HAMILTON, Bermuda, March 15, 2004 (PRIMEZONE) -- Alea Group Holdings (Bermuda) Ltd.:
-Operating profit based on longer-term investment return up by 274% to $80.8 million (2002: $21.6 million); reflects single-minded underwriting focus on profitability hurdle rates
-Gross premiums written up by 39.6% to $1,300.2 million (2002: $931.6 million); more growth anticipated from targeted casualty, alternative risk and excess & surplus lines
-Group combined ratio of 94.9% (2002: 100.7%) exceeds expectations(2)
-Net IPO proceeds of $263.7 million ensure Group is well positioned to capture growth opportunity in chosen markets
-January renewals affirm exciting business prospects with underwriting discipline in targeted classes of business expected to prolong benign rate environment
-Continued positive outlook for 2004 across all business lines
John Reeve, Chairman, commented: "I am delighted to report a strong set of maiden results for Alea as a listed Company. Our targeted growth segments in the United States and Europe produced excellent results in 2003 and have continued to remain strong during the important January renewal period."
Dennis Purkiss, Chief Executive Officer, commented: "We are very well placed to seize the opportunity we expect to be sustained in casualty reinsurance and in our specialty insurance businesses that are continuing to grow strongly. We have built a solid base over the past few years and the early indications for 2004 are positive."
"The excellent position we find ourselves in is no accident. We spent considerable time and effort developing the depth of capabilities we believe are so essential to delivering long-term value and we're pleased that many investors have shared that view during the successful IPO."
Highlights
2003 2002
Gross premiums written $1,300.2m $931.6m
Net earned premiums $858.5m $518.1m
Underwriting profit (1) $85.5m $28.2m
Claims ratio (2) 61.6% 62.1%
Expense ratio (2) 33.3% 38.6%
Combined ratio (2) 94.9% 100.7%
Total assets $3,477.1m $2,713.5m
Net asset value per share (2) $4.15 $4.34
Operating profit $80.8m $21.6m
Profit attributable to shareholders (3) $48.5m $54.6m
Operating earnings per share (4) $0.54 $0.24
Earnings per share (3),(4) $0.42 $0.51
1 Underwriting profit includes allocated investment return and excludes claims equalisation reserves (see technical account)
2 Amounts and ratios have been defined in the Finance Director's Report
3 Profit attributable to shareholders and earnings per share are impacted in 2003 by $ 17.0 million loss (2002: $33.9 million profit) in respect of total realised and unrealised gains on investments.
4 Operating earnings per share and earnings per share are both diluted and are defined in Note 3 to the preliminary statement.
A recording of a briefing held for the investment community on 15 March 2004 to announce the results for the year ended 31 December 2003 and an indexed version of a presentation given by Dennis Purkiss and Amanda Atkins will be available at www.aleagroup.com from midday GMT.
CAUTIONARY STATEMENTS
Certain information in this report is or may constitute forward-looking statements. Because such statements are inherently subject to risks and uncertainties, actual results may differ significantly from those expressed or implied by such forward-looking statements. We caution you not to place undue reliance on such forward-looking statements. We do not undertake any obligation (except reporting obligations imposed on us in relation to our listed shares traded on the London Stock Exchange) to update such forward-looking statements to reflect events or circumstances occurring after the date hereof.
NOTES FOR EDITORS
Alea is a global reinsurance and specialty insurance company focused on underwriting for profit and return on equity. It has expertise in a wide range of property and casualty reinsurance, insurance, alternative risk and finite risk products and maintains a significant presence in major insurance and reinsurance markets worldwide.
Alea was admitted to the Official List of the UK Listing Authority on 19 November 2003 when unconditional dealings in the shares began on the London Stock Exchange. On 10 March 2004, FTSE Group announced Alea is eligible to become a constituent of the FTSE 250 Index effective 22 March 2004.
The Group used the proceeds raised from its Global Offer to support the continued development of its business units. The majority of funds are allocated to the US subsidiary to support the Group's expanding alternative risk and casualty treaty operations and the remainder allocated to London and Europe where continued growth is expected in the insurance and small to medium regional reinsurance categories, respectively.
Alea is headquartered in Hamilton, Bermuda and has operations in the United Kingdom, the United States, Bermuda, Switzerland, Sweden, Australia and Jersey. At 30 September 2003, it had 375 employees.
Alea has its origins in an investment thesis developed in 1997 by KKR 1996 Fund (Overseas) Limited Partnership, its major shareholder: to create a new global reinsurer focused on generating sustainable profitability and growth over the longer term.
The core of this thesis was that underwriting discipline, strong controls; broad capabilities in reinsurance and select insurance markets, a focus on less volatile lines of business and long-term relationships with small to medium-sized clients would result in sustainable profitability in any market environment.
Since new management joined in 1999, Alea has acquired or built the talent, local infrastructure, licenses and client relationships to be able to react quickly to attractive return opportunities in the major markets worldwide. It has leveraged this platform to develop a sizeable book of business diversified by class and geography.
CHAIRMAN'S STATEMENT
I am pleased to present my first Chairman's Statement in a year that has seen Alea Group Holdings (Bermuda) Ltd (Alea) take further significant steps in its overall development. From inception, the Group was established as a global reinsurer and insurer differentiated not by size but by a focus on the bottom line, the fundamentals of underwriting for profit and the necessary control infrastructure to deliver superior results over the longer term.
In 2003, the Group evidenced the benefits of such focus by delivering significant operating profit and, more importantly, by completing a successful Initial Public Offering (IPO) on the London Stock Exchange (LSE).
The efforts over recent years to establish and build Alea are now beginning to be rewarded. The Group's philosophy is based on the analysis and understanding of the reinsurance/insurance cycle over differing classes of business and geographies. From the outset, the Group was designed to build reinsurance and insurance capabilities in each of the principal international marketplaces, resulting in the ability to allocate capital and resources to those markets best able to offer suitable returns.
Driven by such considerations, at the end of the reporting year the Group was heavily focused on casualty reinsurance lines of business, where we believe that there is still opportunity for further rate improvement; on alternative risk and on excess and surplus lines business, where both rates and terms and conditions remain firm; and on Continental Europe, where the opportunity, arising from recent market turmoil, has been taken to improve the Group's competitive positioning. Conversely, the Group sought to withdraw from the marine marketplace where, despite a profitable book of business, signs of a softening in both rates and terms led to expectations that return on capital criteria could no longer be met.
Overall, the Group believes that it is well positioned in markets where rates and terms, currently and prospectively, are at their strongest.
RESULTS
Profit attributable to shareholders was $48.5 million for 2003 compared to $54.6 million in 2002. There was a significant improvement in underwriting performance. Underwriting profits before the allocation of the longer term investment return and movement in claims equalisation provision was $27.7 million compared to a loss of $18.8 million in 2002 (see the Finance Director's Report). The underlying improvement in underwriting performance was masked by short term fluctuations in investments year-on-year (negative $ 22.4 million in 2003, positive $33.3 million in 2002). In addition in 2002 the Group had the benefit of a tax credit of $2.0 million compared to $13.5 million expense in 2003.
As recommended for companies listed on the LSE by the ABI SORP operating profit includes the allocation of the longer term investment return based on a return rate which the Group has selected of 4.5%. Operating profit excludes the movements in claims equalisation reserve and a $7.5 million profit on the purchase of the subordinated preferred shares. Operating profits showed strong growth increasing by 274% to $80.8 million and translates into a return on equity of 12.0% (2002 5.8%), in line with the objective to deliver double digit returns over the insurance cycle. Gross premiums written for the period increased 39.6% to $1,300.2 million, from $931.6 million in 2003. The Group combined ratio improved to 94.9% compared with 100.7% in the previous year.
DIVIDEND
As indicated at the time of the Group's IPO, the Group will not declare a dividend in respect of 2003 since to do so would, effectively, constitute a return of recently raised capital. The Group intends to commence paying dividends in 2004. It is intended that the Group will pay a dividend in the region of $0.10 per share for the year ended 31 December 2004. The dividend will be split between one third interim and two thirds final. The interim dividend will be declared with the Group's interim results for the period ended 30 June 2004 on 20 September 2004, payable on 19 November 2004 to those shareholders on the register on 22 October 2004.
REVIEW OF MARKET CONDITIONS
Market conditions for reinsurance remained favourable throughout 2003. The requirement for many market participants to address prior year issues and resultant weakened balance sheets together with continuing low interest rates and correspondingly low investment income combined to support a firm rate environment in most market segments.
In Europe, there was some turmoil associated with certain long established companies ceasing to write business and others experiencing significant deterioration in relation to "old year" reserves. There was a similar story in the United States with numerous companies being downgraded by the rating agencies and ceasing to underwrite or withdrawing from certain lines of business.
The result of such market conditions was that casualty rates rose strongly throughout the year in conjunction with a general tightening of terms and conditions. Additional capacity created in Bermuda brought the beginnings of some rate pressure in the property areas, particularly the catastrophe markets, but rates remained well above the level required to meet the Group's hurdle rates of return. Primary insurance rates also remained firm with both alternative risk and excess and surplus lines insurance markets maintaining rate improvements.
Alea's balance of reinsurance and insurance capabilities, lack of distracting "old year" legacy issues, maintenance of its overall rating from the rating agencies in the face of widespread downgrades and strong presence in selected markets resulted in the Group being well placed to grow substantially in an improving pricing environment.
IPO
Alea's IPO was completed by a listing on the LSE on 19 November 2003, raising a total of $263.7 million after expenses and after the over-allocation option was exercised. This issue attracted significant interest, being the fourth largest IPO on the LSE during 2003.
The funds from the IPO are being used to support the continued growth of the business by enhancing the capitalisation of the reinsurance and insurance subsidiaries in the United Kingdom, United States, Bermuda and Continental Europe.
This capital raising leaves Alea well positioned to capture the significant expansion opportunity that exists through leveraging the infrastructure and capabilities established over the past three years. The Group possesses both a strong book of renewal business and excellent new business prospects that are capable of generating attractive returns on equity.
BOARD AND SHAREHOLDERS
I am pleased to welcome Glenn Hilliard and Amanda Atkins to the Board as an independent non-executive director and an executive director respectively. Glenn brings with him a wealth of experience in the industry and Amanda has served as Group Chief Financial Officer since 2000. Their expertise will make a major contribution to the deliberations of the Board, which is strengthened as a result.
I am also delighted to welcome the new investors who have embraced the Alea story. Directors, management and staff look forward to working on behalf of all shareholders to deliver significant growth in value.
PROSPECTS
Conditions have remained strong in all Alea's operating segments over the important January 2004 renewal period. The Group's targeted growth areas of Europe, alternative risk, excess and surplus lines and United States casualty reinsurance, all experienced strong trading conditions and each represents a real opportunity for continued growth.
Finally, I wish to thank my fellow directors, management and staff for the great effort that they have made to achieve the excellent results currently reported. Combined with the invaluable support of brokers, clients and shareholders, this has enabled the Group to achieve notable successes during 2003. The first significant underwriting profit contribution and the IPO are defining moments in the Group's history and I am confident that Alea is exceptionally well placed to continue to build value in the year ahead.
John Reeve
Chairman
CHIEF EXECUTIVE OFFICER'S REPORT
2003 was an important year for the Group. Over the last four years we have set about building a global insurance and reinsurance operation focused on the delivery of long term value.
During those four years we have marked several milestones in the Group's development. Alea has set up licensed insurance and reinsurance operations in the United States, United Kingdom and Continental Europe; we've built a system and control infrastructure that we believe is unique amongst our peers; and we've established strong market positions in all our core operations.
More importantly we've established a mindset that focuses entirely on the bottom line. The global insurance and reinsurance markets are not one homogeneous whole. Each line of business responds to different factors -- economic, regulatory or social -- and therefore the speed and degree of change vary by class of business. Our fundamental approach has been to build our expertise, our licence base and our infrastructure in such a way that we can proactively manage this overall portfolio of potential risks. Above all else we are underwriters -- the ability to not only select the right risks and price them correctly but also to recognise and react to underlying trends quickly enough is all important.
As a consequence our current focus is heavily on the Alternative Risk and Excess and Surplus Lines (E&S) businesses in the United States and the casualty reinsurance businesses in the United States and Europe. In casualty reinsurance we believe there is more improvement to come -- rates are still rising (albeit not as steeply as last year and varying by line of business), terms are good and there is a longevity to the cycle that we believe will certainly outlast the more capacity driven property lines of business. On the insurance side the excess and surplus lines rates are firm and demand is high. The alternative risk arena is still improving and with the longer earnings profile of risks written in both these areas we will see the benefits of this business in our Profit and Loss Account for at least the next two to three years. Finally, in Europe we have deliberately set about capitalising on a series of market dislocations. As others have experienced difficulty we have grown the business substantially over the last two years, all the time whilst rates were improving, to establish ourselves as a preferred provider to our target customer base of small to medium-sized regional insurers.
On 19 November 2003 we completed our listing on the LSE. The IPO was very well received generating $263.7 million after expenses. This additional capital is being put to immediate use and deployed to support the targeted growth in the areas I mention above.
2003 Performance
In 2003 we met all our financial goals and achieved an operating return on equity of 12.0% (defined in note 7). Details of segmental performance and overall financial performance are set out in the Operating Review and the Finance Director's review respectively.
Operational Targets
The IPO was a major achievement in itself but the Group as a whole and each of the main operating units continued to enhance skills and capabilities during the year.
For example, in North America we have enhanced our ability to service our clients by continuing our licensing of Alea North America Specialty Insurance Company (ANASIC). We now have admitted and non-admitted paper in 49 and 23 states respectively. This initiative further improves the flexibility of the Group in being able to write business in selected lines in a number of ways -- insurance or reinsurance, using admitted or non-admitted paper.
We also continue to devote considerable time and expense to the development of our IT systems and 2003 saw enhancements in our core underwriting, financial control and reporting systems. We view this investment as essential. Our systems provide the control and reporting capabilities you would expect and a great deal more. They are an intrinsic part of our process and critical to the management of our overall portfolio.
During 2003 both AM Best and Standard and Poor's (S&P) affirmed the Group's ratings at A- with a stable outlook in each case. Both cited the strong operating controls, good business position and improving performance in their rationales. In each of these areas we have seen further improvement since their review.
