging Activities." This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FAS Statement No. 133 "Accounting for Derivative Instruments and Hedging Activities." The changes in FAS Statement No. 149 improve financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. Those changes will result in more consistent reporting of contracts as either derivatives or hybrid instruments. FAS Statement No.149 is effective for contracts entered into or modified after June 30, 2003 except in certain instances detailed in the Statement, and hedging relationships designated after June 30, 2003. Except as otherwise stated in FAS Statement No. 149, all provisions should be applied prospectively. FAS Statement No. 149 will not have an impact on the Company. In May 2003, the FASB issued FAS Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity." FAS Statement No. 150 establishes standards for the classification and measurement of certain financial instruments that have both liability and equity characteristics. It requires that an issuer classify a financial instrument that is within the scope of the Statement as a liability (or as an asset in some circumstances). Many of those instruments were previously classified as equity. FAS Statement No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period commencing after June 15, 2003, except for mandatorily redeemable financial instruments. FAS Statement No. 150 will not have an impact on the Company. FASB Interpretation No. 46 "Consolidation of Variable Interest Entities" ("FIN 46") provides accounting and disclosure rules for variable interest entities. A variable interest entity 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 8 finance its activities without additional subordinated financial support from other parties. Variable interest entities are often created for a single specific purpose, for example, to facilitate asset securitization. FIN 46 became effective in the first quarter of 2003 for variable interest entities created, or in which an enterprise obtains an interest, after January 31, 2003. It became effective July 1, 2003 for variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. FIN 46 requires variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risk among the parties involved. FIN 46 requires disclosures for entities that have either a primary or significant variable interest in a variable interest entity. FIN 46 will not have an impact on the Company. Comprehensive Income (Loss) The Company's total comprehensive income(loss) was $20.1 million and $(48.1) million for the three months ended September 30, 2003 and 2002, and $77.2 million and $(16.4) million for the nine months ended September 30, 2003 and 2002. Comprehensive income(loss) includes the Company's net earnings adjusted for changes in unrealized appreciation (depreciation) of investments, which were $(54.9) million and $(69.4) million for the three months ended September 30, 2003 and 2002, and $(17.6) million and $(74.8) million for the nine months ended September 30, 2003 and 2002, and cumulative translation adjustments, which were $0.1 million and $(0.5) million for the three months ended September 30, 2003 and 2002, and $6.2 million and $1.9 million for the nine months ended September 30, 2003 and 2002. Segment Information Information concerning the Company's operations by industry segment is summarized below:
For the three months ended For the nine months ended September 30, September 30, September 30, September 30, (dollars in millions) 2003 2002 2003 2002 ------- ------- ------- ------- REVENUES Property and casualty insurance $ 221.5 $ 32.5 $ 298.5 $ 96.4 Mining and filtration 67.4 65.6 198.6 189.5 Corporate activities 66.0 45.3 140.8 157.3 ------- ------- ------- ------- Total $ 354.9 $ 143.4 $ 637.9 $ 443.2 ======= ======= ======= =======
9
For the three months ended For the nine months ended September 30, September 30, September 30, September 30, (dollars in millions) 2003 2002 2003 2002 ------- ------- ------- ------- EARNINGS (LOSSES) BEFORE INCOME TAXES Property and casualty insurance $ 75.0 $ (10.4) $ 82.6 $ (11.4) Mining and filtration 6.9 7.3 18.3 18.0 Corporate activities 25.9 8.2 27.2 51.2 ------- ------- ------- ------- Total 107.8 5.1 128.1 57.8 Income taxes 32.9 (16.6) 39.5 1.4 ------- ------- ------- ------- Net earnings $ 74.9 $ 21.7 $ 88.6 $ 56.4 ======= ======= ======= =======
September 30, December 31, (dollars in millions) 2003 2002 -------- -------- IDENTIFIABLE ASSETS Property and casualty insurance $1,900.5 $ 666.8 Mining and filtration 316.6 320.9 Corporate activities 608.9 1,146.7 -------- -------- Total $2,826.0 $2,134.4 ======== ========
