Item 1. Financial Statements
CastlePoint Holdings, Ltd.
Consolidated Balance Sheets
(Unaudited)
September 30, December 31,
2007 2006
------------- -------------
($ in thousands, except par
value and share amounts)
Assets
Fixed-maturity securities, available-for-sale, at fair value (amortized cost $494,769 for
2007; $293,878 for 2006) $ 494,332 $ 295,527
Equity securities, available-for-sale, at fair value (cost $46,233 for 2007; $0 for 2006) 40,085 --
Short-term investments, available-for-sale, at fair value (amortized cost $0 for 2007; $51,626
for 2006) -- 51,638
------------- -------------
Total available-for-sale investments 534,417 347,165
Investment in Tower Group, Inc. preferred stock -- 40,000
Investment in partnerships, equity method 9,351 --
Common trust securities - statutory business trusts, equity method 4,022 3,094
------------- -------------
Total investments 547,790 390,259
Cash and cash equivalents 127,576 34,784
Accrued investment income 4,049 2,211
Assumed premiums receivable (primarily with related parties - See note 3 ) 93,111 44,930
Premiums receivable - programs (primarily with related parties - See note 3 ) 2,644 1,295
Prepaid reinsurance premiums 2,343 --
Deferred acquisition costs (primarily with related parties - See note 3) 55,613 30,363
Deferred income taxes 4,067 1,089
Deferred financing fees 3,703 3,084
Funds held by reinsured companies 3,049 577
Other assets 2,085 2,750
------------- -------------
Total Assets $ 846,030 $ 511,342
============= =============
Liabilities and Shareholders' Equity
Liabilities
Loss and loss adjustment expenses (primarily with related parties - See note 3) $ 100,810 $ 34,192
Unearned premium (primarily with related parties - See note 3) 164,359 86,181
Assumed losses payable (primarily with related parties - See note 3) 3,798 3,496
Premiums payable-programs (primarily with related parties - See note 3) 5,799 1,072
Accounts payable and accrued expenses 1,658 2,869
Payable for securities 21,703 --
Other liabilities 1,105 725
Subordinated debentures 134,022 103,094
------------- -------------
Total Liabilities 433,254 231,629
------------- -------------
Shareholders' Equity
Common shares ($0.01 par value, 100,000,000 shares authorized; 38,289,430 and 29,580,000
shares issued in 2007 and 2006) 383 296
Additional paid-in-capital 384,492 269,472
Accumulated other comprehensive net (loss) income (5,863) 1,657
Retained earnings 33,764 8,288
------------- -------------
Total Shareholders' Equity 412,776 279,713
------------- -------------
Total Liabilities and Shareholders' Equity $ 846,030 $ 511,342
============= =============
|
See accompanying notes to the consolidated financial statements
1
CastlePoint Holdings, Ltd.
Consolidated Statements of Income and
Comprehensive Income
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2007 2006 2007 2006
------------------ --------------- ---------------- ---------------
($ in thousands, except share and per share amounts)
Revenues
Net premiums earned (primarily with related parties - See
note 3) $ 65,610 $ 27,003 $ 167,146 $ 47,390
Insurance service revenue (primarily with related parties
- See note 3) 1,667 854 3,902 1,392
Net investment income 7,538 3,791 21,417 6,697
Net realized investment (losses) gains (79) 7 (98) 10
------------------ --------------- ---------------- ---------------
Total revenues 74,736 31,655 192,367 55,489
------------------ --------------- ---------------- ---------------
Expenses
Loss and loss adjustment expenses (primarily with related
parties - See note 3) 34,482 13,919 87,790 25,297
Commission and other acquisition expenses (primarily with
related parties - See note 3) 24,147 9,903 60,110 17,421
Other operating expenses 4,268 2,448 11,983 8,998
Interest expense 2,254 -- 6,608 --
------------------ --------------- ---------------- ---------------
Total expenses 65,151 26,270 166,491 51,716
------------------ --------------- ---------------- ---------------
Income before income taxes 9,585 5,385 25,876 3,773
Income tax benefit 956 -- 2,254 --
------------------ --------------- ---------------- ---------------
Net income $ 10,541 $ 5,385 $ 28,130 $ 3,773
================== =============== ================ ===============
Comprehensive Income
Net income $ 10,541 $ 5,385 $ 28,130 $ 3,773
Other comprehensive income:
Gross unrealized investment holding (losses) gains
arising during period (2,032) 3,471 (7,977) 2,141
Less: reclassification adjustment for gains included
in net income 287 7 268 10
------------------ --------------- ---------------- ---------------
(2,319) 3,465 (8,245) 2,131
Income tax recovery related to items of other
comprehensive income 140 -- 725 --
------------------ --------------- ---------------- ---------------
Total other comprehensive (loss) income (2,179) 3,465 (7,520) 2,131
------------------ --------------- ---------------- ---------------
Comprehensive Income $ 8,362 $ 8,850 $ 20,610 $ 5,904
================== =============== ================ ===============
Earnings Per Share
Basic earnings per common share $ 0.28 $ 0.18 $ 0.79 $ 0.22
================== =============== ================ ===============
Diluted earnings per common share $ 0.27 $ 0.18 $ 0.78 $ 0.22
================== =============== ================ ===============
Weighted Average Common Shares Outstanding:
Basic 38,277,148 29,580,000 35,658,652 17,075,431
Diluted 38,549,306 29,780,879 36,008,824 17,075,431
|
See accompanying notes to the consolidated financial statements
2
CastlePoint Holdings, Ltd.
Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended September 30,
2007 2006
---------------- ----------------
($ in thousands)
Cash flows from operating activities:
Net income $ 28,130 $ 3,773
Adjustments to reconcile net income to net cash provided by (used in)
operations:
(Gain)/ loss on sale of investments 98 (10)
Depreciation and amortization 131 9
Amortization of bond premium or discount (438) (219)
Equity in limited partnership 499
Amortization of stock-based compensation expense 1,456 665
Amortization of deferred financing fees 78 --
Warrants issued -- 4,605
Deferred income taxes (2,254) --
(Increase)/decrease in assets:
Accrued investment income (1,837) (2,145)
Assumed premiums receivable (48,181) (31,466)
Premiums receivable - programs (1,350) (1,688)
Prepaid reinsurance premiums (2,343) --
Deferred acquisition costs (25,250) (24,200)
Funds held with reinsured companies (2,472) (309)
Other assets 246 (306)
Increase in liabilities:
Loss and loss adjustment expenses 66,618 22,230
Unearned premium 78,177 69,018
Assumed losses payable 303 1,655
Premiums' payable - programs 4,727 2,263
Accounts payable and accrued expenses (880) 837
Other liabilities 380 271
---------------- ----------------
Net cash flows provided by operations 95,838 44,983
---------------- ----------------
Cash flows from investing activities:
Cost of fixed assets purchased (998) (124)
Purchases of investments:
Cost of fixed-maturity securities purchased (384,713) (357,107)
Cost of equity securities (46,124) --
Sale of investments:
Proceeds from sales of fixed-maturity securities 205,966 73,174
Other investments 40,000 --
Cost of limited partnerships purchased (10,000) --
Net short term investments (purchased)/sold 51,626 (1,771)
---------------- ----------------
Net cash flows used in investing activities (144,243) (285,828)
---------------- ----------------
Cash flows from financing activities:
Net proceeds from Tower Group Inc. -- 15,000
Net proceeds from initial public offering 114,549 --
Net proceeds from private offering -- 248,901
Net proceeds from subordinated debentures 29,302 --
Dividends to shareholders (2,654) (1,479)
---------------- ----------------
Net cash flows provided by financing activities 141,197 262,422
---------------- ----------------
Increase in cash and cash equivalents 92,792 21,577
Cash and cash equivalents, beginning of period 34,784 --
---------------- ----------------
Cash and cash equivalents, end of period $ 127,576 $ 21,577
================ ================
Supplemental disclosures of cash flow information:
Cash paid for income taxes $ 19 $ --
Cash paid for interest $ 6,719 $ --
|
See accompanying notes to the consolidated financial statements
3
CastlePoint Holdings , Ltd.
