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ENH > SEC Filings for ENH > Form 10-Q on 7-Nov-2012All Recent SEC Filings

Show all filings for ENDURANCE SPECIALTY HOLDINGS LTD

Form 10-Q for ENDURANCE SPECIALTY HOLDINGS LTD


7-Nov-2012

Quarterly Report


MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is a discussion and analysis of the financial condition and results of operations for the three and nine months ended September 30, 2012 of Endurance Specialty Holdings Ltd. ("Endurance Holdings") and its wholly-owned subsidiaries (collectively, the "Company"). This discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and related notes contained in this Quarterly Report on Form 10-Q (this "Form 10-Q") as well as the audited consolidated financial statements and related notes for the fiscal year ended December 31, 2011, the discussions of critical accounting policies and the qualitative and quantitative disclosure about market risk contained in Endurance Holdings' Annual Report on Form 10-K for the fiscal year ended December 31, 2011 (the "2011 Form 10-K").

Some of the information contained in this discussion and analysis or set forth elsewhere in this Form 10-Q, including information with respect to the Company's plans and strategy for its business, includes forward-looking statements that involve risk and uncertainties. Please see the section "Cautionary Statement Regarding Forward-Looking Statements" below for more information on factors that could cause actual results to differ materially from the results described in or implied by any forward-looking statements contained in this discussion and analysis. You should review the "Risk Factors" set forth in the 2011 Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained herein.

Overview

Endurance Holdings was organized as a Bermuda holding company on June 27, 2002 and has seven wholly-owned operating subsidiaries:

Endurance Specialty Insurance Ltd. ("Endurance Bermuda"), domiciled in Bermuda with branch offices in Switzerland and Singapore;

Endurance Reinsurance Corporation of America ("Endurance U.S. Reinsurance"), domiciled in Delaware;

Endurance Worldwide Insurance Limited ("Endurance U.K."), domiciled in England;

Endurance American Insurance Company ("Endurance American"), domiciled in Delaware;

Endurance American Specialty Insurance Company ("Endurance American Specialty"), domiciled in Delaware;

Endurance Risk Solutions Assurance Co. ("Endurance Risk Solutions"), domiciled in Delaware; and

American Agri-Business Insurance Company ("American Agri-Business"), domiciled in Texas and managed by ARMtech Insurance Services, Inc. (together with American Agri-Business, "ARMtech").

The Company writes specialty lines of property and casualty insurance and reinsurance on a global basis and seeks to create a portfolio of specialty lines of business that are profitable and have limited correlation with one another. The Company's portfolio of specialty lines of business is organized into two business segments, Insurance and Reinsurance.


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In the Insurance segment, the Company writes agriculture, professional lines, casualty, property, healthcare liability and surety and other specialty insurance. In the Reinsurance segment, the Company writes catastrophe, casualty, property, aerospace and marine and surety and other specialty reinsurance.

The Company's Insurance and Reinsurance segments both include property related coverages which provide insurance or reinsurance of an insurable interest in tangible property for property loss, damage or loss of use. In addition, the Company's Insurance and Reinsurance segments include various casualty insurance and reinsurance coverages which are primarily concerned with the losses caused by injuries to third parties, i.e., not the insured, or to property owned by third parties and the legal liability imposed on the insured resulting from such injuries.

Application of Critical Accounting Estimates

The Company's condensed consolidated financial statements are based on the selection of accounting policies and application of significant accounting estimates which require management to make significant estimates and assumptions. The Company believes that some of the more critical judgments in the areas of accounting estimates and assumptions that affect its financial condition and results of operations are related to the recognition of premiums written and ceded, reserves for losses and loss expenses, other-than-temporary impairments within the investment portfolio and fair value measurements of certain portions of the investment portfolio. For a detailed discussion of the Company's critical accounting estimates, please refer to the 2011 Form 10-K and the Notes to the Unaudited Condensed Consolidated Financial Statements in this Form 10-Q. There were no material changes in the application of the Company's critical accounting estimates subsequent to the 2011 Form 10-K. Management has discussed the application of these critical accounting estimates with the Company's Board of Directors and the Audit Committee of the Board of Directors.