10 Contingencies The Company's subsidiaries are parties to pending claims and litigation in the ordinary course of their businesses. Each such operating unit makes provisions on its books in accordance with generally accepted accounting principles for estimated losses to be incurred as a result of such claims and litigation, including related legal costs. In the opinion of management, such provisions are adequate as of September 30, 2003. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION. The following discussion and analysis presents a review of the Company and its subsidiaries for the three and nine months ended September 30, 2003 and 2002. This review should be read in conjunction with the consolidated financial statements and other data presented herein as well as Management's Discussion and Analysis of Financial Condition and Results of Operation contained in the Company's 2002 Form 10-K, 2003 First Quarter Form 10-Q and 2003 Second Quarter Form 10-Q. The Company reported net earnings in the third quarter of 2003 of $74.9 million, compared with net earnings of $21.7 million in the third quarter of 2002. Third quarter 2003 net earnings include the results of operations of RSUI Group, Inc. ("RSUI"), acquired on July 1, 2003 from Royal & Sun Alliance Group plc ("R&SA"), and net gains on investment transactions after taxes of $50.6 million, primarily reflecting the proceeds from the disposition of approximately 4.4 million shares of common stock of Burlington Northern Santa Fe Corporation. Such disposition generated $119.1 million of aggregate cash proceeds, $87.7 million of which was generated at the Company's insurance operating units for the purpose of diversifying their investment portfolios. In the first nine months of 2003, the Company's net earnings were $88.6 million, compared with net earnings of $56.4 million in the first nine months of 2002. The 2003 nine-month results include net gains on investment transactions after taxes of $53.8 million, compared with $28.3 million in the corresponding 2002 period. The Company's common stockholders' equity per share at September 30, 2003 was $195.61, an increase from common stockholders' equity per share of $186.16 as of December 31, 2002 (both as adjusted for the stock dividend declared in March 2003). AIHL recorded pre-tax earnings of $75.0 million on revenues of $221.5 million in the third quarter of 2003, compared with a pre-tax loss of $10.4 million on revenues of $32.5 million in the 2002 third quarter, and pre-tax earnings of $82.6 million on revenues of $298.5 million in the first nine months of 2003, compared with a pre-tax loss of $11.4 million on revenues of $96.4 million in the first nine months of 2002. AIHL's 2003 third quarter net earnings include pre-tax investment income of $7.4 million and a realized pre-tax net gain on investment transactions of $46.3 million, compared with pre-tax 11 investment income of $3.6 million and a realized pre-tax net loss on investment transactions of $3.8 million in the corresponding 2002 period. AIHL's 2003 pre-tax investment income reflects a larger invested asset base, principally due to capital contributions by Alleghany and the acquisition of RSUI. AIHL's 2003 pre-tax net gain on investment transactions primarily reflects the disposition of 3.2 million shares of common stock of Burlington Northern Santa Fe for aggregate cash proceeds of $87.7 million for the purpose of diversifying the investment portfolios of the insurance operating units. The comparative pre-tax contributions to AIHL's results made by RSUI (since July 1, 2003) and Capitol Transamerica Corporation ("CATA") were as follows (in thousands, except ratios): THREE MONTHS ENDED SEPTEMBER 30
2003 RSUI CATA(1) TOTAL ---- ---- ------- ----- Gross premiums written $489,868 $ 49,519 $539,387 Net premiums earned $135,777 $ 32,042 $167,819 Loss and loss adjustment expenses 81,645 18,964 100,609 Underwriting expenses 25,439 14,658 40,097 -------- --------- -------- Underwriting profit (loss) (2) $ 28,693 $ (1,580) $ 27,113 ======== ========= ======== Loss ratio (3) 60.1% 59.2% 59.9% Expense ratio (4) 18.8% 45.7% 23.9% Combined ratio (5) 78.9% 104.9% 83.8% 2002 Gross premiums written -- $ 37,705 $ 37,705 Net premiums earned -- $ 32,700 $ 32,700 Loss and loss adjustment expenses -- 30,192 30,192 Underwriting expenses -- 12,145 12,145 -------- --------- -------- Underwriting loss (2) -- $ (9,637) $ (9,637) ======== ========= ======== Loss ratio (3) -- 92.3% 92.3% Expense ratio (4) -- 37.1% 37.1% Combined ratio (5) -- 129.4% 129.4%
NINE MONTHS ENDED SEPTEMBER 30
2003 RSUI CATA(1) TOTAL ---- ---- ------- ----- Gross premiums written $489,868 $ 132,089 $621,957 Net premiums earned $135,777 $ 98,982 $234,759 Loss and loss adjustment expenses 81,645 58,632 140,277
12