Consolidated Statement of Changes in Shareholders' Equity
for the period ended September 30, 2007
(Unaudited)
Additional Accumulated Other Total
Common Paid-In Comprehensive Retained Shareholders'
Shares Capital Income Earnings Equity
----------- ------------- ----------------- ---------------- ---------------
($ in thousands)
----------- ------------- ----------------- ---------------- ---------------
Balance at December 31, 2006 $ 296 $ 269,472 $ 1,657 $ 8,288 $ 279,713
=========== ============= ================= ================ ===============
Initial public offering, net proceeds 87 113,564 113,651
Net income 28,130 28,130
Net unrealized losses (7,520) (7,520)
Stock based compensation 1,456 1,456
Dividends to shareholders (2,654) (2,654)
----------- ------------- ----------------- ---------------- ---------------
Balance at September 30, 2007 $ 383 $ 384,492 $ (5,863) $ 33,764 $ 412,776
=========== ============= ================= ================ ===============
|
See accompanying notes to the consolidated financial statements
4
CastlePoint Holdings, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
Note 1 - Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with instructions for Form 10-Q and in conformity with
Article 10 of Regulation S-X. Accordingly, the accompanying consolidated
financial statements do not include all of the information and footnote
disclosures required by generally accepted accounting principles ("GAAP") in the
United States of America. These statements should be read in conjunction with
the consolidated financial statements as of and for the year ended December 31,
2006 and notes thereto included in the Registration Statement on Form S-1 (File
No. 333-139939) of the Company relating to the initial public offering of its
common shares, initially filed with the Securities and Exchange Commission (the
"SEC") on January 11, 2007, as amended (as so amended, the "Registration
Statement"). The accompanying consolidated financial statements have not been
audited by an independent registered public accounting firm in accordance with
standards of the Public Company Accounting Oversight Board (United States), but
in the opinion of management such financial statements include all adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation of the Company's financial position and results of operations. The
results of operations for the three months and nine months ended September 30,
2007 may not be indicative of the results that may be expected for the year
ending December 31, 2007. The consolidated financial statements include the
accounts of CastlePoint Holdings, Ltd. (sometimes referred to as "CastlePoint
Holdings" or the "Company"), and its wholly owned subsidiaries, CastlePoint
Bermuda Holdings Ltd. ("CastlePoint Bermuda Holdings"), CastlePoint Reinsurance
Company, Ltd. ("CastlePoint Re"), CastlePoint Management Corp. ("CastlePoint
Management") and CastlePoint Insurance Company ("CastlePoint Insurance"). All
significant inter-company balances have been eliminated. Business segment
results are presented gross of all material inter-segment transactions.
Investments
The Company accounts for its investments generally in accordance with SFAS
No. 115, "Accounting for Certain Investments in Debt and Equity Securities"
("SFAS No. 115"), which requires that fixed-maturity and equity securities that
have readily determinable fair values be segregated into categories based upon
the Company's intention for those securities. In accordance with SFAS No. 115,
the Company has classified its fixed maturity securities and equity securities
as available-for-sale. The Company may sell its available-for-sale securities in
response to changes in interest rates, risk/reward characteristics, liquidity
needs or other factors. Investments in limited partnerships are accounted for
under the equity method, at cost or at fair value, depending upon the nature of
the partnership and the Company's ownership interest. See "--Investments in
partnerships and other funds" below. Short term investments are securities with
a remaining maturity of less than one year at the date of purchase and are
classified as available for sale.
Fixed maturity and equity securities: Marketable fixed-maturity securities
and equity securities are reported at their estimated fair values based
primarily on quoted market prices from a recognized pricing service or a broker-
dealer, with unrealized gains and losses, net of tax effects, excluded from net
income and reported as a separate component of accumulated other comprehensive
income in shareholders' equity. Premiums and discounts on fixed maturity
investments are charged or accreted to income over the anticipated life of the
investment. Net investment income, consisting of interest and dividends, net of
investment expenses, is recognized when earned and included in "Net investment
income" in the accompanying statement of income. Realized investment gains and
losses on the sale of investments are determined based on the specific
identification method and are included in the accompanying statement of income.
Investments in partnerships and other funds: Investments in limited
partnerships where the Company has more than a minor interest are accounted for
under the equity method of accounting pursuant to SOP 78-9, "Accounting for
Investments in Real Estate Ventures," and classified on the balance sheet as
"Investments in partnerships, equity method." The Company's share of net income
is reported in the Company's net investment income. The Company calculates its
share of net income on the basis of the Company's ownership percentage.
5
Investments in limited partnerships where the Company's interest is
considered to be minor and all other fund investments are accounted for at
either cost or fair value and classified on the balance sheet as "Equity
securities." For these investments, net investment income and realized gains and
losses are recognized as related distributions are received. Unrealized gains
(losses), net of tax effects, are excluded from net income and reported as a
separate component of accumulated other comprehensive income in shareholders'
equity. The Company calculates its fair value on the basis of the Company's
ownership percentage generally using the net asset value.
Common trust securities--statutory business trusts: The Company's
investment in the common trust securities of the trusts are reported as
investments in equities separately in the balance sheet. The securities are
recorded using the equity basis of accounting, which currently approximates
original cost.
Impairment of investment securities and limited partnerships results in a
charge to net realized gains or losses on investments when market value decline
below cost is deemed to be other-than-temporary. The Company regularly reviews
all investments to evaluate the necessity of recording impairment losses for
other-than-temporary declines in the fair value of investments. In general,
attention is focused on those securities where fair value has been less than 80%
of the amortized cost or cost, as appropriate, for six or more consecutive
months. In evaluating potential impairment, management considers, among other
criteria: the current fair value compared to amortized cost or cost, as
appropriate; the length of time the security's fair value has been below
amortized cost or cost; management's intent and ability to retain the investment
for a period of time sufficient to allow for any anticipated recovery in value;
specific credit issues related to the issuer; and current economic conditions.
Other-than-temporary impairment losses result in a permanent reduction of the
cost basis of the underlying investment. During 2007, the Company did not record
any other-than-temporary impairments.
Note 2 - Initial Public Offering
On March 28, 2007, we completed the sale of 8,697,148 common shares at
$14.50 in a firm commitment underwritten initial public offering. In addition,
119,500 shares were sold in that offering by selling shareholders who previously
purchased such shares in the private offering of our common shares we completed
in April 2006. Included in the 8,697,148 shares sold by us were 1,134,410 shares
purchased by the underwriters to cover over-allotments. The net proceeds to the
Company of the initial public offering were approximately $114 million after the
deduction of underwriting discounts and other estimated offering expenses.
The common shares of CastlePoint Holdings are listed on the Nasdaq Global
Market under the symbol "CPHL."
On August 6, 2007, the SEC declared effective the Company's Registration
Statement on Form S-1, as amended (Registration No. 333-134628) covering the
resale by selling shareholders named therein of 26,646,589 common shares
originally issued by the Company in the private offering completed in April
2006.
Note 3 - Related Party Transactions
The Company and/or its subsidiaries are parties to a master agreement,
certain reinsurance agreements, management agreements and service and expense
sharing agreements with Tower Group, Inc., a Delaware corporation that is
publicly traded in the U.S. ("Tower"), or its insurance subsidiaries. In
addition, CastlePoint Re participates as a reinsurer on Tower's property and
excess of loss reinsurance agreements.
Reinsurance Agreements: CastlePoint Re entered into three multi-year quota
share reinsurance agreements with Tower's insurance subsidiaries: the brokerage
business quota share reinsurance agreement, the traditional program business
quota share reinsurance agreement, and the specialty program business and
insurance risk-sharing business quota share reinsurance agreement. For the three
months ended March 31, 2007 CastlePoint Re assumed 49% of Tower's brokerage
business under the brokerage business quota share reinsurance agreement. For the
three months ended June 30, 2007, CastlePoint Re's participation in the
brokerage business quota share reinsurance agreement was reduced to 40% and
CastlePoint Insurance participated in that agreement 9%, keeping the overall
percentage participation of CastlePoint at 49%. As of July 1, 2007, Tower began
placing brokerage business directly into CastlePoint Insurance and consequently
CastlePoint Insurance no longer participated in the brokerage business quota
share reinsurance agreement, while CastlePoint Re continued to participate in
that agreement at 40%.
