Final Results - Part 2
Catlin Group Limited
06 March 2008
PART 2
Catlin Group Limited
Notes to the Consolidated Financial Statements
For the years ended 31 December 2007 and 2006
(US dollars in thousands, except share amounts)
1. Nature of operations
Catlin Group Limited ('Catlin' or the 'Company') is a holding company
incorporated on 25 June 1999 under the laws of Bermuda. Through its
subsidiaries, which together with the Company are referred to as the 'Group',
Catlin underwrites specialty classes of insurance and reinsurance on a global
basis.
The Group consists of four underwriting platforms:
•The Catlin Syndicate (Syndicate 2003) which operates at Lloyd's of London;
•Catlin Bermuda (Catlin Insurance Company Ltd.);
•Catlin UK (Catlin Insurance Company (UK) Limited); and
•Catlin US, which is the trading name for the Company's various subsidiaries in
the United States. Catlin US includes Catlin Inc. as well as two insurance
companies: Catlin Insurance Company Inc. and Catlin Specialty Insurance Company
Inc.
At 31 December 2007, the Company, through intermediate companies, also had
established operations in Canada, Australia, Singapore, Malaysia, China,
Germany, Belgium, Guernsey, France, Spain, Austria, Switzerland, Italy and
Brazil.
On 18 December 2006, the Company declared unconditional its offer to acquire all
of the issued and to be issued share capital of Wellington Underwriting plc
('Wellington'). The core of Wellington's business was in the Lloyd's market.
Wellington also owned a managing general agent in the United States and a
US-based specialist insurance company. This acquisition is described in Note 3.
In May 2006, the Group, through its wholly owned subsidiary Catlin Inc.,
acquired 100 per cent of the outstanding common shares of American Indemnity
Company. That company, renamed Catlin Insurance Company Inc., is now part of the
Company's US operations.
Through its subsidiaries, the Company writes a broad range of products,
including property, casualty, energy, marine and aerospace insurance products
and property, catastrophe and per-risk excess, non-proportional treaty,
aviation, marine, casualty and motor reinsurance business. Business is written
from many countries, although business from the United States predominates.
2. Significant accounting policies
Basis of presentation
The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America ('US GAAP'). The preparation of financial statements in conformity with
US GAAP requires management to make estimates when recording transactions
resulting from business operations based on information currently available. The
most significant items on the Group's balance sheet that involve accounting
estimates and actuarial determinations are reserves for losses and loss
expenses, deferred policy acquisition costs, reinsurance recoverables, valuation
of investments, intangible assets and goodwill and derivatives. The accounting
estimates and actuarial determinations are sensitive to market conditions,
investment yields, commissions and other policy acquisition costs. As additional
information becomes available, or actual amounts are determinable, the recorded
estimates will be revised and reflected in operating results. Although some
variability is inherent in these estimates and actual results may differ from
the estimates used in preparing the consolidated financial statements,
management believes the amounts recorded are reasonable.
Certain insignificant reclassifications have been made to prior years' amounts
to conform to the 2007 presentation.
Principles of consolidation
The consolidated financial statements include the accounts of the Company and
all of its wholly owned subsidiaries. All significant inter-company transactions
and balances are eliminated on consolidation.
Reporting currency
The financial information is reported in United States dollars ('US dollars' or
'$').
Investments in fixed maturities
The Group's investments in fixed maturities are considered to be
available-for-sale and are carried at fair value. The fair value is based on the
quoted market price of these securities provided by either independent pricing
services, or, when such prices are not available, by reference to broker or
underwriter bid indications.
Net investment income includes interest income together with amortisation of
market premiums and discounts and is net of investment management and custody
fees. Interest income is recognised when earned. Premiums and discounts are
amortised or accreted over the lives of the related fixed maturities as an
adjustment to yield using the effective-interest method and is recorded in
current period income. For mortgage-backed securities and any other holdings for
which there is a prepayment risk, prepayment assumptions are evaluated and
revised as necessary. Any adjustments required due to the resultant change in
effective yields and maturities are recognised prospectively.
Realised gains or losses are included in net income and are derived using the
specific-identification method.
Net unrealised gains or losses on investments, net of deferred income taxes, are
included in accumulated other comprehensive income in stockholders' equity.
Other than temporary impairments
The Group regularly monitors its investment portfolio to ensure that investments
that may be other than temporarily impaired are identified in a timely fashion
and properly valued, and that any impairments are charged against net income
(through net realised losses on investments) in the proper period. The Group's
decision to make an impairment provision is based on regular objective reviews
of the issuer's current financial position and future prospects, its financial
strength rating and an assessment of the probability that the current market
value will recover to former levels and requires the judgment of management. In
assessing the potential recovery of market value for debt securities, the Group
also takes into account the timing of such recovery by considering whether it
has the ability and intent to hold the investment to the earlier of (a)
settlement or (b) market price recovery. Any security whose price decrease is
deemed other-than-temporary is written down to its then current market level and
the cumulative net loss previously recognised in stockholders' equity is removed
and charged to net income. Inherently, there are risks and uncertainties
involved in making these judgments. Changes in circumstances and critical
assumptions such as a continued weak economy, financial markets disruption or
unforeseen events which affect one or more companies, industry sectors or
countries could result in additional writedowns in future periods for
impairments that are deemed to be other-than-temporary. Additionally, unforeseen
catastrophic events may require us to sell investments prior to the forecast
market price recovery.
Short-term investments
Short-term investments are carried at amortised cost, which approximates fair
value, and are composed of securities due to mature between 90 days and one year
from the date of purchase.
Investments in funds
The Group's investments in funds are considered to be trading and are carried at
fair value. The fair value is based on either the quoted market price of these
funds provided by independent pricing services or the net asset value of the
individual funds. The change in fair value of the individual funds is recorded
in net income as net investment income.
Investment in associate
Investment in associate comprises an investment in a limited liability
corporation. This investment is accounted for using the equity method.
Derivatives
In accordance with Financial Accounting Standard No. 133, Accounting for
Derivative Instruments and Hedging Activities ('FAS 133'), the Group recognises
derivative financial instruments as either assets or liabilities measured at
fair value. Gains and losses resulting from changes in fair value are included
in net income.
The fair values of the catastrophe swap agreements described in Note 9 are
determined by management using internal models based on the valuation of the
underlying notes issued by the counterparty, which are publicly quoted. The
determination of fair value takes into account changes in the market for
catastrophe reinsurance contracts with similar economic characteristics and the
potential for recoveries from events preceding the valuation date. The fair
value of options to purchase shares in Aspen Insurance Holdings Ltd ('Aspen')
was estimated using the Black-Scholes valuation model. The fair values of all
other derivative financial instruments are obtained from independent valuation
sources.
Cash and cash equivalents
Cash equivalents are carried at cost, which approximates fair value, and include
all investments with original maturities of 90 days or less.
Securities lending
Certain entities within the Group participate in securities lending arrangements
whereby specific securities are loaned to other institutions, primarily banks
and brokerage firms, for short periods of time. Under the terms of the
securities lending agreements, the loaned securities remain under the Group's
control and therefore remain on the Group's balance sheet. Collateral in the
form of cash, government securities and letters of credit is required and is
monitored and maintained by the lending agent. The Group receives interest
income on the invested collateral, which is included in net investment income in
the Consolidated Statements of Operations.
Premiums
Premiums written are primarily earned on a daily pro rata basis over the terms
of the policies to which they relate. Accordingly, unearned premiums represent
the portion of premiums written which is applicable to the unexpired risk
portion of the policies in force.
Reinsurance premiums assumed are recorded at the inception of the policy and are
estimated based on information provided by ceding companies. The information
used in establishing these estimates is reviewed and subsequent adjustments are
recorded in the period in which they are determined. These premiums are earned
over the terms of the related reinsurance contracts.
For multi-year policies written which are payable in annual instalments, and
where the insured or reinsured has the ability to commute or cancel coverage
within the term of the policy, only the annual premium is included as written
premium at policy inception. Annual instalments are included as written premium
at each successive anniversary date within the multi-year term.
Reinstatement premiums are recognised and fully earned as they fall due.
Deferred policy acquisition costs
Certain policy acquisition costs, consisting primarily of commissions and
premium taxes, that vary with and are primarily related to the production of
premium, are deferred and amortised over the period in which the related
premiums are earned.
A premium deficiency is recognised immediately by a charge to net income to the
extent that future policy premiums, including anticipation of interest income,
are not adequate to recover all deferred policy acquisition costs ('DPAC') and
related losses and loss expenses. If the premium deficiency is greater than
unamortised DPAC, a liability will be accrued for the excess deficiency.
Value of in-force business acquired
Upon the Group's acquisition of Wellington, an asset representing the present
value of estimated future profits associated with unearned premiums was
recorded. The value of in-force insurance contracts is amortised over the period
in which the related premiums are earned and was fully amortised as at 31
December 2007.
Reserves for losses and loss expenses
A liability is established for unpaid losses and loss expenses when insured
events occur. The liability is based on the expected ultimate cost of settling
the claims. The reserve for losses and loss expenses includes: (1) case reserves
for known but unpaid claims as at the balance sheet date; (2) incurred but not
reported ('IBNR') reserves for claims where the insured event has occurred but
has not been reported to the Group as at the balance sheet date; and (3) loss
adjustment expense reserves for the expected handling costs of settling the
claims.
Reserves for losses and loss expenses are established based on amounts reported
from insureds or ceding companies and according to generally accepted actuarial
principles. Reserves are based on a number of factors, including experience
derived from historical claim payments and actuarial assumptions to arrive at
loss development factors. Such assumptions and other factors include trends, the
incidence of incurred claims, the extent to which all claims have been reported,
and internal claims processing charges. The process used in establishing
reserves cannot be exact, particularly for liability coverages, since actual
claim costs are dependent upon such complex factors as inflation, changes in
doctrines of legal liability and damage awards. The methods of making such
estimates and establishing the related liabilities are periodically reviewed and
updated.
Reinsurance
In the ordinary course of business, the Company's insurance subsidiaries cede
reinsurance to other insurance companies. These arrangements allow for greater
diversification of business and minimise the net loss potential arising from
large risks. Ceded reinsurance contracts do not relieve the Group of its
obligation to its insureds. Reinsurance premiums ceded are recognised and
commissions thereon are earned over the period that the reinsurance coverage is
provided.
Reinstatement premiums are recorded and fully expensed as they fall due. Return
premiums due from reinsurers are included in premiums and other receivables in
the Consolidated Balance Sheets.
Reinsurers' share of unearned premiums represent the portion of premiums ceded
to reinsurers applicable to the unexpired terms of the reinsurance contracts in
force.
Reinsurance recoverables include the balances due from reinsurance companies for
paid and unpaid losses and loss expenses that will be recovered from reinsurers,
based on contracts in force. A reserve for uncollectible reinsurance has been
determined based upon a review of the financial condition of the reinsurers and
an assessment of other available information.
Deferred gain
The Group may enter into retroactive reinsurance contracts, which are contracts
where an assuming company agrees to reimburse a ceding company for liabilities
incurred as a result of past insurable events. Any initial gain and any benefit
due from a reinsurer as a result of subsequent covered adverse development is
deferred and amortised into income over the settlement period of the recoveries
under the relevant contract.