Each operating unit has continued to expand and develop its market position, operating capabilities and long term value. In London, Chief Executive Officer Stephen Cane and his team saw gross premium written rise by 50.4% from $376.4m to $566.0m as we reinforced our position in this market. Alea London is a key part of the Group's focus on United States Excess and Surplus Lines insurance and also underwrites the Group's property catastrophe book of business. Rates continued to improve in the E&S market in 2003 and although we saw the beginnings of supply side competition in the very best priced catastrophe business we believe rates remain well above our minimum hurdles at this time.
In North America the Group operates two segments: Alea North America focuses on treaty business and Alea Alternative Risk, as the name would suggest, on alternative risk business.
Alea North America's primary focus is the provision of casualty and property treaty reinsurance to smaller, specialist clients. It is heavily biased towards casualty at this time as rates continue to improve and gross premiums written grew by 9.9% from $257.4 million to $282.9 million in 2003. Chief Executive Officer Mike Hayes and his team have a wealth of experience in this market and have made great progress in targeting the smaller, specialist insurers we prefer.
Alea Alternative Risk is the Group's centre of expertise for alternative risk transfer and United States insurance program business. Chief Executive Officer Rob Byler and his team are continuing to see rate improvements in these areas and we will be looking to continue our expansion in this area. This business typically has high retention ratios and the ability to control the assumed risk makes this a very attractive area for us. Gross premiums written grew by 84.7% from $141.4m to $261.1m.
In Continental Europe, the Group has achieved considerable success in the light of major market dislocation over the last few years. Gross premiums written grew by 21.5% from $156.4m to $190.1m. I'd like to congratulate Chief Executive Officer Gilles Meyer and his team on their achievements over the last couple of years. After the changes made in 2000 and 2001 to realign the inherited book they have made excellent progress. Concentrating on small to medium sized clients and with an emphasis on the German, French, Spanish and Austrian markets the Alea Europe team has sought opportunities to provide a high level of service to customers. In doing, so they have established strong customer relationships and grown the book markedly in a period of strong rate improvement. Our story in Europe is an excellent example of the Group's ability to seek out and target opportunity in the marketplace.
Looking Forward
In looking forward to 2004 I believe that we are extremely well placed. Whilst there is plenty of capacity available to buyers underwriting discipline is, to a great extent, holding firm and in all our targeted growth areas we expect continuing strong trading conditions. We have built a solid base over the past few years and the early indications are positive for 2004.
The excellent position we find ourselves in is no accident. We spent considerable time and efforts developing the depth of capabilities we believe are so essential to delivering long-term value and we're pleased that many investors shared that view during the successful IPO.
I'd like to reiterate our Chairman's thanks to all our staff for their hard work, particularly in achieving the IPO in such a short space of time and, of course, to our shareholders, both existing and new, for the faith they have shown in our story.
We are excited about the Group's market position, pleased with a strong financial result in 2003 and looking forward to continuing the Alea story and rewarding that faith in 2004 and beyond.
Dennis Purkiss
Chief Executive Officer
OPERATING REVIEW
Overview
Our strategy is to create strong market positions focused on lines of business in which we have extensive experience and are appropriately rated to generate significant profitability. We deliberately remain focused on casualty, alternative risk and United States insurance lines where trading conditions have remained strong for all of the Group's business units. By targeting these sectors, we have a lower-risk business capable of producing a steadier stream of profits which we can use to support our longer term growth and generate significant shareholder value.
The success of our strategy is reflected in an excellent operating profit before tax of $80.8 million (2002: $21.6 million). As recommended by the ABI SORP for companies listed on the LSE, operating profit includes the allocation of investment based on the long term rate which Alea has selected as 4.5%. Worldwide gross premiums written increased by 39.6% to $1,300.2 million from $931.6 million in 2002.
One of our key performance measures is the Group's core combined operating ratio (COR), which broadly expresses the total of claims costs, commission and expenses excluding other technical charge expense on prior period reinsurance contracts as a percentage of net premiums earned. We produced a better-than-expected COR of 93.1% (see the Finance Director's Report) as a result of our disciplined underwriting and efficient claims handling. Other technical charges added 1.8 points to give a total combined ratio of 94.9% compared to 100.7% in 2003. This excellent result gives us confidence that we are capable of sustaining our target COR over the underwriting cycle.
During the 2004 renewal season we have seen confirmation that our strategy of anticipating changes in market conditions has borne fruit. Over the last four years we have built our infrastructure to enable us to develop further in business areas where we see the most promise both currently and in the medium term. We increased our casualty reinsurance skill set in both Continental Europe and North America and our insurance skills in North America with a continuing programme of recruitment. We also increased our overall North American licensed capabilities in 2003.
Alea North America Insurance Company (ANAIC) is now a licensed insurer in 49 states plus the District of Columbia. Alea London has now nearly completed its E &S infrastructure being authorised in 47 jurisdictions with Alaska and Florida being the latest two additions. Development of the licensing infrastructure in Alea North America Specialty Insurance Company (ANASIC) is also progressing rapidly with that company now being a licensed or accredited reinsurer in 44 states with surplus lines insurance authorizations in a further 23 states.
Whilst we have seen some deterioration in capacity driven property rates to date in 2004 these are not major markets for Alea. We will not chase premium volume at the expense of profit. Our strategic focus on specialty insurance and low volatility casualty risks focused on smaller companies leaves us well positioned to take advantage of current market conditions. Our clear strategy, combined with scale and presence in our chosen markets, positions us to continue to produce excellent returns for our shareholders.
ALEA LONDON
The Alea London segment is the Group's access point to the London global insurance marketplace. Alea London operates through Alea London Limited, a United Kingdom licensed insurance and reinsurance company with excess and surplus lines authorities in the United States and a branch office underwriting in Australia. Alea London transacts an international book of business sourced through the London broker market. The London market is one of the world's leading insurance and reinsurance marketplaces with in excess of $30 billion in capacity in 2002. Alea London's business includes a broad range of products, including specialty and non-traditional insurance, reinsurance and excess and surplus lines.
Alea London is an established market participant with a solid book of existing business, fully operational infrastructure and excellent market reputation. Its largest business is United States E&S insurance, comprising over 33% (2002: 37%) of its gross premium written. The Alea London segment also writes casualty treaty reinsurance business in the United States and international markets and is the Group's global centre of expertise in property catastrophe reinsurance. With its strong underwriting platform and a leading market position, Alea London will write other lines of business on an opportunistic basis when pricing is attractive, when specific expertise is available and when the Group's underwriting criteria, such as terms and conditions, are fulfilled.
The overall strategy of Alea London is to continue growth in existing lines of business by:
-expanding the volume of business written through intermediaries in the excess and surplus lines; -continuing to write property treaty business within established aggregate exposures; -utilising the Group's existing expertise in affinity groups and alternative risk structures to create new products; and -Leveraging the Group's expertise in the management of underwriting agents and the licences it has in the United Kingdom to expand its United Kingdom insurance portfolio.
An overall summary of the underwriting performance of Alea London is as follows:
Year Ended Year Ended Year Ended Year Ended
31 Dec 31 Dec 31 Dec 31 Dec
2003 2002 2003 2002
Including Bristol West Excluding Bristol West
Premiums
($million)
Gross
premiums
written 566.0 376.4 407.5 311.4
Net
premiums
written 487.8 300.2 329.3 235.2
Retention
ratio 86.2% 79.7% 80.8% 75.5%
Net
premiums
earned 407.7 220.9 281.3 178.9
Key
ratios (%)
Claims ratio 55.2 49.4 44.0 42.1
Acquisition
costs ratio 22.7 22.5 25.3 23.8
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Composite
ratio 77.9 71.9 69.3 65.9
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Gross premiums written in the year ended 31 December 2003 increased 50.4% to $566.0 million compared to $376.4 million for the year ended 31 December 2002. The growth in 2003 reflected the focus on excess and surplus lines business and the growth of premium arising from the Bristol West contract.
Excluding Bristol West the growth rate was 30.9% to $ 407.5 million from $311.4 million. Figures are presented excluding Bristol West because this is a three year contract which we do not anticipate will be renewed in 2005.
Net premiums written to 31 December 2003 increased 62.5% to $487.8 million compared to $300.2 million to 31 December 2002 including Bristol West and increased 40.0% to $329.3 million from $235.2 million excluding Bristol West.
The retention ratio increased from 79.7% to 86.2% as the proportion of property catastrophe business reduced. Bristol West and another large contract written by Alea London, both with limited risk transfer characteristics are not covered by the Max Re aggregate cover, which therefore inflated the overall Alea London growth rates in net premium written and earned, compared to the rest of the Group. The Max Re aggregate cover is defined in the Finance Director's review
Net premiums earned for the year ended 31 December 2003 increased 84.6% to $407.7 million compared to $220.9 million for the year ended 31 December 2002. The high growth rate achieved in 2003 reflected the factors outlined above.
The claims incurred, net of reinsurance, ratio for the year ended 31 December 2003 increased to 55.2% compared to 49.4% for the year ended 31 December 2002. There were no catastrophe losses in either year. Prior year reserve development increased Alea London's claims incurred, net of reinsurance ratio by 0.6 points and the Group claims incurred, net of reinsurance ratio by 0.3 points.
Thus the increase in loss ratio for the year ended 31 December 2003 compared to the year ended 31 December 2002 is primarily a function of business mix, in particular the growth of premiums under the Bristol West contract which has relatively high loss ratios but relatively low volatility and thus earns a reduced return at lower risk than some of the other classes of business. The Directors believe that this contract has a significant benefit of contributing relatively low but stable earnings under a wide range of scenarios, adding $3.8 million and $1.3 million to the 31 December 2003 and 31 December 2002 underwriting result respectively. In addition, Alea London earned investment income on $68.2 million cumulative positive cash flows under this contract.
The acquisition costs ratio was 22.7% in 2003 compared to 22.5% in 2002. Both of these ratios are distorted by Bristol West. The underlying ratios excluding the Bristol West contact were 44.0% loss ratio (2002 42.1%) and 25.3% acquisition costs ratio (2002 23.8%).
On the closing of the Imperial acquisition in 2000, the Group reinforced the reserve strengthening of the Imperial business by entering into the OPL (see Finance Director's Review). Since that date there continues to be immaterial development of these reserves.
Total loss reserves covered by the OPL contract increased to $87.1 million compared to $84.5 million in 2002 such that the full $85 million balance of the contract was utilised at 31 December 2003. The increase in loss reserves excess of the OPL contract was a function of the relative exchange rates of the underlying loss reserves compared to the dollar denominated reinsurance.
On the balance sheet, paid claims had exceeded the aggregate excess point under the contract at 31 December 2003 by $16.2 million and thus reinsurance recoveries were made reducing the deposits received from reinsurers under the contract by the same amount. The interest charged on the deposit is the main component of other technical charges in Alea London operating segment.
2004 Outlook
Alea London has already secured the retention of its two largest contracts including the final year of the Bristol West contract with total premiums in excess of $220 million for these two contracts at expiring terms and conditions.
During 2004 Alea London anticipates a continued focus on the E&S lines business where rates, terms and conditions are showing no signs of weakening and an increased focus on building its non-dollar business base to help offset its sterling cost base. United States and non-dollar casualty lines continue to show rate improvement over 2003 conditions with gross premium written being marginally ahead of plan. Rates on international property treaty business are showing signs of weakening with an average 10% reduction over comparable 2003 figures. These rates do, however, remain well within planned expectations and above the Group's hurdle rates of return. North American property business rates have shown less signs of weakening and have remained slightly above planned expectations.
UNITED STATES BASED OPERATIONS
The Group's United States based operations are comprised of two segments, Alea North America (ANA) and Alea Alternative Risk (AAR), both supported by a common services platform. These two segments underwrite through ANAIC, a New York domiciled property and casualty insurance company licensed to write most admitted lines of property and casualty insurance and reinsurance in 49 states plus the District of Columbia. ANAIC commenced underwriting on 1 January 2002. At inception, ANAIC had a renewable base of business which formed its core was business which had previously been underwritten by Alea (Bermuda) Ltd pursuant to arrangements with Lumbermens Mutual Casualty Company (LMC).
Prior to 1 January 2002, the United States operation acted as a reinsurance intermediary manager. For ease of reference, the results discussed in the two North America segments below combine the 2003 results for the product lines which now comprise each segment regardless of whether the premiums were originally underwritten in Alea (Bermuda) Ltd under the LMC arrangements between December 1999 and 31 December 2001 or since 1 January 2002 by ANAIC or its subsidiary ANASIC.
ANA specialises in treaty reinsurance and alternative risk transfer products. The treaty reinsurance operation is a broker market for United States property and casualty treaty and facultative casualty reinsurance business, specialising in working layer business with a focus on small, medium-sized companies, specialty companies and specialty insurance departments of larger insurance groups.
AAR specialises in providing insurance and reinsurance solutions to clients who share risk, want unbundled services and to utilise alternative funding mechanisms. Lines of business include workers' compensation, commercial general liability and property and automobile liability. This business is written on both an individual account and on a programme basis, with the account protected through the purchase of high quality reinsurance supplemented by collateral requirements.
AAR's ability to target the E&S market is being strengthened with the ongoing licensing of ANASIC, a wholly owned subsidiary of ANAIC, which is currently authorised to write excess and surplus lines in 23 states and began writing business in 2003. Additional licensing is ongoing. The marketing of this capability has recently commenced, further expanding the options available to AAR's clients.
ALEA ALTERNATIVE RISK
AAR, based in Rocky Hill, specialises in the provision of ART programmes and structures which may include captives and rent-a-captives, excess over self-insurance, risk retention groups, purchasing groups, pools, trusts and large deductibles for Workers Compensation, General Liability, Auto Liability and Property lines of business. In addition, AAR's Insurance Programs (IP) segment underwrites traditional programme business for the liability lines only.
Within these four lines of business, AAR's areas of focus are retail operations, wholesale/distribution operations, service operations, franchise operations, habitation, light to medium contracting and manufacturing, fleets and short haul trucking.
AAR markets ART to knowledgeable and target producers who seek to assume a significant element of risk within their programme. Every programme written also involves the client adopting some level of risk sharing and the "unbundling" of services such as claims, loss control and captive management.