6
There were no changes during the nine months ended September 30, 2007 to
our arrangements with Tower pursuant to the traditional program business quota
share reinsurance agreement and the specialty program business and insurance
risk-sharing business quota share reinsurance agreement.
Premiums receivable from and losses payable to Tower as of September 30,
2007 were $70.5 million and $3.3 million, respectively, compared to $42.4
million and $3.5 million as of December 31, 2006. The unearned premium reserves
and loss reserves with Tower as of September 30, 2007 were $137.2 million and
$87.1million, respectively, compared to $80.7 million and $33.2 million as of
December 31, 2006. Deferred acquisition costs were $46.3 million and $28.0
million as of September 30, 2007 and December 31, 2006, respectively. The total
underwriting impact related to our agreements with Tower discussed above is as
follows:
Three Months Ended September 30, Nine Months Ended September 30,
2007 2006 2007 2006
-------------- ------------------ --------------- -----------------
($ in thousands)
Net premiums earned $ 53,751 $ 26,104 $ 137,526 $ 46,441
Net losses incurred 28,058 13,495 70,907 24,846
Net commission expense 18,768 8,975 48,066 16,075
|
Management Agreements: The New York State Insurance Department did not
approve the pooling agreements and related pool management agreements between
Tower and CastlePoint Insurance that were to take effect as of January 1, 2007.
Consequently, in June 2007 the Company and Tower withdrew the pooling agreements
and related pool management agreements from consideration by the New York State
Insurance Department, and the Company filed alternative insurance risk-sharing
agreements and related business management agreement for the brokerage business.
The New York State Insurance Department has approved the business management
agreement, although the two aggregate excess of loss reinsurance agreements for
the brokerage business, which are part of the alternative insurance risk-sharing
agreements, currently remain subject to regulatory review. The accompanying
unaudited consolidated financial statements include the effects of all our
agreements, but do not include the effects of the two aggregate excess of loss
reinsurance agreements for the brokerage business because they remain subject to
further regulatory review.
The business management agreement for brokerage business with Tower Risk
Management Corp. that has been approved by the New York State Insurance
Department provides that Tower Risk Management Corp., a subsidiary of Tower, is
authorized to write brokerage business using CastlePoint Insurance's policies
and manage such business for CastlePoint Insurance. For managing such business,
Tower Risk Management Corp. is paid a management fee calculated using the
sliding-scale formula that was originally intended by the master agreement to be
paid to Tower Insurance Company of New York for managing the brokerage business,
net of specific aggregate and property catastrophe excess of loss reinsurance
costs.
The Company and Tower jointly submitted two aggregate excess of loss
reinsurance agreements for the brokerage business for review by the New York
State Insurance Department. These agreements remain subject to regulatory
review. The purpose of the two aggregate excess of loss reinsurance agreements
is to cause the loss ratios for the brokerage business of CastlePoint Insurance
and Tower to be approximately equal. Under the first agreement, Tower will
reinsure 85% (which percentage will be adjusted to equal Tower's actual
percentage of the total brokerage business written by Tower and CastlePoint
Insurance) of CastlePoint Insurance's brokerage business losses that are in
excess of a specified loss ratio for brokerage business written through Tower
Risk Management Corp., net of premiums paid for specific excess reinsurance,
property catastrophe reinsurance and facultative reinsurance, if any, which
inure to the benefit of the agreement, and before any cessions to quota share
reinsurance. Under the second agreement, CastlePoint Insurance will reinsure 15%
(which percentage will be adjusted to equal CastlePoint's actual percentage of
the total brokerage business written by Tower and CastlePoint) of Tower's
brokerage business losses that are in excess of the same specified loss ratio,
net of premiums paid for specific excess reinsurance, property catastrophe
reinsurance and facultative reinsurance, if any, which inure to the benefit of
the agreement, and before any cessions to quota share reinsurance.
7
CastlePoint Management is a party to program management agreements with
Tower, whereby CastlePoint Management was appointed to perform certain
underwriting and claims services with respect to program business. Premiums
collected and due to Tower for program business at September 30, 2007 were $2.8
million. For the three months and nine months ended September 30, 2007,
CastlePoint Management recorded commission revenue of $1.5 million and $3.7
million, respectively, from Tower.
Service and Expense Sharing Agreements: CastlePoint Management is a party
to service and expense sharing agreements with Tower and certain of its
subsidiaries. Tower charged CastlePoint Management $0.2 million for the three
months ended September 30, 2007 and $0.5 million, for the nine months ended
September 30, 2007 for services rendered in support of CastlePoint Management's
infrastructure as contemplated by the service and expense sharing agreements.
In addition to the services rendered in support of CastlePoint
Management's infrastructure, Tower rendered services for CastlePoint
Management's program business contemplated by the service and expense sharing
agreements. For these services, Tower charged CastlePoint Management $0.1
million for the three months ended September 30, 2007 and $0.3 million for the
nine months ended September 30, 2007.
Note 4 - Investments
The amortized cost and fair value of the investments by investment type as
of September 30, 2007 and December 31, 2006 are as follows:
Cost or Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ----------- ------------ ---------
($ in thousands)
September 30, 2007:
Fixed Maturities:
US government and agencies securities $ 30,895 $ 90 $ (11) $ 30,975
Corporate fixed maturities 125,768 801 (768) 125,800
Mortgage and asset-backed securities 338,106 1,537 (2,086) 337,557
---------- ----------- ------------ ---------
Total fixed maturities 494,769 2,428 (2,865) 494,332
Equity Securities 46,233 38 (6,186) 40,085
---------- ----------- ------------ ---------
Total available-for-sale investments $ 541,002 $ 2,466 $ (9,051) $ 534,417
========== =========== ============ =========
December 31, 2006:
Fixed Maturities:
US government and agencies securities $ 18,650 $ 19 $ (10) $ 18,659
Corporate fixed maturities 88,785 398 (22) 89,161
Mortgage and asset-backed securities 186,443 1,342 (78) 187,707
---------- ----------- ------------ ---------
Total fixed maturities 293,878 1,759 (110) 295,527
Short term investments 51,626 12 -- 51,638
---------- ----------- ------------ ---------
Total available-for-sale investments $ 345,504 $ 1,771 $ (110) $ 347,165
========== =========== ============ =========
|
The Company's invested assets that were in an unrealized loss position at
September 30, 2007 and December 31, 2006 had all been held for less than 12
months. In applying its accounting policy, the Company determined that it did
not need to record any other than-temporary impairment charges. Management has
both the ability and intent to hold securities in an unrealized loss position
until recovery in value.
Included in net investment income are the results of the Company's
investment in limited partnerships. For the three months ended September 30,
2007, the Company recorded a net investment loss of $0.7 million comprised of
net investment income of $0.2 million, realized gains of $0.4 million and an
unrealized loss of $1.3 million. For the nine months ended September 30, 2007,
the Company recorded a net investment loss of $0.6 million comprised of net
investment income of $0.3 million, realized gains of $0.4 million and an
unrealized loss of $1.3 million. There were no investments in partnerships in
2006.
8
Redemption of Tower Non-Cumulative Convertible Redeemable Perpetual
Preferred Stock
On December 4, 2006, CastlePoint Management purchased 40,000 shares of
Series A non-cumulative convertible redeemable perpetual preferred stock (as
subsequently exchanged for a new series of such convertible perpetual preferred
stock reflecting substantially similar terms, the "perpetual preferred stock")
of Tower, for an aggregate consideration of $40 million. CastlePoint Management
completed such purchase pursuant to an assignment by CastlePoint Re of its
related obligations under a stock purchase agreement CastlePoint Re entered into
with Tower in November 2006.
