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| XL > SEC Filings for XL > Form 10-Q on 6-Aug-2009 | All Recent SEC Filings |
6-Aug-2009
Quarterly Report
The following is a discussion of the Company's financial condition and liquidity and results of operations. Certain aspects of the Company's business have loss experience characterized as low frequency and high severity. This may result in volatility in both the Company's and an individual segment's results of operations and financial condition.
This "Management's Discussion and Analysis of Financial Condition and Results of Operations" contains forward-looking statements that involve inherent risks and uncertainties. Statements that are not historical facts, including statements about the Company's beliefs and expectations, are forward-looking statements. These statements are based upon current plans, estimates and projections, all of which involve risk and uncertainty. Actual results may differ materially from those included in such forward-looking statements, and therefore undue reliance should not be placed on them. See "Cautionary Note Regarding Forward-Looking Statements" below for a list of factors that could cause actual results to differ materially from those contained in any forward-looking statement.
This discussion and analysis should be read in conjunction with the "Management's Discussion and Analysis of Financial Condition and Results of Operations", and the audited Consolidated Financial Statements and notes thereto, presented under Item 7 and Item 8, respectively, of the Company's Form 10-K for the year ended December 31, 2008.
See "Executive Overview" in Item 7 of the Company's Form 10-K for the year ended December 31, 2008.
Results of Operations
The following table presents an analysis of the Company's net income
available to ordinary shareholders and other financial measures (described
below) for the three months ended June 30, 2009 and 2008:
(Unaudited)
Three Months Ended
June 30,
----------------------
(U.S. dollars and shares in thousands, except per share
amounts) 2009 2008 (1)
---------- ---------
Net income available to ordinary shareholders $ 79,949 $ 237,851
Earnings per ordinary share - basic $ 0.23 $ 1.33
Earnings per ordinary share - diluted $ 0.23 $ 1.33
Weighted average number of ordinary shares and ordinary
share equivalents - basic 342,154 179,054
Weighted average number of ordinary shares and ordinary
share equivalents - diluted 342,468 179,054
Change in fully diluted book value per share (2) $ 3.87 $ (2.72 )
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The following table presents an analysis of the Company's net income available to ordinary shareholders and other financial measures (described below) for the six months ended June 30, 2008 and 2007:
(Unaudited)
Six Months Ended
June 30,
---------------------
(U.S. dollars and shares in thousands, except per share
amounts) 2009 2008 (1)
--------- ---------
Net income available to ordinary shareholders $ 258,328 $ 449,724
Earnings per ordinary share - basic $ 0.76 $ 2.52
Earnings per ordinary share - diluted $ 0.76 $ 2.52
Weighted average number of ordinary shares and ordinary
share equivalents - basic 339,155 178,701
Weighted average number of ordinary shares and ordinary
share equivalents - diluted 339,262 178,701
Change in fully diluted book value per share (2) $ 3.43 $ (6.91 )
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(1) Basic and diluted earnings per ordinary share were adjusted for 2008. For further information, see Note 14 to the Consolidated Financial Statements, "Computation of Earnings per Ordinary Share and Ordinary Share Equivalents."
(2) Fully diluted book value per ordinary share is a non-GAAP measure and represents book value per ordinary share combined with the impact from dilution of share based compensation including in-the-money stock options at any period end. The Company believes that fully diluted book value per ordinary share is a financial measure important to investors and other interested parties who benefit from having a consistent basis for comparison with other companies within the industry. However, this measure may not be comparable to similarly titled measures used by companies either outside or inside of the insurance industry.
1) Impact of credit market movements on the Company's investment portfolio
2) Factors impacting the underwriting environment
3) Favorable prior year reserve development
4) Redemption of Series C Preference Ordinary Shares
1) Impact of credit market movements on the Company's investment portfolio
During the quarter ended June 30, 2009, financial market conditions continued to be extremely challenging as the global credit crisis that began in July 2007 continued to impact global markets. This unprecedented market volatility directly and materially affected the Company's results of operations and investment portfolio during the three and six month periods ended June 30, 2009.