Contract deposits
Contracts written by the Group which are not deemed to transfer significant
underwriting and/or timing risk are accounted for as contract deposits and are
included in premiums and other receivables. Liabilities are initially recorded
at an amount equal to the assets received and are included in accounts payable
and other liabilities in the Consolidated Balance Sheets.
The Group uses the risk-free rate of return of equivalent duration to the
liabilities in determining risk transfer and records the transactions using the
interest method. The Group periodically reassesses the estimated ultimate
liability. Any changes to this liability are reflected as an adjustment to
interest expense to reflect the cumulative effect of the period the contract has
been in force, and by an adjustment to the future internal rate of return of the
liability over the remaining estimated contract term.
Goodwill and intangible assets
Goodwill represents the excess of acquisition costs over the net fair values of
identifiable assets acquired and liabilities assumed in a business combination.
Pursuant to Statement of Financial Accounting Standards No. 142, Goodwill and
Other Intangible Assets ('FAS 142'), goodwill is deemed to have an indefinite
life and is not amortised, but rather tested at least annually for impairment.
The goodwill impairment test has two steps. The first step identifies potential
impairments by comparing the fair value of a reporting unit with its book value,
including goodwill. If the fair value of the reporting unit exceeds the carrying
amount, goodwill is not impaired and the second step is not required. If the
carrying value exceeds the fair value, the second step calculates the possible
impairment loss by comparing the implied fair value of goodwill with the
carrying amount. If the implied goodwill is less than the carrying amount, a
writedown would be recorded. The measurement of fair values of the reporting
units is determined based on an evaluation of a number of factors, including
ranges of future discounted earnings. Certain key assumptions considered include
forecasted trends in revenues, operating expenses and effective tax rates.
Intangible assets are valued at their fair value at the time of acquisition. The
Group's intangible assets relate to the purchase of syndicate capacity, the
distribution network and admitted as well as surplus lines licenses.
Purchased syndicate capacity and admitted licenses are considered to have an
indefinite life and as such are subject to annual impairment testing. Surplus
lines authorisations are considered to have a finite life and are amortised over
their estimated useful lives of five years. Distribution channels are amortised
over their useful lives of five years.
The Group evaluates the recoverability of its intangible assets whenever changes
in circumstances indicate that an intangible asset may not be recoverable. If it
is determined that an impairment exists, the excess of the unamortised balance
over the fair value of the intangible asset is recognised as a change in net
income.
Other assets
Other assets are principally composed of prepaid items and property and
equipment.
Property and equipment are stated at cost less accumulated depreciation.
Depreciation of property and equipment is calculated using the straight-line
method over the estimated useful lives of four to ten years for fixtures and
fittings, four years for automobiles and two years for computer equipment.
Leasehold improvements are amortised over the life of the lease or the life of
the improvement, whichever is shorter. Computer software development costs are
capitalised when incurred and depreciated over their estimated useful lives of
five years.
Comprehensive income/(loss)
Comprehensive income/(loss) represents all changes in equity that result from
recognised transactions and other economic events during the period. Other
comprehensive income/(loss) refers to revenues, expenses, gains and losses that
are included in comprehensive income/(loss) but excluded from net income/(loss),
such as unrealised gains or losses on available for sale investments and foreign
currency translation adjustments.
Foreign currency translation and transactions
Foreign currency translation
The presentation currency of the Group has been determined to be US dollars. The
financial statements of each of the Group's entities are initially measured
using the entity's functional currency, which is determined based on its
operating environment and underlying cash flows. For entities with a functional
currency other than US dollars, foreign currency assets and liabilities are
translated into US dollars using period end rates of exchange, while statements
of operations are translated at average rates of exchange for the period. The
resulting translation differences are recorded as a separate component of
accumulated other comprehensive income/(loss) within stockholders' equity.
Foreign currency transactions
Monetary assets and liabilities denominated in currencies other than the
functional currency are revalued at period end rates of exchange, with the
resulting gains and losses included in income. Revenues and expenses denominated
in foreign currencies are translated at average rates of exchange for the
period.
Income taxes
Income taxes have been provided for those operations that are subject to income
taxes. Deferred tax assets and liabilities result from temporary differences
between the amounts recorded in the consolidated financial statements and the
tax basis of the Group's assets and liabilities. Such temporary differences are
primarily due to, the recognition of untaxed profits, and intangible assets
arising from the acquisition of Wellington in December 2006. The effect on
deferred tax assets and liabilities of a change in tax rates is recognised in
income in the period that includes the enactment date. A valuation allowance
against deferred tax assets is recorded if it is more likely than not that all
or some portion of the benefits related to deferred tax assets will not be
realised.
Stock compensation
The Group accounts for stock-based compensation arrangements under the
provisions of Statement of Financial Accounting Standards No. 123 (Revised
2004), Accounting for Stock-Based Compensation ('FAS 123R').
The fair value of options is calculated at the date of grant based on the
Black-Scholes Option Pricing Model. The corresponding compensation charge is
recognised on a straight-line basis over the requisite service period.
The fair value of non-vested shares is calculated on the grant date based on the
share price and the exchange rate in effect on that date and is recognised on a
straight-line basis over the vesting period. This calculation is updated on a
regular basis to reflect revised expectations and/or actual experience.
Warrants
In 2002, the Group issued convertible preference shares with detachable stock
purchase warrants. The preference shares were converted into common shares in
2004. The portion of the proceeds allocable to the warrants has been accounted
for as additional paid-in capital. This allocation was based on the relative
fair values of the two securities at the time of issuance. Warrant contracts are
classified as equity so long as they meet all the conditions of equity outlined
in EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company's Own Stock. Subsequent changes in fair value
are not recognised in the Statement of Operations as long as the warrant
contracts continue to be classified as equity.
Pensions
The Group operates defined contribution pension schemes for eligible employees,
the costs of which are expensed as incurred.
As a result of the acquisition of Wellington in December 2006, the Group also
sponsors a defined benefit pension scheme which was closed to new members in
1993. The recorded asset related to the plan was set equal to the value of plan
assets in excess of the defined benefit obligation at the date of the business
combination.
Risks and uncertainties
In addition to the risks and uncertainties associated with unpaid losses and
loss expenses described above and in Note 7, cash balances, investment
securities and reinsurance recoveries are exposed to various risks, such as
interest rate, market, foreign exchange and credit risks. Due to the level of
risk associated with investment securities and the level of uncertainty related
to changes in the value of investment securities, it is at least reasonably
possible that changes in risks in the near term would materially affect the
amounts reported in the financial statements. The cash balances and investment
portfolio are managed following prudent standards of diversification. Specific
provisions limit the allowable holdings of a single institution issue and
issuers. Similar diversification provisions are in place governing the Group's
reinsurance programme. Management believes that there are no significant
concentrations of credit risk associated with its investments and its
reinsurance programme.
New accounting pronouncements
In February 2006, the Financial Accounting Standards Board ('FASB') issued
Financial Accounting Standard 155, ('FAS 155'), Accounting for Certain Financial
Instruments: an amendment of FASB Statements No. 133 and 140. This Statement
resolves issues addressed in FAS 133 Implementation Issue No. D1, 'Application
of Statement 133 to Beneficial Interests in Securitized Financial Assets'. FAS
155 is effective for reporting periods beginning after 15 September 2006,
although early adoption is permitted. The adoption of FAS 155 has not had a
material effect on the Group's financial position or results of operations
In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109, ('FIN
48'). FIN 48 provides guidance on financial statement recognition, measurement
and disclosure of uncertain tax positions. FIN 48 is effective for fiscal years
beginning after 15 December 2006. The Group adopted the provisions of FIN 48
effective 1 January 2007. There were no changes to the Group's financial
position as a result of adopting FIN 48. The Group's tax uncertainties are
described in Note 12.
In September 2006, the FASB issued Financial Accounting Standard 157, Fair Value
Measurements ('FAS 157'). FAS 157 provides a common definition of fair value and
establishes a framework to make the measurement of fair value in generally
accepted accounting principles more consistent and comparable. FAS 157 also
requires expanded disclosures to provide information about the extent to which
fair value is used to measure assets and liabilities, the methods and
assumptions used to measure fair value, and the effect of fair value measures on
earnings. FAS 157 is effective for reporting periods beginning after 15 November
2007, although early adoption is permitted. The adoption of FAS 157 in 2008 is
not expected to have a material effect on the Group's financial position or
results of operations.
In September 2006, the FASB issued Financial Accounting Standard No. 158,
Employers' Accounting for Defined Benefit Pension and Other Postretirement
Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R) ('FAS 158').
This statement requires recognition of the overfunded or underfunded status of
defined benefit pension and other postretirement plans as an asset or liability
in the balance sheet and changes in that funded status to be recognised in
comprehensive income in the year in which the changes occur. FAS 158 also
requires measurement of the funded status of a plan as at the balance sheet
date. The recognition provisions of FAS 158 are effective for reporting periods
ending after 15 December 2006, while the measurement date provisions are
effective for reporting periods ending after 15 December 2008. The adoption of
the measurement date provisions of FAS 158 in 2009 will not have a material
effect on the Group's financial position or results of operations.
In February 2007, the FASB issued Financial Accounting Standard No. 159, The
Fair Value Option for Financial Assets and Financial Liabilities ('FAS 159').
FAS 159 permits companies to choose to measure many financial instruments and
certain other items at fair value. The objective is to improve financial
reporting by providing companies with the opportunity to mitigate volatility in
reported earnings caused by measuring related assets and liabilities differently
without having to apply complex hedge accounting provisions. FAS 159 is
effective for fiscal years beginning after 15 November 2007. Companies are not
allowed to adopt FAS 159 on a retrospective basis unless they chose early
adoption. The Group will adopt FAS 159 effective 1 January 2008 and has elected
to apply the fair value option to its available-for-sale investment portfolio.
On adoption of FAS 159, net unrealised gains of $14,424, after allowing for tax
effects, will be reclassified from accumulated other comprehensive income to
retained earnings as at 1 January 2008.
In December 2007, the FASB issued Financial Accounting Standard 141(R), Business
Combinations - a replacement of FASB Statement No.141 ('FAS 141(R)'), which
changes the principles and requirements for how the acquirer of a business
recognises and measures in its financial statements the identifiable assets
acquired, the liabilities assumed, and any non-controlling interest in the
acquiree. The statement also provides guidance for recognising and measuring the
goodwill acquired in the business combination and determines what information to
disclose to enable users of the financial statements to evaluate the nature and
financial effects of the business combination. This statement is effective
prospectively for fiscal years beginning after 15 December 2008. The Group will
adopt FAS 141(R) in 2009. The adoption of FAS 141(R) is not expected to have a
material effect on the Group's financial position or results of operations.
