10-Q 1 y68569e10vq.txt ALLEGHANY CORPORATION SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004 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 SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO -------------------------------------------------------------------------------- INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS DEFINED IN RULE 12B-2 OF THE EXCHANGE ACT). YES X NO -------------------------------------------------------------------------------- INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF COMMON STOCK, AS OF THE LAST PRACTICABLE DATE. 7,676,197 SHARES AS OF OCTOBER 31, 2004 -------------------------------------------------------------------------------- ITEM 1. FINANCIAL STATEMENTS ALLEGHANY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS (LOSSES) FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 (dollars in thousands, except share and per share amounts) (unaudited)
2004 2003 ----------- ----------- REVENUES Net fastener sales $ 41,846 $ 30,559 Interest, dividend and other income 18,156 11,096 Net insurance premiums earned 198,606 167,819 Net mineral and filtration sales 73,276 67,502 Net gain on investment transactions 6,688 77,874 ----------- ----------- Total revenues 338,572 354,850 ----------- ----------- COSTS AND EXPENSES Underwriting expenses 48,700 40,097 Salaries, administrative and other operating expenses 26,701 22,914 Loss and loss adjustment expenses 242,166 100,609 Cost of goods sold - fasteners 32,880 23,614 Cost of mineral and filtration sales 55,974 50,174 Interest expense 1,346 1,381 Corporate administration 10,299 8,218 ----------- ----------- Total costs and expenses 418,066 247,007 ----------- ----------- (Loss) earnings before income taxes (79,494) 107,843 Income tax (benefit) provision (32,490) 32,973 ----------- ----------- Net (loss) earnings ($ 47,004) $ 74,870 =========== =========== Basic (loss) earnings per share of common stock * ($ 6.12) $ 9.83 =========== =========== Diluted (loss) earnings per share of common stock ** ($ 6.12) $ 9.79 =========== =========== Dividends per share of common stock *** *** =========== =========== Average number of outstanding shares of common stock * 7,675,313 7,617,920 =========== ===========
* Adjusted to reflect the common stock dividend declared in March 2004. ** Adjusted to reflect the common stock dividend declared in March 2004. The diluted loss per share amount in 2004 was anti-dilutive. Therefore, basic loss per share is presented. *** In March 2003 and 2004, Alleghany declared a stock dividend consisting of one share of Alleghany common stock for every fifty shares outstanding. See Notes to Unaudited Consolidated Financial Statements. ALLEGHANY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 (dollars in thousands, except share and per share amounts) (unaudited)
2004 2003 ---------- ---------- REVENUES Net fastener sales $ 123,226 $ 85,804 Interest, dividend and other income 46,175 36,187 Net insurance premiums earned 591,489 234,759 Net mineral and filtration sales 211,603 198,410 Net gain on investment transactions 44,223 82,716 ---------- ---------- Total revenues 1,016,716 637,876 ---------- ---------- COSTS AND EXPENSES Underwriting expenses 133,088 68,380 Salaries, administrative and other operating expenses 76,874 60,498 Loss and loss adjustment expenses 427,280 140,277 Cost of goods sold - fasteners 93,221 65,182 Cost of mineral and filtration sales 162,417 150,295 Interest expense 3,905 4,127 Corporate administration 29,193 21,001 ---------- ---------- Total costs and expenses 925,978 509,760 ---------- ---------- Earnings before income taxes 90,738 128,116 Income taxes 26,955 39,526 ---------- ---------- Net earnings $ 63,783 $ 88,590 ========== ========== Basic earnings per share of common stock * $ 8.32 $ 11.68 ========== ========== Diluted earnings per share of common stock * $ 8.29 $ 11.64 ========== ========== Dividends per share of common stock ** ** ========== ========== Average number of outstanding shares of common stock * 7,665,295 7,586,665 ========== ==========
* Adjusted to reflect the common stock dividend declared in March 2004. ** In March 2003 and 2004, Alleghany declared a stock dividend consisting of one share of Alleghany common stock for every fifty shares outstanding. See Notes to Unaudited Consolidated Financial Statements. ALLEGHANY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2004 AND DECEMBER 31, 2003 (dollars in thousands, except share amounts)
SEPTEMBER 30, 2004 DECEMBER 31, (UNAUDITED) 2003 * ---------- ---------- ASSETS Available for sale securities at fair value: 9/30/2004 12/31/2003 Equity securities (cost: $321,155 $370,982 ) $612,454 $620,754 Debt securities (cost: $1,325,242 $910,307 ) 1,327,385 917,270 Short-term investments 74,422 135,079 ---------- ---------- 2,014,261 1,673,103 Cash 275,838 231,583 Notes receivable 91,804 92,082 Accounts receivable, net 76,592 75,154 Premium balances receivable 170,578 279,682 Reinsurance receivables 580,425 211,753 Ceded unearned premium reserves 284,589 231,166 Deferred acquisition costs 56,885 47,282 Property and equipment - at cost, net of accumulated depreciation 170,924 177,708 Inventory 85,696 84,612 Goodwill and other intangibles, net of amortization 230,483 233,739 Deferred tax assets 111,074 85,736 Current taxes receivable 21,555 0 Other assets 75,909 94,898 ---------- ---------- $4,246,613 $3,518,498 ========== ========== LIABILITIES AND COMMON STOCKHOLDERS' EQUITY Current taxes payable $ 0 $ 49,605 Losses and loss adjustment expenses 1,153,846 437,994 Other liabilities 224,738 211,000 Reinsurance payable 103,990 255,117 Unearned premiums 735,208 644,068 Subsidiaries' debt 158,724 167,050 Deferred tax liabilities 216,233 190,842 ---------- ---------- Total liabilities 2,592,739 1,955,676 Common stockholders' equity 1,653,874 1,562,822 ---------- ---------- $4,246,613 $3,518,498 ========== ========== COMMON SHARES OUTSTANDING ** 7,675,313 7,644,232 ========== ==========