The deterioration in the market value of the Company's investment portfolio reported in the first quarter of 2009 was almost completely offset by the improved market conditions in the second quarter. During the three month period ended June 30, 2009, credit spreads across most classes of fixed maturity investments tightened significantly. While the benefits of improved credit markets were partially offset by increasing global interest rates and the impact of FSP FAS 115, the net impact of the market conditions on the Company's investment portfolio for the quarter resulted in a decrease in net unrealized losses on available-for-sale investments of $860.0 million and net realized losses of $80.4 million. This represents approximately a 2.4% appreciation of on average assets for the quarter ended June 30, 2009. See Item 1A, "Risk Factors," "Deterioration in the public debt and equity markets could lead to additional investment losses" and "We are exposed to significant capital markets risk related to changes in interest rates, credit spreads, equity prices and foreign exchange rates which may adversely affect the Company's results of operations, financial condition or cash flows," in the Company's Annual Report on Form 10-K for the year ended December 31, 2008. To the extent a period of inflation occurs as a result of the current market environment, such inflation may adversely impact the securities markets and the value of financial instruments.
The following table provides further detail regarding the extreme volatility in the global credit markets, as well as in government interest rates using some sample market indices:
Interest Rate Movement Credit Spread Movement
for the quarter ended for the quarter ended
June 30, 2009 (1) June 30, 2009 (2)
('+'/'-' represents an ('+'/'-' represents a
increase/decreases in widening/narrowing of credit
interest rates) spreads)
------------------------- ----------------------------------
United States + 90 basis points (5 year - 276 basis points (US Corporate A
Treasury) rated)
- 48 basis points (US Agency RMBS,
AAA rated)
- 228 basis points (US CMBS, AAA
rated)
United Kingdom + 52 basis points (10 - 121 basis points (UK Corporate,
year Gilt) AA rated)
Euro-zone + 26 basis points (5 year - 158 basis points (Europe
Bund) Corporate, A rated)
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(1) Source: Bloomberg Finance L.P.
(2) Source: Merrill Lynch Global Indices
Net realized losses on investments in the three months ended June 30, 2009 included net realized losses of approximately $84.9 million related to the write-down of certain of the Company's fixed income, equity and other investments, where the Company determined that there was an other than temporary decline in the value of those investments. Of the other-than-temporary impairments, $27.0 million related to changes of intent to hold, of which $1.4 million was within the Company's life operations. See below for further information.
$26.8 million of impairments related to the change in the intent to hold on certain Tier One and Upper Tier Two securities and $23.4 million related to credit impairments on securities with sub-prime and Alt-A collateral. The remaining impairment during the second quarter of 2009 was spread across the portfolio including structured credit and other fixed income investments. Consistent with prior quarters, management continues to evaluate the impairment of the portfolio and satisfy itself that the remaining gross unrealized losses are temporary in nature.
2) Factors Impacting the Underwriting Environment
Market concerns around the Company's financial condition continue to dissipate, although market conditions in general remain challenging due to general economic conditions and continuation of soft market behavior, seen over the last year.
To date, 2009 renewals are flat (no rate change) across the entire book as compared to a 6.5% decrease in rates for the same period a year ago. There was a continuing rate strengthening from April through June, albeit gradual, where rates increased 2% for the period in aggregate. For the quarter, low single digit price decreases were seen in property (-2%) and professional (-1%) which were offset by moderate increases in specialty (+3%) and casualty (+3%) pricing. The impact of the S&P ratings downgrade in December 2008 has affected premiums particularly in certain longer tail lines, but this impact continues to lessen quite rapidly. Premium volumes have also been negatively impacted by the global economic conditions, ratable exposure bases down and reduction in M&A, the exiting of certain lines of business and the ongoing efforts of risk managers to reduce their concentration of risk (limits) with all insurers. Partially offsetting these impacts have been strengthening of retentions broadly in the segment during the second quarter, and in particular in our professional lines and property books where stronger retentions and increases in new business written occurred.
The following table provides an analysis of gross premiums written, net premiums written and net premiums earned for the Insurance segment for the six month periods ended June 30, 2009 and 2008:
(Unaudited) (Unaudited)
Six Months Ended Six Months Ended
June 30, 2009 June 30, 2008
----------------------------------------- -----------------------------------------
Gross Net Net Gross Net Net
Premiums Premiums Premiums Premiums Premiums Premiums
(U.S. dollars in thousands) Written Written Earned Written Written Earned
----------- ----------- ----------- ----------- ----------- -----------
Casualty - professional
lines $ 582,110 $ 539,128 $ 627,260 $ 690,471 $ 624,297 $ 688,167
Casualty - other lines 563,034 352,661 315,158 831,813 555,741 425,370
Property catastrophe (25 ) 1,762 1,762 (59 ) (2,162 ) 107
Other property 407,925 187,416 215,090 600,697 398,873 258,766
Marine, energy, aviation,
and satellite 344,182 266,055 287,483 408,377 325,022 322,618
Other specialty lines (1) 313,147 247,430 324,087 430,827 355,917 324,924
Other (2) 4,882 4,112 10,831 11,529 (29,831 ) (27,359 )
Structured indemnity 210 210 9,930 43,465 40,815 34,159
- --------- - --------- - --------- - --------- - --------- - ---------
Total $ 2,215,465 $ 1,598,774 $ 1,791,601 $ 3,017,120 $ 2,268,672 $ 2,026,752
- --------- - --------- - --------- - --------- - --------- - ---------
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(1) Other specialty lines within the Insurance segment includes: environmental, programs, equine, warranty, specie, middle markets, and excess and surplus lines.