In December 2007, the FASB issued FAS 160, Non-Controlling Interests in
Consolidated Financial Statements - an amendment of ARB No. 51 ('FAS 160'). This
statement establishes accounting and reporting standards for the non-controlling
interest in a subsidiary and for the deconsolidation of a subsidiary. The
statement requires consolidated net income to be reported at amounts that
include the amounts attributable to both the parent and the non-controlling
interest. It also requires disclosures to be on the face of the consolidated
statement of operations, of the amounts of consolidated net income attributable
to the parent and to the non-controlling interest. This statement is effective
prospectively, except for certain retrospective disclosure requirements, for
reporting periods beginning after 15 December 2008. The Group will adopt FAS 160
in 2009 and is currently evaluating the impact of adoption. The adoption of FAS
160 is not expected to have a material effect on the Group's financial position
or results of operations.
3. Business combination
On 18 December 2006, the Group declared unconditional its offer to acquire
Wellington, which was announced on 30 October 2006 (the 'Offer'). The business
combination was deemed effective 31 December 2006 for accounting purposes;
accordingly the net assets acquired are valued as at that date and the operating
results of Wellington are included in the Group's consolidated financial
statements in periods following 31 December 2006.
Prior to the acquisition, Wellington managed and underwrote a diversified book
of insurance and reinsurance business at Lloyd's and in the US. As a result of
the acquisition, the enlarged Group is a major international specialty insurance
and reinsurance business with well established underwriting platforms in the
United Kingdom and Bermuda and a significantly enhanced underwriting and
distribution platform in the United States.
Under the terms of the Offer, Wellington shareholders received 0.17 shares of
the Company's common stock and 35 pence in cash for each Wellington share
surrendered. Total consideration paid by the Group was $1,186,300, including $
347,431 of cash and 86,094,294 shares of the Company's common stock valued at $
812,427. The value of the common shares issued was determined based on the
average market price of the Company's common shares for the period from 20
October to 2 November 2006, inclusive, which commenced two business days before
the announcement that the Company and Wellington were in discussions regarding a
possible combination and ended two business days after the terms of the Offer
were announced.
As at 31 December 2006, acceptances representing 93 per cent of Wellington's
issued share capital had been received, and acceptances representing 88 per cent
of Wellington's issued share capital had been settled in the form of $300,286 of
cash and 74,414,657 shares. The remaining 12 per cent was accrued in the 31
December 2006 balance sheet as a liability for the cash consideration and within
additional paid-in capital for the equity consideration, and was acquired in
early 2007.
Changes to the purchase price allocation in 2007 have resulted in an increase in
goodwill from $68,970 to $74,512. This increase is primarily due to additional
acquisition expenses of $1,366 and an increase of $2,664 in the liability for
restructuring costs as described below.
The following table summarises the estimated fair values of the assets acquired
and liabilities assumed at the date of acquisition.
------------------------------------ --------------
Investments and cash $2,288,886
Premiums and other receivables 339,366
Reinsurance recoverable 804,787
Value of in-force business acquired 118,384
Intangible assets 472,556
Other assets 119,676
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Total assets acquired 4,143,655
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Reserves for losses and loss expenses 2,026,268
Unearned premiums 491,756
Reinsurance payable 65,306
Subordinated debt 99,936
Deferred tax 133,539
Other liabilities 222,552
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Total liabilities assumed 3,039,357
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Net assets acquired $1,104,298
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The table below summarises the calculation of goodwill arising on the
acquisition.
------------------------------------ --------------
Cash consideration $347,431
Catlin share consideration 812,427
Acquisition expenses 26,442
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Total consideration $1,186,300
------------------------------------ --------------
Net assets acquired 1,104,298
Treasury shares acquired 7,490
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Goodwill $74,512
------------------------------------ --------------
Of the $472,556 of acquired intangible assets, $461,580 was assigned to
purchased syndicate capacity, which is not subject to amortisation as it is
deemed to have an indefinite life. The remaining acquired intangible assets
consist of $4,900 of distribution network with an average life of five years and
$6,076 of licenses with an average life of five years. The values assigned to
goodwill and intangible assets with finite and indefinite lives were determined
based on independent third-party valuations.
The value of in-force business acquired of $118,384 represents the estimated
present value of future profits associated with the unearned premium acquired
and replaces the deferred policy acquisition costs that were carried on
Wellington's historical balance sheet. Its value was determined based on an
independent third-party valuation.
Of the goodwill arising on the acquisition of Wellington, $64,289 was allocated
to Catlin Syndicate, and the remaining $10,223 was allocated to Catlin US.
The unaudited pro forma financial information presented below assumes the
acquisition occurred as at 1 January 2006. The following unaudited pro forma
results have been prepared for comparative purposes only and do not purport to
be indicative of the actual results of operations that would have occurred had
the acquisition been consummated at the beginning of the period presented.
2006
-------------------------------- ----------
Gross premiums written $2,721,800
Total revenues 2,488,451
Net income 395,327
Earnings per share:
Basic $1.67
Diluted $1.58
Shares outstanding:
Basic 236,601,569
Diluted 250,078,528
-------------------------------- ----------
Restructuring costs
In December 2006, the Group's management approved and committed to plans to
reduce staff headcount as part of the integration of the two businesses. A
liability of $5,565 representing the cost associated with terminating the
employment of certain former Wellington employees was included in the initial
allocation of the purchase price of the Wellington acquisition as at 31 December
2006. During 2007, the actual amount of this liability was determined to be
$9,429. The increase of $3,864 has been treated as an adjustment to the purchase
price allocation and has resulted in an increase in goodwill of $2,664 after
allowing for deferred tax effects. All termination costs were paid in 2007 and
charged against this liability. Costs associated with terminating the employment
of certain legacy Catlin employees as part of the integration process were
recorded as part of administrative expenses.
4. Segmental information
Following the acquisition of Wellington in December 2006, Catlin has made
certain changes to its segmental reporting to reflect the manner in which
results are now reviewed by management. Comparative segmental disclosures have
been restated accordingly.
In 2006, Catlin had four reportable segments: Catlin Syndicate Direct, Catlin
Syndicate Reinsurance, Catlin Bermuda and Catlin UK. From 2007, Catlin Syndicate
Direct and Catlin Syndicate Reinsurance have been combined into a single
segment, and Catlin US has been added as an additional reportable segment.
Catlin US did not generate business in its own right in 2006, and is
consequently not shown separately in the comparative disclosures.
In 2006, the segment result was based on income or loss before income tax
expense. From 2007, the segment result is based on net premiums earned less
losses, loss expenses and brokerage costs.
In 2006, segment revenue and results included the effects of intra-Group
reinsurance. From 2007, segment revenue and results are stated prior to the
effects of intra-Group reinsurance and therefore reflect reinsurance with
external parties only.
Catlin determines its reportable segments by platform, consistent with the
manner in which results are reviewed by management. The four reportable segments
are:
•Catlin Syndicate, which comprises direct insurance and reinsurance business
underwritten by the Catlin Syndicate at Lloyd's;
•Catlin Bermuda, which primarily underwrites reinsurance business, excluding
intra-Group reinsurance;
•Catlin UK, which primarily underwrites direct insurance; and
•Catlin US, which primarily underwrites speciality business in the United States.
At 31 December 2007, there were four intra-Group reinsurance contracts in place:
the 50% Corporate Quota Share ('CQS'), which cedes Catlin Syndicate risk to
Catlin Bermuda, the 60% Quota Share contract ('CUK QS') which cedes Catlin UK
risk to Catlin Bermuda and also two 75% Quota Share contracts ('CUS QS') which
cede Catlin US risk to Catlin Bermuda. The Long Tail Stop Loss ('LTSL') between
the Catlin Syndicate and Catlin Bermuda has not been renewed and the CQS
covering the 2004 underwriting year of account has been commuted; however there
is still some movement in 2007 on these contracts as the covered years continued
to develop. The effects of each of these reinsurance contracts are excluded from
segmental revenue and results, as this is the basis upon which the performance
of each segment is assessed.
Net underwriting contribution by operating segment for the year ended 31
December 2007 is as follows:
-------------- -------- -------- -------- -------- ---------
Catlin Catlin Catlin Catlin
Syndicate Bermuda UK US Total
-------------- -------- -------- -------- -------- ---------
Gross premiums written $2,537,904 $311,976 $439,440 $71,306 $3,360,626
Reinsurance premiums ceded (665,581) (48,151) (69,427) (3,949) (787,108)
-------------- -------- -------- -------- -------- ---------
Net premiums written 1,872,323 263,825 370,013 67,357 2,573,518
-------------- -------- -------- -------- -------- ---------
Net premiums earned 1,903,044 228,647 305,198 52,645 2,489,534
Losses and loss expenses
and profit commission (835,089) (88,925) (200,010) (30,646) (1,154,670)
Brokerage (399,137) (43,427) (72,649) (15,759) (530,972)
-------------- -------- -------- -------- -------- ---------
Net underwriting contribution $668,818 $96,295 $32,539 $6,240 $803,892
-------------- -------- -------- -------- -------- ---------
Net underwriting contribution by operating segment for the year ended 31
December 2006 is as follows:
--------------------- -------- -------- -------- ---------
Catlin Catlin Catlin
Syndicate Bermuda UK Total
--------------------- -------- -------- -------- ---------
Gross premiums written $1,106,620 $199,144 $299,255 $1,605,019
Reinsurance premiums ceded (144,479) (6,235) (44,182) (194,896)
--------------------- -------- -------- -------- ---------
Net premiums written 962,141 192,909 255,073 1,410,123
--------------------- -------- -------- -------- ---------
Net premiums earned 917,530 180,320 228,011 1,325,861
Losses and loss expenses and
profit commission (462,503) (59,852) (159,194) (681,549)
Brokerage (194,196) (31,617) (57,323) (283,136)
--------------------- -------- -------- -------- ---------
Net underwriting contribution $260,831 $88,851 $11,494 $361,176
--------------------- -------- -------- -------- ---------
Total revenue is the total of net premiums earned as disclosed above, plus net
investment income and net realised losses on investments, net realised (losses)/
gains on foreign currency exchange, and other income. Of these items, only net
premiums earned are measured and managed on a segmental basis.
Total assets by segment at 31 December 2007 and 2006 are as follows:
2007 2006
-------------------------------- ---------- ----------
Catlin Syndicate $7,366,964 $2,788,605
Catlin Bermuda 5,355,747 2,932,168
Catlin UK 1,117,368 708,546
Catlin US 363,740 -
Other 4,320,178 2,438,957
Assets acquired from Wellington - 4,214,867
Consolidation adjustments (8,710,862) (4,276,825)
-------------------------------- ---------- ----------
Total assets $9,813,135 $8,806,318
-------------------------------- ---------- ----------
'Other' in the table above includes assets such as investments in Group
companies which are not allocated to individual segments. In 2007 the assets
acquired from Wellington have been allocated to the appropriate segment. At 31
December 2006 net assets acquired from Wellington had not yet been allocated to
segments and therefore were included in one line above.
The amount of goodwill allocated as at 31 December 2007 was $79,245 (2006:
$18,363) for Catlin Syndicate and $13,806 (2006: $nil) for Catlin US. At 31
December 2006 goodwill of $68,970 associated with the acquisition of Wellington
had not yet been allocated to segments.