* Certain amounts have been restated and reclassified to conform to the 2004 presentation. ** Adjusted to reflect the common stock dividend declared in March 2004. See Notes to Unaudited Consolidated Financial Statements. ALLEGHANY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 (dollars in thousands) (unaudited)
2004 2003* ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES Net earnings $ 63,783 $ 88,590 Adjustments to reconcile net earnings to cash provided by operations: Depreciation and amortization 36,578 15,979 Net gain on investment transactions (44,223) (82,716) Tax benefit on stock options exercised 1,251 3,388 Increase in accounts and notes receivable (1,160) (16,827) (Increase) decrease in inventory (1,084) 27,352 Decrease (increase) in other assets 17,554 (141,559) Increase in reinsurance receivable, net of reinsurance payable (519,799) 10,538 Decrease (increase) in premium balances receivable 109,104 (84,454) Increase in ceded unearned premium reserves (53,423) (32,751) Increase in deferred acquisition costs (9,603) (32,101) (Decrease) increase in other liabilities and current taxes (41,831) 99,123 Increase in unearned premiums 91,140 369,572 Increase in losses and loss adjustment expenses 715,852 69,280 ----------- ----------- Net adjustments 300,356 204,824 ----------- ----------- Net cash provided by operating activities 364,139 293,414 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of investments (1,161,234) (687,270) Sales of investments 844,109 437,580 Purchases of property and equipment (12,389) (15,709) Net change in short-term investments 60,657 120,005 Other, net (24,807) 114,837 Acquisition of insurance companies, net of cash acquired (17,742) (131,389) ----------- ----------- Net cash used in investing activities (311,406) (161,946) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Principal payments on long-term debt (16,326) (82,931) Proceeds of long-term debt 8,000 114,371 Other, net (152) 4,631 ----------- ----------- Net cash (used in) provided by financing activities (8,478) 36,071 ----------- ----------- Net increase in cash 44,255 167,539 Cash at beginning of period 231,583 27,423 ----------- ----------- Cash at end of period $ 275,838 $ 194,962 =========== =========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the period for: Interest $ 4,095 $ 2,977 Income taxes $ 114,144 $ 9,019
* Certain amounts have been restated and reclassified to conform to the 2004 presentation. See Notes to Unaudited Consolidated Financial Statements. Notes to the Unaudited Consolidated Financial Statements This report should be read in conjunction with the Annual Report on Form 10-K for the year ended December 31, 2003 (the "2003 Form 10-K") and the Quarterly Reports on Form 10-Q for the quarters ended March 31, 2004 (the "2004 First Quarter Form 10-Q") and June 30, 2004 (the "2004 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. Principles of Consolidation The Company's consolidated financial statements include the financial results of Alleghany Corporation and its majority-owned subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation. Stock-Based Compensation Accounting In December 2002, the Financial Accounting Standards Board issued SFAS No. 148, "Accounting for Stock-Based Compensation Transition and Disclosure" ("SFAS 148"). SFAS 148 amended FASB Statement No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") to provide alternative methods of transition for enterprises that elect to change to the SFAS 123 fair value method of accounting for stock-based employee compensation and to amend the disclosure requirements of SFAS 123. The Company maintains fixed option plans and a performance-based stock plan. Effective January 1, 2003, the Company adopted the fair value recognition provisions of SFAS 123 prospectively for all employee and/or director awards granted, modified or settled under any of its stock-based compensation plans after January 1, 2003. Fair value is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions: no cash dividend yield for all years; expected volatility of 19 percent for all years; risk-free interest rates ranging from 3.02 percent to 3.75 percent; and expected lives of seven years. Prior to 2003, the Company accounted for its fixed option plans and performance-based stock plan under the recognition and measurement provisions of APB Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). During the third quarter of 2004 and 2003, no stock options were granted under the Company's fixed option plans. The expense relating to options issued in prior periods was $47,000 in the third quarter of 2004 and $21,000 in the third quarter of 2003. 6 With respect to its performance-based stock plan, the Company recognized after-tax compensation expense of approximately $2.5 million in the 2004 third quarter and approximately $1.1 million in the 2003 third quarter (in each case calculated pursuant to the prospective method under SFAS 123). Had the Company applied SFAS 123 to all option awards outstanding under its fixed option plans during the 2004 and 2003 third quarters, the Company would have recognized after-tax expense of $64,000 in the 2004 third quarter and $30,000 in the 2003 third quarter. Had the Company applied SFAS 123 to all awards outstanding under its performance-based stock plan during the same periods, the Company would have recognized additional after-tax expense of approximately $1.9 million in the 2004 third quarter and approximately $1.2 million in the 2003 third quarter. 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.