Tower redeemed all of its perpetual preferred stock held by CastlePoint
Management on January 26, 2007, at the redemption price of $40 million in the
aggregate plus approximately $0.3 million in interest that was paid in January
2007. We used the proceeds of such redemption to further capitalize CastlePoint
Insurance. Although Tower effected such redemption, we retained the right of
first refusal from Tower, with respect to any insurance companies Tower may
acquire during the term of our master agreement, subject to the receipt of any
necessary regulatory approvals, to assume such companies' historical losses
pursuant to a loss portfolio transfer agreement (which must be on mutually
acceptable market competitive terms) if Tower desires to cause these insurance
companies to effect loss portfolio transfers.
Note 5 - Accounting Pronouncements
In February 2006, the Financial Accounting Standards Board (FASB) issued
SFAS No.155, "Accounting for Certain Hybrid Financial Instruments, an amendment
of SFAS No.133 and SFAS No.140" (SFAS 155) and Statement 133 Implementation
Issue No. B40, "Embedded Derivatives: Application of Paragraph 13 (b)
Securitized Interests in Prepayable Financial Assets" ("B40"). SFAS 155 is
effective for all financial instruments acquired or issued after January 1,
2007. B40, under specific criteria, is effective July 1, 2007. SFAS 155 provides
entities with relief from having to separately determine the fair value of an
embedded derivative that would otherwise be required to be bifurcated from its
host contract in accordance with SFAS 133. SFAS 155 allows an entity to make an
irrevocable election to measure such a hybrid financial instrument at fair value
in its entirety, with changes in fair value recognized in earnings. The election
may be made on an instrument-by-instrument basis and can be made only when a
hybrid financial instrument is initially recognized or when certain events occur
that constitute a remeasurement (i.e., new basis) event for a previously
recognized hybrid financial instrument. B40 provides a narrow scope exception
for certain securitized interests from the tests required under paragraph 13 (b)
of SFAS No. 133. Adoption of SFAS 155 and B40 has not had a material impact on
the Company's consolidated financial condition or results of operations.
In June 2006, the FASB issued FIN No. 48 ("FIN 48") "Accounting for
Uncertainty in Income Taxes," an Interpretation of FASB Statement No. 109 ("SFAS
109"). FIN 48 is effective for fiscal years beginning after December 15, 2006.
FIN 48 provides an interpretation to SFAS 109 with respect to the recognition
and measurement of tax uncertainties. Specifically, it prescribes a recognition
threshold and a measurement attribute for the financial statement recognition
and measurement for uncertain tax positions taken or expected to be taken in
income tax returns. The Company is to determine whether it is "more likely than
not" (i.e., greater than 50% certain) that our position would be sustained upon
examination by tax authorities. Tax positions that meet the "more likely than
not" threshold are then measured using a probability weighted approach
recognizing the largest amount of tax benefit that has greater than a 50%
likelihood of being realized upon ultimate settlement. The adoption of FIN 48
has not had a material impact on the Company's consolidated financial condition
or results of operations. Interest on underpayment of taxes will be shown on the
Consolidated Statements of Income and Comprehensive Income as "interest
expense." Penalties accrued will be classified as "other expense."
In September 2006, the FASB issued SFAS No. 157 ("SFAS 157"), "Fair Value
Measurements". The provisions of SFAS 157 are effective for financial statements
issued in respect of fiscal years beginning after November 15, 2007. This new
standard provides guidance for using fair value to measure assets and
liabilities. Under SFAS 157, fair value refers to the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants in the market in which the reporting
entity transacts. In this standard, the FASB clarifies the principle that fair
value should be based on the assumptions market participants would use when
pricing the asset or liability. In support of the principle, SFAS 157
establishes a fair value hierarchy that prioritizes the information used to
develop those assumptions. The fair value hierarchy gives the highest priority
to quoted prices in active markets and the lowest priority to unobservable data
such as the reporting entity's own data. Under the standard, fair value
measurements would be separately disclosed by level within the fair value
hierarchy. The Company is currently reviewing the impact that adoption of SFAS
157 will have on its consolidated financial position and results of operations.
9
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities" ("SFAS 159"). The standard is
effective as of the beginning of an entity's first fiscal year that begins after
November 15, 2007. This statement permits entities to choose to measure many
financial instruments and certain other items at fair value at specified
election dates. The objective is to improve financial reporting by providing the
entities with the opportunity to mitigate volatility in reported earnings caused
by measuring related assets and liabilities differently without having to apply
complex hedge accounting provisions. This standard also establishes presentation
and disclosure requirements designed to facilitate comparisons between entities
that choose different measurement attributes for similar types of assets and
liabilities. This statement is expected to expand the use of fair value
measurement. The Company is currently reviewing the impact that adoption of SFAS
159 will have on its consolidated financial position and results of operations.
In January 2007, the AICPA issued Statement of Position (SOP) 07-01,
Clarification of the Scope of the Audit and Accounting Guide "Investment
Companies" and Accounting by Parent Companies and Equity Method Investees for
Investments in Investment Companies. In October 2007, the AICPA voted to
indefinitely defer the effective date of SOP 07-1 (Investment Company Scope) so
that certain implementation issues may be addressed. The decision to defer the
SOP will be subject to a 30-day comment period. The guidance provides for
determining whether an entity is within the scope of the AICPA Audit and
Accounting Guide (AAG), Audits of Investment Companies. In addition, for such
entities, SOP 07-1 also provides guidance concerning whether specialized
industry accounting principles as set forth in the AAG should be applied by a
parent company in consolidation or by an equity method investor in an investment
company. The Company is currently reviewing the impact that adoption of SOP 07-1
will have on its consolidated financial position and results of operations.
Note 6 -Dividends Declared
Dividends declared by the Company on its common shares for the three
months ended September 30, 2007 were $957,236, or $0.025 per share. For the nine
months ended September 30, 2007, dividends declared by the Company on its common
shares were $2,653,794 or $0.075 per share. For three months and nine months
ended September 30, 2006, the Company declared a quarterly dividend of $0.025
per share and a special dividend of $0.025 per share, in the aggregate amount of
$1,479,000.
10
Note 7 - Earnings Per Share
The following table shows the computation of the Company's earnings per
share:
Income Shares Per Share
(Numerator) (Denominator) Amount
-------------------- ---------------- -------------------
($ in thousands, except shares and per share amounts)
Three Months Ended
September 30, 2007
Net income $ 10,541
--------------------
Basic earnings per share 10,541 38,277,148 $ 0.28
===================
Effect of dilutive securities:
Stock options 51,106
Unvested restricted stock 0
Warrants 221,051
-------------------- ---------------- -------------------
Diluted earnings per share $ 10,541 38,549,306 $ 0.27
==================== ================ ===================
Three Months Ended
September 30, 2006
Net income $ 5,385
--------------------
Basic income per share 5,385 29,580,000 $ 0.18
===================
Effect of dilutive securities:
Stock options 98,424
Unvested restricted stock 0
Warrants 102,455
-------------------- ---------------- -------------------
Diluted earnings per share $ 5,385 29,780,879 $ 0.18
==================== ================ ===================
Nine Months Ended
September 30, 2007
Net income $ 28,130
--------------------
Basic earnings per share 28,130 35,658,652 $ 0.79
===================
Effect of dilutive securities:
Stock options 76,960
Unvested Restricted Stock 0
Warrants 273,212
-------------------- ----------------
Diluted earnings per share $ 28,130 36,008,824 $ 0.78
==================== ================ ===================
Nine Months Ended
September 30, 2006
Net income $ 3,773
--------------------
Basic per share 3,773 17,075,431 $ 0.22
-------------------- ---------------- ===================
Diluted per share $ 3,773 17,075,431 $ 0.22
==================== ================ ===================
|
Basic earnings per common share is net income divided by the weighted
average number of common shares outstanding during the period. Diluted earnings
per common share includes the dilutive effect of additional potential common
shares issuable under agreements relating to grants or issuances thereof. For
the three months ended September 30, 2007 and September 30, 2006, weighted
outstanding stock options of 542,829 and zero and weighted restricted stock of
9,988 and zero, respectively, were not considered in computing diluted earnings
per share because they were antidilutive. For the nine months ended September
30, 2007 and September 30, 2006, weighted outstanding stock options of 381,957
and 608,355, weighted outstanding warrants of zero and 1,127,000, and weighted
restricted stock of 5,220 and zero, respectively, were not considered in
computing diluted earnings per share because they were antidilutive.