Consolidated Results of Operations - For the Three Months Ended September 30, 2012 and 2011

Results of operations for the three months ended September 30, 2012 and 2011 were as follows:

                                                Three Months Ended September 30,
                                                 2012                      2011               Change(1)
                                                  (U.S. dollars in thousands, except for ratios)
Revenues
Gross premiums written                     $        621,255          $        700,866              (11.4 )%
Ceded premiums written                             (107,175 )                (149,539 )            (28.3 )%

Net premiums written                                514,080                   551,327               (6.8 )%

Net premiums earned                                 551,872                   561,493               (1.7 )%
Net investment income                                45,882                    14,100             225.4  %
Net realized and unrealized investment
gains                                                10,097                     1,033             877.4  %
Net impairment losses recognized in
earnings (losses)                                      (131 )                    (240 )            (45.4 )%
Other underwriting loss                              (1,347 )                  (2,141 )            (37.1 )%

Total revenues                                      606,373                   574,245               5.6  %

Expenses
Net losses and loss expenses                        407,523                   456,691              (10.8 )%
Acquisition expenses                                 88,782                    72,249              22.9  %
General and administrative expenses                  52,715                    58,574              (10.0 )%
Amortization of intangibles                           2,434                     2,976              (18.2 )%
Net foreign exchange losses (gains)                   3,774                    (4,085 )               NM (2)
Interest expense                                      9,041                     9,055               (0.2 )%
Income tax expense (benefit)                          1,986                    (1,197 )               NM (2)

Net income (loss)                          $         40,118          $        (20,018 )               NM (2)

Net loss ratio                                        73.8  %                   81.3  %             (7.5 )
Acquisition expense ratio                             16.1  %                   12.9  %              3.2
General and administrative expense
ratio                                                  9.6  %                   10.4  %             (0.8 )

Combined ratio                                        99.5  %                  104.6  %             (5.1 )

(1) With respect to ratios, changes show increase or decrease in percentage points.

(2) Not meaningful.


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Premiums

Gross premiums written in the three months ended September 30, 2012 were $621.3 million, a decrease of $79.6 million, or 11.4%, compared to the same period in 2011. Net premiums written in the three months ended September 30, 2012 were $514.1 million, a decrease of $37.2 million, or 6.8%. The change in net premiums written was driven by the following factors:

Within the agriculture line of the Insurance segment, premiums declined due to a lack of positive premium adjustments in the current period while in the third quarter of 2011 significant positive premium adjustments were recorded as a result of the commodity price increases and greater acreage planted;

Growth in the property line of the Reinsurance segment resulting from increased renewal premiums and new business recorded across the Company's businesses; and

Growth in the casualty line of the Reinsurance segment resulting from new business and a number of positive premium adjustments, offset by a modest amount of non-renewals.

The decline in ceded premiums written by the Company in the quarter ended September 30, 2012 as compared to the same period in 2011 was primarily driven by the decrease in gross premiums written in the agriculture insurance line that drove a corresponding reduction in cessions to the Federal Crop Insurance Corporation.

Net premiums earned for the three months ended September 30, 2012 were $551.9 million, a decrease of $9.6 million, or 1.7%, from the third quarter of 2011. The decrease in net premiums earned resulted from the decline in net written premiums recorded in the agriculture line in the current period, offset by growth in premiums recorded across other lines in more recent periods.

Net Investment Income

The Company's net investment income of $45.9 million increased by 225.4% or $31.8 million for the quarter ended September 30, 2012 as compared to the same period in 2011. Net investment income during the third quarter of 2012 included net mark to market gains of $15.1 million on Other Investments, comprised of alternative funds and specialty funds, as compared to mark to market losses of $22.5 million in the third quarter of 2011. Investment income generated from the Company's fixed income investments, which consist of fixed maturity investments and short-term investments, declined by $5.9 million for the three months ended September 30, 2012 compared to the same period in 2011. This decline resulted primarily from lower reinvestment rates over the past 12 months. Investment expenses, including investment management fees, for the three months ended September 30, 2012 were $3.4 million compared to $3.4 million for the same period in 2011.