AAR's strategy is based on the following:
-positioning itself as one of the five dedicated, unbundled carriers in the United States traditional ART market with admitted and non-admitted capabilities; -aligning its interests with those of its clients, through risk sharing on all business written; -unbundling of services to known and preferred providers; -maintaining strong relationships with target producers who can provide repeat business; -comprehensive due diligence and audit processes that include all facets of a programme, including underwriting, finance, compliance and claims; and -creating an insurance organisational structure with a strong controls environment.
Historically, the alternative risk market has grown during periods of harder pricing in the conventional insurance and reinsurance markets. However, the alternative risk market has shown resilience during periods of softer pricing as well. Consequently, industry surveys now estimate the ART market to comprise 50% of the total United States property and casualty market.
In 2003, the ART and IP market was robust. AAR experienced rate increases for all lines of business. In addition, it renewed 85% of business underwritten in 2002. The level of due diligence and vetting necessary to bring a programme to fruition invites a higher than average retention ratio and AAR leverages this as part of its strategy to create long-term relationships which will produce repeat business.
An overall summary of the underwriting performance of AAR is as follows:
Year Ended 31 Dec 2003 Year Ended 31 Dec 2002
Premiums
($ million)
Gross premiums
written 261.1 141.4
Net premiums written 132.0 74.6
Retention ratio 50.5% 52.8%
Net premiums earned 97.9 22.0
Key Ratios % %
Claims ratio 72.1 65.1
Acquisition costs ratio 20.1 31.1
Composite ratio 92.2 96.1
AAR's gross premiums written increased 84.7% to $261.1 million in the year ended 31 December 2003 compared to $141.4 million for the year ended 31 December 2002.
Net premiums written to 31 December 2003 increased 76.9% to $132 million compared to $74.6 million to 31 December 2002. Net premiums written were 50.5% of gross premiums written for the year ended 31 December 2003 and 52.8% of gross premiums written for the year ended 31 December 2002. The structure of AAR's products means that there will always be a high reinsurance percentage, primarily due to premiums ceded to captives. This is also why AAR places such emphasis on financial due diligence and obtaining appropriate collateral from the counter parties to its transactions.
Net premiums earned for the year ended 31 December 2003 increased 343.9% to $97.9 million compared to $22.0 million for the year ended 31 December 2002. The build up of earned premium through the profit and loss account in respect of the alternative risk business is slower than anywhere else in the group. For example, nearly 70% of the net premiums earned in the 2003 financial statements came from the 2002 underwriting year, with the balance from 2003. The ratio of claims incurred, net of reinsurance to net earned premiums was 72.1% for the year ended 31 December 2003 and 65.1% for 2002. Prior year reserve movement increased AAR's net loss ratio by 1.7 points and the Group net loss ratio by 0.2 points. This was primarily the result of one full breach of a programme in the 2001 underwriting year which required an additional net loss reserve of $1.6 million (1.6% on net premiums earned).
The acquisition costs ratio to net premiums earned for the year ended 31 December 2003 was 20.1% to 31 December 2003 compared to 31.1% for 2002 reflecting the transition towards our desired business mix.
2004 Outlook
In 2004 the ART and IP market is expected to remain strong. Rate increases are anticipated, but not expected to be as dramatic as in 2003. Early indications are of up to 10% across all lines. AAR had its best January to date, with gross premiums written up by 273% from January 2003. It is anticipated that as the AAR portfolio matures approximately 50% of premiums will be earned in the same financial year as the underwriting year in which they are written, with the balance being earned mainly in the subsequent financial year. All of this means that the profitability outlook looks healthy in 2004.
ALEA NORTH AMERICA
ANA, base in Wilton, specialises in the provision of property and casualty treaty reinsurance, writing primarily automobile liability, general liability, professional liability, workers' compensation and property business accessed through the reinsurance intermediary distribution system. Additionally, since November 2003, ANA has provided reinsurance on a facultative basis for casualty business.
Key elements of ANA's strategy include:
-Focusing on the provision of traditional reinsurance solutions to three well-defined client segments: (1) small to medium-sized insurance companies (generally with $500 million or less in policyholder surplus); (2) specialty companies; and (3) specialty divisions of larger companies. More than 90% of ANA's current premium volume is derived from these target market segments.
-Concentrating on working layer business in order to provide a more predictable underwriting result, characterised by a shorter duration and more moderate volatility than higher layer excess business and by an excellent premium to limit relationship. Working layer business currently comprises more than 90% of ANA's written premiums.
-Seeking to derive a significant percentage of its business from excess and surplus lines insurers and insurers operating in the specialty admitted market, in order to benefit from the attractive underwriting margins that have historically characterized these business segments. E&S and specialty admitted business comprised approximately 75% of ANA's 2003 volume.
-Positioning as a "consensus market" -- i.e., as one of the three to five reinsurers ultimately agreeing to consensus terms on the typical working layer cover. The resulting participations (typically in a range of 20% -- 40%) provide ANA with influence over treaty terms and conditions and ensure access to the client, both of which ANA regards as important elements in achieving the superior underwriting results that it seeks. In the 2003 Underwriting Year, 83% of ANA's volume was derived from reinsurance covers on which its share was 20% or greater.
-Differentiating from competitors by providing superior service as measured by speed of initial response to offers of business, timeliness of additional information requests, rapid communication of underwriting decisions and promptness in the payment of claims and delivery of contract documentation.
ANA's strategy is executed by an underwriting team that is both deep and experienced, with its two senior underwriting managers and 13 underwriters averaging more than 21 years of experience.
An overall summary of the underwriting performance of ANA is as follows:
Year Ended 31 Dec 2003 Year Ended 31 Dec 2002
Premiums
($ million)
Gross premiums
written 282.9 257.4
Net premiums written 249.7 209.0
Retention ratio 88.3% 81.2%
Net premiums earned 189.3 142.7
Key Ratios (%) % %
Claims ratio 68.7 61.4
Acquisition costs ratio 29.2 31.5
Composite ratio 97.9 92.9
Gross premiums written for the year ended 31 December 2003 increased 9.9% to $282.9 million from $257.4 million for the year ended 31 December 2002. The modest growth in overall gross premiums written masked much more substantial growth in ANA's core account casualty treaty portfolio, which benefited from the strong reinsurance and primary market conditions that prevailed throughout 2003. For the year casualty gross premiums written increased by $53 million, or 25%, over the $213 million written in 2002. This growth in casualty writings also reflected ANAIC's increased acceptance in the United States treaty reinsurance market following its first full year of operations in 2002.
The growth in casualty writings was partially offset by a sharp decline in ANA's modest property portfolio. As the Property Treaty account is very focused on E&S type specialty accounts of a non-catastrophic nature that generally tend to generate large premiums on a per account basis, the loss of a handful of renewals during 2003 severely impacted these premium writings. Accounts were not renewed due to increased client retentions as well as from some account specific softening in original property rates that generated returns below the Group's hurdles and hence were unacceptable. Property gross premium written decreased by 70%, from $44 million in 2002 to $13 million in 2003.
A small amount of additional unrelated premium actually underwritten in Alea Bermuda has been included in the ANA operating segment in both 2002 and 2003 but not separately identified as it is not material to the premium or underwriting results.
Net premiums earned for the year ended 31 December 2003 increased 32.7% to $189.3 million from $142.7 million for the year ended 31 December 2002. The increase in 2003 net premiums earned was substantially greater than the increase in 2003 net written premiums, in part reflective of the fact that 2002 was the first full year of operations for ANAIC and in part attributable to variances in the inception profile of premiums written during these two years.
The ratio of claims incurred, net of reinsurance, to net earned premiums was 68.7% for the year ended 31 December 2003 versus 61.4% for the year ended 31 December 2002.
Prior year development increased the segment net loss ratio by 11.6 points and the Group net loss ratio by 2.3 points. Loss reserves for the period 1999 to 2001 were increased for a handful of umbrella and excess liability accounts as well as for two professional liability accounts that have suffered greater than expected severity losses. This adverse development arises from individual accounts no longer underwritten and reflective of a business mix profile that has been substantially altered in the subsequent years as ANA made the transition from the original business base available to it under the LMC arrangements to its chosen business mix. Since 2000 we have actively reduced such volatility as the portfolio make up has been shifted to reflect the desired business classes made up of a shorter duration, less volatile blend of lower limit exposures substantially shielded from these type of shock loss developments.
The acquisition costs ratio to net premiums earned was 29.2% for the year ended 31 December 2003 compared to 31.5% for the comparable period in 2002. The decrease in the acquisition ratio for 2003 is due principally to a change in the underlying business mix.
Casualty reinsurance market conditions remained exceptionally firm throughout 2003. This fact was in no small measure attributable to the de facto withdrawal over the past two years of at least seven prominent reinsurers or their U.S. subsidiaries (Gerling Global, AXA, Trenwick, Insurance Corporation of Hannover, Hart Re, CNA and PMA) and the downgrade of another (SCOR). Together, these entities had recorded 2002 gross premiums written of approximately $5.5 billion, amounting to almost 25% of the broker market's then available capacity.
With the departure of these competitors, ANA remains as one of only a dozen viable, consensus broker market reinsurers. With respect to the many casualty lines in which it specializes, it is one of an even smaller number of reinsurers with both the appetite and the capability to assess the risks presented and to offer lead terms that will attract the necessary subscription market support.
Conditions in the underlying casualty insurance market remained almost equally firm throughout 2003, particularly in the excess and surplus lines and admitted specialty markets on which ANA focuses and underlying rate increases for a majority of ANA's specialist clients remained in the healthy single-digit to moderate double-digit range.
Both Property reinsurance and underlying property insurance market conditions, were at best flat, and often down, over the course of 2003. Reflective of the relatively greater availability of property reinsurance capacity and the willingness to deploy it, "per risk" reinsurance pricing also registered generally moderate declines, with occasional, sharp downward deviations to this rule. Modestly increased commission terms and more relaxed coverage conditions were also available.
2004 Outlook
With respect to reinsurance market conditions, the January renewal season confirmed the continuation of the trends in place during the second half of 2003 with the casualty reinsurance market demonstrating continued pricing discipline. Our expectation for original rates is that increases for most casualty lines will be in the mid single-digit range, with double-digit increases continuing only in those lines marked by significant ongoing capacity shortages. In property, we expect original rates to be flat-to-down, with continued modest rate erosion in a majority of areas. With the Group's continued focus on United States casualty treaty business the continuing firm rating environment is reassuring.
ALEA EUROPE
The Alea Europe operating segment comprises of Alea Europe Ltd., a licensed reinsurance company based in Basel, Switzerland, with a branch office in Stockholm, and branches in run-off in Toronto and Singapore.
Alea Europe focuses on business sourced from Continental Europe. The segment has historically been a property treaty reinsurance operation but also writes casualty reinsurance, primarily motor liability business. Alea Europe sources business either on a direct basis or through European brokers. The segment is organised along geographic lines into seven units with supporting specialist lines of business expertise. Alea Europe's major classes of business are: proportional and catastrophe property, motor liability and general liability. Alea Europe's approach supports the client focus required in these markets and allows a significant volume of business to be written on a direct basis (approximately 45% in 2003).
The Group is focused on continuing to enhance its position as a primary provider of reinsurance products to the smaller insurers and mutual companies within Continental Europe. Key strategic initiatives involve:
-focusing on small to medium-sized clients that require reinsurance in order to achieve their own business plans; -maintaining a line of business focus on property (risk, catastrophe and proportional) while furthering the development of the casualty book (primarily automobile); -increasing line sizes on existing business; and -leveraging local market knowledge and language skills.
The Continental European market has undergone significant change in the last two years as large participants such as the Gerling Group have withdrawn and a number of other competitors have experienced credit rating agency downgrades. By focusing on the small to medium-sized client base and by leveraging its close client contacts, the Directors believe that Alea Europe is well positioned to grow its business profitably.
Alea Europe's geographic focus is on the German, French, Spanish and Austrian markets. For the year ended 31 December 2003, more than 59% of Alea Europe's business was written in these markets.
An overall summary of the operating performance of Alea Europe is as follows:
Europe Year Ended 31 Dec 2003 Year Ended 31 Dec 2002 Premiums ($ million) Gross premiums written 190.1 156.4 Net premiums written 159.2 124.4 Retention ratio 83.8% 79.5% Net premiums earned 163.6 132.5 Key Ratios (%) % % Claims ratio 63.0 83.7 Acquisition costs ratio 17.1 19.7 --------------- --------- --------- Composite ratio 80.1 103.4 --------------- --------- ---------
Alea Europe was able to take advantage of increasing business opportunities in a broader spread of business lines in 2003. Gross premiums written increased 21.5% to $190.1 million compared to $156.4 million to 31 December 2002. For 2003 approximately 95% of business incepted on 1 January and thus the gross premiums written in this segment are heavily weighted towards the first half year.
Net premiums written to 31 December 2003 increased 28.0% to $ 159.2 million compared to $124.4 million to 31 December 2002. This follows the trend of gross premiums written.
Net premiums earned increased 23.5% to $163.6 million compared to $132.5 million for the year ended 31 December 2002. This is mainly due to the significant increase in 2003 net written premiums which given the inception profile was mostly earned in 2003.
The claims incurred net of reinsurance ratio to net earned premium for the year ended 31 December 2003 decreased from 83.7% in 2002 to 63.0%. The main factor of this improvement was that Alea Europe suffered $14.9 million in net losses in respect of the European floods in the third quarter of 2002. Excluding the European floods and the arbitration decision discussed below the ratio of claims incurred net of reinsurance ratio to net earned premium was 58.3% for the year ended 31 December 2003 and 65.8% for the year ended 31 December 2002.
Overall prior period reserve development in Alea Europe was positive reducing the segment's net loss ratio by 4.4 points and the Group's net loss ratio by 0.8 points.
To date the only significant Group exposure to asbestos and environmental losses is within Alea Europe and as a result of an arbitration decision in February 2003 this generated additional gross and net loss provisions before discount of $8.7 million for year ended 31 December 2002 and $8.4 million for the year ended 31 December 2003. These provisions were based on an independent consulting firm's estimate of total United States industry asbestos reserve requirements of $99.5 billion compared to a Q3 2003 A.M. Best report estimate of $65 billion.