For the three months ended For the nine months ended (dollars in thousands, except per September 30, September 30, September 30, September 30, share amounts) 2004 2003 2004 2003 ---------- ---------- ---------- ---------- Net (loss) earnings, as reported $ (47,004) $ 74,870 $ 63,783 $ 88,590 Add: stock-based employee compensation expense included in reported net earnings, net of related tax 2,534 1,167 6,994 2,504 Less: stock-based compensation expense determined under fair value method for all stock options, net of related tax 1,983 1,288 6,556 3,543 ---------- ---------- ---------- ---------- Pro forma net (loss) earnings $ (46,453) $ 74,749 $ 64,221 $ 87,551 ========== ========== ========== ========== (Loss) earnings per share Basic - as reported $ (6.12) $ 9.83 $ 8.32 $ 11.68 Basic - pro forma $ (6.05) $ 9.81 $ 8.29 $ 11.54 Diluted - as reported $ (6.12)* $ 9.79 $ 8.38 $ 11.64 Diluted - pro forma $ (6.05)* $ 9.78 $ 8.34 $ 11.50
* As diluted net loss per share was anti-dilutive, basic net loss per share figures are presented. 7 Employee Benefit Plans The Company has several noncontributory defined benefit pension plans, including plans in place at its World Minerals, Inc. operating unit. Under executive retirement plans, defined benefits are based on years of service and the employee's average annual base salary over a consecutive three-year period during the last ten years or, if applicable, shorter period of employment, plus one-half of the highest average annual bonus over a consecutive five-year period during the last ten years, or, if applicable, shorter period of employment. With respect to its funded plans, the Company's policy is to contribute annually the amount necessary to satisfy the Internal Revenue Service's funding requirements. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. Additional details regarding the Company's noncontributory defined benefit pension plans can be found in Note 11 to the Consolidated Financial Statements in the Company's 2003 Form 10-K. The Company plans to contribute approximately $4.9 million to the plans in 2004, compared with contributions of approximately $6.9 million in 2003. The components of net periodic pension cost for the three and nine months ended September 30, 2004 and 2003 consisted of the following:
For the three months ended For the nine months ended September 30, September 30, September 30, September 30, (dollars in thousands) 2004 2003 2004 2003 ------------- ------------- ------------- ------------- Net periodic pension cost included the following expense (income) components: Service cost-benefits earned during the quarter $0.9 $0.8 $2.6 $2.4 Interest cost on projected benefit 1.1 1.0 3.3 3.1 obligation Expected return on plan assets (0.9) (0.8) (2.8) (2.3) Net amortization 0.6 0.7 1.9 2.0 Settlement loss 1.1 -- 1.1 -- ---- ---- ---- ---- Net periodic pension cost $2.8 $1.7 $6.1 $5.2 ==== ==== ==== ====
Pursuant to the requirements of SFAS No. 88 "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits," the Company recognized a $1.1 million settlement loss in the 2004 third quarter due to an amendment of the parent company executive retirement plan from a funded to an unfunded plan and the resulting distribution of all accrued benefits to date to vested participants. 8 Comprehensive Income The Company's total comprehensive (loss) income for the three months ended September 30, 2004 and 2003 was $(21.1) million and $20.1 million, and $86.3 million and $(16.4) million for the nine months ended September 30, 2004 and 2003. Comprehensive income (loss) includes the Company's net earnings (losses) adjusted for changes in unrealized appreciation (depreciation) of investments, which were $24.5 million and $(54.9) million for the three months ended September 30, 2004 and 2003, and $24.1 million and $(17.6) million for the nine months ended September 30, 2004 and 2003, and cumulative translation adjustments, which were $1.5 million and $(0.1) million for the three months ended September 30, 2004 and 2003, and $(1.6) million and $6.2 million for the nine months ended September 30, 2004 and 2003. Segment Information Summary information concerning the Company's operations is as follows:
For the three months ended For the nine months ended September 30, September 30, September 30, September 30, (dollars in millions) 2004 2003 2004 2003 ------------- ------------- ------------- ------------- REVENUES Property and casualty insurance $ 216.4 $ 221.5 $ 664.7 $ 298.5 Mining and filtration 72.9 67.4 211.2 198.6 Corporate activities 49.2 66.0 140.8 140.8 -------- -------- -------- -------- Total $ 338.6 $ 354.9 $1,016.7 $ 637.9 ======== ======== ======== ======== EARNINGS (LOSSES) BEFORE INCOME TAXES Property and casualty insurance $ (81.5) $ 75.0 $ 84.4 $ 82.6 Mining and filtration 6.0 6.9 16.8 18.3 Corporate activities (4.0) 25.9 (10.5) 27.2 -------- -------- -------- -------- Total (79.5) 107.8 90.7 128.1 ======== ======== ======== ======== Income tax (benefit) provision (32.5) 32.9 26.9 39.5 -------- -------- -------- -------- Net (loss) earnings $ (47.0) $ 74.9 $ 63.8 $ 88.6 ======== ======== ======== ========
September 30, December 31, (dollars in millions) 2004 2003 ---------- ---------- IDENTIFIABLE ASSETS Property and casualty insurance $ 3,257.3 $ 2,557.4 Mining and filtration 338.8 331.3 Corporate activities 650.5 629.8 ---------- ---------- Total $ 4,246.6 $ 3,518.5 ========== ==========