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The annualized net earned yield and total return of the investment portfolio for the three months ended September 30, 2012 and 2011 and the market yield and portfolio duration as of September 30, 2012 and 2011 were as follows:

                                                        Three Months Ended September 30,
                                                    2012                               2011
Annualized net earned yield(1)                          2.97 %                             0.90 %
Total return on investment portfolio(2)                 1.75 %                             0.37 %
Market yield(3)                                         1.10 %                             1.91 %
Portfolio duration(4)                                   2.52  years                        2.48  years

(1) The actual net earned income from the investment portfolio after adjusting for expenses and accretion of discount and amortization of premium from the purchase price divided by the average book value of assets.

(2) Includes realized and unrealized gains and losses.

(3) The internal rate of return of the investment portfolio based on the given market price or the single discount rate that equates a security price (inclusive of accrued interest) for the portfolio with its projected cash flows. Excludes Other Investments and operating cash.

(4) Includes only cash and cash equivalents and fixed income investments managed by the Company's investment managers.

During the third quarter of 2012, the yield on the benchmark three year U.S. Treasury bond fluctuated within a 28 basis point range, with a high of 0.82% and a low of 0.54%. Trading activity in the Company's portfolio during the third quarter included reductions in agency residential mortgage-backed securities, foreign government bonds and corporate securities, and increased allocations to short-term investments, U.S. government and government agencies securities, government guaranteed corporate securities, non-agency commercial mortgage-backed securities, asset-backed securities and equity securities. The duration of the fixed income investments increased to 2.52 years at September 30, 2012 from 2.39 years at December 31, 2011.

Net Realized and Unrealized Investment Gains

The Company's investment portfolio is actively managed on a fair value basis to generate attractive economic returns and income. Movements in financial markets and interest rates influence the timing and recognition of net realized investment gains and losses as the portfolio is adjusted and rebalanced. Proceeds from sales of investments classified as available for sale during the three months ended September 30, 2012 were $908.0 million compared to $566.0 million during the same period a year ago. Net realized investment gains increased during the three months ended September 30, 2012 compared to the same period in 2011. Realized investment gains and losses and the change in the fair value of derivative financial instruments for the three months ended September 30, 2012 and 2011 were as follows:

                                                         Three Months Ended September 30,
                                                         2012                       2011
                                                           (U.S. dollars in thousands)
Gross realized gains on investment sales            $        11,976            $         6,904
Gross realized losses on investment sales                    (2,222 )                   (5,735 )
Change in fair value of derivative financial
instruments                                                     343                       (136 )

Net realized and unrealized investment gains        $        10,097            $         1,033


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Net Impairment Losses Recognized in Earnings (Losses)

During the three months ended September 30, 2012, the Company identified available for sale securities that were considered to be other-than-temporarily impaired. The Company considered whether it intended to sell or would be more likely than not required to sell the securities in an unrealized loss position at September 30, 2012. The Company did not identify any such securities meeting these criteria. As such, the Company performed various analyses and reviews, which are described in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates" in our 2011 Form 10-K, to determine whether the securities in an unrealized loss position were other-than-temporarily impaired as a result of credit related factors or non-credit related factors. Net impairment losses recognized in earnings for the three months ended September 30, 2012 and 2011 were as follows:

                                                        Three Months Ended September 30,
                                                        2012                        2011
                                                          (U.S. dollars in thousands)
Total other-than-temporary impairment
losses                                             $         (126 )            $         (168 )
Portion of loss recognized in other
comprehensive income                                           (5 )                       (72 )

Net impairment losses recognized in
earnings (losses)                                  $         (131 )            $         (240 )

The $0.1 million and $0.2 million of other-than-temporary impairment ("OTTI") losses recognized by the Company in the third quarters of 2012 and 2011, respectively, relating to specific credit events occurred primarily due to reductions in expected recovery values on residential mortgage-backed securities during the period.