11
Note 8 -Employee Stock Option Plan
The Company adopted the provision of SFAS No. 123-R effective January 1,
2006 and granted all of its stock options after that date. The compensation cost
of awards is based on the grant-date value of those awards as calculated under
SFAS No. 123-R and amortized over the vesting period. The Company's 2006
Long-Term Equity Compensation Plan (the "Plan") provides for grants of any
option, stock appreciation right ("SAR"), restricted share, restricted share
unit, performance share, performance unit, dividend equivalent or other
share-based award. The total number of shares initially reserved for issuance
under the Plan was 1,735,021 common shares, of which 1,126,166 options were
issued to senior management and non-employee directors of the Company and its
subsidiaries in 2006; 539,447 options were issued to non-employee directors and
certain officers and employees of the Company and its subsidiaries during the
three months ended March 31, 2007; and an additional 16,807 options were issued
to senior management for the three months ended June 30, 2007. The Company did
not grant any options during the three months ended September 30, 2007. The Plan
is administered by the Compensation Committee of the Board of Directors of the
Company. The stock options granted to employees vest in installments over 42
months of service and the stock options and restricted shares granted to
non-employee directors vest after 12 months of service. No SARs have been
granted to date. Each of the Company's three current non-employee directors
received 4,094 restricted common shares during the nine months ended September
30, 2007.
As of September 30, 2007, there was $4.5 million of unrecognized
compensation costs related to 1,242,650 non-vested stock options. For employees,
the cost is expected to be recognized over the vesting periods of the individual
options which extend to 42 months. For non-employee directors, the cost is
expected to be recognized over the vesting period of 12 months. For the nine
months ended September 30, 2007, the Company recognized $1.5 million of
compensation expense related to share-based compensation.
Nine Months Ended Nine Months Ended
September 30, 2007 September 30, 2006
------------------------------- -------------------------------
Weighted
Number of Average Number of Weighted Average
Shares Exercise Price Shares Exercise Price
--------------- --------------- -------------- ----------------
Outstanding, beginning of period 1,082,666 $ 10.00 -- $ --
Granted at market value 566,254 14.52 1,126,166 10.00
Forfeitures and expirations (20,137) -- (43,500) --
Exercised -- -- -- --
--------------- --------------
Outstanding, end of period 1,618,783 10.90 1,082,666 10.00
=============== ==============
Exercisable, end of period 376,133 10.00 -- --
=============== ==============
Weighted average fair value per share
of options granted 4.28 4.09
|
Options outstanding are shown on the following schedule:
Options exercisable
----------------------
Average Weighted Weighted
Remaining Average Average
Number of Contractual Exercise Number of Exercise
Exercise Prices Shares Life Price Shares Price
--------------------- -------------------------------------- ----------------------
December 31, 2006:
$10.00 1,082,666 9.25 years $ 10.00 -- --
-------------------------------------- ----------------------
Total Options 1,082,666 9.25 years $ 10.00 -- --
====================================== ======================
September 30, 2007:
$10.00 1,082,666 8.50 years $ 10.00 376,133 $ 10.00
$14.50 519,310 9.50 years $ 14.50 -- --
$15.25 16,807 9.60 years $ 15.25 -- --
-------------------------------------- ----------------------
Total Options 1,618,783 8.83 years $ 10.90 376,133 $ 10.00
====================================== ======================
|
12
Note 9 -Reserves
The components of the liability for loss and loss adjustment expenses are
as follows:
September 30, 2007 December 31, 2006
------------------- -------------------
($ in thousands)
Case-basis reserves $ 40,515 $ 11,813
IBNR reserves 60,295 22,379
------------------- -------------------
Total $ 100,810 $ 34,192
=================== ===================
|
Activity in the liability for loss and loss adjustment expenses is
summarized as follows:
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, 2007 September 30, 2006 September 30, 2007 September 30, 2006
------------------ ------------------ ------------------- ------------------
($ in thousands)
Balance at beginning of period: $ 73,288 $ 10,764 $ 34,192 $ --
Incurred related to:
Current year 34,861 13,919 88,365 25,297
Prior years (379) -- (575) --
------------------ ------------------ ------------------- ------------------
Total incurred 34,482 13,919 87,790 25,297
Loss portfolio transfer -- -- -- 21
Paid and payable related to :
Current year 6,172 2,453 11,172 3,088
Prior years 788 -- 10,000 --
------------------ ------------------ ------------------- ------------------
Total paid and payable 6,960 2,453 21,172 3,088
------------------ ------------------ ------------------- ------------------
Balance at end of period $ 100,810 $ 22,230 $ 100,810 $ 22,230
================== ================== =================== ==================
|
Prior year favorable development of $379,000 for the three months ended
September 30, 2007 is due to favorable experience in the Company's brokerage
business quota share reinsurance agreement with Tower and, to a lesser extent,
in Tower's property and casualty excess of loss reinsurance agreements, in which
CastlePoint Re participates, and in a specialty program.
Prior year favorable development of $575,000 for the nine months ended
September 30, 2007 is primarily due to favorable experience in the Company's
brokerage business quota share reinsurance agreement with Tower and, to a lesser
extent, Tower's property and casualty excess of loss reinsurance agreements, in
which CastlePoint Re participates.
Note 10 - Segment Information
The Company reports its results in three business segments: reinsurance,
insurance and insurance services. The insurance segment includes the results of
CastlePoint Insurance and will include the results of any other U.S. licensed
insurance companies that we may acquire and of CastlePoint Re for excess lines
written on a primary basis. The reinsurance segment includes the results from
the reinsurance business written through CastlePoint Re. The insurance services
segment includes the results from managing the program business. The insurance
services segment will include results from providing unbundled insurance
services to program underwriting agents, although no such services were provided
prior to September 30, 2007.
The Company evaluates segment performance based on segment profit, which
excludes investment income, realized gains and losses, general corporate
expenses, interest expenses, income taxes and any other non-core business income
or expenses.
13
The Company does not allocate assets to segments because assets, which
consist primarily of investments, are considered in total by management for
decision-making purposes.
Tower is a major customer of the Company. See Note 3 "Related Party
Transactions." The breakdown of net earned premiums from Tower by segment is as
follows:
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2007 2006 2007 2006
Reinsurance Segment $ 49,265 $ 26,104 $ 131,709 $ 46,411
Insurance Segment 4,486 -- 5,817 --
Total 53,751 26,104 137,526 46,441
|
The reinsurance segment's geographic risk spread is concentrated in the
northeastern U.S., as Tower represents the largest client of this segment and
Tower's writings are concentrated in the Northeast of the U.S. CastlePoint Re is
geographically expanding, as (1) non-Tower business continues to grow as a
percentage of total business, and (2) Tower pursues its own geographic
expansion.
The products provided by the reinsurance segment are predominantly quota
share reinsurance and, to a lesser extent, excess of loss reinsurance provided
to regional U.S. insurance companies. The products provided by the insurance
segment are insurance for programs produced by program underwriting agents and
insurance provided for U.S. regional companies on a direct or assumed basis.
All customers of the insurance segment are located in the U.S. The
reinsurance segment conducts all of its business in Bermuda, but all of the
underlying risks are located in the U.S.