9 The Company's operating businesses are segmented based on the nature of products and services provided. Segment accounting policies are the same as the Consolidated Accounting Policies described in Note 1 to the Consolidated Financial Statements in the 2003 Form 10-K. Property and casualty insurance operations, which are conducted by Alleghany Insurance Holdings LLC ("AIHL") and its subsidiaries RSUI Group, Inc. ("RSUI"), Capitol Transamerica Corporation ("CATA") and Darwin Professional Underwriters, Inc. ("Darwin"), and mining and filtration operations, which are conducted by World Minerals, Inc. ("World Minerals"), are the Company's largest businesses. The primary components of "corporate activities" are Heads & Threads International LLC ("Heads & Threads"), Alleghany Properties, Inc. and corporate activities at the parent level. Correction of Error The Consolidated Balance Sheet at December 31, 2003 has been restated to reflect the correction of an accounting error made at one of the Company's insurance businesses. The asset and liability accounts affected by the correction, the amount previously reported, the amount of the correction and the restated amount are as follows:
AMOUNT PREVIOUSLY AMOUNT OF DECEMBER 31, 2003 (in millions) REPORTED CORRECTION RESTATED AMOUNT ----------------- ---------- ----------------- ASSETS Reinsurance receivables $ 228.4 $ (16.7) $ 211.8 Ceded unearned premium reserves $ 264.0 (32.8) $ 231.2 -------- Total assets $ 3,568.0 $ 49.5 $ 3,518.5 ======== LIABILITIES Loss and loss adjustment expenses $ 454.7 $ (16.7) $ 438.0 Unearned premiums $ 676.9 (32.8) $ 644.1 -------- Total liabilities $ 2,005.2 $ 49.5 $ 1,955.7 ========
The correction recorded in the 2004 third quarter was identified by management during a financial statement review and relates to certain inter-company reinsurance balances that had not been eliminated on the Consolidated Balance Sheet. The correction had no impact on the Statement of Earnings (Losses) and Stockholders' Equity. The Statements of Cash Flow have been adjusted for the correction. There was no impact on cash flows from operating activities, investing activities and financing activities. 10 Contingencies The Company's subsidiaries are parties to pending claims and litigation in the ordinary course of their businesses. Each such subsidiary 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, 2004. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion and analysis presents a review of the Company and its subsidiaries for the three and nine months ended September 30, 2004 and 2003. 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 2003 Form 10-K, 2004 First Quarter Form 10-Q and 2004 Second Quarter Form 10-Q. The Company reported a net loss in the third quarter of 2004 of $47.0 million, compared with net earnings of $74.9 million in the third quarter of 2003. The Company's 2004 third quarter results primarily reflect $97.8 million of after-tax catastrophe losses, net of reinsurance and $6.9 million of reinsurance reinstatement premiums, at its RSUI and CATA operating units due to the impact of Hurricanes Charley, Frances, Ivan and Jeanne during the period. The 2004 third quarter net losses include net gains on investment transactions after taxes (taxed at the federal income tax rate) of $4.3 million, compared with $50.6 million in the corresponding 2003 period. In the first nine months of 2004, the Company's net earnings were $63.8 million, compared with net earnings of $88.6 million in the first nine months of 2003. The 2004 nine-month net earnings results include net gains on investment transactions after taxes (taxed at the federal income tax rate) of $28.7 million, compared with $53.8 million in the corresponding 2003 period. The Company's common stockholders' equity per share at September 30, 2004 was $215.48, a decrease from common stockholders' equity per share of $218.32 as of June 30, 2004, but an increase from common stockholders' equity per share of $204.44 as of December 31, 2003 (all as adjusted for the stock dividend declared in March 2004). Alleghany Insurance Holdings LLC ("AIHL") recorded a net loss of $52.1 million on revenues of $216.4 million in the 2004 third quarter, compared with net earnings of $48.5 million on revenues of $221.5 million in the third quarter of 2003, and net earnings of $56.9 million on revenues of $664.7 million in the first nine months of 2004, compared with net earnings of $55.2 million on revenues of $298.5 million in the first nine months of 2003. AIHL's 2004 third quarter results primarily reflect $97.8 million of after-tax catastrophe losses, net of reinsurance and $6.9 million of reinsurance reinstatement premiums, from third quarter hurricane activity. AIHL's 2004 third quarter net losses include net investment income after taxes (taxed at the federal income tax rate) of $5.9 million and net gains on 11 investment transactions after taxes (taxed at the federal income tax rate) of $4.3 million, compared with net investment income after taxes (taxed at the federal income tax rate) of $3.7 million and net gains on investment transactions after taxes (taxed at the federal income tax rate) of $30.1 million in the corresponding 2003 period. AIHL's net earnings for