The Company assessed its intent and ability to hold certain equity securities that were in an unrealized loss position at September 30, 2012 and 2011 and determined it did not need to recognize any OTTI losses in the three months ended September 30, 2012 and 2011.

Net Foreign Exchange Gains and Losses

For the three months ended September 30, 2012, the Company remeasured its monetary assets and liabilities denominated in foreign currencies, which resulted in a net foreign exchange loss of $3.8 million compared to a net foreign exchange gain of $4.1 million for the same period of 2011. This loss resulted from offsetting exposures across the Company as the U.S. dollar weakened against the major currencies in the period. In the prior year, the net foreign exchange gain resulted from the strengthening of the U.S. dollar against other major currencies which reduced foreign denominated net liabilities.

Net Losses and Loss Expenses

The Company's reported net losses and loss expenses are characterized by various factors and are significantly impacted by the occurrence or absence of catastrophic events and subsequent loss emergence related to such events. For the three months ended September 30, 2012, the Company incurred lower levels of catastrophe losses compared to the prior year. The Company recorded losses, net of reinsurance, reinstatement premiums and other loss sensitive accruals of $13.2 million related primarily to Hurricane Isaac and unfavorable development on an earthquake in Italy which added 2.5 percentage points to the Company's net loss ratio for the third quarter of 2012. For the three months ended September 30, 2011, Hurricane Irene, Danish floods, brushfires in Texas and multiple storms in the Midwest United States which, when accumulated, triggered certain aggregate catastrophe contracts, adversely affected the Company's net loss ratio in the Reinsurance and Insurance segments. The Company recorded losses, net of reinsurance, reinstatement premiums and other loss sensitive accruals, of $98.6 million in relation to these events, which added 17.7 percentage points to the Company's net loss ratio for the third quarter of 2011. The reduction in net losses incurred was partially offset by increased losses recorded in the agriculture line of the Insurance segment which was impacted by extreme drought conditions in the Midwest United States.


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Favorable prior year loss reserve development was $55.6 million for the third quarter of 2012 compared to $44.4 million during the same period in 2011. In the third quarter of 2012, prior year loss reserves emerged favorably across the short, long and other tail business of the Insurance segment and the short and long tail business of the Reinsurance segment. Favorable reserve development in the third quarter of 2012 was higher than the third quarter of 2011 principally due to the short tail business of the Reinsurance segment where increased favorable reserve development was experienced in the property and marine lines of business partially offset by a decline in the catastrophe line.

The Company participates in lines of business where claims may not be reported for many years. Accordingly, management does not believe that reported claims are the only valid means for estimating ultimate obligations. Ultimate losses and loss expenses may differ materially from the amounts recorded in the Company's consolidated financial statements. These estimates are reviewed regularly and, as experience develops and new information becomes known, the reserves are adjusted as necessary. Reserve adjustments, if any, are recorded in earnings in the period in which they are determined. The overall loss reserves were established by the Company's actuaries and reflect management's best estimate of ultimate losses. See "Reserve for Losses and Loss Expenses" below for further discussion.

Acquisition Expenses

The acquisition expense ratio for the three months ended September 30, 2012 increased by 3.2 percentage points compared to the acquisition expense ratio for the same period in 2011. The change in the acquisition expense ratio was driven by the following factors:

Higher commissions and the accelerated expensing of deferred commissions in the agriculture line of the Insurance segment due to the increased level of losses incurred during the period;

An increase in net earned premiums in the Company's contract binding authority business, which carries higher commission rates, and a decline in net earned premiums in the Company's excess casualty business written in Bermuda, which attracts relatively lower acquisition expenses, in the Company's casualty line of business in the Insurance segment; and

The combination of new business, non-renewed contracts and the restructuring of certain business in the casualty line of the Reinsurance segment.