The figures shown above are after the application of the Inter-Ocean Adverse Development Cover which covers underwriting years 1987 through 1999 and provides cover of $125 million excess of $500 million together with 75% of losses in excess of $625 million up to $750 million to provide a maximum recoverable of $218.8 million for the non-life reserves of Alea Europe Ltd. and Alea (Bermuda) Ltd. At 31 December 2003 $133.0 million is recoverable under this cover. As paid claims had exceeded the aggregate excess point under the contract at 31 December 2003, $33.6 million of reinsurance recoveries were made reducing the deposit received under the contract by the same amount. The interest charged on the deposit is the main component of other technical charges in Alea Europe operating segment.
2004 Outlook
Continental European business has a higher concentration of 1 January inception date business than other markets. Alea Europe targets small to medium sized insurers, often mutual in nature, and is on target to exceed expectations with gross premium written currently anticipated to reach more than $220m in 2004. In particular Alea Europe has continued to see strong gross written premium growth with particular success in Austria (with over 100% growth compared to the comparable period in 2003), the Netherlands (with over 100% growth) and Eastern Europe (with over 25% growth). Alea Europe's strong client relationships also bore fruit with the volume of business written on a direct basis increasing from 45% to 60% of the gross premium written to date.
The January 2004 renewal season has proved very successful with significant gains in some markets and continued growth over last year. Underlying property rates have generally been flat with reinsurance rates remaining stable to 10% lower in the more capacity driven markets where Alea Europe does not generally compete. The rates though remain comfortably ahead of our hurdle returns. Casualty lines saw improvements over 2003 although these have varied by country with some Eastern European lines for example showing marked improvement.
Alea (Bermuda) Ltd
Alea (Bermuda) Ltd (Alea Bermuda) is a registered Class 3 Bermudan insurer with authority to conduct general insurance and reinsurance business. Alea Bermuda is the Group's primary access point to the finite market. In addition, Alea Bermuda acts as a finite risk resource for other operations within the Group as well as providing quota share and aggregate excess of loss capacity to other Alea operations.
Alea Bermuda splits its resources between targeting external clients and leveraging intra-group relationships and opportunities to provide bespoke coverage to existing clients of the Group. These structured insurance and reinsurance products are highly customised and assist the buyers in addressing the management of higher retentions, filling of reinsurance and collateral gaps, access to soft capital and management of surplus requirements and cash flow financing. The Directors believe that this expertise will provide strong internally generated deal flow and will serve to cement existing client relationships for other business segments.
The results of Alea Bermuda's finite operations before intra-group reinsurances are immaterial to the whole at present. For ease of reference, its results are therefore consolidated into AAR when it is in respect of collateral gap products written for clients of AAR, with the balance being included in the ANA result.
In 2003, Alea Bermuda had success in writing collateral gap products for clients of AAR. This business generated $37.9 million gross premium written in Alea Bermuda as a standalone entity, most of which was eliminated on consolidation of the Group, and $0.8 million incremental net premiums written with profits emerging from the underwriting profit on the net premium written and strong cash flows generated from the gross premiums. A further $2.6 million of net premiums earned has been allocated to the Alea North America segment for financial reporting purposes.
Alea Bermuda's preferred classes of business are workers' compensation, automobile, general liability and property.
Alea Bermuda's strategy is to:
-provide flexible quota share capacity to other Group entities; -leverage existing Group contacts to cross-sell finite risk products to the Group's existing clients; and -for third parties target the small to medium-sized deals where competition is based more on technical proficiency than price.
The Finite market experienced a difficult year in 2002 following the dramatic increase in regulation and scrutiny following recent accounting scandals. Those initial concerns have now given way to a growing recognition of acceptable transactions and the emergence of a new set of ground rules, albeit more stringent ones, with increased activity towards the end of 2002 continuing in 2003.
We consider the greater emphasis on solvency, through the introduction of International Accounting Standards (IAS) by 2005 and the proposed implementation of enhanced capital requirements for non-life insurers in the United Kingdom, may give rise to additional finite opportunities for Alea Bermuda. The Group maintains significant capital and therefore has significant investments in its Bermuda operations. Individual underwriting units have access to Alea Bermuda's capital principally by means of intra-group quota shares. After these quota shares Alea Bermuda legal entity gross premiums written increased 67.9% in 2003 to $269.3 million compared to $160.3 million in 2002.
FINANCE DIRECTOR'S REPORT
Performance Management
The highlights of the consolidated financial statements are as follows:
Summary of results 2003 2002
$ million
Gross premiums written 1,300.2 931.6
Net premiums earned 858.5 518.1
Underwriting profit before change in
Claims
Equalisation Provision 27.7 (18.8)
Net investment income 52.4 46.4
Interest expense (4.7) (6.5)
Net realised and unrealised gains
on investment (17.0) 33.9
Change in Claims Equalisation
Provision (3.8) (2.4)
--------- ----------
Profit before tax 54.5 52.6
Tax (13.5) 2.0
--------- ----------
Profit after tax 41.0 54.6
Minority interest 7.5 -
--------- ----------
Profit attributable to
equity shareholders 48.5 54.6
--------- ----------
Total net assets $725.4 $460.5
--------- ----------
Per share data
Number of shares
in issue (m) (1) 174,707,415 106,094,720
Earnings per share -- diluted $0.42 $0.51
Operating earnings per share
-diluted $0.54 $0.24
Net asset value per share $4.15 $4.34
Return on equity (see note 7) 9.3% 12.4%
Return on operating equity
(see note 7) 12.0% 5.8%
Operating profit reconciliation
Underwriting profit before Claims
Equalisation
Provision 27.7 (18.8)
Allocated investment income at 4.5% 57.8 47.0
Interest expense (4.7) (6.5)
------------------------- --------- ----------
Operating profit before tax,
based on longer-term
investment return 80.8 21.6
------------------------- --------- ----------
(1) 2002 adjusted for 19 :1 bonus share grant (comparable to 20 : 1 stock split)
In 2003 the Group successfully achieved its financial goals. Gross premiums written increased to 39.6% to $1,300.2 million from $931.6 million. The Group achieved an underwriting result before claims equalisation provision of $27.7 million which was approximately 10% better than its expectation and achieved net investment income of $52.4 million which was in line with expectations. Debt interest cost was $4.7 million reflecting the reduction in LIBOR rates year on year. The overall investment return of 3.0 % reflected the Group's focus on fixed income securities, which in a rising interest rate environment gave rise to net realised and unrealised losses of $17 million.
Profit before tax was $54.5 million compared to $52.6 million in 2002. Profit after tax was $41.0 million compared to $54.6 million in 2002.
The reduction in profit before and after tax was impacted by the net movement in realised and unrealised losses in 2003 of $17.0 million compared to a net gain in 2002 of $33.9 million. Alea has a conservative investment portfolio. The goal is to match assets and liabilities for currency and duration whilst minimising credit risk. This may well give rise to fluctuations in the short term performance of the portfolio which can be significant in terms of profit attributable to shareholders in any one period. For example, in the period from 1 January 2004 to 11 March 2004, Alea showed a change in invested asset value of $20.8 million comprising realised gains of $3.2 million and change in unrealised gains of $17.6 million. The company constantly reviews its approach to investment risk based on market conditions.
In 2003, in accordance with the recommendations of the ABI SORP for insurance companies listed on the London Stock Exchange, the Group included allocated investment income using a longer term rate of 4.5% in both 2002 and 2003 technical accounts. Use of this longer term rate gave rise to operating profits in 2003 of $80.8 million compared to $21.6 million in 2002.
The tax charges in both 2003 and 2002 are distorted by the application of deferred tax assets and the profit mix between territories. In 2002 the Group saw an overall tax credit as profits in London allowed for the recognition of additional deferred tax assets. In 2003 the tax charge similarly benefited from the recognition of the remaining Alea London deferred tax asset not previously recognised. However, a reduction in the rate at which the Swiss deferred tax asset was recognised and unrealised investment losses on the Bermudan portfolio have adversely affected the rate. The actual tax rates for both 2002 and 2003 are not indicative of the longer term rates which the Group believes should be achievable. The Group's goal is to arrange its affairs so that Alea Bermuda provides capacity to each insurance subsidiary within the Group and therefore shares in the underwriting result of each entity. To the extent that such business is profitable then this arrangement will have the effect of reducing the Group's overall tax rate. Conversely if such business is unprofitable then this intra-group reinsurance arrangement could limit the amount of tax relief available on such loss making business.
The Group made a $7.5 million gain on the purchase of the subordinated preferred shares issued by subsidiaries which has been included in the minority interest line of the profit and loss account.
Overall earnings per share were 42 cents compared to 51 cents in 2002. Operating earnings per share were 55 cents compared to 24 cents in 2002. Net assets per share were $4.15 compared to $4.34 as at year end 2002 adjusting for the 19 to 1 bonus share grant (comparable to 20 : 1 stock split). The reduction in book value per share was primarily a function of the dilution effect of the listing on the LSE on 19 November 2003.
Return on Equity
In calculating its return on equity, the Group has used the following formula:
Operating profits after tax divided by (Shareholders' equity including subordinated preferred at each of 1 July 2003 + 31 December 2003 excluding capital raised between 1 July 2003 and 31 December 2003)/2 + Adjusted Proceeds (as set out below)
Adjusted Proceeds are the net proceeds of the offering $221.2 million after the $42.5 million purchase of the subordinated preferred equity plus $1.9 million equity capital raised in the second half year primarily alongside the offering. The total $223.1 million proceeds were available for six weeks from 19 November 2003 to give additional weighted capital of $25.7 million in 2003.
On the above basis the Group achieved a return on equity of 9.3% during 2003 ( 2002: 12.4%). The actual profits are distorted by changes in realised and unrealised gains period on period which benefited the return on equity ratio in 2002 and adversely affected the return on equity in 2002. Operating return on equity increased 106.8% to 12.0% from 5.8% in 2002.
Underwriting performance
Gross premiums written increased by 39.6% to $1,300.2 million from $931.6 million in 2002. Net premiums written increased by 44% to $1,028.7 million from $708.2 million in 2002. Each operating segment grew substantially:
Alea London + 62.5% (40.0% excluding Bristol West) Alea North America + 19.4% Alternative Risk + 76.8% Alea Europe + 28.0% Total + 45.3%
The amount of business retained increased to 79.1% of gross premiums written compared to 76.0% in 2002. This small change masked two significant factors. A reduction in the percentage of premiums allocated to the Max Re contract, 7.6% of gross premiums written compared to 12.2% in 2002, was offset by the growth in reinsurance connected with AAR, where only 50.7% of gross premiums earned were retained net which is wholly in line with our expected business model for that line of business. Both of these factors are expected to continue to contribute to the retention ratio in 2004.
Net premiums earned increased by 65.7% influenced by the sharp increase in premiums written in 2002 which were translated into earned premiums in 2003. In all operating segments except Alea Europe where the majority of premiums incept on 1 January each year, the time lag between the written premium growth achieved in 2002, and how long it takes to earn those premiums through the income statement increased the earned growth rates compared to the written growth rates as follows:
Alea London + 84.6% (57.3% excluding Bristol West) Alea North America + 32.7% Alternative Risk + 343.9% Alea Europe + 23.5%
The growth in AAR is a function of the low earned premiums base in 2002 of only $22.0 million.
As the Group's business mix continued to develop the quantum of unearned premium reserves continued to increase. Gross unearned premium reserves as at 31 December 2002 were 53% of gross premiums written in 2003 compared to 51% in 2002 and 54% of net premiums written in 2003 compared to 53% in 2002.
Combined ratio
The core combined ratio comprises claims incurred net of reinsurance to net premiums earned (NPE) plus expenses before adjusting for the change in deferred acquisition costs less fee income less other technical charges as a percentage of net premium written (NPW). The expense ratio was 4.8 points lower at 31.5% in 2003 compared to 36.3% in 2002. Technical charges as a percentage of NPW are measured separately to derive the final combined ratio.
2003 2002
$'millions
NPW 1,028.7 708.2
NPE 858.5 518.1
Claims incurred, net of reinsurance 528.7 321.9
Net operating expenses 285.5 204.0
Other technical income -2.4 -5.7
-------------------- ------- -------
283.1 198.3
Change in deferred acquisition costs 40.8 58.5
-------------------- ------- -------
Total net written expenses 324.0 256.8
-------------------- ------- -------
2003 2002
Claims incurred net of reinsurance
to NPE ratio 61.6% 62.1%
Total net written expenses to NPW 31.5% 36.3%
------------------------ ------ -------
Core combined ratio 93.1% 98.4%
Other technical charges to NPW 1.8% 2.3%
------------------------ ------ -------
Combined ratio 94.9% 100.7%
------------------------ ------ -------
Impact of prior year reserve developments on incurred claims ratio
Prior year developments increased the claims incurred net of reinsurance loss ratio by 2.2 points in 2003 compared to 4.4 points in 2002 and are summarised by segment and underwriting year as follows:
Impact on loss ratio By Segment Group Alea London 0.2 Alea Alternative Risk 0.2 Alea North America 2.6 Alea Europe -0.8 Total 2.2 Impact on loss ratio By underwriting year Group 1999 & prior 1.0 2000 1.8 2001 -0.5 2002 -0.1 Total 2.2
Further details of the underlying events which gave rise to these developments are set out in the Operating Review. In all operating segments the Group was pleased to note that where substantial reserve increases were required, the segment had usually already non-renewed the relevant policies as it positioned itself to towards its target customer and product segments. The Group is particularly pleased with the positive performance of Alea Europe and the continuing immaterial development in the Alea London 1999 and prior portfolio. Reserve development in North America was disappointing but limited to a small number of contracts which form part of the transition which the segment made in 2001 and 2000 from the portfolio originally available to it to the desired business classes made up of a shorter duration, less volatile blend of lower limit exposures.
Expenses
All expenses are allocated to individual business segments; however the Group monitors expenses for each profit and corporate cost centre. Because of the business model which the Group has adopted, ensuring that each local unit also incorporates some elements of group oversight and development, Corporate Centre costs are incurred in most of the locations in British Pounds, Swiss Francs and United States Dollars and are recharged to the various profit centre by cross charging mechanisms. In a rapidly growing environment the physical quantum of internal expense movement year on year is not meaningful. Instead the Group manages its expense base against the operational plans required to meet the next stage of development.