the first nine months in 2004 include net investment income after taxes (taxed at the federal income tax rate) of $19.5 million and net gains on investment transactions after taxes (taxed at the federal income tax rate) of $27.6 million, compared with net investment income after taxes (taxed at the federal income tax rate) of $10.0 million and net gains on investment transactions after taxes (taxed at the federal income tax rate) of $30.6 million in the corresponding 2003 period. AIHL's increase in net investment income after taxes reflects a larger invested asset base, principally due to capital contributions by the Company and the acquisition of the operations of RSUI in July 2003. At September 30, 2004, AIHL had reinsurance receivables of $580.4 million, compared with $211.8 at December 31, 2003. The increase in such receivables primarily reflects increased business written by RSUI and Darwin, as well as $263.3 million of 2004 third quarter catastrophe losses ceded to reinsurers. The Company currently believes that its reinsurance receivables are collectible. The Company regularly reviews the credit quality of its reinsurance counterparties and limits exposure in terms of amount and duration based on its assessment of each reinsurer's credit quality. Approximately 94.0 percent of the Company's reinsurance receivables balances are from reinsurers that are rated A or better by A.M. Best Company, Inc. ("A.M. Best"). Of the remaining 6.0 percent of reinsurance receivables balances which are placed with reinsurers rated A- or less by A.M. Best, 75.0 percent are collateralized. The comparative pre-tax contributions to AIHL's results made by its operating units RSUI, CATA and Darwin, and total AIHL results, were as follows (in thousands, except ratios): 12 Three Months Ended September 30,
RSUI(1) CATA(2) Darwin(3) AIHL --------- -------- -------- --------- 2004 ---- Gross premiums written (4) $305,460 $43,750 $25,283 $374,493 Net premiums written (4) 155,736 39,134 17,212 212,082 Net premiums earned $147,498 $37,687 $13,421 $198,606 Loss and loss adjustment expenses 212,199 21,238 8,729 242,166 Underwriting expenses 23,252 20,918 4,530 48,700 ------ ------ ----- ------ Underwriting (loss) profit (5) $(87,953) $(4,469) $162 (92,260) ========= ======== ======= Interest, dividend and other income 11,094 Net gain on investment transactions 6,688 Other expenses (6,982) --------- Earnings (losses) before income taxes $(81,460) ========= Loss ratio (6) 143.9 56.4 65.0 121.9 Expense ratio (7) 15.7 55.5 33.8 24.5 Combined ratio (8) 159.6 111.9 98.8 146.4 2003 Gross premiums written (4) $489,868 (9) $43,003 $6,177 $539,383 Net premiums written (4) 457,157 35,217 5,547 497,921 Net premiums earned $135,777 $30,935 $1,107 $167,819 Loss and loss adjustment expenses 81,645 18,239 725 100,609 Underwriting expenses 25,439 12,837 1,821 40,097 ------ ------ ----- --------- Underwriting profit (loss) (5) $28,693 $(141) $(1,439) 27,113 ========= ======== ======== Interest, dividend and other income 7,359 Net gain on investment transactions 46,275 Other expenses (5,780) --------- Earnings before income taxes $74,967 ========= Loss ratio (6) 60.1 59.0 65.5 59.9 Expense ratio (7) 18.7 41.5 164.5 23.9 Combined ratio (8) 78.8 100.5 230.0 83.8
13 Nine Months Ended September 30,
RSUI(1) CATA(2) Darwin(3) AIHL --------- -------- -------- ----------- 2004 ---- Gross premiums written (4) $907,941 $132,130 $66,065 $1,106,136 Net premiums written (4) 465,241 118,134 45,831 629,206 Net premiums earned $449,810 $111,660 $30,019 $591,489 Loss and loss adjustment expenses 345,565 62,628 19,087 427,280 Underwriting expenses 70,241 51,679 11,168 133,088 --------- -------- -------- --------- Underwriting profit (loss) (5) $34,004 $(2,647) $(236) 31,121 ========= ======== ======== Interest, dividend and other income 30,754 Net gain on investment transactions 42,488 Other expenses (19,947) --------- Earnings before income taxes $84,416 ========= Loss ratio (6) 76.8 56.1 63.6 72.3 Expense ratio (7) 15.6 46.3 37.2 22.4 Combined ratio (8) 92.4 102.4 100.8 94.7 2003 Gross premiums written (4) $489,868 (9) $123,477 $8,273 $621,618 Net premiums written (4) 457,157 106,892 7,531 571,580 Net premiums earned $135,777 $97,768 $1,214 $234,759 Loss and loss adjustment expenses 81,645 57,843 789 140,277 Underwriting expenses 25,439 39,683 3,258 68,380 --------- -------- -------- --------- Underwriting profit (loss) (5) $28,693 $242 $(2,833) 26,102 ========= ======== ======== Interest, dividend and other income 16,569 Net gain on investment transactions 47,147 Other expenses (7,257) --------- Earnings before income taxes $82,561 ========= Loss ratio (6) 60.1 59.2 65.0 59.8 Expense ratio (7) 18.7 40.6 268.4 29.1 Combined ratio (8) 78.8 99.8 333.4 88.9