2003 RSUI CATA(1) TOTAL ---- ---- ------- ----- Underwriting expenses 25,439 42,941 68,380 -------- --------- -------- Underwriting profit (loss) (2) $ 28,693 $ (2,591) $ 26,102 ======== ========= ======== Loss ratio (3) 60.1% 59.2% 59.8% Expense ratio (4) 18.8% 43.4% 29.1% Combined ratio (5) 78.9% 102.6% 88.9% 2002 Gross premiums written -- $ 113,188 $113,188 Net premiums earned -- $ 92,370 $ 92,370 Loss and loss adjustment expenses -- 73,419 73,419 Underwriting expenses -- 32,505 32,505 -------- --------- -------- Underwriting loss (2) -- $ (13,554) $(13,554) ======== ========= ======== Loss ratio (3) -- 79.5% 79.5% Expense ratio (4) -- 35.2% 35.2% Combined ratio (5) -- 114.7% 114.7%
(1) Includes the results of Platte River Insurance Company and other insurance operations. (2) Represents net premiums earned less loss and loss adjustment expenses and underwriting expenses, all as determined in accordance with generally accepted accounting principles ("GAAP"), and does not include income derived from investments. Underwriting profit (loss) does not replace net income (loss) determined in accordance with GAAP as a measure of profitability; rather, it provides a basis for management to evaluate the underwriting performance of its insurance operating units. (3) Loss and loss adjustment expenses divided by net premiums earned, all as determined in accordance with GAAP. (4) Underwriting expenses divided by net premiums earned, all as determined in accordance with GAAP. (5) The sum of the Loss Ratio and Expense Ratio, all as determined in accordance with GAAP, representing the percentage of each premium dollar an insurance company has to spend on losses (including loss adjustment expenses) and underwriting expenses. RSUI's 2003 third quarter gross premiums written include $320.0 million of unearned premiums which were acquired with RSUI in July 2003, as well as $169.9 million of gross premiums written since acquisition, reflecting continued strong markets in its lines of business. In addition, RSUI's 2003 third quarter results reflect pre-tax catastrophe losses of approximately $10.0 million due to the East Coast blackout in August 2003 and approximately $4.8 million due to Hurricane Isabel in September 2003. CATA's 2003 third quarter results reflect a $3.3 million pre-tax reduction in loss reserves due to better than expected loss emergence in the current year following an independent actuarial review, an increase in gross premiums written due to price increases and increased submission activity in its property and casualty lines of business. CATA's 2003 third quarter results also reflect the recording of additional prior year loss reserve development of $3.4 million pre-tax ($1.4 million of which was pursuant to an arbitration settlement) related to assumed reinsurance treaties written prior to 1980. CATA has commenced a review of claims and coverages related to its assumed reinsurance reserves and expects to complete such review in the 2003 fourth quarter, 13 prior to its next independent actuarial review. Should such review result in the need for an increase in assumed reinsurance reserves, such increase would be reflected as an expense in the Company's statement of earnings in the period in which the determination is made. Although the results of RSUI and CATA reflect their continued ability to achieve rate increases across their lines of business, rates have increased at a slower rate or declined in certain lines of business, particularly with respect to RSUI's property line of business. In connection with the acquisition of RSUI, AIHL also acquired RSUI Indemnity Company ("RIC") to write business on an admitted basis, and RIC acquired Landmark American Insurance Company ("Landmark") to write business on a non-admitted basis. In order to be able to write admitted business in a state, a company must be licensed by the state and become subject to the state's form and rate regulations. It is anticipated that it will take up to mid-2004 for RIC to obtain all necessary licenses to be able to write business on an admitted basis in most states, while Landmark (which, as a non-admitted company, is not subject to state form and rate regulations and thus has more flexibility in its rates and coverages for specialized or hard-to-place risks) is currently approved to write business on a non-admitted basis in 48 states. Although R&SA agreed to provide policy issuance services to RIC through June 2004 to cover this regulatory transition period, all of the major rating agencies downgraded the ratings of R&SA's issuing carriers in the 2003 third quarter to levels that have substantially reduced the acceptability of their insurance policies to agents, brokers, and insureds. As an alternative, RSUI has been offering coverage written by Landmark on a non-admitted basis for classes of business predominantly written on an admitted basis. This may reduce RSUI's premium volume for those classes of business that are predominantly written on admitted paper, including the excess umbrella liability and general liability insurance lines. World Minerals recorded pre-tax earnings of $6.9 million on revenues of $67.4 million in the 2003 third quarter, compared with pre-tax earnings of $7.3 million on revenues of $65.6 million in the 2002 third quarter, and pre-tax earnings of $18.3 million on revenues of $198.6 million in the first nine months of 2003, compared with pre-tax earnings of $18.0 million on revenues of $189.4 million in the first nine months of 2002. The 2003 nine-month results reflect the favorable impact of the strengthening of the Euro and pound sterling against the dollar (had foreign exchange rates remained constant with those of the first nine months in 2002, World Minerals' revenues would have been approximately flat), lower margins due to competitive pricing pressures and increased labor and benefit costs. As of September 30, 2003, the Company beneficially owned approximately 11.6 million shares, or 3.1 percent, of the outstanding common stock of Burlington Northern 14 Santa Fe Corporation, which had an aggregate market value on that date of approximately $335.7 million, or $28.87 per share. The aggregate cost of such shares is approximately $138.1 million, or $11.88 per share. The Company has previously announced that it may purchase shares of its common stock in open market transactions from time to time. In the third quarter of 2003, the Company did not purchase any shares of its common stock. As of September 30, 2003, the Company had 7,487,885 shares of common stock outstanding (which includes the stock dividend declared in March 2003). The Company's results in the first nine months of 2003 are not indicative of operating results in future periods. On September 26, 2003, the Company borrowed $25.0 million under its three-year credit agreement for the purpose of making equity investments. The Company repaid in full such borrowings on November 12, 2003. The Company and its subsidiaries have adequate internally generated funds and unused credit facilities to provide for the currently foreseeable needs of its and their businesses. Information regarding the Company's accounting policies is included in the Company's 2002 Form 10-K and the Notes to the Consolidated Financial Statements included in this report on Form 10-Q. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Market risk is the risk of loss from adverse changes in market prices and rates, such as interest rates, foreign currency exchange rates and commodity prices. The primary market risk related to the Company's non-trading financial instruments is the risk of loss associated with adverse changes in interest rates. The investment portfolios of the Company and its insurance subsidiaries may contain, from time-to-time, debt securities with fixed maturities that expose them to risk related to adverse changes in interest rates. The table below presents a sensitivity analysis of the debt securities of the Company and its insurance subsidiaries that are sensitive to changes in interest rates. Sensitivity analysis is defined as the measurement of potential changes in future earnings, fair values or cash flows of market sensitive instruments resulting from one or more selected hypothetical changes in interest rates over a selected period of time. In this sensitivity analysis model, the Company uses fair values to measure the potential change, and a +/- 300 basis point range of change in interest rates to measure the hypothetical change in fair value of the financial instruments included in the analysis. The change in fair value is determined by calculating a hypothetical September 30, 2003 ending price based on yields adjusted to reflect a +/- 300 basis point range of change in interest rates, comparing such hypothetical ending price to actual ending price and multiplying the difference by the par outstanding. 15 SENSITIVITY ANALYSIS At September 30, 2003 (dollars in millions) Interest Rate Shifts -300 -200 -100 0 100 200 300 ---- ---- ---- - --- --- --- ASSETS Debt securities 839.3 832.7 814.5 774.8 772.8 752.1 732.7 Estimated change in value 64.5 57.9 39.7 -- (2.0) (22.7) (42.1) LIABILITIES Parent and subsidiaries' debt 183.8 183.8 183.4 183.9 184.5 185.1 185.7 Estimated change in value (0.1)* (0.1) (0.5) -- 0.6 1.2 1.8
*The weighted average interest rate for parent and subsidiaries' debt is 2.73%. For purposes of this table, no change in value of such debt is reflected below -200 basis points as any decrease in interest rates greater than 273 basis points (or 2.73%) would result in an effective interest rate of 0%. The Company's 2002 Form 10-K provides a more detailed discussion of the market risks affecting its operations. Based on the Company's estimates as of September 30, 2003, no material change has occurred in its assets and liabilities, as compared with amounts disclosed in its 2002 Form 10-K. 16 ITEM 4. CONTROLS AND PROCEDURES The Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Chief Executive Officer (the "CEO") and the Chief Financial Officer (the "CFO"), of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of the end of the period covered by this report on Form 10-Q pursuant to Rule 13a-15 promulgated under the Securities Exchange Act of 1934. Based on that evaluation, the Company's management, including the CEO and CFO, concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information required to be included in the Company's periodic reports required to be filed with the Securities and Exchange Commission. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. There have been no significant changes in internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting subsequent to the date of such evaluation, including any corrective actions with regard to significant deficiencies or material weaknesses. Forward-Looking Statements "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Quantitative and Qualitative Disclosures About Market Risk" contain disclosures which are forward-looking statements. Forward-looking statements include all statements that do not relate solely to historical or current facts, and can be identified by the use of words such as "may," "will," "expect," "project," "estimate," "anticipate," "plan" or "continue." These forward-looking statements are based upon the Company's current plans or expectations and are subject to a number of uncertainties and risks that could significantly affect current plans, anticipated actions and the Company's future financial condition and results. These statements are not guarantees of future performance, and the Company has no specific intention to update these statements. The uncertainties and risks include, but are not limited to, those relating to conducting operations in a competitive environment and conducting operations in foreign countries, effects of acquisition and disposition activities, adverse loss development for events insured by the Company's insurance operations in either the current year or prior years, general economic and political conditions, including the effects of a prolonged U.S. or global economic downturn or recession, changes in costs, including changes in labor costs, energy costs and raw material prices, variations in political, economic or other factors such as currency exchange rates, inflation rates or recessionary or expansive trends, changes in market prices of the Company's significant equity investments, tax, legal and regulatory changes, extended labor disruptions, significant weather-related or other natural or human-made disasters, especially with respect to their impact on losses at the Company's insurance subsidiaries, civil unrest or other external factors over which the Company has no control, and changes in the Company's plans, strategies, objectives, expectations or intentions, 17 which may happen at any time at the Company's discretion. As a consequence, current plans, anticipated actions and future financial condition and results may differ from those expressed in any forward-looking statements made by or on behalf of the Company. 18 PART II. OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES. (c) Recent Sales of Unregistered Securities. On July 15, 2003, the Company issued 867 shares of common stock to Paul F. Woodberry, a director of Alleghany Properties, Inc., a wholly owned subsidiary of the Company, pursuant to a long-term incentive arrangement with the Company in respect of sales of real estate assets by Alleghany Properties, Inc. The issuance of common stock was exempt from registration under the Securities Act of 1933 pursuant to Section 4(2) thereof, as a transaction not involving a public offering. On August 25, 2003, the Company sold 10,000 shares of common stock to Weston M. Hicks, Executive Vice President of the Company, for a purchase price of $200.185 per share. The sale was exempt from registration under the Securities Act of 1933, as amended, pursuant to Section 4(2) thereof, as a transaction not involving a public offering. Pursuant to a Restricted Stock Unit Matching Grant Agreement dated as of October 7, 2002 with Mr. Hicks, which provided for the grant of two restricted stock units for each share of common stock purchased by Mr. Hicks on or before September 30, 2003, the Company granted 20,000 restricted stock units to Mr. Hicks on August 25, 2003. Mr. Hicks paid no consideration for such units. Upon the satisfaction of vesting and certain other conditions, the restricted stock units are payable in cash, shares of common stock or a combination thereof, based on the fair market value on the payment date of a number of shares of common stock equal to the number of restricted stock units in respect of which Mr. Hicks is entitled to payment. The above does not include unregistered issuances of the Company's common stock that did not involve a sale, consisting of issuances of common stock and other securities pursuant to employee incentive plans. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits.