Measured against net premiums earned the net internal expense ratio improved 3.5 points to 10.2% compared to 13.7% in 2002 as the premium base of the Group expanded more rapidly than the administrative infrastructure. Measured against net premiums written the internal expense ratio improved 1.5 points to 8.5 % compared to 10.0% in 2003.
Reserves
The Group's provisions for gross claims outstanding excluding claims equalisation reserves increased by 24% to $1,398.6 million from $1,126.9 million. Net loss reserves (defined as the gross claims outstanding less the reinsurers' share of claims outstanding) increased by 38% to $672.0 million from $488.1 million. The ratio of gross loss reserves to gross premiums earned reduced to 126% in 2003 from 167% in 2002 as would be expected with a growing portfolio of business.
Invested assets and cash were 123.9% of gross claims reserves and 257.8% of net claims reserves, compared to 109.5% and 251.5% in 2002. These ratios were already strong by industry standards in 2002 before the public offering and demonstrate the strength and simplicity of the overall balance sheet.
The evaluation of required claims outstanding both gross and net of reinsurers' share is the most critical element of the Group's underwriting performance. The provision for claims outstanding is made on an individual case basis and is based on the estimated ultimate cost of all claims notified but not settled by the balance sheet date, together with the provision for related claims handling costs and net of salvage and subrogation recoveries. The provision also includes the estimated cost of claims incurred but not reported at the balance sheet date based on statistical methods together with an assessment of any related reinsurance recoveries. The Group follows robust quarterly processes worldwide to assess the amounts it believes it requires and employs independent consultants to consider these provisions on an annual basis. The last independent review was carried out by Deloitte & Touche as at 30 June 2003 as part of the public offering. Estimates of technical provisions for claims and related recoveries inevitably contain significant inherent uncertainties because significant periods of time may elapse between the occurrence of an incurred loss, the claim triggering the insurance or reinsurance, the reporting of that claim to the Group and the Group's payment of the claim and receipt of related reinsurance recoveries. Accordingly the cost of such claims cannot be known with certainty at the balance sheet date. Subsequent information and events may result in the ultimate liability being less than, or greater than, the amount provided. Adjustments to the amount of the provisions are reflected in the financial statements for the periods in which the adjustments are made.
Reinsurance recoverables
Reinsurance recoverables are analysed between the three large aggregate excess contracts with Inter-Ocean, Overseas Partners, and Max Re which are each significant contracts and other smaller reinsurances.
Inter-Ocean contract
The Inter-Ocean contract is an Adverse Loss Development and Aggregate Excess of Loss Reinsurance Agreement dated 18 May 2000 among Inter-Ocean Reinsurance Company Ltd. and Alea London Limited, Alea Europe Ltd and Alea (Bermuda) Ltd that provides cover to Alea Europe Ltd and Alea (Bermuda) Ltd of up to $125 million cover in excess of $500 million with 75% of losses in excess of $625 million up to $700 million with respect to underwriting years 1987 through 1999 with a maximum recoverable of $218.8 million for certain non life reserves, and cover to Alea London, Alea Europe and Alea (Bermuda) Ltd in excess of a loss ratio retention of 59% of net earned premium up to a maximum limit of 20% of net earned premium but not exceeding $107.8 million and subject to certain other retentions and sub-limits.
OPL contract
The OPL contract is an Adverse Loss Development Reinsurance Agreement between Alea London Limited and Overseas Partners Ltd. dated 31 December 1999 that provides cover of up to $85 million for business incepting on or prior to 31 December 1999 (but excluding certain specified risks such as asbestos) in excess of Alea London Limited's agreed retention of $101.9 million.
Max Re contract
The Max Re contract is an Excess of Loss Agreement effective 1 January 2001 among Max Re Ltd and Alea Europe Ltd, Alea London Limited, Alea North America Insurance Company, Alea (Bermuda) Ltd and Alea Group Holdings (Bermuda) Ltd that provides cover in respect of the period from 1 January 2001 through 31 December, 2003 for worldwide business written (with certain exceptions) on $1.578 billion of net earned premium during the period with a limit equal to the lesser of 16.5% of total net earned premium over the period or $285 million plus a catastrophe cover equal to 1.67% of total net earned premium over the period, with the cover subject to agreed loss ratio attachment points. Reinsurance recoverable - aggregate excess contracts:
$ million Amount Discount Net Amount Collateral
Recoverable
Inter-Ocean
contract 196.2 -- 11.9 184.3 139.0
OPL contract 84.3 -- 84.3 60.9
Max Re contract 228.4 -- 23.4 205.0 228.4
Both the Inter-Ocean contract and the OPL contract are collateralised through deposits received from reinsurers. The deposits increase each year through the allocation of other technical charges which were $19.0 and $16.7 million respectively in 2003 and 2002. The overall value of the reinsurance recovery under these contracts is reassessed each year and any adjustments made are processed through the profit and loss account as increases or reductions to the change in reinsurers' share of provision for claims. These contracts were also the subject of a prior year adjustment in 2003 which is detailed in the accounting policies section of this report.
The Max Re contract is collateralised through trust funds and letters of credit which do not appear on Alea's balance sheet but which provide security for the amounts due to Alea by that company. The trust funds are held in AA rated securities. In addition all unearned premiums paid by Alea to Max Re are also collateralised through trust funds.
Excluding the above contracts the reinsurers' share of claims outstanding in respect of the other reinsurance contracts at 31 December 2003 was $252.9 million (2002: $238.6 million). The Group analyses potential doubtful debts carefully and holds a provision of $7.7 million (2002: $7.2 million) the majority of which is in Alea London, relating to the business written prior to the Group's acquisition of Alea London in 2000. In addition the Group holds offsetting balances of $96.4 million (2002: $70.3 million) made up of collateral provided by the reinsurer or amounts payable to the same reinsurer leaving total net balances due of $156.5 million at 31 December 2003 (2002 $168.3 million) which represents 22% of shareholders funds, a significant improvement compared to 34 % in 2002.
As of 31 December 2003, 89% (2002 95%) of the net balances due are in respect of entities rated A and above, of which 5% (2002 6%) is with AAA rated entities, 23% (2002 47%) is in respect of AA rated entities and 61% (2002 42%) is in respect of A rated entities. The ten largest ten reinsurers had net amounts due ranging from $5.7 million to $21.4 million and were all rated A or above.
Recent years have seen a substantial reduction in credit quality for the entire industry. In the twelve month period to 31 December 2003, there were more than 450 downgrades of industry participants (during 2002: 870) by Standard & Poor's' alone. The Group's reinsurance security profile has been affected by these industry changes. For 2002, following the settlement of a number of large claims, the net balance due from reinsurers rated BBB or lower reduced from 20% to 5% of the total reinsurance recoverable. Reinsurers rated BBB or lower have increased from 5% to 11% for the twelve month period to 31 December 2003 as a result of rating downgrades. The three largest net balances due from BBB or lower reinsurers are $3.8 million (2.2%) from Sorema (BBB), $ 2.9 million (1.9%) from Baloise (BBB), and $1.6 million (1.1%) from Trenwick (NR) against which the Group provides $0.3 million doubtful debt reserve. No other reinsurer rated BBB or below accounted for more than $0.7 million of net balances due at 31 December 2003.
Capital Management
Investment management
I am pleased to report that Alea had no write-offs on its investment portfolio. During a year which has seen a number of insurance companies write-off significant amounts of their investment portfolio due to some significant corporate failures and reductions in credit quality this is a significant achievement and vindicates our conservative investment strategy.
The Group's investment strategy emphasises a high quality diversified portfolio of liquid investment grade fixed income securities as a method of preserving equity capital and prompt claim payment capability. The investment portfolio does not currently consist of equity or real estate investments. The Group utilises recognised external expert investment managers to invest its assets. The Investment Committee establishes the Group's investment policies and creates guidelines for its external investment managers. These guidelines specify criteria on the overall credit quality and liquidity characteristics of the portfolio and include limitations on the size of certain holdings as well as restrictions on purchasing certain types of securities.
At 31 December 2003, fixed income securities and deposits at credit institutions comprised $1,582.2 million an increase of 42.9% since 31 December 2002. The Group's fixed income portfolio consisted of US and non-US sovereign government obligations, corporate bonds and other securities all of which were rated A or better and 98.4% were rated AA or better by either Standard & Poor's or Moody's. The portfolio had a weighted average rating of AAA based on ratings assigned by Standard & Poor's or Moody's. Other than with respect to US, Canadian and European Union government and agency securities, the Group's investment guidelines limit its aggregate exposure to any single issuer to 5% of its portfolio. All securities must be rated A or better at the time of purchase and the weighted average rating requirement of the Group's portfolio is AAA. At 31 December 2003, the Group did not have an aggregate exposure to any single issuer of more than 4.7% (GE Capital) of its shareholders' equity, other than with respect to US, Canadian and European Union government and agency securities.
Depending upon the duration of the liabilities supported by a particular portfolio, the Group's portfolio investment duration targets may range from three to five years. The duration of an investment is based on the maturity of the security and also reflects the payment of interest and the possibility of early principal payment of such security. The Group seeks to utilise investment benchmarks that reflect this duration target. The Investment Committee periodically revises the Group's investment benchmarks based on business and economic factors including the average duration of the Group's potential liabilities. At 31 December 2003, the Group's investment assets had an effective duration of approximately three and a quarter years, which approximates the duration of its liabilities.
The Group's investment assets are subject to interest rate risk. The Group's interest rate risk is concentrated in the United States and Europe and is highly sensitive to many factors, including governmental monetary polices and domestic and international economic and political conditions. The estimated potential exposure to one percentage point increase of the yield curve would be a reduction in fixed income assets of $47.7 million.
The Group continued its conservative investment strategy following the sale of its equity portfolio in May 2000. This strategy reflected our perception of the increased risk in equity and bond markets over the period coupled with our desire to utilise our capital primarily to take underwriting risk. In 2003 we achieved a total return on the investment portfolio of 3.0% (2002: 7.4%). The investment return comprised 4.4% (2002: 4.4%) investment income, 0.9% (2002: 0.8%) realised gains and -2.3% (2002: 2.2%) unrealised gains on average invested assets of $1,294 m (2002: $1,119m). The total return for an investment portfolio is a combination of price and income return. Price return is affected by movements in interest rates whereas income return is affected by the level of interest rates. The lower total return period over period was a result of negative price return due to increases in US interest rates from 31 December 2002 on a portfolio weighted basis and a lower income return due to lower level of interest rates during 2003 for the portfolio.
In 2003 in conformity with other LSE listed insurance companies we have allocated an assumed investment return rate to the underwriting result in respect of both 2003 and 2002. The return rate we have chosen is 4.5% and reflects our heavy weighting in fixed income investments. The Group continues to explore investment strategies which have the potential to deliver incremental returns to fixed income investments, however our overall investment risk appetite will remain low.
There is a floating pledge over certain investments for the issuance, in the normal course of business, of letters of credit. As at 31 December 2003 the pledge covered total investment assets of $227.6 million compared to $175.7 million as at 31 December 2002. In addition $ 19.8 million (31 December 2002 $11.1 million) is held as statutory deposits for local regulators and a further $540.5 million (31 December 2002 $402.0 million) is held in trust for the benefit of holders of North American policy holders which includes $185.4 million (31 December 2002 $ 46.3 million) that Alea (Bermuda) Ltd has placed in trust on behalf of Alea North American Insurance Company under the quota share arrangements between these two companies.
Included within "Debt securities unit trusts listed" as at 31 December 2003 the Group held Societe d'Investissement a Capital Variable (SICAV) of $34.1 million (31 December 2002: $21.7 million) pledged for the benefit of French and Belgian Cedants. These SICAVs are mutual funds invested in European fixed income securities which average credit quality of AA and duration of approximately 5 years.
Equity finance
The Group successfully listed on the LSE on 19 November 2003. The initial public offering raised total net proceeds of $263.7 million. None of the equity shareholders sold any stock in the offering.
As at 31 December 2003, 38.7% of the Group's stock was publicly held as set out in the table below:
No. of Shares Ownership % Fully Diluted Fully Diluted
Held Ownership %
KKR & related
parties 70,740,080 40.5% 70,740,080 38.0%
Management 4,199,835 2.4% 15,429,235 8.3%
Other
Investors 32,193,500 18.4% 32,193,500 17.3%
Publicly Held 67,574,000 38.7% 67,574,000 36.3%
-------- --------- -------- ---------
174,707,415 100.0% 185,936,815 100.0%
-------- --------- -------- ---------
Other investors invested in Alea during the capital enhancement program in 2001. KKR and related parties and other investors entered into Lock up agreements for a period of six months from 19 November 2003. Management have a twelve month lock up subject to prorate sell-down rights in the event of an offering of KKR shares prior to 19 November 2004.
A portion of the net proceeds of $263.7 million were used to purchase $50 million subordinated preferred shares from a third party shareholder for $42.5 million. The majority of the remainder was used to inject capital to support business growth in the Group's insurance subsidiaries as set out in the following table below, the balance being retained for general corporate purposes.
Use of proceeds $ million
Alea North America 157.0
Alea Europe 30.0
Alea London 10.2
Alea Bermuda 12.4
-----------
209.6
-----------
Purchase of subordinated preferred shares 42.5
General corporate purposes 11.6
-----------
Total 263.7
-----------
Debt finance
Alea Group Holdings AG (AGHAG), a Swiss wholly owned subsidiary of the Group entered into term loan facilities which comprise three elements; Term "A" facility of CHF 100 million repayable in annual tranches in 2002 to 2004 with the balance due in 2005; Revolving credit facility of up to CHF 100 million which it can draw down until the expiry of the Term "A" Loan; and Term "B" facility providing incremental debt of $75 million on a non amortising basis repayable in 2007.
The Group had total debt finance as at 31 December 2003 of $178.3 million (2002: $168.5 million). The increase year-on-year is solely due to the change in exchange rates between the Swiss Franc and the United States Dollar. Funds under the revolver have been utilised to repay the Term A amounts due in 2003. The total amount remaining available under the revolver facility was $30.7 million at 31 December 2003.
The loan facilities include certain restrictive covenants which were comfortably met in 2003.