(1) Since July 1, 2003. (2) Includes the results of Platte River Insurance Company, which was acquired contemporaneously with CATA in January 2002 and operates in conjunction with CATA. (3) Although Darwin is an underwriting manager for Platte River and certain subsidiaries of CATA, Darwin is managed on an operating unit basis and therefore, the results of business generated by Darwin have been separated from CATA's results for purposes of this table. 14 (4) Amounts do not reflect the impact of an inter-company pooling agreement. (5) Represents net premiums earned less loss and loss adjustment expenses and underwriting expenses, all as determined in accordance with generally accepted accounting principles in the United States of America ("GAAP"), and does not include interest, dividend and other income or net gains on investment transactions. 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. (6) Loss and loss adjustment expenses divided by net premiums earned, all as determined in accordance with GAAP. (7) Underwriting expenses divided by net premiums earned, all as determined in accordance with GAAP. (8) 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. (9) Includes $320.8 million of unearned premiums which were acquired with RSUI in July 2003 and $169. 9 million of premiums assumed on a net basis. RSUI recorded an underwriting loss of $87.9 million in the 2004 third quarter, primarily reflecting $146.7 million of pre-tax catastrophe losses, net of reinsurance and $10.5 million of reinsurance reinstatement premiums, from Hurricanes Charley, Francis, Ivan and Jeanne. An underwriting profit of $28.7 million was earned for the comparable period in 2003 during which there were $16.6 million of catastrophe losses. Despite the hurricane losses in the 2004 third quarter, RSUI reported an underwriting profit of $34.0 million for the first nine months of 2004, primarily reflecting strong property results in the first half of 2004. RSUI uses reinsurance on an extensive basis in order to build stable capacity and provide protection against the accumulation of catastrophe risk. For the first nine months of 2004, RSUI ceded 48.8% of its gross premium written to reinsurers. While the amount retained by RSUI varies by line of business, as of September 30, 2004, RSUI retained a maximum net exposure for any single risk of $7.5 million. To protect against multiple losses due to catastrophes, RSUI maintains excess of loss reinsurance coverage in an amount estimated to be its loss exposure from a one-in-250 year catastrophic event. Of RSUI's $410.0 million of estimated gross losses from the third quarter hurricanes, $263.3 million were ceded to RSUI's reinsurers under all of RSUI's reinsurance programs and represented 54.0% of RSUI's reinsurance receivables as of September 30, 2004. RSUI's reported hurricane losses represent management's current best estimate and are based on management's assessment of information from actual claim reports, information derived from catastrophe computer modeling, as well as industry loss estimates. Due to the unusual frequency and strength of the third quarter hurricanes, as well as the proximity of Hurricanes Ivan and Jeanne to the end of the 2004 third quarter, the ultimate, actual amount of RSUI losses attributable to Hurricanes Charley, Frances, Ivan and Jeanne could vary from current estimated losses. 15 Gross premiums written by RSUI during the 2004 third quarter decreased from 2003 third quarter levels, reflecting overall industry trends, with flat or marginally increased rates in RSUI's casualty lines of business (except for professional liability which experienced more significant increases in rates) and decreased rates in its property lines of business primarily due to increased competition. The continuation of such trends may result in lower levels of gross premiums written by RSUI during the remainder of 2004, since RSUI is expected to write less business when it considers prices inadequate to support acceptable profit margins. Gross premiums written by RSUI during the 2003 third quarter include $320.0 million of unearned premiums which were acquired with RSUI in July 2003 and $169.9 million of net premiums assumed pursuant to arrangements entered into in connection with the acquisition of RSUI from Royal Group, Inc., a subsidiary of Royal & Sun Alliance Insurance Group plc ("R&SA") in July 2003. The Company acquired RSUI Indemnity Company ("RIC") to write business underwritten by RSUI on an admitted basis. As RIC did not possess all necessary licenses to be able to write business on an admitted basis in most states at the time of acquisition, R&SA agreed to provide policy issuing services to RIC through June 2004. Under such service arrangement and in respect of the unearned premiums acquired with RSUI, RIC assumed the policy and the related premiums (net of reinsurance paid by R&SA), from R&SA by reinsuring the obligations of the R&SA carrier under the policy. CATA's 2004 third quarter underwriting results primarily reflect $3.8 million of catastrophe losses, higher underwriting expenses and continued unfavorable results in its surety lines of business, partially offset by better underwriting margins in its casualty lines of business on the current accident year. The increase in CATA's gross premiums written in the first nine months of 2004 compared with the corresponding 2003 periods reflect the continued expansion of its business into the excess and surplus markets. Rates at CATA for the 2004 third quarter as compared with the 2003 third quarter reflect slightly lower levels of rate increases in its casualty lines of business and rate decreases in its property lines of business, primarily due to increased competition. Darwin's results in the third quarter and first nine months of 2004 reflect organizational build-up expenses incurred to support premium levels, as well as increased competition