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- --------------------
2007 2006 2007 2006
----------- ---------- --------- ----------
($ in thousands)
Insurance Segment
Revenues:
Net premiums earned $ 4,644 $ -- $ 5,975 $ --
----------- ---------- --------- ----------
Total revenues 4,644 -- 5,975 --
----------- ---------- --------- ----------
Expenses:
Net loss and loss adjustment expenses 2,997 -- 3,715 --
Underwriting expenses 2,127 -- 2,697 --
----------- ---------- --------- ----------
Total expenses 5,124 -- 6,412 --
----------- ---------- --------- ----------
Segment loss $ (480) $ -- $ (437) $ --
=========== ========== ========= ==========
|
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ---------------------
2007 2006 2007 2006
------------ ---------- ---------- ----------
($ in thousands)
Reinsurance Segment
Revenues:
Net premiums earned $ 60,965 $ 27,003 $ 161,171 $ 47,390
------------ ---------- ---------- ----------
Total revenues 60,965 27,003 161,171 47,390
------------ ---------- ---------- ----------
Expenses:
Net loss and loss adjustment expenses 31,485 13,919 84,075 25,297
Commission expenses 20,929 9,286 54,634 16,405
Other underwriting expenses 1,125 331 2,614 535
------------ ---------- ---------- ----------
Total expenses 53,539 23,537 141,323 42,238
------------ ---------- ---------- ----------
Segment profit $ 7,426 $ 3,465 $ 19,848 $ 5,153
============ ========== ========== ==========
|
14
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- --------------------
2007 2006 2007 2006
----------- ---------- ---------- ---------
($ in thousands)
Insurance Services Segment
Revenues:
Direct commission revenue from program business $ 1,667 $ 854 $ 3,902 $ 1,392
----------- ---------- ---------- ---------
Total revenues 1,667 854 3,902 1,392
----------- ---------- ---------- ---------
Expenses:
Direct commission expenses from program business 1,222 617 2,930 1,016
Other insurance services expenses 1,435 1,032 4,566 1,757
----------- ---------- ---------- ---------
Total expenses 2,657 1,649 7,496 2,773
----------- ---------- ---------- ---------
Segment loss $ (990) $ (795) $ (3,594) $ (1,381)
=========== ========== ========== =========
|
Three Months Nine Months
Ended September 30, Ended September 30,
----------------------- ---------------------
2007 2006 2007 2006
------------ ---------- ----------- ---------
($ in thousands)
Revenues:
Insurance segment $ 4,644 $ -- $ 5,975 $ --
Reinsurance segment 60,965 27,003 161,171 47,390
Insurance services segment 1,667 854 3,902 1,392
------------ ---------- ----------- ---------
Total segment revenues 67,277 27,857 171,048 48,782
------------ ---------- ----------- ---------
Net Investment income 7,538 3,791 21,417 6,697
Net realized capital (losses)/gains (79) 7 (98) 10
------------ ---------- ----------- ---------
Consolidated revenues $ 74,735 $ 31,655 $ 192,367 $ 55,489
============ ========== =========== =========
|
Three Months Nine Months
Ended September 30, Ended September 30,
---------------------- ---------------------
2007 2006 2007 2006
----------- ---------- ---------- ----------
($ in thousands)
Insurance segment loss $(480) $-- $(437) $--
Reinsurance segment profit 7,426 3,465 19,848 5,153
Insurance services segment loss (990) (795) (3,594) (1,381)
----------- ---------- ---------- ----------
Segment profit 5,957 2,670 15,817 3,772
Net investment income 7,538 3,791 21,417 6,6967
Net realized capital (losses)/gains (79) 7 (98) 10
Corporate expenses (1,576) (1,083) (4,652) (2,100)
Interest expense (2,254) -- (6,608) --
Other expense -- -- -- (4,605)
----------- ---------- ---------- ----------
Income before taxes $9,585 $5,385 $25,876 $3,773
=========== ========== ========== ==========
|
15
Note 11 - Trust Agreements
Under the terms of the quota share reinsurance agreements between
CastlePoint Re and Tower's insurance companies, CastlePoint Re is required to
provide security to Tower's insurance companies to support reinsurance
recoverables owed to these reinsureds in a form acceptable to the insurance
commissioners of the State of New York and Commonwealth of Massachusetts, the
domiciliary states of Tower's insurance companies. These trust arrangements
permit Tower's insurance companies to take credit on their statutory financial
statements for the reinsurance ceded to CastlePoint Re, either as an additional
asset or as a reduction in liability. CastlePoint Re is also required by its
reinsurance agreements with its other cedents to collateralize amounts through a
letter of credit, cash advance, funds held or a trust account meeting the
requirements of the applicable state insurance regulations.
As of September 30, 2007, CastlePoint Re had fixed maturities and cash
held in trust accounts for the benefit of its reinsureds totaling approximately
$181.9 million, an increase of approximately $84.1 million since December 31,
2006. CastlePoint Re earns and collects the interest on the trust funds.
Note 12 - Subsequent Events
On October 31, 2007, the Board of Directors of CastlePoint Holdings
approved a quarterly dividend of $0.025 per share payable December 31, 2007 to
the Company's shareholders of record as of December 17, 2007.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Note on Forward-Looking Statements
Some of the statements in this quarterly report, including without
limitation, in the section entitled "Management's Discussion and Analysis of
Financial Condition and Results of Operations," including those using words such
as "believes," "expects," "intends," "estimates," "projects," "predicts,"
"assumes," "anticipates," "plans" and "seeks," and comparable terms, are
forward-looking statements. Forward-looking statements are not statements of
historical fact and reflect our views and assumptions as of the date of this
quarterly report regarding future events and operating performance. Because we
have a very limited operating history, many statements relating to us and our
business, including statements relating to our competitive strengths and
business strategies, are forward-looking statements.
All forward-looking statements address matters that involve risks and
uncertainties. Accordingly, there are important factors that could cause our
actual results to differ materially from those indicated in these statements. We
believe that these factors include, but are not limited to, the risk factors
identified in our Registration Statement on Form S-1 (File No. 333-139939)
relating to the initial public offering, initially filed with the SEC on January
11, 2007 (as amended, the "Registration Statement") and the following:
o our relatively short operating history and our delays in receiving
regulatory approval for some of the transactions described in this
quarterly report and/or in our other filings with the SEC;
o our heavy dependence on Tower for revenue in our initial years of
operation, and possibly beyond, and the continued growth of Tower's
business, including as a result of its acquisition of Preserver Group
Inc. in April 2007, in the future consistent with Tower's past growth;
o the risk that CastlePoint Bermuda Holdings or CastlePoint Holdings may
be deemed to be engaged in a U.S. trade or business, or CastlePoint Re
may be considered to be doing business through a permanent
establishment in the U.S., either of which would subject these
companies to U.S. taxation, which could have a material adverse effect
on our business, financial condition and results of operations;
o the terms of our arrangements with Tower may change as a result of the
regulatory review and approval process;
16
o our ability to write premiums with clients other than Tower;
o the possibility that we may need additional capital to further
capitalize CastlePoint Re and CastlePoint Insurance for our
reinsurance business and insurance business, respectively, as well as
at least one additional broadly licensed U.S. insurance company for
our insurance business, and to make strategic investments in some of
our clients, including Tower, and the risk that we may not be able to
obtain future financing on favorable terms or at all;
o our ability to hire, retain and integrate our management team and
other personnel;
o the risk that we may not be able to implement our business strategy;
o the ineffectiveness or obsolescence of our planned business strategy
due to changes in current or future market conditions;
o changes in regulation or tax laws applicable to us, our brokers or our
customers;
o changes in the availability, cost or quality of insurance business
that meets our reinsurance underwriting standards;
o actual results, changes in market conditions, the occurrence of
catastrophic losses and other factors outside our control that may
require us to alter our anticipated methods of conducting our
business, such as the nature, amount and types of risk we assume and
the terms and limits of the products we intend to write;
o inability of any additional U.S. licensed insurance companies that we
may acquire to obtain acceptable ratings from A.M. Best;
o possible future downgrade in the rating of CastlePoint Re, CastlePoint
Insurance or any additional U.S. licensed insurance companies we may
acquire. See also "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Ratings";
o changes in rating agency policies or practices;
o changes in accounting policies or practices; and
o changes in general economic conditions, including inflation, foreign
currency exchange rates, interest rates and other factors.