5. Investments
Fixed maturities
The fair values and amortised costs of fixed maturities at 31 December 2007 and
2006 are as follows:
----------------- -----------------
2007 2006
----------------- -----------------
Fair Amortised Fair Amortised
value cost value cost
---------------- ---------- ---------- ---------- ----------
US government and
agencies $721,952 $704,623 $733,861 $744,753
Non-US governments 424,098 426,520 338,525 342,150
Corporate securities 529,906 527,476 424,901 426,167
Asset-backed securities 428,508 429,438 535,718 535,974
Mortgage-backed
securities 844,486 840,660 636,432 636,916
---------------- ---------- ---------- ---------- ----------
Total fixed maturities $2,948,950 $2,928,717 $2,669,437 $2,685,960
---------------- ---------- ---------- ---------- ----------
$289,091 (2006: $177,943) of the total mortgage-backed securities at 31 December
2007 are represented by investments in Government National Mortgage Association,
Federal National Mortgage Association, Federal Home Loan Bank and Federal Home
Loan Mortgage Corporation bonds.
The composition of the amortised cost of fixed maturities by ratings assigned by
ratings agencies is as follows:
----------------- -----------------
2007 2006
----------------- -----------------
Amortised Amortised
cost % cost %
---------------- ---------- ---------- ---------- ----------
US government and agencies $704,623 24% $744,753 28%
Non-US governments 426,520 14% 342,150 13%
AAA 1,302,147 45% 1,156,200 43%
AA 182,793 6% 165,875 6%
A 282,386 10% 263,875 10%
BBB 27,438 1% 12,513 -%
Other 2,810 -% 594 -%
---------------- ---------- ---------- ---------- ----------
Total fixed maturities $2,928,717 100% $2,685,960 100%
---------------- ---------- ---------- ---------- ----------
The gross unrealised gains and losses related to fixed maturities at 31 December
2007 and 2006 are as follows:
----------------- -----------------
2007 2006
----------------- -----------------
Gross Gross Gross Gross
unrealised unrealised unrealised unrealised
gains losses gains losses
---------------- ---------- ---------- ---------- ----------
US government and
agencies $17,409 $80 $540 $11,432
Non-US governments 3,243 5,665 261 3,886
Corporate securities 5,226 2,796 486 1,752
Asset-backed securities 1,381 2,311 240 495
Mortgage-backed
securities 5,754 1,928 756 1,241
---------------- ---------- ---------- ---------- ----------
Total fixed maturities $33,013 $12,780 $2,283 $18,806
---------------- ---------- ---------- ---------- ----------
In 2007, net realised losses in investments included a loss of $76,787 relating
to certain fixed maturities where the Group determined that there was an other
than temporary decline in the value of those investments. There were no other
than temporary declines in the value of investments in the year to 31 December
2006. The net realised losses on fixed maturities for the year ended 31 December
2007 were $78,604 (2006: $17,236).
The following is an analysis of how long each of the fixed maturities that were
in an unrealised loss position as at 31 December 2007 had been in a continual
loss position.
----------------- ----------------------------------
Less than 12 months Equal to or greater than 12 months
----------------- ----------------------------------
Gross Gross
Fair unrealised Fair unrealised
value losses value losses
------------- ---------- ---------- ---------- ----------
US government
and agencies $39,426 $80 $- $-
Non-US
governments 42,075 4,809 82,200 856
Corporate
securities 140,021 2,316 29,387 480
Asset-backed
securities 171,210 2,233 2,724 78
Mortgage-backed
securities 206,134 1,421 35,069 507
-------------- ---------- ---------- ---------- ----------
Total fixed
maturities $598,866 $10,859 $149,380 $1,921
-------------- ---------- ---------- ---------- ----------
Over 80 per cent of the unrealised losses at 31 December 2007 is related to 40
securities. The securities in an unrealised loss position as at 31 December 2007
have been reviewed by the Group with regard to the severity and duration of the
losses, and to the nature of the investments and of the issuers. On this basis,
the Group has determined that the unrealised losses are temporary.
Proceeds from the sales and maturities of fixed maturities during 2007 were
$2,733,266 (2006: $2,122,297). Proceeds from the sales and maturities of
short-term investments during 2007 were $191,106 (2006: $102,219). Gross gains
of $13,558 (2006: $1,705) and gross losses of $92,528 (2006: $18,896) were
realised on fixed maturities and short-term investments in 2007.
Fixed maturities at 31 December 2007, by contractual maturity, are shown below.
Expected maturities could differ from contractual maturities because borrowers
may have the right to call or prepay obligations, with or without call or
prepayment penalties.
Fair Amortised
value cost
-------------------------------- ---------- ----------
Due in one year or less $51,344 $51,265
Due after one through five years 1,350,723 1,340,211
Due after five years through ten years 262,969 256,522
Due after ten years 10,920 10,621
-------------------------------- ---------- ----------
1,675,956 1,658,619
Asset-backed securities 428,508 429,438
Mortgage-backed securities 844,486 840,660
-------------------------------- ---------- ----------
Total $2,948,950 $2,928,717
-------------------------------- ---------- ----------
The Group did not have an aggregate investment with a single counterparty, other
than the US government, in excess of 10 per cent of total investments at 31
December 2007 and 2006.
Investments in funds
Investment in funds comprises investments in a fixed maturities fund, an equity
fund, direct hedge funds, funds of hedge funds and cash on deposit with fund
managers. As at 31 December 2007 investment in funds included cash on deposit
with 13 direct hedge fund managers of $275 million which were made to allow
units in the funds to be issued to the Group in January 2008. The Group has
classified its investment in funds as trading securities and, accordingly the
change in fair value of the individual funds will be recorded in net income as
net investment income. The amount of net investment income for the year ended 31
December 2007 that relates to investment in funds still held at year end was
$29,824 (2006: $2,960).
Net investment income
The components of net investment income for the years ended 31 December 2007 and
2006 are as follows:
2007 2006
-------------------------------- ---------- ----------
Interest income $259,164 $102,438
Amortisation of premium/(discount) 3,450 6,185
Equity in income of associate 983 1,275
Change in fair value of investment in funds 29,824 2,960
-------------------------------- ---------- ----------
Gross investment income 293,421 112,858
Investment expenses (3,308) (6,869)
-------------------------------- ---------- ----------
Net investment income $290,113 $105,989
-------------------------------- ---------- ----------
Restricted assets
The Group is required to maintain assets on deposit with various regulatory
authorities to support its insurance and reinsurance operations. These
requirements are generally promulgated in the statutory regulations of the
individual jurisdictions. These funds on deposit are available to settle
insurance and reinsurance liabilities. The Group also has investments in
segregated portfolios primarily to provide collateral or guarantees for Letters
of Credit ('LOC'), as described in Note 10. Finally, the Group also utilises
trust funds set up for the benefit of the ceding companies, generally in place
of LOC requirements.
The total value of these restricted assets by category at 31 December 2007 and
2006 are as follows:
2007 2006
-------------------------------- ---------- ----------
Fixed maturities $1,422,521 $1,666,967
Short term investments 22,881 10,951
Cash and cash equivalents 558,868 751,908
-------------------------------- ---------- ----------
Total restricted assets $2,004,270 $2,429,826
-------------------------------- ---------- ----------
Securities lending
The Group participates in securities lending programmes under which certain of
its fixed maturity investments are loaned to third parties through a lending
agent. Collateral in the form of cash, government securities and letters of
credit is required at a minimum rate of 102 per cent of the market value of the
loaned securities and is monitored and maintained by the lending agent. The
Group had $43,917 (2006: $124,486) of securities on loan at 31 December 2007.
6. Investment in associate
The Group, through Catlin Inc., one of its US subsidiaries, has a 25 per cent
membership interest in Southern Risk Operations, L.L.C. ('SRO') which is
accounted for using the equity method. The Group received cash distributions
from SRO during the year ended 31 December 2007 of $1,064 (2006: $1,452). The
share of SRO's profit included within the Consolidated Statement of Operations
during 2007 was $983 (2006: $1,275). In management's opinion, the fair value of
SRO is not less than its carrying value.
7. Reserves for losses and loss expenses
The Group establishes reserves for losses and loss expenses, which are estimates
of future payments of reported and unreported claims for losses and related
expenses, with respect to insured events that have occurred. The process of
establishing reserves is complex and imprecise, requiring the use of informed
estimates and judgments. The Group's estimates and judgments may be revised as
additional experience and other data become available and are reviewed, as new
or improved methodologies are developed or as current laws change. Any such
revisions could result in future changes in estimates of losses or reinsurance
recoverable, and would be reflected in earnings in the period in which the
estimates are changed. Management believes they have made a reasonable estimate
of the level of reserves at 31 December 2007 and 2006.
The reconciliation of unpaid losses and loss expenses for the years ended 31
December 2007 and 2006 is as follows:
2007 2006
-------------------------------- ---------- ----------
Gross unpaid losses and loss expenses, beginning of
year $4,005,133 $1,995,485
Reinsurance recoverable on unpaid loss and loss
expenses (996,896) (575,522)
-------------------------------- ---------- ----------
Net unpaid losses and loss expenses, beginning of
year 3,008,237 1,419,963
-------------------------------- ---------- ----------
Net incurred losses and loss expenses for claims
related to:
Current year 1,293,914 679,115
Prior years (139,244) 2,434
-------------------------------- ---------- ----------
Total net incurred losses and loss expenses 1,154,670 681,549
-------------------------------- ---------- ----------
Net paid losses and loss expenses for claims related
to:
Current year (105,218) (64,247)
Prior year (832,278) (528,661)
-------------------------------- ---------- ----------
Total net paid losses and loss expenses (937,496) (592,908)
-------------------------------- ---------- ----------
Foreign exchange and other 50,930 86,607
Loss portfolio transfer 101,003 -
Business combinations (1) - 1,413,026
-------------------------------- ---------- ----------
Net unpaid losses and loss expenses, end of year 3,377,344 3,008,237
Reinsurance recoverable on unpaid loss and loss
expenses 860,181 996,896
-------------------------------- ---------- ----------
Gross unpaid losses and loss expenses, end of year $4,237,525 $4,005,133
-------------------------------- ---------- ----------
(1) Wellington net unpaid losses and loss expenses at 31 December 2006.
Wellington gross unpaid losses and loss expenses at 31 December 2006 were
$2,026,268.
As a result of the changes in estimates of insured events in prior years, the
2007 reserves for losses and loss expenses net of reinsurance recoveries
decreased by $139,244 (2006: increase of $2,434). In 2007 the decrease in
reserves relating to prior years is due to reductions in expected ultimate loss
costs and reductions in uncertainty surrounding the quantification of the net
cost of claim events. In 2006 the increase was due to a deterioration of $52,454
in respect of the 2005 hurricanes and $29,400 in respect of a South African
motor loss, offset by positive development in respect of recent underwriting
years over a number of business classes.