across all of its lines of business. As Darwin commenced operations in May 2003, it does not have any meaningful claims experience on which to base its reserves. In the absence of such history, Darwin's management and outside actuaries have used industry data related to the lines of business underwritten by Darwin to establish reserves until sufficient claims experience exists. The table below presents, as of September 30, 2004, the components of reserves established in connection with the loss and loss adjustment expense liabilities of the Company's insurance operating units, as well as the changes in such reserve levels since December 31, 2003. Such loss reserve amounts represent the accumulation of estimates of ultimate losses (including losses incurred but not reported) and loss adjustment 16 expenses, before reinsurance protection.
LOSSES AND LOSS ADJUSTMENT CHANGE FROM LOSSES AND LOSS EXPENSE RESERVES AT ADJUSTMENT EXPENSE RESERVES (in millions) SEPTEMBER 30, 2004 AT DECEMBER 31, 2003 ------------------ -------------------- Property $484.4 $426.4 Casualty 440.2 303.9 Commercial Multiple Peril 79.8 9.7 Surety 17.6 (0.1) All Other 131.8 (24.2) ------- ------ Total $1,153.8 $715.8 ======= ======
The increase in total loss and loss adjustment expense reserves at September 30, 2004 from the year ended December 31, 2003 primarily reflects losses incurred in connection with 2004 third quarter hurricane losses and an increase in business generated by the Company's insurance businesses. The Company had no significant development in loss reserve estimates during 2004 in its loss reserves at December 31, 2003 of $438.0 million. With respect to property lines of business, the increase in loss and loss adjustment expense reserves primarily reflects $413.5 million of gross catastrophe losses from 2004 third quarter hurricanes. The increase in loss and loss adjustment expense reserves for casualty lines of business (which include, among others, excess and umbrella liability, directors and officers' liability, professional liability, general liability and workers' compensation) primarily reflects increased business generated by the Company's insurance businesses. With respect to commercial multiple peril ("CMP") line of business, which includes both property and casualty exposures, the increase in loss and loss adjustment expense reserves primarily reflects $3.8 million of catastrophe losses, as well as adverse development on prior year loss reserves related to higher than expected CMP claims settlements which also resulted in an increase of loss development tail factors. All other lines of business primarily consists of non-core loss reserves exposure reported on the balance sheet of the Company's insurance businesses that are from discontinued lines of business or loss reserves acquired in the acquisition of companies in which the seller guaranteed the loss reserves. The decrease in loss and loss adjustment expense reserve in connection with such lines of business reflects a $2.9 million decrease in reserves related to assumed reinsurance written by CATA during the years 1969-1976 as a result of settlement of losses and loss commutations, as well as a $11.2 million decrease in loss reserves acquired in connection with Platte River in January 2002 which were guaranteed by the seller. 17 Additional information regarding the assumptions and estimates, and the techniques involved in making such assumptions and estimates, used in the establishment of liabilities for unpaid losses and loss adjustment expenses can be found in the Company's 2003 Form 10-K. On October 14, 2004, the New York State Attorney General brought a lawsuit against Marsh & McLennan Companies, Inc. and Marsh Inc. challenging certain insurance broker contingent commission compensation practices, and containing allegations of bid-rigging and price-fixing. Currently, neither the Company nor any of its subsidiaries has been subpoenaed by the New York State Attorney General regarding any matters related to insurance broker contingent commission compensation practices, bid-rigging or price-fixing. Darwin has in place two broker contingent commission agreements of the type covered the New York State Attorney General's lawsuit. After a review, the Company does not believe that Darwin has participated in any activities involving bid-rigging or price-fixing. In the first nine months of 2004, Darwin paid approximately $1.0 million in contingent commissions and accrued an additional $0.3 million under such contingent commission agreements. Such contingent commission agreements have been suspended. World Minerals recorded pre-tax earnings of $6.0 million on revenues of $72.9 million in the 2004 third quarter, compared with pre-tax earnings of $6.9 million on revenues of $67.4 million in the 2003 third quarter, and pre-tax earnings of $16.8 million on revenues of $211.2 million in the first nine months of 2004, compared with pre-tax earnings of $18.3 million on revenues of $198.6 million in the first nine months of 2003. The 2004 nine-month results reflect lower margins due to competitive pricing pressures, increased energy, labor and benefit costs and expenses in connection with information technology initiatives, partially offset by an increase in net shipments and the continuing favorable impact of the strong euro versus the U.S. dollar. Corporate activities recorded a pre-tax loss of $4.0 million on revenues of $49.3 million in the third quarter of 2004, compared with pre-tax earnings of $25.9 million on revenues of $66.0 million in the corresponding period in 2003, and a pre-tax loss of $10.5 million on revenues of $140.8 million in the first nine months of 2004, compared with pre-tax earnings of $27.2 million on revenues of $140.8 million in the corresponding 2003 period. The 2004 third quarter net earnings include no net gains or (losses) on investment transactions, compared with net gains on investment transactions after taxes (taxed at the federal income tax rate) of $20.5 million in the corresponding 2003 period. 