This list of factors is not exhaustive and should be read with the other
cautionary statements that are included in this quarterly report.
If one or more of these or other risks or uncertainties materialize, or if
our underlying assumptions prove to be incorrect, actual results may vary
materially from our projections. Any forward-looking statements you read in this
quarterly report reflect our current views with respect to future events and are
subject to these and other risks, uncertainties and assumptions relating to,
among other things, our operations, results of operations, growth strategy and
liquidity. All subsequent written and oral forward-looking statements
attributable to us or individuals acting on our behalf are expressly qualified
in their entirety by this paragraph. All investors and potential investors in
our common shares should specifically consider the factors identified in this
quarterly report and the risk factors identified in our Registration Statement
filed with the SEC that could cause actual results to differ from those
discussed in the forward-looking statements before making an investment
decision. We undertake no obligation to publicly update or review any
forward-looking statement, whether as a result of new information, future events
or otherwise.
17
Critical Accounting Estimates
The Company's consolidated financial statements and the related
disclosures included in this quarterly report have been prepared in accordance
with U.S. GAAP. The preparation of financial statements in accordance with U.S.
GAAP requires management to make estimates and assumptions that affect reported
and disclosed amounts of assets and liabilities, as well as disclosure of
contingent assets and liabilities as at the balance sheet date and the reported
amounts of revenues and expenses during the reporting period. We believe the
following accounting policies are critical to our operations, as their
application requires management to make the most significant judgments. We
believe the items that require the most subjective and complex estimates are:
o premiums;
o losses and loss adjustment expense reserves;
o deferred acquisition costs;
o investments;
o reinsurance accounting;
o deferred taxes; and
o U.S. taxation.
Of the items mentioned above, management believes that a discussion of
premiums, losses and loss adjustment expense reserves, deferred tax and U.S.
taxation is appropriate in this quarterly report due to the developments that
occurred during the third quarter of 2007. More information regarding our other
critical accounting estimates is included in the section entitled "Critical
Accounting Estimates" in the "Management Discussion and Analysis of Financial
Condition and Results of Operations" included in the Registration Statement.
Regarding premium estimates, while we attempt to obtain current assumed
premiums written statements from ceding companies, it is common that the most
recent month statements are not received from the ceding company until after the
period ending and, in some cases, the most recent quarter. Therefore, assumed
premiums written from these ceding companies are estimated for the most recent
month or, in some cases, for several months. With respect to CastlePoint Re's
three quota share reinsurance agreements with Tower's insurance companies, we
obtain current monthly statements and record assumed premiums written from Tower
on an actual, rather than estimated, basis. For ceding companies from which we
have not received current monthly statements and therefore must estimate the
most recent period's assumed premiums written, the difference between the
estimated assumed premiums written and actual assumed premiums written is
reflected in the subsequent accounting period or as soon as the actual assumed
premiums written are obtained. For our most recent quarter ended September 30,
2007, approximately 17% of the assumed written premiums and approximately 3% of
the corresponding assumed earned premiums are based upon premium estimates.
After provision for applicable loss and loss adjustment expenses and commission
and other acquisition expenses, the impact of these estimates would not have a
material effect on the Company's consolidated financial position or results of
operations.
Regarding loss and loss adjustment expense estimates, changes in loss
reserve estimates may result from (1) variability in the estimation process
itself, and (2) the fact that external factors may cause changes in the future
that are not reflected in historical patterns. With respect to the former source
of variability, i.e. estimation process variation, we attempt to reduce this
source of variation by evaluating the underlying data accuracy from our clients
and the impact of underwriting and pricing changes on expected loss ratios.
Using all of the information made available to us by our clients, we determine a
best estimate of the loss ratio for each client and each program or treaty. With
regard to the potential variability in loss reserve estimates due to the fact
that future patterns may differ from historical patterns, we measure actual
reported claim results by contract as compared to the expected claims results.
If reported claims results differ significantly from expected claim results,
then we revise our estimated reserves accordingly. Nevertheless, there can be no
assurances that our reserves will prove to be adequate, as there may still be
variability in the estimation process and future claims may vary significantly
from historical patterns.
18
The deferred tax asset at September 30, 2007 was $4.1 million, which was
comprised of the tax effects for cost of stock options, unrealized losses and
CastlePoint Management's net loss. In assessing the valuation of deferred tax
assets, we consider whether it is more likely than not that some portion or all
the deferred tax will be realized. The ultimate realization of deferred tax
assets is dependent upon the generation of future taxable income to offset
previous operating losses or during periods in which temporary differences
become deductible. Our management currently believes that it is more likely than
not that we will recover all of the assets based primarily upon future
profitability of our U.S. operations.
Regarding U.S. taxation, if either CastlePoint Bermuda Holdings or
CastlePoint Holdings are deemed by the U.S. Internal Revenue Service to be
engaged in a U.S. trade or business, or if CastlePoint Re is considered to be
doing business through a permanent establishment in the U.S., then these
entities would be subject to U.S. taxation. FIN No. 48 prescribes a recognition
threshold and a measurement attribute for the financial statement recognition
and measurement for uncertain tax positions taken or expected to be taken in
income tax returns. The Company is to determine whether it is "more likely than
not" (i.e., greater than 50% certain) that our position would be sustained upon
examination by tax authorities. Tax positions that meet the "more likely than
not" threshold are then measured using a probability weighted approach
recognizing the largest amount of tax benefit that has greater than a 50%
likelihood of being realized upon ultimate settlement. The adoption of FIN 48
has not had a material impact on the Company's consolidated financial position
or results of operations.
Consolidated Results of Operations
Three Months Ended September 30, Nine Months Ended September 30,
2007 2006 2007 2006
------------------- ----------------- ----------------- -----------------
($ in thousands)
Revenues
Net premiums earned $ 65,610 $ 27,003 $ 167,146 $ 47,390
Commission income 1,667 854 3,902 1,392
Net investment income 7,538 3,791 21,417 6,697
Net realized investment (losses)/gains (79) 7 (98) 10
------------------- ----------------- ----------------- -----------------
Total revenues 74,736 31,655 192,367 55,489
------------------- ----------------- ----------------- -----------------
Expenses
Net loss and loss adjustment expenses 34,482 13,919 87,790 25,297
Commission and other acquisition expenses 24,147 9,903 60,110 17,421
Other operating expenses 4,268 2,448 11,983 8,998
Interest expenses 2,254 -- 6,608 --
------------------- ----------------- ----------------- -----------------
Total expenses 65,151 26,270 166,491 51,716
------------------- ----------------- ----------------- -----------------
Income before taxes 9,585 5,385 25,876 3,773
Income tax benefit 956 -- 2,254 --
------------------- ----------------- ----------------- -----------------
Net Income $ 10,541 $ 5,385 $ 28,130 $ 3,773
=================== ================= ================= =================
Key Measures
Return on average equity 10.3% 8.0% 10.7% 2.8%
Consolidated combined ratio 93.3% 94.1% 93.3% 106.2%
|
We calculate our loss and expense ratios by segment. See "--Insurance
Segment Results of Operations," "--Reinsurance Segment Results of Operations"
and "--Insurance Services Segment Results of Operations" below.
Consolidated Results of Operations for the Three Months Ended September 30, 2007
and 2006
Summary. Despite softening market conditions reported by some companies in
the property and casualty industry, CastlePoint has not yet experienced
significant weakening in pricing or a softening in demand for its products.
Management believes that this is in large part due to CastlePoint's emphasis on
providing solutions to small insurance companies and program underwriting
agents, which results in the transfer by such companies and program underwriting
agents to CastlePoint of large blocks of business composed of small policies,
and a growing industry awareness of CastlePoint's capabilities to provide
primary insurance company capacity combined with reinsurance capacity and
customized insurance services.
19
Net income increased 96% to $10.5 million for the three months ended
September 30, 2007, compared to $5.4 million for the same period in 2006. Net
income excluding realized and unrealized gains (losses) increased 113.0% to
$11.5 million for the three months ended September 30, 2007, compared to $5.4
million for the same period in 2006. Net earned premiums increased 143.0% to
$65.6 million, based upon growth from Tower, CastlePoint's largest client, as
well as growth from other clients. CastlePoint Insurance implemented its
alternative insurance risk-sharing solutions with Tower during the third quarter
of 2007, and as a result, wrote $23.4 million in direct premiums from Tower.