Total loan repayments under the above facilities fall due as follows:
Year ended 31
December
$ million
2004 12.9
2005 92.9
2006 --
2007 75.0
Total before capital raising expenses 180.8
Capitalised debt raising expenses (2.4)
Total 178.4
Interest on bank borrowings under the Term "A" loan and the Revolving Credit Facility is charged at a rate per annum according to applicable currency LIBOR rates designated as the British Bankers Association interest settlement rate plus a margin of ) 0.625% (2002 0.625%). The margin charged on the Term "B" loan is 3.25% (2002 3.25%). The interest expense in 2003 amounted to $4.7 million (2002 $6.5 million). The estimated increase in interest expense in the event of a 100 basis point increase in applicable rates is $1.7 million.
At 31 December 2003 the Group also had collateralised bank letters of credit and loan facilities available from a variety of sources to support the need to collateralise commitments made in the normal course of business outlined above, including $100 million and $10 million uncommitted letter of credit facilities entered into by Alea (Bermuda) Ltd with the Royal Bank of Scotland and The Bank of N. Butterfield respectively, $97 million uncommitted letter of credit facility entered into by Alea Europe Ltd. with UBS and a $15 million working capital facility extended to Alea Europe Ltd. by UBS. Additionally Alea London has access to letters of credit through collateral arrangements with Citibank.
Interest cover
Operating Interest cover improved in 2003. This was a combination of the increase in profits coupled with the reduction in interest costs following reductions in applicable LIBOR rates compared to 2002.
2003 2002
$ million $ million
Operating profit before interest
and taxation 85.5 28.2
Interest 4.7 6.5
Interest cover based on operating profit 18.1x 4.3x
Capitalisation
The capital structure of the Group was simplified in 2003. The $50 million subordinated preferred shares were purchased from a third party shareholder from the proceeds of the offering for $42.5 million creating a $7.5 million profit in the second half of 2003 and removing a contingent liability in respect of the cumulative accretion of subordinated preferred return dividends of $13.6 million as at 30 June 2003.
CHF 16 million was repaid under the Term A loan facility which was offset by a draw down of CHF 16 million under the revolver facility to create new USD debt of $0.5 million. The increases in debt shown on the balance sheet reflects the retranslation of the CHF facility into USD as the Swiss franc appreciated against the United States Dollar to CHF1.24:1 from CHF 1.4 to 1.
The debt to total capitalisation ratio reduced from 26.8% in 2002 to 19.7% in 2003 following the initial public offering. Alea intends to augment group liquidity and operating subsidiary capital through the continued use of down-streamed holding company level debt -- to the extent such debt does not detrimentally affect debt ratings and bank/capital market access. To this end, Alea will consider refinancing elements of the existing bank facilities during 2004.
As at 31 As at 31
December 2003 December 2002
$ million $ million
Debt 178.4 168.5
Subordinated preferred shares -- 50.0
Equity 725.4 410,5
--------------------- ----------- -----------
Total capitalisation 903.8 629.1
--------------------- ----------- -----------
Debt 19.7% 26.8%
Subordinated preferred shares 0.0% 7.9%
Equity 80.3% 65.3%
----------- -----------
Total capitalisation 100.0% 100.0%
----------- -----------
Capital expenditure
The Group invested $10.2 million (2002: $9.3 million) in capital expenditure principally computer equipment and software, including capitalised costs from the continued internal development of the software supporting the Group's operations and received $7.3 million from the proceeds of the disposal of fixed assets at profit on disposal of $1.6 million.
Liquidity and cash flow
Total proceeds from the issue of common share capital during 2003 were $291.9 million including the proceeds of the Group's offering on the London Stock Exchange which raised GBP168.9 million ($287.5 million). The balance being raised from the issues of shares to employees under the Group's share and options scheme.
The expenses of raising capital were $23.7 million. In addition the Group used $42.5 million of the proceeds to purchase subordinated preferred shares with a face value of $ 50 million creating a gain on redemption of $7.5 million. The remaining proceeds of the IPO were employed as capital to support profitable growth within the operating subsidiaries rather than to support specific cash flow needs. The Group met its liquidity requirements primarily from funds provided by operations.
Cash provided by operating activities primarily consists of premiums collected, investment income and collected reinsurance recoverable balances, less paid claims, retrocession payments, operating expenses and tax payments. Net cash flow from operating activities was $250.9 million (2002: $99.4 million).
The $250.9 million cash inflow in 2003 is after payment of $68.9 million (2002: $62.0 million) in respect of the Max Re aggregate excess contract. On a like-for-like basis after adjusting for the Max Re aggregate excess contract, cash flow was $319.8 million (2002: $161.4 million). Thus underlying cash flow has improved by $158.4 million year-on-year, reflecting the growth in the business coupled with the reduction in settlements related to reducing run-off portfolios in Alea Europe and the Imperial book of business that was acquired in 2000. The Max Re aggregate excess contract covered underwriting years 2001- 2003 and has not been replaced in 2004, thus amounts paid to this contract will reduce further in 2004 compared to 2003.
Cash flows from operating activities were used to pay interest in bank loans of $4.7 million (2002: $6.5 million) and to pay taxes $1.7 million (2002: tax refunds $1.2 million) and capital expenditures described above.
Total net cash flows were $466.4 million (2002: $121.8 million) which was primarily used to invest in debt securities and other fixed income instruments. The total investments including cash balances increased 41% from $1,732.3 million (2002: $1,227.8 million).
Intra-group arrangements
Whilst recognising the separate legal status of each entity, business processes are standardised and managed consistently. The Group continues to view each of its insurance operating entities as core to the whole. Mindful of local market conditions, regulatory requirements and the capital adequacy requirements of the rating agencies, the Group ensures that each balance sheet retains risk commensurate with its capital base.
The primary means of achieving this is by arranging capacity through internal quota shares primarily with Alea (Bermuda) Ltd which now has the majority of the Group's operating capital of $435.2 million. For 2002 and 2003 underwriting years we have put into effect a 70% quota share to Alea (Bermuda) Ltd of Alea North America's insurance and reinsurance business. This will be particularly important for Alea North America during its growth phase.
In addition the Group makes public its view of the interdependence of each subsidiary with the issue of intra-group cross guarantees that, whilst inevitably affected by local regulatory requirements, make clear that it is management's intention to view each subsidiary as part of the whole. Through consultation with A.M. Best and Standard & Poor's, a form of wording for the guarantees has been developed that is acceptable to both agencies. Group guarantors may only terminate these guarantees after giving one month's notice to these agencies. Any contract written whilst the guarantees are in force remains guaranteed should the guarantee be cancelled.
In the third quarter of 2002, in recognition of its new status as the ultimate holding company of the Group, Alea Group Holdings (Bermuda) Ltd entered into a top down guarantee with each of the seven rated insurance operating entities. These guarantees are in addition to the pre-existing cross company guarantees already in place between the various subsidiaries of the Group. Details of these guarantees have been made available to the rating agencies and broker security committees.
Alea (Bermuda) Ltd also entered into an aggregate stop loss arrangement designed to protect the balance sheet of Alea Europe Ltd in both 2003 and 2002.
Rating Agencies
On a Group basis, Standard & Poor's and A.M. Best provided financial strength ratings of all of the Group's operating subsidiaries of "A- (Strong)" and "A- (Excellent)" respectively. These ratings were issued on 2 June 2002 and 2 July 2003 respectively. In each case, the ratings are expressed to have stable outlooks. Other agencies may rate the Group or one or more of the Group's subsidiaries on an unsolicited basis.
Standard & Poor's has assigned a "BBB-" counterparty credit rating to AGHAG and a "BBB-" senior debt rating to the $75 million term loan supplement to the Credit Agreement. In each case, the ratings are expressed to have stable outlooks. The "BBB-" rating is one full rating category below the Group's claims paying ability rating because the senior debt is subordinated to the obligations of the Group's operating subsidiaries.
Lumbermens (LMC)
The Group has a significant reinsurance relationship with LMC which arose in connection with the Group's acquisition of the Equus Re reinsurance division of LMC on 3 December 1999, Alea Bermuda and LMC entered into a 100% quota share reinsurance of the LMC business written by Equus Re through 30 September 1999 (namely, business written by Equus Re prior to the Group's acquisition of its operations). In turn, LMC provides stop loss reinsurance to Alea Bermuda for losses in excess of a 75% paid loss ratio on the same business ("Protected Business"). In addition to the Protected Business, LMC also authorised the Group to write new and renewal business on behalf of LMC (as reinsurer) through 31 December 2001, which business is ceded by a 100% quota share reinsurance to Alea Bermuda ("Fronted Business"). As is required for credit for reinsurance purposes when cessions are made to non-U.S. licensed reinsurers such as Alea Bermuda, the Group collateralises its obligations to LMC. Pursuant to contract, the required collateral is equal to 120% of the estimated loss reserves. Concurrent with these arrangements, LMC retained Alea North America Company (ANAC) as its agent to adjust and pay claims and collect premiums for both the Protected Business and the Fronted Business. The respective obligations of Alea Bermuda and LMC noted above are subject to contractual mutual offset provisions under the reinsurance agreements and as permitted under Illinois law. Further, in respect of the Protected Business, LMC is contractually required to fund (and has been funding) losses on its own behalf now that the 75% paid loss ratio has been met.
LMC's financial strength ratings were downgraded and then withdrawn by A.M. Best and by Standard & Poor's, at LMC's request, following LMC's announcement in 2002 that it would cease writing new business. LMC announced that at 31 December 2003, it had remaining audited statutory surplus of $202.4 million. LMC risk based capital level allows the Illinois Department of Insurance to assume control of LMC at its discretion. As noted above, in light of the mutual offset provisions under the reinsurance agreements and as permitted under applicable Illinois law, the Directors believe that the Group should not be exposed to material credit risk resulting from its arrangements with LMC.
Management of Financial Risks
The Group recognises the critical importance of efficient and effective risk management systems. Close attention is paid to asset and liability management.
Asset and liability management
The Group's general practice is to invest in assets that match the currency in which it expects related liabilities to be paid. Shareholders' equity held in local insurance units is primarily kept in local currencies to the extent that shareholders' equity is required to satisfy regulatory and self-imposed capital requirements. This facilitates the Group's efforts to ensure that capital held in local insurance units will be able to support the local insurance business irrespective of currency movements.
Derivatives
Derivative instruments are only used to a limited extent within guidelines established by the Board. Derivatives may be used for efficient portfolio management, hedging debt and the outcome of corporate transactions. Speculative activity is prohibited and all derivative transactions should be covered fully, either by cash or by corresponding assets and liabilities. The only hedging transaction undertaken in 2003 was the sale of 20 million Canadian Dollars into United States Dollars representing Canadian assets held in excess of the Group's requirements as a result of regulatory requirements in Canada.
Foreign exchange management
The Group publishes its financial statements in United States Dollars. Therefore, fluctuations in exchange rates used to translate other currencies, particularly European currencies including the Euro, British Pound and Swiss Franc, into United States Dollars will impact its reported financial condition, results of operations and cash flows from year to year.
As a result of the international diversity of its operations, approximately 18% (2002: 19%) of the Group's premium income arises in currencies other than United States Dollars. Similarly, its net assets are denominated in a variety of currencies, with approximately 22% (2002: 21%) of invested assets and cash being non-United States Dollar investments.
In managing the Group's foreign currency exposures we do not hedge revenues as these are substantially retained locally to support the growth of our business and to meet local regulatory and market requirements. The Group's net assets and, to a more limited extent its solvency, are exposed to movements in exchange rates.
Total Group exchange losses were $1.9 million based on total gross assets of $3,477 million compared to $0.4 million in 2002 based on total gross assets of $2,713 million in 2002 reflecting the essentially matched nature of the Group's assets and liabilities despite the significant exchange devaluation of the United States Dollar, particularly compared to the Euro, British Pound and Swiss Franc, that occurred during the year.
Reinsurance security management
Reinsurance is a key tool in managing our catastrophe exposure. In designing our reinsurance programmes we take account of our risk assessment, the financial strength of reinsurance counterparties, the benefits to shareholders of capital efficiency and reduced volatility, and the cost of reinsurance protection.
The Group purchases retrocessional reinsurance to improve the extent to which it can manage risk exposures, protect against catastrophic losses, access additional underwriting capacity and stabilise financial ratios.
As a general rule, the Group's aggregate net line with respect to risks assumed under contracts written will not exceed $10 million or its equivalent in foreign currencies. In addition, where considered appropriate, the Group purchases reinsurance protections that provide coverage against accumulations of risk. The Group selects its reinsurers and retrocessionaires primarily based upon credit quality and monitors them closely over time. It also seeks to diversify its business among reinsurers and retrocessionaires and requires collateral where deemed prudent to do so.
Accounting Policies
Prior Year Adjustments (see note 4)
In 2003, in accordance with the recommendations of the ABI SORP for companies listed on the LSE, the Group included allocated investment income using a longer term rate of 4.5% selected by the Group in both 2002 and 2003 technical accounts. Use of this longer term rate gave rise to operating profits in 2003 of $80.8 million compared to $21.6 million in 2002.
As part of the Listing process the Group determined that it would be appropriate to record in the accounts of the Group the $1.7 million adjustment net of taxation in respect of the Claims Equalisation Provisions established by Alea London Ltd.
The Group also reviewed the application of the deficit payback and commutation provisions of each of the Inter-Ocean contract and the OPL contract and determined that the financial statements did not fully reflect the consequences of the deficit payback and commutation/ termination provisions of the contracts This had an adverse impact to the Group of $43.2 million for the Inter-Ocean contract and a positive impact of $13.2 million for the OPL contract. Accordingly reinsurance recoverables were reduced by $24 million in respect of the 2000 annual financial result and $6 million in respect of the 2001 annual financial result. These amounts have been accounted as a prior year adjustment in the financial statements.
International Financial Reporting Standards
Alea Group Holdings (Bermuda) Ltd, as a publicly listed company, is required to prepare its accounts under International Financial Reporting Standards (IFRS) from 1 January 2005.
An evaluation of the impact of IFRS on the Group has been completed which suggests that the current IFRS endorsed by the Accounting Regulatory committee of the European Commission which excludes, in particular, the accounting for insurance contracts exposure draft, will have little impact on the net asset position of the Group compared to that produced under current United Kingdom accounting standards. However, there will be significant increases in disclosure particularly with regard to business risk and management.