The Group's ultimate gross loss arising from Hurricanes Katrina, Rita and Wilma
in 2005 is estimated to be $1,734,281 (2006: $1,661,898) and its ultimate net
loss after reinsurance recoveries of $975,190 (2006: $942,997) and net
reinstatement premiums of $61,514 (2006: $58,540) is estimated to be $820,605
(2006: $777,441). These amounts represent management's best estimate of the
likely final losses to the Group from the three hurricanes. In making this
estimate, management has used the best information available, including
estimates performed by the Group's underwriters, actuarial and claims staff,
retained external actuaries, outside agencies and market studies. Allowance is
made in the overall management best estimate of net unpaid losses for an
appropriate level of sensitivity, for both individual large losses and the
overall portfolio of business. In respect of the 2005 hurricanes, management
have particularly considered sensitivities relating to gross losses on direct
and reinsurance accounts, underlying loss experience of cedants and reinsurance
coverage and security issues.
Loss portfolio transfer
In 2007 Syndicate 2020 closed the 2004 Lloyd's underwriting year of account by
way of a Lloyd's reinsurance to close. In closing the 2004 year of account, all
outstanding losses were transferred into the 2005 year of account. The Group had
an additional ownership of approximately 10 per cent acquired from the external
Names in respect of the 2005 year of account, which resulted in an increase in
loss reserves of $101,003; this has been treated as a loss portfolio transfer.
To the extent that the future run-off of the 2004 year of account differs from
what has been recorded, that development will be recorded in the Consolidated
Statement of Operations in the period that it is incurred.
8. Reinsurance
The Group purchases reinsurance to limit various exposures including catastrophe
risks. Although reinsurance agreements contractually obligate the Group's
reinsurers to reimburse it for the agreed upon portion of its gross paid losses,
they do not discharge the primary liability of the Group. The effect of
reinsurance and retrocessional activity on premiums written and earned is as
follows:
----------------- -----------------
2007 2006
----------------- -----------------
Premiums Premiums Premiums Premiums
written earned written earned
-------------- ---------- ---------- ---------- ----------
Direct $2,505,216 $2,355,056 $1,154,851 $1,070,621
Assumed 855,410 804,110 450,168 434,417
Ceded (787,108) (669,632) (194,896) (179,177)
---------------- ---------- ---------- ---------- ----------
Net premiums $2,573,518 $2,489,534 $1,410,123 $1,325,861
---------------- ---------- ---------- ---------- ----------
The Group's provision for reinsurance recoverable as at 31 December 2007 and
2006 is as follows:
2007 2006
-------------------------------- ---------- ----------
Gross reinsurance recoverable $1,153,307 $1,284,322
Provision for uncollectible balances (33,460) (46,791)
-------------------------------- ---------- ----------
Net reinsurance recoverable $1,119,847 $1,237,531
-------------------------------- ---------- ----------
The Group evaluates the financial condition of its reinsurers and potential
reinsurers on a regular basis and also monitors concentrations of credit risk
with reinsurers. All current reinsurers have a financial strength rating of at
least 'A' from Standard & Poor's or 'A-' from A M Best, or provide appropriate
collateral. However, certain reinsurers from prior years have experienced
reduced ratings which has led to the need for the provision. At 31 December
2007, there were four reinsurers which accounted for 5 per cent or more of the
total reinsurance recoverable.
% of reinsurance A.M. Best
recoverable rating
------------------------------- ----------- ---------
Hannover Ruck AG 11% A
Munich Re 11% A+
GE Frankona Reinsurance
Limited 7% A
National Indemnity Company 6% A++
-------------------------------- ----------- ---------
9. Derivative financial instruments
Catastrophe swap agreements
Newton Re
On 17 December 2007, Catlin Bermuda entered into a catastrophe swap agreement
('cat swap') that provides up to $225,000 in coverage in the event of one or
more natural catastrophes. Catlin Bermuda's counterparty in the cat swap is a
special purpose vehicle, Newton Re Limited ('Newton Re'). Newton Re has issued
to investors $225,000 in three-year floating rate notes, divided into Class A
and Class B notes. The proceeds of those notes provide the collateral for Newton
Re's potential obligations to Catlin Bermuda under the cat swap.
The Newton Re cat swap responds to certain covered risk events occurring during
a three year period. The categories of risk events covered by the transaction
are US hurricanes (Florida, Gulf States, East Coast and Hawaii) and US
earthquakes. Newton Re will pay a maximum of $137,500 for US hurricane events
and $87,500 for US earthquake events.
The Newton Re cat swap will be triggered for risk events if aggregate insurance
industry losses, as estimated by Property Claims Services, meet or exceed
defined threshold amounts.
Bay Haven
On 17 November 2006, Catlin Bermuda entered into a cat swap that provides up to
$200,250 in coverage in the event of a series of natural catastrophes. Catlin
Bermuda's counterparty in the cat swap is a special purpose vehicle, Bay Haven
Limited ('Bay Haven'). Bay Haven has issued to investors $200,250 in three-year
floating rate notes, divided into Class A and Class B notes. The proceeds of
those notes provide the collateral for Bay Haven's potential obligations to
Catlin Bermuda under the cat swap.
The Bay Haven cat swap responds to certain covered risk events occurring during
a three-year period. No payment will be made for the first three such risk
events. Bay Haven will pay Catlin Bermuda $33,375 per covered risk event
thereafter, up to a maximum of six events. The aggregate limit potentially
payable to Catlin Bermuda is $200,250.
The categories of risk events covered by the Bay Haven transaction are: US
hurricanes (Florida, Gulf States and East Coast), California earthquakes, US
Midwest earthquakes, UK windstorms, European (excluding UK) windstorms, Japanese
typhoons and Japanese earthquakes. Only one payment will be made for each
covered risk event, but the cat swap will respond to multiple occurrences of a
given category of risk event, such as if more than one qualifying US hurricane
occurs during the period.
The Bay Haven cat swap will be triggered for US risk events if aggregate
insurance industry losses, as estimated by Property Claims Services, meet or
exceed defined threshold amounts. Coverage for non-US risk events will be
triggered if specific parametric criteria, such as wind speeds or ground
motions, are met or exceeded. The first two events paid under the catastrophe
swap would impact the Class B notes; subsequent events, up to the limit of six
events over the three year period, would impact the Class A notes.
In addition, on 17 November 2006 Catlin Bermuda entered into a further cat swap
agreement with ABN AMRO Bank N.V. London Branch which will respond to the third
covered risk event (that is, the covered risk event before the Class B notes are
triggered). The terms are otherwise as described for the Class A and Class B
notes, except that the limit payable is $56,500 (2006: $46,500).
Accounting treatment
The Newton Re and Bay Haven cat swaps fall within the scope of FAS 133 and are
therefore measured in the balance sheet at fair value with any changes in the
fair value included in earnings. As at 31 December 2007, the fair value of the
cat swaps is a liability of $9,099 (2006: $619). As there is no quoted market
value available for these derivatives, the fair values are determined by
management based on the valuation of the notes issued by Newton Re and Bay
Haven, which are publicly quoted. The fair value of the Newton Re cat swap is
derived from indicative prices for the Class A and Class B notes issued by
Newton Re. The fair value of the Bay Haven cat swap is determined using an
internal model that takes into account changes in the market for catastrophe
reinsurance contracts with similar economic characteristics and the potential
for recoveries from events preceding the valuation date.
Other derivative instruments
On acquisition of Wellington, the Group acquired various foreign currency
derivatives (forward contracts, caps and collars) and options to purchase shares
in Aspen. As at 31 December 2007, the fair value of the foreign currency
derivatives was an asset of $9,035 (2006:$24,847), of which $6,139 (2006:
$18,324) had a remaining term of less than 12 months. All of the options to
purchase shares in Aspen were exercised during 2007. The exercise of the Aspen
options resulted in a loss of $6,354, recorded in net realised losses on
derivatives. The fair value of the Aspen options at 31 December 2006 was
$21,190.
10. Notes payable, debt and financing arrangements
The Group's outstanding debt as at 31 December 2007 and 2006 consisted of the
following:
2007 2006
--------------------------------- --------- ---------
Notes payable
Revolving bank facility $- $50,000
--------------------------------- --------- ---------
Total notes payable - 50,000
--------------------------------- --------- ---------
Subordinated debt
Variable rate, face amount €7,000, due 15 March 2035 10,873 10,032
Variable rate, face amount $27,000, due 15 March 2036 28,831 29,274
Variable rate, face amount $31,300, due 15 September
2036 33,480 34,103
Variable rate, face amount $9,800, due 15 September 2036 10,482 10,677
Variable rate, face amount €11,000, due 15 September
2036 17,159 15,850
--------------------------------- --------- ---------
Total subordinated debt 100,825 99,936
--------------------------------- --------- ---------
Bridge financing - 500,290
--------------------------------- --------- ---------
Total debt $100,825 $650,226
--------------------------------- --------- ---------
Subordinated debt
On 12 May 2006 Wellington Underwriting plc (which has been subsequently renamed
'Catlin Underwriting') issued $27,000 and €7,000 of variable rate unsecured
subordinated notes. The notes are subordinated to the claims of all Senior
Creditors, as defined in the agreement. The notes pay interest based on the rate
on three-month deposits in US dollars plus a margin of 317 basis points for the
Dollar note and 295 basis points for the Euro note. Interest is payable
quarterly in arrears. The notes are redeemable at the discretion of the issuer
beginning on 15 March 2011 with respect to the Dollar notes and 22 May 2011 with
respect to the Euro notes.
On 20 July 2006 Wellington Underwriting plc issued $31,300, $9,800 and €11,000
of variable rate unsecured subordinated notes. The notes are subordinated to the
claims of all Senior Creditors, as defined in the agreement. The notes pay
interest based on the rate on three-month deposits in US dollars plus a margin
of 310 basis points for the $31,300 notes and 300 basis points for the other two
notes. Interest is payable quarterly in arrears. The notes are each redeemable
at the discretion of the issuer on 15 September 2011.
Bridge financing
On 30 October 2006 Catlin entered into a bridge financing arrangement under
which it could borrow up to $500,000. On 27 and 28 December 2006 Catlin borrowed
$325,000 and $175,000, respectively, under this bridge facility to partially
finance the Wellington acquisition. The interest rate on this bridge loan was
based on three-month Libor plus 45 basis points. The weighted average interest
rate on the bridge loan at 31 December 2006 was 5.8 per cent. As at 31 December
2006 the Group had a balance of $500,290 outstanding on this facility. The
bridge financing was repaid in full with the proceeds of the non-cumulative
perpetual preferred shares in January 2007.
Bank facilities
Since November 2003, the Group has participated in a Letter of Credit/Revolving
Loan Facility (the 'Club Facility'). The Club Facility has been varied, amended
and restated since it was originally entered into, most recently on 15 December
2006 when the credit available under the Club Facility increased from $250,000
and £150,000 to $400,000 and £275,000, respectively. The facility initially
included three banks, on 15 December 2006 it increased to four banks and on 25
January 2007 it expanded to seven banks. Each bank participates equally in the
Club Facility. The Club Facility is composed of three tranches as detailed
below. The following amounts were outstanding under the Club Facility as at 31
December 2007:
• A 364-day $50,000 revolving facility with a one-year term-out option
('Facility A') is available for utilisation by the Group. Facility A, while
not directly collateralised, is secured by floating charges on Group assets
and cross-guarantees from material subsidiaries (together with Facilities B
and C). Facility A was fully drawn at 31 December 2006 and was repaid
including interest on 22 January 2007.