(2) Other includes employers' liability, surety, political risk and other lines.
Reinsurance
Across the Reinsurance segment, January 1, 2009 and April 1, 2009 renewals resulted in a moderate rise in premium rates across most major lines of business. Market conditions continued to harden across short tail lines as a result of the reduction in available reinsurer capital, due in part to the credit and liquidity crisis, causing a firming in market pricing across most lines of business. U.S. and non-U.S. catastrophe exposed property lines experienced rate increases of approximately 10% to 15%, while other property lines in the U.S. remain generally flat. U.S. casualty rates, excluding D&O, were down slightly as rate reductions in underlying primary portfolios have slowed during the second quarter. International renewals in the second quarter were principally in Japan where rates increased approximately 4%.
While rate changes have positively impacted gross premiums written, such increases have been more than offset by the Company's focus on short-tail lines, certain lost renewals and reduced shares on certain accounts as a result of the S&P ratings downgrade in December 2008, most notably within the Company's European based reinsurance operations. In addition, unfavorable foreign exchange rate movements negatively impacted gross premiums written as a result of the increase in the value of the U.S. Dollar against most major currencies over the past six months.
(Unaudited) (Unaudited)
Six Months Ended Six Months Ended
June 30, 2009 June 30, 2008
----------------------------------- ---------------------------------------
Gross Net Net Gross Net Net
(U.S. dollars in Premiums Premiums Premiums Premiums Premiums Premiums
thousands) Written Written Earned Written Written Earned
----------- --------- --------- ----------- ----------- -----------
Casualty - professional
lines $ 104,632 104,632 110,237 $ 138,193 $ 138,090 $ 130,436
Casualty - other lines 144,546 139,714 137,335 250,444 244,610 222,645
Property catastrophe 295,896 251,341 146,174 331,278 231,106 171,510
Other property 431,843 324,927 283,096 455,300 349,595 342,374
Marine, energy, aviation,
and satellite 62,259 58,988 41,614 89,321 83,266 60,702
Other (1) 126,559 106,995 92,037 204,109 179,321 104,915
Structured indemnity (1,782 ) (1,782 ) 1,342 1,360 1,360 2,233
- --------- - ------- - ------- - --------- - --------- - ---------
Total $ 1,163,953 984,815 811,835 $ 1,470,005 $ 1,227,348 $ 1,034,815
- --------- - ------- - ------- - --------- - --------- - ---------
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(1) Other includes employers' liability, surety, political risk and other lines.
3) Favorable prior year reserve development
The Company incurred net favorable prior year reserve development in property and casualty operations for the three and six month periods ended June 30, 2009 of $89.6 million and $179.7 million, respectively compared to $182.5 million and $249.5 million, respectively, for the same periods in 2008. Reinsurance segment favorable development for the three and six month periods ended June 30, 2009 accounted for $55.3 million and $138.7 million, respectively, of the favorable development in 2009, with the balance from the Insurance segment. For further details see the segment results in "Income Statement Analysis" below.
4) Redemption of Series C Preference Ordinary Shares
On March 26, 2009, the Company completed a cash tender offer for its outstanding Series C Preference Ordinary Shares that resulted in approximately 12.7 million Series C Preference Ordinary Shares with a liquidation value of $317.3 million being purchased by the Company for approximately $104.7 million plus accrued and unpaid dividends, combined with professional fees totaling $0.8 million. As a result, a book value gain to ordinary shareholders of approximately $211.8 million was recorded.