The changes in accounting resulting from adoption of the insurance exposure draft may lead to significant changes in the future as it proposes a fundamentally different basis for recognition of profit on insurance contracts. However, it is not expected that these proposals will be formal requirements within the next three reporting periods and the proposals may change materially before they are finalised.
Unaudited
Consolidated profit and loss account
Restated
Technical account Year ended Year ended
-- general business Notes 31 Dec 03 31 Dec 02
$'000 $'000
Gross premiums written 2 1,300,182 931,631
Outward reinsurance premiums 2 (271,471) (223,399)
--------- ---------
Net premiums written 2 1,028,711 708,232
--------- ---------
Change in the provision for unearned
premiums
-- gross amount (185,907) (257,603)
-- reinsurers' share 15,677 67,422
--------- ---------
Change in the net provision for unearned
premiums (170,230) (190,181)
Earned premiums, net of reinsurance 858,481 518,051
Allocated investment return
transferred from
the non-technical account 57,811 46,952
Other technical income, net of reinsurance 2,364 5,671
--------- ---------
Total technical income 918,656 570,674
--------- ---------
Claims paid
-- gross amount 468,537 397,422
-- reinsurers' share (114,987) (77,663)
--------- ---------
Net claims paid 353,550 319,759
Change in the provision for claims
-- gross amount 249,743 8,491
-- reinsurers' share (74,643) (6,396)
--------- ---------
Change in the net provision for claims 175,100 2,095
Claims incurred, net of reinsurance 528,650 321,854
Change in other technical provisions,
net of reinsurance
Net operating expenses 285,499 203,981
Other technical charges, net of
reinsurance 19,004 16,678
--------- ---------
Total technical charges 833,153 542,513
Balance on the technical account for
general business before claims
equalisation provision 2 85,503 28,161
Change in claims equalisation provision 4 (3,771) (2,368)
--------- ---------
Balance on the technical account for
general business 81,732 25,793
========= =========
This preliminary announcement was approved by the Board on 12 March 2004. The results constitute unaudited non-statutory accounts.
Unaudited
Consolidated profit and loss account
Restated
Year ended Year ended
Non-technical account Notes 31 Dec 03 31 Dec 02
$'000 $'000
Balance on the general business
technical account 81,732 25,793
Gross investment income 56,337 49,170
Net realised gains on investments 12,146 8,477
Net unrealised (losses)/gains on (29,173) 25,388
investments
Other investment expenses (3,975) (2,761)
-------- ---------
35,335 80,274
Allocated investment return
transferred to the
technical account -- general business (57,811) (46,952)
Debt interest (4,718) (6,530)
Profit on ordinary activities before
tax -------- ---------
-continuing operations 54,538 52,585
-------- ---------
Comprising:
------------------------------ -------- -------- ---------
Operating profit 80,786 21,631
Short-term fluctuations in investment (22,477) 33,322
return
Movement in claims equalisation
provision 4 (3,771) (2,368)
-------------------------------------------------------------------
54,538 52,585
-------- ---------
Tax (charge)/credit on profit on
ordinary activities (13,528) 1,994
-------- ---------
Profit on ordinary activities after tax 41,010 54,579
Minority interest -- gain on purchase
subordinated preferred shares issued by
subsidiaries 7,500 --
-------- ---------
Profit for the financial year
attributable to equity shareholders 3 48,510 54,579
======== =========
The results in each of the financial years are derived from the Group's continuing activities.
Unaudited earnings per share attributable to equity shareholders Operating profit is based on long term investment returns excluding movements in claims equalisation provision and the gain on purchase of subordinated preferred shares issued by subsidiaries.
Earnings per share -- basic ($) 3 0.42 0.52
======== ========
Earnings per share -- fully diluted ($) 3 0.42 0.51
======== ========
Operating earnings per share -- basic ($)3 0.55 0.24
======== ========
Operating earnings per share -- fully
diluted ($) 3 0.54 0.24
======== ========
Unaudited consolidated statement of total recognised gains and losses
Year ended Year ended
31 Dec 03 31 Dec 02
$'000 $'000
Profit for the financial year
attributable to equity shareholders 48,510 --
Profit for the financial year
attributable to equity shareholders
as previously reported -- 56,238
Exchange differences (1,893) (445)
--------- --------
Total gains and losses recognised for
the financial year 46,617 55,793
========
Prior year adjustments (see note 4) 4 (31,659)
---------
Total recognised gains and losses
since last annual report and accounts 14,958
=========
Unaudited
Consolidated balance sheet
Restated
Year ended Year ended
Notes 31 Dec 03 31 Dec 02
$'000 $'000
ASSETS
Intangible assets
Licences 9,968 9,968
-------- --------
9,968 9,968
Investments
Other financial investments 1,582,357 1,106,739
Deposits with ceding undertakings 105,513 92,106
-------- --------
1,687,870 1,198,845
Reinsurers' share of
technical provisions
Provision for unearned premiums 123,606 101,312
Claims outstanding
-- Aggregate excess reinsurance 473,569 400,175
Claims outstanding
-- Other reinsurance 252,992 238,625
-------- --------
Claims outstanding 726,561 638,800
-------- --------
850,167 740,112
Debtors
Debtors arising out of
insurance operations 66,931 111,489
Debtors arising out of
reinsurance operations 531,635 377,654
Amounts due from reinsurance
operations not
transferring significant
insurance risk 44,385 50,429
Other debtors 55,693 66,227
-------- --------
698,644 605,799
Other assets
Tangible assets 12,212 13,130
Cash at bank and in hand 44,307 28,989
-------- --------
56,519 42,119
Prepayments and accrued income
Accrued interest and rent 14,968 10,545
Deferred acquisition costs 153,243 97,449
Other prepayments and
accrued income 5,680 8,708
-------- --------
173,891 116,702
-------- --------
TOTAL ASSETS 3,477,059 2,713,545
======== ========
Unaudited
Consolidated balance sheet
Restated
Notes 31 Dec 03 31 Dec 02
$'000 $'000
LIABILITIES
Capital and reserves
Called up share capital 1,747 53
Share premium account 633,053 361,407
Profit and loss account 14,958 (50,287)
Capital reserve 75,644 99,367
-------- --------
Shareholders' funds
attributable to equity
interests 725,402 410,540
Minority interests
subordinated preferred
shares issued by
subsidiaries 50,000
-------- --------
TOTAL CAPITAL EMPLOYED 725,402 460,540
Technical provisions
Provision for unearned premiums 686,935 477,121
Claims outstanding 1,398,551 1,126,949
Claims equalisation provision 4 6,408 2,368
-------- --------
2,091,894 1,606,438
Deposits received from
reinsurers 199,903 225,144
Creditors
Creditors arising out of
insurance and
reinsurance operations 196,371 158,770
Liabilities from reinsurance
operations not
transferring significant
insurance risk 44,319 53,130
Amounts owed to credit
institutions 178,375 168,536
Other creditors including
taxation and social security 2,995 4,629
-------- --------
621,963 610,209
Accruals and deferred income 37,800 36,358
-------- --------
TOTAL LIABILITIES 3,477,059 2,713,545
======== ========
Unaudited
Consolidated cash flow statement
Restated
Year ended Year ended
Notes 31 Dec 03 31 Dec 02
$'000 $'000
Net cash inflow
from operating activities 6 250,979 99,394
Servicing of finance
Interest paid (4,718) (6,530)
Taxation
Taxation (paid)/refunded (1,674) 1,222
Capital expenditure
Purchase of tangible assets (10,266) (9,237)
Proceeds on disposal of tangible assets 5,977
Financing
Issue of common share capital 291,968 7,092
Purchase of subordinated
preferred shares
issued by subsidiaries (42,500)
Receipt of cash from Capital
Enhancement Program 30,000
Capital raising expenses (23,723) (172)
--------- ---------
466,043 121,769
========= =========
Cash flows were invested as follows:
Increase/(decrease) in cash holdings 13,752 (3,243)
Net portfolio investments
Shares and other variable
yield securities (331) (704)
Debt securities
-- unit trusts -- Listed 6,973 6,978
Debt securities and other fixed income
securities 453,123 414,079
Deposits with credit institutions (7,474) (295,341)
--------- ---------
452,291 125,012
--------- ---------
Net investment of cash flows 466,043 121,769
========= =========
Unaudited
Notes to the Financial Statements
1. ACCOUNTING POLICIES
Basis of preparation
The financial information is prepared in accordance with applicable United Kingdom accounting standards and under the historical cost accounting rules as modified by the revaluation of investments. The principal accounting policies, which have all been applied consistently throughout the periods covered by this report with the exception of the policy for the recognition of equalisation provision explained below, and which comply with the recommendations of the United Kingdom Statement of Recommended Practice on Accounting for Insurance Business issued by the Association of British Insurers in December 1998 (the "ABI SORP") are set out below.
The Company is a registered Bermuda company. As such it is obliged to prepare its financial information in accordance with the Bermuda Companies Act 1981, which permits the Company to prepare its financial information under generally accepted accounting principles of the United Kingdom ("UK GAAP"). Accordingly, the financial information has been prepared in accordance with Bermuda Law and under the historical cost accounting rules as modified by the revaluation of investments.
This preliminary announcement does not constitute statutory accounts for the financial year ended 31 December 2003. The auditors have not reported on these accounts.
This preliminary announcement uses the accounting policies set out in the Group's Listing Particulars except for the policy in respect of employing the longer term rate of return for investments as recommended for UK listed companies by the ABI SORP. This policy has changed since the publication of the Listing Particulars and details of the change are disclosed further below.
The financial information in this preliminary announcement for the year ended 31 December 2003 does not constitute statutory accounts for that period but is derived from those accounts, which are currently unaudited, and have been restated for the effects of the change in accounting policy.
Basis of consolidation
The consolidated financial statements incorporate the financial statements of the Company and all its subsidiary undertakings.
From 1 January 2001 to 26 February 2002 the parent company of the Group was Alea Group Holdings AG, a company incorporated in Switzerland. On 7 December 2001 the Company was incorporated in Bermuda to become the new ultimate parent company of the Group. As at 31 December 2001 following a series of capital injections from existing shareholders and share for share exchanges, certain subsidiaries of Alea Group Holdings AG were partially owned by both the Company and Alea Group Holdings AG, in varying percentages. Alea Group Holdings AG remained the controlling entity as at 31 December 2001.
As at 26 February 2002 following completion of regulatory approvals, Alea Group Holdings AG became a 94.49% subsidiary of the Company by way of a share for share exchange and the Company became the new ultimate parentcompany. Following the staff equity exchange becoming effective on 3 April 2002, and certain repurchases from terminating employees, the Company's interest in Alea Group Holdings AG increased to 100%.
The above share for share exchanges qualify as a Group reorganisation as the ultimate shareholders and their rights remained the same and no minority interests have been affected. Accordingly, as permitted under FRS 6 "Acquisitions and Mergers" this Group reconstruction has been accounted for using merger accounting.
Change in accounting policies
The Group has determined that it is appropriate to record in the accounts of the Group the claims equalisation provision established by Alea London Limited. This is a change in accounting policy. The Group has opted to comply with the ABI SORP recommendation for UK listed companies of allocating investment return to the technical account based on the longer term rate of return, which the Group has selected as 4.5%. This is a change in accounting policy and has no impact on the profit on ordinary activities after tax. The cumulative effect of the prior year adjustments is shown in the statement of total recognised gains and losses and detailed in note 4.
Unaudited
Notes to the Financial Statements
2. SEGMENTAL INFORMATION
Underwriting results by operating segment before intra-group quota share arrangements
The Group's business is composed of four underwriting segments, consisting of London, Alternative Risk, North America (treaty reinsurance) and Europe.
The following tables summarise the underwriting results for the Group's business segments as of and for the years ended 31 December 2003 and 31 December 2002. Net premiums written and net premiums earned are presented prior to intra-group quota share arrangements, the underwriting results are also stated before quota share arrangements, and the impact of quota share arrangements on these pre-quota segmental results is presented separately.