• Clean, irrevocable standby LOCs of $497,500 (£250,000) are provided to support
the Catlin Syndicate's underwriting at Lloyd's ('Facility B'). As at 31
December 2007, the Catlin Corporate names and Syndicate have utilised Facility
B and deposited with Lloyd's 13 LOCs which total the amount of $497,500
(£250,000). In the event that the Catlin Syndicate fails to meet its
obligations under policies of insurance written on its behalf, Lloyd's could
draw down this letter of credit. These LOCs have an initial expiry date of 20
November 2011. Collateral of $79,600 (£40,000) was provided in 2007.
• A two-year $350,000 standby LOC facility is available for utilisation by
Catlin Bermuda and Catlin UK ('Facility C'). It is split into two equal
tranches of $175,000 with the first being fully secured by OECD Government
Bonds, US Agencies and or cash discounted at varying rates. The second tranche
is unsecured. At 31 December 2007, $163,376 in LOCs were outstanding, of which
$160,043 were issued for the benefit of insureds and reinsureds of Catlin
Bermuda, and $3,333 (£1,675) issued for the benefit of an insured of Catlin
UK. $80,132 of the LOCs were issued on an unsecured basis.
The terms of the Club Facility require that certain financial covenants be met
on a quarterly basis through the filing of Compliance Certificates. These
include maximum levels of possible exposures to realistic disaster scenarios for
the Group, as well as requirements to maintain minimum Tangible Net Worth and
Adjusted Tangible Net Worth levels. The Group was in compliance with all
covenants during 2007.
A second Letter of Credit Facility administered by Citibank on behalf of Lloyd's
acting for the Lloyd's Syndicates had letters of credit totalling $9,848
outstanding at December 31, 2007. These letters of credit are fully secured.
11. Intangible assets and goodwill
The Group's intangibles relate to the purchase of syndicate capacity, customer
relationships, distribution channels and US insurance licenses (as admitted and
eligible surplus lines insurers).
Net intangible assets and goodwill as at 31 December 2007 and 2006 consist of
the following:
Indefinite Finite
life life
Goodwill intangibles intangibles Total
-------------------- --------- --------- --------- ---------
Net value at 1
January 2006 $14,913 $48,677 $49 $63,639
-------------------- --------- --------- --------- ---------
Movements during 2006:
Business
combination 68,970 461,580 10,976 541,526
Additions 704 253,446 325 254,475
Foreign
exchange
revaluation 1,648 6,792 21 8,461
Amortisation
charge - - (75) (75)
-------------------- --------- --------- --------- ---------
Total
movements
during 2006 71,322 721,818 11,247 804,387
-------------------- --------- --------- --------- ---------
Net value at
31 December
2006 86,235 770,495 11,296 868,026
-------------------- --------- --------- --------- ---------
Movements during 2007:
Amendments to
purchase price
allocation 5,542 - - 5,542
Foreign
exchange
revaluation 1,274 11,721 80 13,075
Amortisation
charge - - (2,215) (2,215)
-------------------- --------- --------- --------- ---------
Total
movements
during 2007 6,816 11,721 (2,135) 16,402
-------------------- --------- --------- --------- ---------
Net value at
31 December
2007 $93,051 $782,216 $9,161 $884,428
-------------------- --------- --------- --------- ---------
Goodwill, purchased syndicate capacity and admitted licenses are considered to
have an indefinite life and as such are subject to annual impairment testing.
Neither goodwill nor intangibles were impaired in 2007 or 2006.
Distribution channels and surplus lines authorisations are considered to have a
finite life and are amortised over their estimated useful lives of five years.
As at 31 December 2007, the gross carrying amount of finite life intangibles was
$11,456 (2006: $11,376) and accumulated amortisation was $2,295 (2006: $80).
Amortisation of intangible assets at current exchange rates will amount to
approximately $2,290 per annum for the next four years and nil thereafter.
Purchased syndicate capacity
In connection with the Wellington acquisition in December 2006, the Group
purchased Wellington's 67 per cent share of the underwriting capacity of
Syndicate 2020. Of the purchase price of Wellington, $461,580 was allocated to
this capacity (see Note 3 for further details).
In a separate transaction executed simultaneously with the Wellington
acquisition, the Group, by way of cessation of Syndicate 2020, in effect
acquired the remaining 33 per cent of Syndicate 2020's capacity from the
unaligned members. As compensation for the cessation (and, in effect, for
surrendering the capacity), unaligned members were given the option of i) 50
pence per £1.00 of capacity; or ii) 40 pence per £1.00 of capacity and the
ability to participate in a new reinsurance syndicate that writes a whole
account quota-share reinsurance of Syndicate 2003 for the 2007 and 2008 years of
account. Approximately one-third of unaligned members elected to take option i),
with the balance taking option ii).
This asset was valued at $250,071, or 50 pence per £1.00 of capacity acquired.
This represents the cash paid plus an amount representing the participation in a
new reinsurance syndicate, a non-monetary asset, which has been valued at 10
pence per £1.00 of capacity acquired. This non-monetary amount, $30,514, has
been accounted for as a reinsurance creditor and is amortised over the two years
of participation in the new reinsurance syndicate.
Effective 1 January 2007, Syndicate 2020 ceased underwriting and the purchased
capacity (and that falling to the Group by way of cessation of Syndicate 2020)
has been re-deployed to increase the capacity of Syndicate 2003.
The syndicate capacity intangible asset also includes amounts purchased by
Catlin in 2002.
12. Taxation
Bermuda
Under current Bermuda law neither the Company nor its Bermuda subsidiary, Catlin
Bermuda, are required to pay any taxes in Bermuda on their income or capital
gains. Both the Company and Catlin Bermuda have received undertakings from the
Minister of Finance in Bermuda that, in the event of any taxes being imposed,
they will be exempt from taxation in Bermuda until March 2016.
United Kingdom
The Group also operates in the UK through its UK subsidiaries and the income of
the UK companies is subject to UK corporation taxes.
Income from the Group's operations at Lloyd's is also subject to US income
taxes. Under a Closing Agreement between Lloyd's and the Internal Revenue
Service ('IRS'), Lloyd's Members pay US income tax on US connected income
written by Lloyd's Syndicates. US income tax due on this US connected income is
calculated by Lloyd's and remitted directly to the Internal Revenue Service and
is charged by Lloyd's to Members in proportion to their participation on the
relevant Syndicates. The Group's Corporate Members are all subject to this
arrangement but, as UK tax residents, will receive UK corporation tax credits
for any US income tax incurred up to the value of the equivalent UK corporation
income tax charge on the US income.
United States
The Group also operates in the US through its US subsidiaries, and their income
is subject to both US state and federal income taxes.
Other international income taxes
The Group has a network of international operations and they also are subject to
income taxes imposed by the jurisdictions in which they operate, but they do not
constitute a material component element of the Group's tax charge.
The Group is not subject to taxation other than as stated above. There can be no
assurance that there will not be changes in applicable laws, regulations or
treaties, which might require the Group to change the way it operates or become
subject to taxation.
The income tax expense for the years ended 31 December 2007 and 2006 is as
follows:
2007 2006
--------------------------------- --------- ---------
Current tax benefits - $(5,438)
Deferred tax expense $59,790 22,044
--------------------------------- --------- ---------
Expense for income taxes $59,790 $16,606
--------------------------------- --------- ---------
The weighted average expected tax expense has been calculated using pre-tax
accounting income/(loss) in each jurisdiction multiplied by that jurisdiction's
applicable statutory tax rate. The weighted average tax rate for the Group is
11.0 per cent (2006: 6.0 per cent). A reconciliation of the difference between
the expense for income taxes and the expected tax expense at the weighted
average tax rate for the years ended 31 December 2007 and 2006 is provided
below.
2007 2006
--------------------------------- ---------- ----------
Expected tax expense at weighted average rate $98,206 $1,889
Permanent differences:
Disallowed expenses 1,938 474
Prior year adjustments including changes in uncertain tax
positions (23,385) (1,297)
Impact of tax rate changes in the UK (16,969) -
Specific contingency provision - 15,540
--------------------------------- ---------- ----------
Expense for income taxes $59,790 $16,606
--------------------------------- ---------- ----------
The components of the Group's net deferred tax liability as at 31 December 2007
and 2006 are as follows:
2007 2006
--------------------------------- ---------- ----------
Deferred tax assets:
Net operating loss carryforwards $47,694 $73,346
Future UK double tax relief - 7,953
Stock options 7,839 -
Deep discount security unwind 1,146 770
Accelerated capital allowances 1,989 1,137
Compensation accruals 12,329 5,080
Syndicate capacity amortisation and other 3,093 156
--------------------------------- ---------- ----------
Total deferred tax assets $74,090 $88,442
--------------------------------- ---------- ----------
Deferred tax liabilities:
Intra-Group financing charges - (8,932)
Untaxed profits (179,784) (104,030)
Intangible assets arising on business combination (119,148) (127,017)
--------------------------------- ---------- ----------
Total deferred tax liabilities (298,932) (239,979)
--------------------------------- ---------- ----------
Net deferred tax liability $(224,842) $(151,537)
--------------------------------- ---------- ----------
As at 31 December 2007, there are potential deferred tax assets of $9,217 in the
US companies relating to 2007 calendar year losses but a 100 per cent valuation
allowance has been recognised in respect of the losses. A deferred tax asset of
$2,184 relating to US losses was recognised as at 31 December 2006.
As at 31 December 2007, a net deferred tax liability of $224,842 is recognised
in the balance sheet. As at 31 December 2006, a deferred tax asset of $2,184
relating to US losses was included in other assets in the balance sheet and
$153,721 relating to non-US jurisdictions was reported as a deferred tax
liability.
As at 31 December 2007, the Group has net operating loss carry forwards of
approximately $170,336 (2006: $243,401) which are available to offset future
taxable income. The net operating loss carry forwards primarily arise in the UK
subsidiaries where they are expected to be fully used. There are no time
restrictions on the use of these losses.
Uncertain tax positions
With effect from 1 January 2007, the Group adopted FASB Interpretation No. 48,
'Accounting for Uncertainty in Income Taxes - an Interpretation of FASB
Statement No. 109'. On adoption of FIN 48, the total amount of the Group's
unrecognised tax benefits arising from uncertain tax positions was $11,201. As
at 31 December 2007, this amount was $9,300. All unrecognised tax benefits would
affect the effective tax rate if recognised.
A reconciliation of the beginning and ending amount of unrecognised tax benefits
arising from uncertain tax positions is as follows:
2007
-------------------------------- ----------
Unrecognised tax benefits balance at 1 January 2007:
Gross increases for tax positions in current year $11,201
Gross increases for tax positions of prior years 7,031
Gross decreases for tax positions of prior years (8,932)
-------------------------------- ----------
Unrecognised tax benefits balance at 31 December 2007 $9,300
-------------------------------- ----------
The Group does not believe it would be subject to any penalties in any open tax
years and has not accrued any such amounts. The Group accrues interest and
penalties (if applicable) as income tax expenses in the consolidated financial
statements. The Group did not pay or accrue any interest and penalties in 2007
relating to uncertain tax positions.