Financial Measures
The following are some of the financial measures management considers
important in evaluating the Company's operating performance:
(Unaudited)
Three Months Ended
June 30,
-----------------------
(U.S. dollars and shares in thousands, except ratios and per
share amounts) 2009 2008
---------- ---------
Underwriting profit - property and casualty operations $ 89,439 $ 126,356
Combined ratio - property and casualty operations 93.0 % 91.6 %
Net investment income - property and casualty operations (1) $ 218,490 $ 298,128
Annualized return on average shareholders' equity 5.5 % 11.9 %
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(Unaudited)
Six Months Ended
June 30,
-------------------------------
(U.S. dollars and shares in thousands, except ratios and
per share amounts) 2009 2008
------------- --------------
Underwriting profit - property and casualty operations $ 193,291 $ 236,212
Combined ratio - property and casualty operations 92.6 % 92.3 %
Net investment income - property and casualty operations
(1) $ 460,656 $ 606,169
Annualized return on average shareholders' equity 8.9 % 10.8 %
(Unaudited)
June 30, December 31,
2009 2008
------------- --------------
Book value per ordinary share $ 18.91 $ 15.46
Fully diluted book value per ordinary share (2) $ 18.89 $ 15.46
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(1) Net investment income relating to property and casualty operations does not include the net investment income related to the net results from structured products.
(2) Fully diluted book value per ordinary share is a non-GAAP measure and represents book value per ordinary share combined with the impact from dilution of share based compensation including in-the-money stock options at any period end. The Company believes that fully diluted book value per ordinary share is a financial measure important to investors and other interested parties who benefit from having a consistent basis for comparison with other companies within the industry. However, this measure may not be comparable to similarly titled measures used by companies either outside or inside of the insurance industry.
Underwriting profit - property and casualty operations
One way that the Company evaluates the performance of its insurance and reinsurance operations is the underwriting profit or loss. The Company does not measure performance based on the amount of gross premiums written. Underwriting profit or loss is calculated from premiums earned and fee income, less net losses incurred and expenses related to underwriting activities, plus unrealized foreign exchange gains and losses on underwriting balances. Underwriting profit in the six month period ended June 30, 2009 is primarily reflective of the combined ratio discussed below.
Combined ratio - property and casualty operations
The combined ratio for property and casualty operations is used by the Company and many other insurance and reinsurance companies as another measure of underwriting profitability. The combined ratio is calculated from the net losses incurred and underwriting expenses as a ratio of the net premiums earned for the Company's insurance and reinsurance operations. A combined ratio of less than 100% indicates an underwriting profit and greater than 100% reflects an underwriting loss. The Company's combined ratio for the six months ended June 30, 2009, is slightly higher than the same period in the previous year, primarily as a result of an increase in the underwriting expense ratio, partially offset by a decrease in the loss and loss expense ratio. The loss and loss expense ratio has declined as a result of lower levels of catastrophe losses in the reinsurance segment and lower current year professional lines losses in the insurance segment partially offset by larger prior year reserve releases reported in 2008. The increased underwriting expense ratio has been driven largely by increases in operating expenses against lower net premiums earned. Operating expenses increased mainly as a result of the Company's restructuring activities as described further below.
Net investment income - property and casualty operations
Net investment income related to property and casualty operations is an important measure that affects the Company's overall profitability. The largest liability of the Company relates to its unpaid loss reserves, and the Company's investment portfolio provides liquidity for claims settlements of these reserves as they become due, and thus a significant part of the portfolio is invested in fixed income securities. Net investment income is influenced by a number of factors, including the amounts and timing of inward and outward cash flows, the level of interest rates and credit spreads and changes in overall asset allocation. Net investment income related to property and casualty operations decreased by $145.5 million during the first half of 2009 as compared to same period in the prior year. Overall, portfolio yields have decreased as the portfolio mix has changed as a result of the settlement of the GIC liabilities during 2008, as the property and casualty operations assumed a number of the floating rate securities that previously supported this business and are more sensitive to the year-on-year decline in U.S.dollar short-term interest rates. In addition, the Company increased its allocation to lower yielding U.S. Treasuries, cash and agencies as a result of the continued de-risking of the portfolio and to increase liquidity.
Book value per ordinary share
Management also views the change in the Company's book value per ordinary share as an additional measure of the Company's performance. Book value per share is calculated by dividing ordinary shareholders' equity by the number of outstanding ordinary shares at any period end. Book value per ordinary share is affected primarily by the Company's net income (loss), by any changes in the net unrealized gains and losses on its investment portfolio, currency translation adjustments and also the impact of any share repurchase or issuance activity. Book value per ordinary share increased by $3.45 in the first six months of 2009 as compared to a decrease of $6.91 in the first six months of 2008. During the six months ended June 30, 2009, there was an increase in net unrealized losses of $859.8 million, net of tax. Although there was significant quarter-to-quarter volatility, in aggregate the impact of widening credit spreads was slightly larger than the offsetting benefit from declining interest rates. During the second quarter, there was a significant decrease in net unrealized losses as . . .
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