Year ended 31 London AAR North Europe Total
December 2003 America
$'000 $'000 $'000 $'000 $'000
Gross
Premiums 566,042 261,141 282,921 190,078 1,300,182
Written
Outwards (78,198) (129,172) (33,222) (30,879) (271,471)
reinsurance
premiums
---------------------------------------------------------------------
Net
premiums
written 487,844 131,969 249,699 159,199 1,028,711
--------------------------------------------------------------------
Gross
premiums
earned 482,701 205,062 228,361 198,151 1,114,275
Net
premiums
earned 407,656 97,856 189,324 163,645 858,481
Allocated
investment
return 13,995 12,681 19,022 12,113 57,811
Claims
incurred,
net of
reinsurance (224,988) (70,556) (130,024) (103,082) (528,650)
Total net
expenses
comprise :
Acquisition
costs (92,521) (19,654) (55,268) (27,958) (195,401)
Administrative
expenses (32,122) (15,880) (20,984) (21,112) (90,098)
Fee income 1,654 -- 545 165 2,364
Other
technical
charges (5,611) (24) (700) (12,669) (19,004)
Other
expenses (128,600) (35,558) (76,407) (61,574) (302,139)
-------- ------------ -------- -------- -------- --------
Under
writing
result(1) 68,063 4,423 1,915 11,102 85,503
========= =========== ======== ======== ======== ========
Restated
Year
ended 31 London AAR North Europe Total
December America
2002
$'000 $'000 $'000 $'000 $'000
Gross
Premiums
Written 376,428 141,394 257,377 156,432 931,631
Outwards
reinsurance
premiums (76,245) (66,767) (48,328) (32,059) (223,399)
----------
Net premiums 300,183 74,627 209,049 124,373 708,232
written
----------
Gross
premiums
earned 278,535 54,064 176,375 165,054 674,028
Ne
premiums
earned 220,885 22,044 142,663 132,459 518,051
Allocated
investment
return 9,398 9,334 17,334 10,886 46,952
Claims
incurred,
net of
reinsurance (108,997) (14,344) (87,632) (110,881) (321,854)
Total net
expenses
comprise :
Acquisition
costs (49,694) (6,851) (44,904) (26,070) (127,519)
Administrative
expenses (30,572) (5,779) (21,076) (19,035) (76,462)
Fee income 5,807 228 -- (364) 5,671
Other
technical
charges (5,965) (95) (611) (10,007) (16,678)
Other
expenses (80,424) (12,497) (66,591) (55,476) (214,988)
-------- --------- -------- -------- -------- --------
Underwriting
result (1) 40,862 4,537 5,774 (23,012) 28,161
========= ========== ======== ======== ======== ========
(1) Balance on the technical account for general business before claims equalisation provision
Intra-group quota share arrangements
For the year ended 31 December 2002 and 31 December 2003 intra-group quota share arrangements comprise of the following: a 35% quota share of Alea London business to Alea Europe, a 50% quota share of certain 2000 and prior underwriting year business from Alea Europe to Alea Bermuda, a 70% quota share of Alea North America to Alea Bermuda and an intra-group aggregate excess contract from Alea Europe to Alea Bermuda. The effect of all of these arrangements are detailed below :
Year ended London Bermuda US Europe Total
31 December $'000 $'000 $'000 $'000 $'000
2003
Net premiums
earned 407,656 2,520 284,660 163,645 858,481
Intercompany
reinsurance (142,397) 203,005 (197,151) 136,543 --
------- ------- ------- ------- -------
Net premiums
earned after
intercompany
reinsurance 265,259 205,525 87,509 300,188 858,481
Underwriting
result
Before
intercompany
reinsurance 68,063 (10,841) 17,180 11,101 85,503
After
intercompany
reinsurance 45,468 (5,046) (1,168) 46,249 85,503
Year ended London Bermuda US Europe Total
31 December $'000 $'000 $'000 $'000 $'000
2002
Net premiums
earned 220,885 85,325 79,382 132,459 518,051
Intercompany
reinsurance (75,604) 75,030 (55,567) 56,141 --
------- ------- ------- ------- -------
Net premiums
earned after
intercompany
reinsurance 145,281 160,355 23,815 188,600 518,051
Underwriting
result
Before
intercompany
reinsurance 40,862 9,143 1,168 (23,012) 28,161
After
intercompany
reinsurance 25,094 7,902 (2,566) (2,269) 28,161
Year ended Year ended
31 Dec 03 31 Dec 02
$'000 $'000
Gross premiums written
Insurance
Casualty 339,342 125,308
Property 92,226 69,963
Marine, aviation &
transport 88 (77)
Other 745 215
--------- ---------
Total insurance 432,401 195,409
--------- ---------
Reinsurance
Casualty 584,463 365,182
Property 232,198 294,760
Marine, aviation &
transport 32,414 54,709
Other 18,706 21,571
--------- ---------
Total reinsurance 867,781 736,222
--------- ---------
Total 1,300,182 931,631
========= =========
Year ended Year ended
31 Dec 03 31 Dec 02
$'000 $'000
Gross premiums earned
Insurance
Casualty 243,787 57,353
Property 82,466 50,950
Marine, aviation &
transport 88 394
Other 619 665
--------- ---------
Total insurance 326,960 109,362
--------- ---------
Reinsurance
Casualty 481,901 285,193
Property 250,377 210,055
Marine, aviation &
transport 40,176 48,853
Other 14,861 20,565
--------- ---------
Total reinsurance 787,315 564,666
--------- ---------
Total 1,114,275 674,028
========= =========
Year ended Year ended
31 Dec 03 31 Dec 02
$'000 $'000
Net premiums written
Insurance
Casualty 432,537 55,925
Property 64,311 59,163
Marine, aviation &
transport 88 (67)
Other 649 131
--------- ---------
Total insurance 497,585 115,152
--------- ---------
Reinsurance
Casualty 288,674 305,024
Property 207,047 225,375
Marine, aviation &
transport 16,242 40,333
Other 19,163 22,348
--------- ---------
Total reinsurance 531,126 593,080
--------- ---------
Total 1,028,711 708,232
========= =========
Year ended Year ended
31 Dec 03 31 Dec 02
$'000 $'000
Net premiums earned
Insurance
Casualty 108,613 29,927
Property 69,703 41,777
Marine, aviation
& transport 88 491
Other 523 581
--------- ---------
Total insurance 178,927 72,776
--------- ---------
Reinsurance
Casualty 426,111 239,817
Property 213,541 150,065
Marine, aviation &
transport 24,600 34,235
Other 15,302 21,158
--------- ---------
Total reinsurance 679,554 445,275
--------- ---------
Total 858,481 518,051
========= =========
3. EARNINGS PER ORDINARY SHARE
Basic earnings per ordinary share is based on the profits after tax and the weighted average ordinary shares in issue as follows :
Year ended Year ended
31 Dec 03 31 Dec 02
Number Number
Weighted average ordinary
shares in issue 114,269,807 105,872,303
Fully diluted number of shares 116,266,620 107,965,776
Operating earnings per ordinary share based on the investment income are shown because it is considered to be a more appropriate measure of operating performance than earnings per share including short term fluctuations in investment return. Furthermore, as detailed in the note relating to prior year adjustments, transfers to or from claims equalisation provision are transfers to or from a statutory reserve and not a deduction or credit in arriving at operating profit. The gain on the purchase of subordinated preferred shares issued by subsidiaries has also been excluded in calculating operating profit.
The Company has re-denominated the Swiss Franc 110.79 option price to $64.41 for all options issued at that strike price (CHF 5.54 and $3.22, respectively after adjustment for the bonus share grant, comparable to a 20:1 stock split). The Company reports in United States Dollars and the original Swiss Franc price was retained only as a result of the original status of the parent company (AGHAG) before the establishment of the new Bermudan ultimate parent company Alea Group Holdings (Bermuda) Ltd. The impact of converting the Swiss Franc options to United States Dollars options does not change the fully diluted earnings per share and reduces the fully diluted operating earnings per share in 2003 from 55 cents to 54 cents per share.
The reconciliation between earnings per ordinary share and operating earnings per ordinary share is as follows:
Restated
Year ended Year ended
31 Dec 03 31 Dec 02
$'000 $'000
Profit for the financial year attributable
to equity shareholders 48,510 54,579
--------- ---------
Less Gain on purchase of
subordinated preferred 7,500 --
shares issued by subsidiaries
Short term fluctuations in
investment return (22,477) 33,322
Movement in claims equalisation (3,771) (2,368)
provisions --------- ---------
(18,748) 30,954
Tax thereon 4,251 (1,989)
--------- ---------
(14,497) 28,965
--------- ---------
Operating profit after tax 63,007 25,614
Earnings per share - basic ($) 0.42 0.52
Earnings per share - fully diluted ($) 0.42 0.51
Operating earnings per share - basic ($) 0.55 0.2
Operating earnings per share
-- fully diluted ($) 0.54 0.24
4. PRIOR YEAR ADJUSTMENTS
Reinsurers' share of technical provisions -- claims outstanding -- aggregate excess reinsurance
As part of the Listing process the Group reviewed the application of the deficit payback provisions of each of the Inter-Ocean Adverse Development cover, the Inter-Ocean Aggregate Excess Cover and the OPL Adverse Development Cover and determined that the previous financial statements made a fundamental error in that they did not fully reflect the consequences of the deficit payback and commutation/termination provisions of the contracts. Accordingly reinsurance recoverables were reduced by $24 million in respect of the 2000 annual financial result and by $6 million in respect of the 2001 annual financial result. These amounts have been accounted for as prior year adjustments in these financial statements.
Claims equalisation provision Also as part of the Listing process the Group has determined that it is appropriate to record in the accounts of the Group the Claims Equalisation Provision established by Alea London Limited. This change in accounting policy has been accounted for as a prior year adjustment.
A claims equalisation provision for the UK subsidiary has been established in accordance with Chapter 6 of the Interim Prudential Sourcebook for UK Insurers (prior to 1 December 2001, the requirements of the Insurance (Reserves) Act 1995 and the Insurance Companies (Reserves) Regulations 1996) for the purposes of mitigating exceptionally high loss ratios in future years. The amounts provided are not liabilities because they are in addition to the provisions required to meet the anticipated ultimate cost of settlement of outstanding claims at the balance sheet date.
Longer term rate of return
The Group has chosen to allocate investment income to the technical account from the non-technical account using the longer-term rate of return as recommended for listed companies per the ABI SORP. As this is a reallocation of the investment return within the Profit and Loss Account it has no impact on prior year reserves.
The impact of the change in accounting policy and the other prior year adjustment is as follows:
Year ended Year ended
31 Dec 03 31 Dec 02
$'000 $'000
Profit on ordinary activities after tax under
previous accounting policy 43,650 56,238
Change in the claims equalisation provision (3,771) (2,368)
Tax credit 1,131 709
-------- --------
(2,640) (1,659)
-------- --------
Restated profit on ordinary activities after 41,010 54,579
tax ======== ========
Shareholders' funds attributable to equity
interests as previously reported 728,042 442,198
Net effect of the change in accounting policy
as above (2,640) (1,659)
Prior year adjustment -- reinsurers' share of
technical provisions - claims outstanding --
aggregate excess reinsurance -- (30,000)
-------- --------
(2,640) (31,659)
-------- --------
Restated shareholders' funds attributable to
equity interests 725,402 410,540
======== ========
Profit and loss account as previously reported 17,598 (18,628)
Net effect of the change in accounting policy
as above (2,640) (1,659)
Prior year adjustment -- reinsurers' share of
technical provisions -- claims outstanding --
aggregate excess reinsurance -- (30,000)
-------- --------
(2,640) (31,659)
-------- --------
Restated profit and loss account 14,958 (50,287)
======== ========
5. CONTINGENT LIABILITIES
Structured settlements
The Group, through the Canadian branch of Alea Europe Ltd, has assumed ownership of certain structured settlements and has purchased annuities from life assurers to provide fixed and recurring payments to those underlying claimants. As a result of these arrangements, the Group is exposed to a credit risk to the extent that any of these insurers are unable to meet their obligations under the structured settlements. This risk is viewed by the Directors as being remote as the annuities are fully funded and the Group has only purchased annuities from Canadian insurers with a financial stability of AA or higher (Standard & Poor's). The Canadian branch is in run-off and the branch discontinued accepting assignments of annuities in August 2001. In the event of all the relevant life insurers being unable to meet their obligations under the structured settlements, the total exposure, net of amounts that may be recoverable from the Compensation Corporation of Canada (a Canadian industry-backed compensation scheme), is estimated to be 180 million Canadian Dollars ($139 million) and the maximum in relation to any one insurer 83 million Canadian Dollars ($64 million).
Litigation
Lumbermens is in dispute with PXRE Reinsurance Company ("PXRE"), who is seeking rescission (amongst other claims) in respect of a retrocession arrangement reinsuring Lumbermens excess of the 75% paid loss ratio through a retrocessional arrangement. On 26 August, 2003 Alea North America Company ("ANAC") was joined as a third party defendant in the lawsuit between PXRE Reinsurance Company and Lumbermens. The amount in issue is approximately $29.25 million. PXRE's maximum liability under the retrocessional arrangement is $50 million and it has been paid $20.75 million in premium. PXRE will be required to return premium with interest if it is entitled to rescission. Lumbermens has advised the Directors that it will vigorously defend itself against PXRE's claims. ANAC intends to vigorously defend the claims against it. Since ANAC was recently served with the third party complaint and is involved in ongoing discovery, the Directors believe it is premature to provide any assessment of the likelihood of Lumbermens' prevailing on PXRE's claims or ANAC prevailing on Lumbermens' claims.
A claim has been made against the Group and its indirect subsidiary ANAC by a former employee of ANAC alleging, inter alia, discrimination, harassment and retaliation for damages totalling $3.5 million. At this stage it is not possible to estimate the amount of any potential liability that may arise for the Group. The Group believes the allegations are unfounded and intends to vigorously defend itself against the claim. The Group has filed Notice of Service of its Motion for Summary Judgement.
No provision has been made in the accounts for either matter.
6. Note to the Consolidated Cash Flow Statement Reconciliation of profit on ordinary activities before tax to net cash inflow from operating activities
Restated
Year ended Year ended
31 Dec 03 31 Dec 02
$'000 $'000
Profit on ordinary
activities before tax 54,538 52,585
Depreciation of tangible
assets 5,868 5,561
(Profit)/Loss on disposal
of tangible assets (288) 457
Changes to market value and
currencies on investments (24,893) (24,319)
Losses on foreign exchange 9,095 5,746
Change in capital reserve -- (3,372)
Elimination of own shares -- (794)
Change in debtors arising
out of re/insurance (109,423) (172,274)
operations
Change in amounts due
from reinsurance operations not
transferring significant
insurance risk 6,044 25,429
Change in other assets (1,474) 110
Change in prepayments and
accrued income (1,395) (2,729)
Change in technical provisions 481,416 296,083
Change in claims equalisation
provision 3,771 2,368
Change in reinsurers' share
of technical provisions (165,849) (109,883)
Change in deposits with
ceding undertakings (13,407) (11,268)
Change in reinsurance
deposits and creditors 12,360 28,424
Change in liabilities from
reinsurance operations not
transferring significant
insurance risk (8,811) (6,806)
Change in other creditors (2,733) 2,684
Change in accruals and
deferred income 1,442 4,862
Debt interest expense 4,718 6,530
------------------------------- -------- ---------
Net cash inflow from operating
activities 250,979 99,394
=============================== ======== =========
7. RETURN ON EQUITY
Year ended Year ended
31 Dec 03 31 Dec 02
$'000 $'000
Profit after tax 48,510 54,579
Operating profit after tax 63,007 25,614
Net assets as at 30 June 444,927 371,337
Subordinated preferred equity 50,000 50,000
--------- ---------
494,927 421,337
Retained profit movement
1 July -- 31 December 6,374 40,117
Exchange movement 1 July --
31 December 1,009 (914)
--------- ---------
Net equity 31 December
excluding equity proceeds 502,310 460,540
--------- ---------
Repurchase of subordinated
preferred (42,500)
Net proceeds 1 July
-- 31 December 265,592
---------
223,092
---------
Net assets as at 31 December 725,402
---------
--------
Average equity proceeds (6 weeks) 25,741
---------
Average equity June excluding
proceeds 498,619 440,938
Weighted proceeds 25,741
--------- ---------
524,360 440,938
--------- ---------
Return on average equity 9.3% 12.4%
Operating return on average
equity 12.0% 5.8%
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