The following table lists the open tax years that are still subject to
examination by local tax authorities in major tax jurisdictions:
Major tax jurisdiction Years
-------------------------------- -----------------
United Kingdom 2006-2007
United States 2004-2007
-------------------------------- -----------------
13. Stockholders' equity
The following is a detail of the number and par value of common shares
authorised, issued and outstanding as at 31 December 2007 and 2006:
----------------- -----------------
Issued and
Authorised outstanding
----------------- -----------------
Number Number
of Par value of Par value
shares $000 shares $000
---------------- ---------- ---------- ---------- ----------
Ordinary common shares,
par value $0.01 per
share
---------------- ---------- ---------- ---------- ----------
As at 31
December 2007 400,000,000 $4,000 253,122,072 $2,531
---------------- ---------- ---------- ---------- ----------
As at 31
December 2006 400,000,000 $4,000 238,283,281 $2,383
---------------- ---------- ---------- ---------- ----------
Preferred shares, par
value $0.01 per share
---------------- ---------- ---------- ---------- ----------
As at 31
December 2007 600,000 $6 600,000 $6
---------------- ---------- ---------- ---------- ----------
The following table outlines the changes in common shares issued and outstanding
during 2007 and 2006:
2007 2006
--------------------------------- --------- ---------
Balance, 1 January 238,283,281 155,914,616
Exercise of stock options and warrants 3,159,154 249,108
Equity raise - 7,704,900
Business combination 11,679,637 74,414,657
--------------------------------- --------- ---------
Balance, 31 December 253,122,072 238,283,281
--------------------------------- --------- ---------
Equity raise
On 14 March 2006, the Group placed 7,704,900 new common shares with par value of
$0.01 each at $8.68 (£5.00) per share, raising $65,231 net of expenses.
Business combination
As at 31 December 2006 acceptances totalling 88 per cent of Wellington's share
capital subject to the Group's offer to acquire Wellington ('the Offer') had
been settled, resulting in an issuance of 74,414,657 common shares. The
remaining Wellington shares subject to the Offer were settled in 2007, resulting
in a further issuance of 11,679,637 shares.
Preferred shares
On 18 January 2007, Catlin Bermuda issued 600,000 of non-cumulative perpetual
preferred shares, par value of $0.01 per share, with liquidation preference of
$1,000 per share, plus declared and unpaid dividends. Dividends are payable
semi-annually in arrears only if, as and when declared by the Board of
Directors, on 19 January and 19 July, commencing on 19 July 2007, at a rate of
7.249 per cent on the liquidation preference, up to but not including 19 January
2017. Thereafter, if the shares have not yet been redeemed, dividends will be
payable quarterly at a rate equal to 2.975 per cent plus the 3-month LIBOR Rate
of the liquidation preference. Catlin Bermuda received proceeds of approximately
$589,785, net of issuance costs, which were used to repay the $500,000 bridge
facility as well as Facility A described in Note 10, and for general corporate
purposes. The preference shares do not have a maturity date and are not
convertible into or exchangeable into any of Catlin Bermuda's or the Group's
other securities.
Treasury stock
In connection with the Performance Share Plan ('PSP'), at each dividend date, an
amount equal to the dividend that would be payable in respect of the shares to
be issued under the PSP (assuming full vesting) is paid into an Employee Benefit
Trust ('EBT'). The EBT uses these funds to purchase Group shares on the open
market. These shares will ultimately be distributed to PSP holders to the extent
that the PSP awards vest. During 2007, the Group, through the EBT, purchased
484,331 of the Group's shares, at an average price of $9.28 (£4.64) per share.
The total amount paid of $4,497 is shown as a deduction to stockholders' equity.
In conjunction with the Wellington acquisition, the Group agreed to compensate
legacy Wellington employees that held units in the Wellington EBT. There were no
costs associated with the distribution of the Group shares.
Warrants
In 2002, the Company issued warrants to shareholders to purchase 20,064,516
common shares. Warrants may be exercised in whole or in part, at any time, until
4 July 2012 and are exercisable at a price per share of $5.00. During 2007,
warrants to purchase 5,963,369 common shares were exercised and settled net for
2,988,758 common shares, leaving warrants entitling the purchase of 8,980,682
common shares outstanding. No warrants were exercised during 2006.
Dividends
Dividends on common shares
On 8 June 2007, the Group paid a final dividend on the common shares relating to
the 2006 financial year of $0.328 (£0.170) per share to stockholders of record
at the close of business on 11 May 2007. The total dividend paid for the 2006
financial year was $0.441 (£0.230) per share.
On 9 November 2007, the Group paid an interim dividend relating to the 2007
financial year of $0.164 per share (£0.081 per share) to stockholders of record
as at 12 October 2007.
Dividends on preferred shares
On 17 July 2007, the Board of Catlin Bermuda approved a dividend of $21,868 to
the holders of the non-cumulative perpetual preference shares. This dividend was
paid on 19 July 2007.
14. Employee stock compensation schemes
The Group has two stock compensation schemes in place under which awards are
outstanding: a Performance Share Plan, adopted in 2004, and a Long Term
Incentive Plan, adopted in 2002. These financial statements include the total
cost of stock compensation for both plans, calculated using the fair value
method of accounting for stock-based employee compensation. The total cost of
the plans expensed in the year ended 31 December 2007 was $13,668 (2006:
$11,000). Remaining stock compensation to be expensed in future periods relating
to these plans is $27,510.
Performance Share Plan ('PSP')
On 9 March 2007, a total of 2,721,517 options with $nil exercise price and
518,999 non-vested shares (total of 3,240,516 securities) were granted to Group
employees under the PSP. On 10 October 2007, a further 252,737 options with $nil
exercise price and 120,852 non-vested shares (total of 373,589 securities) were
granted, resulting in a total of 3,614,105 securities granted to Group employees
under the PSP in 2007. Up to half of the securities will vest on 9 March 2010
and up to half will vest on 9 March 2011, subject to certain performance
conditions.
These securities have been treated as non-vested shares and as such have been
measured at their fair value on the grant date as if they were fully vested and
issued and assuming an annual attrition rate amongst participating employees of
12 per cent for grants made in 2007, 6 per cent for grants made in 2006 and 3
per cent for grants made in 2005. This initial valuation is revised at each
balance sheet date to take account of actual achievement of the performance
condition that governs the level of vesting and any changes that may be required
on the attrition assumption. The difference is charged or credited to the income
statement, with a corresponding adjustment to equity. The total number of PSP
securities outstanding at 31 December 2007 was 7,732,772 (2006: 4,426,886) and
the total compensation expense relating to the PSP for the year ended 31
December 2007 was $13,313 (2006: $9,669).
None of the PSP securities have vested. The table below shows the unvested PSP
securities as at 31 December:
2007 2006
--------------------------------- --------- ---------
Outstanding, beginning of year 4,426,886 2,203,786
Granted during year 3,614,105 2,295,597
Forfeited during year (308,219) (72,497)
--------------------------------- --------- ---------
Outstanding, end of year 7,732,772 4,426,886
--------------------------------- --------- ---------
Fair value per PSP security as at date of grant -
March $9.70 $8.71
--------------------------------- --------- ---------
Fair value per PSP security as at date of grant -
October $9.46 N/A
--------------------------------- --------- ---------
In addition, at each dividend payment date, an amount equal to the dividend that
would be payable in respect of the shares to be issued under the PSP (assuming
full vesting), is paid into an Employee Benefit Trust. This amount, totalling
$3,879 in 2007, is treated as a deferred compensation obligation and as such is
taken directly to retained earnings and capitalised in stockholders' equity
within additional paid-in capital.
Long Term Incentive Plan ('LTIP')
Interests in a total of 16,791,592 ordinary common shares were granted to
eligible employees. The individual awards were divided into options with an
exercise price of $5.00 and exercisable in four equal annual tranches, and
options with exercise prices of $10.00, $12.50 and $15.00, exercisable on 1 July
2007. The total compensation expense relating to the LTIP for the year ended 31
December 2007 was $359 (2006: $1,331).
The options are fully vested as at 31 December 2007 and all options will expire
by 4 July 2012. Options with exercise prices of $10.00, $12.50 and $15.00
expired on 31 December 2007. The table below shows the vesting dates and the
number of options that have vested on those dates:
Date
--------------------------------------- Number of
options
vesting
-----------
4 July 2003 1,576,110
6 April 2004 (IPO date) 4,815,484
4 July 2004 1,668,261
4 July 2005 1,655,158
4 July 2006 1,647,564
4 July 2007 5,429,015
--------------------------------------- -----------
Total 16,791,592
--------------------------------------- -----------
The table below shows the status of the interests in shares as at 31 December:
---------------- --------- ---------- --------- ----------
2007 2006
---------------- --------- ---------- --------- ----------
Weighted average Weighted average
Number exercise price($) Number exercise price($)
---------------- --------- ---------- --------- ----------
Outstanding, beginning of period
15,270,679 9.76 15,979,915 9.68
Exercised during year (501,044) 5.92 (544,500) 4.97
Forfeited during year (130,168) 12.32 (164,736) 11.94
Expired during year (9,495,358) 12.53 - -
---------------- --------- ---------- --------- ----------
Outstanding, end of period 5,144,109 4.94 15,270,679 9.76
---------------- --------- ---------- --------- ----------
Exercisable, end of period 5,144,109 4.94 10,084,791 8.45
---------------- --------- ---------- --------- ----------
Exercise price Average
--------------------------------- Number of remaining
options contractual
outstanding life (years)
--------- ---------
$5.00 4,945,552 4.5
£3.50 198,557 4.5
--------------------------------- --------- ---------
Total 5,144,109 4.5
--------------------------------- --------- ---------
As at year end, there was no amount receivable from stockholders on the exercise
of interests in shares.
The fair value of the options granted during 2004 was calculated using the
Black-Scholes valuation model and is amortised over the expected vesting period
of the options, being four years for the £3.50 tranche, 1.875 years for the
performance based tranche that vested on admission and 3.625 for the performance
based tranche that vested on 4 July 2007. The valuation has assumed an average
volatility of 40 per cent, no expected dividends and a risk free rate using US
dollar swap rates appropriate for the expected life assumptions: 2.8 per cent
for four years; 1.79 per cent for 1.875 years; and 2.64 per cent for 3.625
years.
The fair value of the options granted prior to 2004 was calculated using the
Black-Scholes valuation model and is being amortised over the expected vesting
period of the options, being 4.5 years from the date of the subscription
agreement. The valuation has assumed a risk free rate of return at the average
of the four- and five-year US dollar swap rates of 3.39 per cent and no expected
volatility (as the minimum value method was utilised because the Company was not
listed on the date the options were issued).
15. Earnings per share
Basic earnings per share is calculated by dividing the earnings attributable to
common stockholders by the weighted average number of common shares in issue
during the year.
Diluted earnings per share is calculated by dividing the earnings attributable
to all stockholders by the weighted average number of common shares in issue
adjusted to assume conversion of all dilutive potential common shares. The
company has the following potentially dilutive instruments outstanding during
the periods presented:
(i) PSP;
(ii) LTIP; and
(iii) Warrants
Income available to common stockholders is arrived after deducting preferred
share dividends of $21,868 (2006: $nil).