Exhibit Number Description -------------- ----------- 10.1 Assignment and Assumption Agreement, dated as of July 1, 2003, by and between AIHL and Underwriters Reinsurance Company (regarding the transfer of rights under the Stock Purchase Agreement, dated as
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Exhibit Number Description -------------- ----------- of June 6, 2003, by and between AIHL and Guaranty National Insurance Company). 10.2 RIC Quota Share Reinsurance Agreement, dated as of September 2, 2003, by and between Landmark and RIC (the "RIC (Landmark) Quota Share Reinsurance Agreement"). 10.3 List of Contents of Exhibits and Schedules to the RIC (Landmark) Quota Share Reinsurance Agreement. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.4 RIC Administrative Services Agreement, dated as of September 2, 2003, by and between RIC and Landmark (the "RIC (Landmark) Administrative Services Agreement"). 10.5 List of Contents of Exhibits and Schedules to the RIC (Landmark) Administrative Services Agreement. Alleghany agrees to furnish supplementally a copy of any omitted exhibit or schedule to the Securities and Exchange Commission upon request. 10.6 Assumption of Liabilities Agreement, dated as of September 2, 2003, by and between Landmark and RIC. 10.7 Amendment to the Trust Agreement, dated as of September 2, 2003, amending the Trust Agreement, dated as of July 1, 2003, by and among RIC, Royal Surplus Lines Insurance Company, Landmark, RIC (f/k/a Underwriters Reinsurance Company) and LaSalle Bank National Association, as Trustee. 10.8 Amendment to the Assignment of Net Premium Receivables, dated as of September 2, 2003, amending the Assignment of Net Premium Receivables, dated as of July 1, 2003, by and between LaSalle Bank National Association and RIC, Royal Surplus Lines Insurance Company and Landmark. 10.9 Amendment to the Assignment of Reinsurance Recoverables, dated as of September 2, 2003, amending the Assignment of Reinsurance Recoverables, dated as of July 1, 2003, by and among RIC (f/k/a Underwriters Reinsurance Company),
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Exhibit Number Description -------------- ----------- LaSalle Bank National Association , RIC, Royal Surplus Lines Insurance Company and Landmark. 10.10 Third Amendment to 364-Day Revolving Credit Agreement, dated as of September 30, 2003, amending the 364-Day Revolving Credit Agreement, dated as of June 14, 2002, by and among the Company, the Banks named therein and U.S. Bank National Association, as agent for the Banks. 10.11 Fourth Amendment to 364-Day Revolving Credit Agreement, dated as of October 17, 2003, amending the 364-Day Revolving Credit Agreement, dated as of June 14, 2002, by and among the Company, the Banks named therein and U.S. Bank National Association, as agent for the Banks. 10.12 Fifth Amendment to 364-Day Revolving Credit Agreement, dated as of November 10, 2003, amending the 364-Day Revolving Credit Agreement, dated as of June 14, 2002, by and among the Company, the Banks named therein and U.S. Bank National Association, as agent for the Banks. 10.13 Second Amendment to Three-Year Revolving Credit Agreement, dated as of October 17, 2003, amending the Three-Year Revolving Credit Agreement, dated as of June 14, 2002, among the Company, the Banks named therein and U.S. Bank National Association, as agent for the Banks. 31.1 Certification of the Chief Executive Officer of the Company pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of the Chief Financial Officer of the Company pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This exhibit shall not be deemed "filed" as a part of this Report on Form 10-Q. 32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This
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Exhibit Number Description -------------- ----------- exhibit shall not be deemed "filed" as a part of this Report on Form 10-Q.
22 (b) Reports on Form 8-K. On November 13, 2003, the Company furnished a report on Form 8-K under Item 12 thereof regarding a press release reporting on the Company's financial results as of and for the quarter ended September 30, 2003. 23 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ALLEGHANY CORPORATION Registrant Date: November 13, 2003 /s/ David B. Cuming David B. Cuming Senior Vice President (and chief financial officer) 24