General and Administrative Expenses

The Company's general and administrative expense ratio for the third quarter of 2012 decreased compared to the same period in 2011 due to increased third party ceding commissions and expense reimbursement offsets in the agriculture line of the Insurance segment and favorable compensation cost adjustments arising from a lower headcount, a lower concentration of more senior staff and changes to the performance measures driving the annual incentive provision. Lower expenditure was partially offset by increased consulting and facilities costs. At September 30, 2012, the Company had a total of 849 employees compared to 864 employees at September 30, 2011.

Income Tax Expense (Benefit)

The Company recorded a tax expense for the quarter ended September 30, 2012 of $2.0 million compared to a tax benefit of $1.2 million for the quarter ended September 30, 2011. The current period tax expense resulted from income generated in the current period by the Company in the U.K.

Net Income (Loss)

The Company generated net income of $40.1 million in the three months ended September 30, 2012 compared to a net loss of $20.0 million in the same period of 2011 primarily as a result of a decrease in catastrophe losses and an improvement in investment returns during the current period, partially offset by agriculture insurance losses from the Midwestern drought.


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Consolidated Results of Operations - For the Nine Months Ended September 30, 2012 and 2011

Results of operations for the nine months ended September 30, 2012 and 2011 were as follows:

                                               Nine Months Ended September 30,
                                                  2012                    2011             Change(1)
                                                 (U.S. dollars in thousands, except for ratios)
Revenues
Gross premiums written                     $        2,286,980         $  2,204,148               3.8  %
Ceded premiums written                               (445,431 )           (412,191 )             8.1  %

Net premiums written                                1,841,549            1,791,957               2.8  %

Net premiums earned                                 1,482,847            1,430,904               3.6  %
Net investment income                                 134,723              106,443              26.6  %
Net realized and unrealized investment
gains                                                  30,258               26,340              14.9  %
Net impairment losses recognized in
earnings (losses)                                        (757 )             (2,819 )            (73.1 )%
Other underwriting loss                                (1,663 )             (2,122 )            (21.6 )%

Total revenues                                      1,645,408            1,558,746               5.6  %

Expenses
Losses and loss expenses                            1,016,187            1,220,514              (16.7 )%
Acquisition expenses                                  229,399              205,754              11.5  %
General and administrative expenses                   181,365              190,421               (4.8 )%
Amortization of intangibles                             7,988                8,800               (9.2 )%
Net foreign exchange gains                            (14,699 )             (7,655 )            92.0  %
Interest expense                                       27,132               27,166               (0.1 )%
Income tax expense (benefit)                            2,893              (19,896 )               NM (2)

Net income (loss)                          $          195,143         $    (66,358 )               NM (2)

Net loss ratio                                          68.5  %              85.3  %            (16.8 )
Acquisition expense ratio                               15.5  %              14.4  %              1.1
General and administrative expense
ratio                                                   12.2  %              13.3  %             (1.1 )

Combined ratio                                          96.2  %             113.0  %            (16.8 )

(1) With respect to ratios, changes show increase or decrease in percentage points.

(2) Not meaningful.

Premiums

Gross premiums written in the nine months ended September 30, 2012 were $2,287.0 million, an increase of $82.8 million, or 3.8%, compared to the same period in 2011. Net premiums written in the nine months ended September 30, 2012 were $1,841.5 million, an increase of $49.6 million, or 2.8%, compared to the same period in 2011. The change in net premiums written was driven by the following factors:

Growth in the Reinsurance segment where property premiums were higher due to new premiums and growth in renewals, particularly from the Company's U.S., Zurich and Singapore offices;

Increased catastrophe premiums in the Reinsurance segment as a result of improved pricing during renewals;

Growth in casualty premiums in the Reinsurance segment due to new business, increased renewal premiums and an increase in positive premium adjustments;

Decreased premiums in the agriculture line of the Insurance segment where the impact of lower commodity prices was partially offset by growth in policy count; and

A decline in premiums in the property line of the Insurance segment as the Company curtailed the underwriting of several insurance products in order to reallocate capital to more profitable lines of business.


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