Reconciliations of the number of shares used in the calculations are set out
below.
2007 2006
--------------------------------- --------- ---------
Weighted average number of shares 250,311,588 162,598,043
Dilution effect of warrants 4,258,094 6,492,633
Dilution effect of stock options and non-vested
shares 10,130,761 6,771,102
Dilution effect of stock options and warrants
exercised in the year 927,684 213,223
--------------------------------- --------- ---------
Weighted average number of shares on a diluted
basis 265,628,127 176,075,001
--------------------------------- --------- ---------
Earnings per common share
Basic $1.84 $1.59
Diluted $1.74 $1.47
--------------------------------- --------- ---------
All options to purchase shares under the LTIP were included in the computation
of diluted earnings per share. In 2006, 9,751,307 options to purchase shares
were outstanding during the year but were not included in the computation of
diluted earnings per share because the options' exercise price was greater than
the average market price of the common shares. All securities awarded under the
PSP were included in the computation of diluted earnings per share because the
performance conditions necessary for these securities to vest were met as at 31
December 2007 and 2006.
16. Other comprehensive income/(loss)
The following table details the tax effect of the individual components of other
comprehensive income/(loss) for 2007 and 2006:
Amount
before Tax benefit Amount
2007 tax (expense) after tax
-------------------------- --------- --------- ---------
Unrealised losses arising during the year $(42,547) $6,450 $(36,097)
Reclassification for losses realised in income 78,970 (13,259) 65,711
-------------------------- --------- --------- ---------
Net unrealised losses on investments 36,423 (6,809) 29,614
Defined benefit pension plan (818) 264 (554)
Cumulative translation adjustments 42,097 (6,247) 35,850
-------------------------- --------- --------- ---------
Change in accumulated other comprehensive income $77,702 $(12,792) $64,910
-------------------------- --------- --------- ---------
Amount
before Tax benefit Amount
2006 tax (expense) after tax
-------------------------- --------- --------- ---------
Unrealised losses arising during the year $18,684 $(5,750) $12,934
Less reclassification for losses realised in income (17,041) 3,564 (13,477)
-------------------------- --------- --------- ---------
Net unrealised losses on investments 1,643 (2,186) (543)
Cumulative translation adjustments (9,055) 4,907 (4,148)
-------------------------- --------- --------- ---------
Change in accumulated other comprehensive loss $(7,412) $2,721 $(4,691)
-------------------------- --------- --------- ---------
The following table details the components of accumulated other comprehensive
income/(loss) as at 31 December:
2007 2006
--------------------------------- --------- ---------
Net unrealised gains/(losses) on investments $14,424 $(15,190)
Cumulative translation adjustments 24,950 (10,900)
Funded status of defined benefit pension plan adjustment (554) -
--------------------------------- --------- ---------
Accumulated other comprehensive income/(loss) $38,820 $(26,090)
--------------------------------- --------- ---------
17. Pension commitments
The Group operates various pension schemes for the different countries of
operation. In addition, the Group acquired a defined benefit pension plan and
defined contribution plans as part of the Wellington acquisition.
In the UK, the Group operates defined contribution schemes for certain directors
and employees, which are administered by third party insurance companies. The
pension cost for the UK scheme was $8,035 for the year ended 31 December 2007
(2006: $4,184).
In Bermuda, the Group operates a defined contribution scheme, under which the
Group contributes a specified percentage of each employee's earnings. The
pension cost for the Bermuda scheme was $733 for the year ended 31 December 2007
(2006: $683).
In the US Catlin Inc. has adopted a 401(k).Profit Sharing Plan ('the Plan')
qualified under the Internal Revenue Code in which all employees meeting
specified minimum age and service requirements are eligible to participate. The
Plan allows eligible participants to contribute a portion of their salary to the
Plan on a tax-deferred basis. Catlin Inc. will match the employee contributions
up to 100 per cent of the first 6 per cent of salary contributed. An additional
discretionary contribution may be made to the plan as determined by the Board of
Directors of Catlin Inc. on an annual basis and is allocated on a pro rate basis
to individual employees based on eligible compensation. In 2005 Catlin Inc.
established a Non-Qualified Deferred Compensation Plan ('Non-Qualified Plan')
under which higher-paid employees are eligible for supplemental retirement
benefits in excess of statutory limitations on Plan contributions and benefits.
The expense related to the Non-Qualified Plan in for the year ended 31 December
2007 was $575 (2006: $183). The pension cost for the Plan for the year ended 31
December 2007 was $2,875 (2006: $384).
In connection with the acquisition of Wellington in December 2006, the Group
assumed liabilities associated with a defined benefit pension scheme which
Wellington sponsored. The scheme has been closed to new members since 1993. The
current membership consists only of pensioners and deferred members. The
movements in the period are shown in the table below.
2007 2006
--------------------------------- --------- ---------
Change in projected benefit obligation:
Projected benefit obligation, beginning of year $32,720 -
Interest cost 1,654 -
Actuarial gain (1,074) -
Benefits paid (1,948) -
Foreign exchange 508 -
Business combination - 32,720
--------------------------------- --------- ---------
Projected benefit obligation, end of year 31,860 $32,720
--------------------------------- --------- ---------
Change in plan assets:
Fair value of plan assets, beginning of year 34,429 -
Expected return on plan assets 1,742 -
Actuarial loss (1,970) -
Benefits paid (1,938) -
Foreign exchange 518 -
Business combination - 34,429
--------------------------------- --------- ---------
Fair value of plan assets, end of year 32,781 $34,429
--------------------------------- --------- ---------
Reconciliation of funded status:
Funded status 921 $1,709
--------------------------------- --------- ---------
Net pension asset recognised at year end 921 $1,709
--------------------------------- --------- ---------
The amounts recognised in net income were as follows:
2007 2006
--------------------------------- --------- ---------
Interest cost 1,654 -
Expected return on plan assets (1,742) -
--------------------------------- --------- ---------
Net credit recognised in net income (88) -
--------------------------------- --------- ---------
The actuarial assumptions used to value the benefit obligation at 31 December
were as follows:
2007 2006
--------------------------------- --------- ---------
Discount rate 5.8% 5.1%
Price inflation 5.8% 5.1%
Pension increases to pensions in payment 3.0% 3.2%
--------------------------------- --------- ---------
As the plan was assumed from Wellington at 31 December 2006, there are no income
statement effects in 2006.
The objectives in managing the scheme's investments are to ensure that
sufficient assets are available to pay members' benefits as they arise, with due
regard to minimum regulatory requirements and the employer's ability to meet
contribution payments. It is believed that, in relation to membership consisting
only of pensioners and deferred members, these objectives are best met by
investment in fixed income securities. The investments are in a pooled,
non-government bond fund which is diversified across a large number of
securities in order to reduce specific risk.
As at 31 December 2007, approximately 100 per cent of plan assets were held in
debt securities, with the remaining insignificant amount held as cash. No plan
assets are expected to be returned to the Group during 2008.
The overall expected return on assets is calculated as the weighted average of
the expected returns on each individual asset class. The return on debt
securities is the current market yield on debt securities. The expected return
on other assets is derived from the prevailing interest rate set by the Bank of
England as at the measurement date.
Estimated future benefit payments for the defined benefit pension plan, are as
follows:
----------------------------------------- ---------
2008 $2,040
2009 $2,488
2010 $2,289
2011 $2,637
2012 $2,587
2013 to 2017 inclusive $14,975
----------------------------------------- ---------
No contributions are expected to be paid to the defined benefit plan in 2008.
18. Statutory financial data
The Group's subsidiaries' statutory capital and surplus was $3,283,887 at 31
December 2007 (2006: $1,459,950). The unaudited statutory surplus of each of its
principal operating subsidiaries is in excess of regulatory requirements.
The Group's ability to pay dividends is subject to certain regulatory
restrictions on the payment of dividends by its subsidiaries. The payment of
such dividends is limited by applicable laws and statutory requirements of the
jurisdictions in which the Group operates.
The Group is also subject to restrictions on some of its assets to support its
insurance and reinsurance operations, as described in Note 5.
19. Commitments and contingencies
Legal proceedings
The Group is party to a number of legal proceedings arising in the ordinary
course of the Group's business which have not been finally adjudicated. While
the results of the litigation cannot be predicted with certainty, management
believes that the outcome of these matters will not have a material impact on
the results of operations or financial condition of the Group.
Concentrations of credit risk
Areas where significant concentration of risk may exist include investments,
reinsurance recoverable and cash and cash equivalent balances.
The cash balances and investment portfolio are managed following prudent
standards of diversification. Specific provisions limit the allowable holdings
of a single institution issue and issuers. Similar principles are followed for
the purchase of reinsurance. The Group believes that there are no significant
concentrations of credit risk associated with its investments or its reinsurers.
Note 8 describes concentrations of more than 5 per cent of the Group's total
reinsurance recoverable asset.
Letters of credit
The Group provides finance under its Club Facility to enable its subsidiaries to
continue trading and to meet its liabilities as they fall due, as described in
Note 10.
Future lease commitments
The Group leases office space and equipment under non-cancellable operating
lease agreements, which expire at various times. Future minimum annual lease
commitments for non-cancellable operating leases as at 31 December 2007 are as
follows:
----------------------------------------- ---------
2008 $14,368
2009 12,228
2010 11,648
2011 9,061
2012 and thereafter 40,443
----------------------------------------- ---------
Total $87,748
----------------------------------------- ---------
Under non-cancellable sub-lease agreements, the Group is entitled to receive
future minimum sub-lease payments of $1,298 (2006: $869).
20. Related parties
The Group purchased services from Catlin Estates Limited and Burnhope Lodge,
both of which are controlled by a Director of the Group. The cost of services
purchased from Catlin Estates Limited and Burnhope Lodge during 2007 was $242
(2006: $58).
During 2007, the Group entered into a lease agreement with The Whitfield Group
Ltd., the president of which is related to a Director of Catlin Bermuda. Total
rent incurred during 2007 amounted to $141 (2006: $nil).
All transactions with related parties were entered into on normal commercial
terms.
21. Subsequent events
Proposed dividend
On 5 March 2008, the Board approved a proposed final dividend of $0.338 per
share (£0.17 per share), payable on 23 May 2008 to stockholders of record at the
close of business on 25 April 2008. The final dividend is determined in US
dollars but partially payable in sterling based on the exchange rate of £1=$1.99
on 4 March 2008.
Catastrophe bond
On 21 February 2008 the Group entered into a further contract with Newton Re
Limited for US$150,000 of annual aggregate protection against accumulated losses
from US windstorm, US earthquake, European windstorm, Japanese typhoon and
Japanese earthquake events in the Group's property treaty book. The transaction
provides coverage on a first-event and accumulated aggregate retrocession
protection on a fully collateralised basis.
Preferred share dividend
The Board of Catlin Bermuda approved a dividend of $21,750 to the holders of the
non-cumulative perpetual preference shares. This dividend was paid on 19 January
2008.
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