2004 nine month net earnings include net gains on investment transactions after taxes (taxed at the federal income tax rate) of $1.1 million, compared with $23.1 million in the first nine months of 2003. 18 As of September 30, 2004, the Company beneficially owned 8.0 million shares, or approximately 2.0 percent, of the outstanding common stock of Burlington Northern Santa Fe Corporation, which had an aggregate market value on that date of approximately $306.5 million, or $38.31 per share, compared with a market value on June 30, 2004 of $280.6 million, or $35.07 per share. The aggregate cost of such shares is approximately $96.6 million, or $12.07 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 2004, the Company did not purchase any shares of its common stock. As of September 30, 2004, the Company had 7,675,313 shares of common stock outstanding (which includes the stock dividend declared in March 2004). The Company's results in the 2004 third quarter are not indicative of operating results in future periods. 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. In this regard, AIHL has adequate internally generated funds and sufficient liquidity to pay claims, including all claims relating to 2004 third quarter hurricane activity. Information regarding the Company's accounting policies is included in the Company's 2003 Form 10-K, 2004 First Quarter Form 10-Q, the 2004 Second Quarter Form 10-Q 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 time. In this sensitivity analysis model, the Company uses fair values to measure its potential change, and a +/- 200 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 19 hypothetical September 30, 2004 ending prices based on yields adjusted to reflect a +/ -200 basis point range of change in interest rates, comparing such hypothetical ending price to actual ending prices, and multiplying the difference by the par outstanding. SENSITIVITY ANALYSIS At September 30, 2004 (dollars in millions)
Interest Rate Shifts -200 -100 0 100 200 -------------------- -------- ------- ------- ------- ------- ASSETS Debt securities, fair value $1,395.6 $1,362.3 $1,327.3 $1,259.0 $1,254.2 Estimated change in fair value $68.4 $35.1 -- $(36.4) $(73.1) LIABILITIES Subsidiaries' debt, fair value $156.8 $157.9 $159.1 $160.3 $161.5 Estimated change in fair value $(2.3) $(1.2) -- $1.2 $2.4
The Company's 2003 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, 2004, no material change has occurred in these liabilities, as compared with amounts disclosed in the 2003 Form 10-K. 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 U.S. Securities and Exchange Commission. Additionally, as of the end of the period covered by this report on Form 10-Q, the Company's CEO and CFO have concluded that there have been no significant changes in internal control over financial reporting that have occurred during the period covered by this report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. 20 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 catastrophes and disasters, especially with respect to their impact on losses at the Company's insurance subsidiaries, acts of terrorism, 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, 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. 21 PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. -------------------------------- (a) Exhibits. --------
Exhibit Number Description -------------- ----------- 3.2 By-laws of the Company, as amended September 21, 2004 10.1 Description of Compensatory Arrangement between the Company and John J. Burns, Jr. 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 exhibit shall not be deemed "filed" as a part of this Report on Form 10-Q.
(b) Reports on Form 8-K. ------------------- On September 23, 2004, the Company filed a report on Form 8-K under Items 1.01, 5.02 and 5.03 relating to the retirement of John J. Burns, Jr. as President and chief executive officer of the Company, effective December 30, 2004, the appointment of Weston M. Hicks as a director and President and chief executive officer of the Company, effective December 31, 2004 and an amendment to the Company's By-laws to provide for the position of Vice Chairman of the Board of Directors of the Company. On November 9, 2004, the Company filed a report on Form 8-K under Item 2.02 thereof regarding a press release reporting on the Company's financial results as of and for the quarter ended September 30, 2004. 22 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 9, 2004 /s/ David B. Cuming -------------------- David B. Cuming Senior Vice President (and chief financial officer) 23