Total revenues. Total revenues increased by 136.1% to $74.7million for the
three months ended September 30, 2007, compared to $31.7 million for the same
period in 2006. The increase is primarily due to the increase in net premiums
earned and net investment income. Revenues for the three months ended September
30, 2007 consisted of net premiums earned (87.8% of the total revenues),
commission income (2.2% of the total revenues) and net investment income and
realized losses (10.0% of the total revenues) compared to net premiums earned
(85.3% of the total revenues), commission income (2.7% of the total revenues)
and net investment income (12.0% of the total revenues) for the same period in
2006.
Premiums earned. Net premiums earned increased by 143.0% to $65.6 million
for the three months ended September 30, 2007 compared to $27.0 million for the
same period in 2006. The business assumed by CastlePoint Re and CastlePoint
Insurance under our reinsurance agreements with Tower's insurance companies and
the business written directly using CastlePoint Insurance's policies through
Tower Risk Management represented 80.2% of net premiums earned for the three
months ended September 30, 2007 compared to 96.7% of net premiums earned for the
same period in 2006.
Commission income. Commission income increased 95.2% to $1.7 million for
the three months ended September 30, 2007 compared to $0.9 million for the three
months ended September 30, 2006. We received this commission income as a result
of CastlePoint Management's management of the specialty and traditional
programs.
Net investment income and realized investment gains/(losses). Net
investment income increased by 98.8% to $7.5 million for the three months ended
September 30, 2007 compared to $3.8 million for the three months ended September
30, 2006. The growth resulted from an increase in cash and invested assets to
$675.4 million as of September 30, 2007 compared to $309.6 million as of
September 30, 2006. The increase in invested assets primarily resulted from the
proceeds of approximately $114 million after the deduction of underwriting
discounts and other estimated offering expenses from our IPO in March 2007 and
$100 million of cash received for the issuance of subordinated debentures in
connection with the trust preferred securities issued in December 2006. The
investment book yield on our invested assets was 4.7% for the three months ended
September 30, 2007 compared to 5.5% for the same period in 2006. The decrease in
yield is generally due to our investment in a limited partnership where we
booked an unrealized loss of $1.3 million offset by a realized gain of $0.4
million in net investment income partially mitigated by an extension in the
average duration of our fixed maturity portfolio from 2.27 years at September
2006 to 2.63 years at September 2007, to take advantage of a more normalized
yield curve compared with a relatively flat yield curve at September 2006. The
partnership invests in highly rated municipal bonds, which were negatively
impacted by the recent "flight to quality" and lack of liquidity. We believe
this impairment to be temporary.
Realized losses were $0.1 million for the nine months ended September 30,
2007, compared with virtually zero for the nine months ended September 30, 2006.
Loss and loss adjustment expenses. Loss and loss adjustment expenses
increased 147.7% to $34.5 million, which produced a 52.6% loss ratio for the
three months ended September 30, 2007 compared to $13.9 million which produced a
51.5% loss ratio for the same period in 2006. The calendar year loss ratio
includes an accident year loss ratio of 52% and reflects $0.4 million of revised
estimates in loss reserves from the prior year. The change in prior year loss
reserves resulted mainly from a reduction in the Tower brokerage quota share
reinsurance agreement and, to a lesser extent, a reduction in various excess of
loss reinsurance agreements assumed from Tower.
20
Operating expenses. Operating expenses increased 130.1% to $28.4 million
for the three months ended September 30, 2007, from $12.4 million for the same
period in 2006. Operating expenses are comprised of commission expense and other
operating expenses, including corporate expenses (primarily, salaries, audit,
legal services and insurance expenses). The increase was due primarily to the
increase in commission and other acquisition expenses resulting from the growth
in premiums earned and, to a lesser extent, an increase in payroll and payroll
related expenses due to increase in staffing.
Interest expense. Our interest expense was $2.3 million for the three
months ended September 30, 2007 compared to zero for the three months ended
September 30, 2006. Interest expense resulted primarily from the $103.1 million
of subordinated debentures issued by us in December 2006 at an average fixed
interest rate of 8.6%.
Income tax benefit. Our income tax benefit was $1.0 million for the three
months ended September 30, 2007 compared to zero for the three months ended 30,
2006. The effective income tax rate was negative 10.0% for the three months
ended September 30, 2007 due to losses generated in our U.S. operations.
Net income and return on average equity. Our net income was $10.5 million
for the three months ended September 30, 2007 compared to $5.4 million for the
same period in 2006. Our annualized return on average equity was 10.3% for the
three months ended September 30, 2007 compared 8.0% for the same period in 2006.
The annualized return for the three months ended September 30, 2007 was
calculated by dividing annualized net income of $42.2 million by weighted
average shareholders' equity of $409.0 million. The annualized return for the
three months ended September 30, 2006 was calculated by dividing annualized net
income of $21.5 million by weighted average shareholders' equity of $270.0
million. The increase in the average return on equity resulted from the
increased earned premiums due to an increased amount of business written in 2007
as well as higher earned premiums from business written in 2006. Also invested
assets as a percentage of equity increased, thereby increasing our net income
relative to equity.
Consolidated combined ratio. One of our key measures of profitability is
what we refer to as our consolidated combined ratio, which is calculated by (i)
dividing the total expenses (excluding interest expenses) minus commission
income by (ii) net premiums earned. Our consolidated combined ratio for the
three months ended September 30, 2007 was 93.3% compared to 94.1% for the same
period in 2006.
Consolidated Results of Operations for the Nine Months Ended September 30, 2007
and 2006
CastlePoint Re commenced writing business as of April 6, 2006. Therefore,
the nine months ended September 30, 2006 are comprised of operations for the
period April 6, 2006 through September 30, 2006. CastlePoint Insurance did not
conduct any business in 2006.
Total revenues. Total revenues increased by 246.7% to $192.4 million for
the nine months ended September 30, 2007, compared to $55.5 million for the same
period in 2006. The increase is primarily due to the increase in net premiums
earned and net investment income. Revenues for the nine months ended September
30, 2007 consisted of net premiums earned (86.9% of the total revenues),
commission income (2.0% of the total revenues) and net investment income and net
realized losses (11.0% of the total revenues) compared to net premiums earned
(85.4% of the total revenues), commission income (2.5% of the total revenues)
and net investment income (12.1% of the total revenues) for the same period in
2006.
Premiums earned. Net premiums earned increased by 252.7% to $167.1 million
for the nine months ended September 30, 2007 compared to $47.4 million for the
same period in 2006. The business assumed by CastlePoint Re and CastlePoint
Insurance under our reinsurance agreements with Tower's insurance companies and
the business written directly in CastlePoint Insurance through Tower represented
80.6% of net premiums earned for the nine months ended September 30, 2007
compared to 98% of net premiums earned for the same period in 2006.
Commission income. Commission income increased 180.2% to $3.9 million for
the nine months ended September 30, 2007 compared to $1.4 million for the nine
months ended September 30, 2006. We received this commission and fee income as a
result of CastlePoint Management's management of the specialty and traditional
programs. This increase reflects growth in existing programs as well as a full
nine months of operations for the current period.
21
Net investment income and realized investment gains/(losses). Net
investment income increased by 219.8% to $21.4 million for the nine months ended
September 30, 2007 compared to $6.7 million for the nine months ended September
30, 2006. The growth resulted from an increase in cash and invested assets to
$675.4 million as of September 30, 2007 compared to $309.6 million as of
September 30, 2006. The increase in invested assets resulted from cash flows
provided by operations of $95.8 million as a result of growth in premiums, the
proceeds of approximately $114 million after the deduction of underwriting
discounts and other estimated offering expenses from our IPO in March 2007 and
approximately $100 million of cash received for the issuance of subordinated
debentures in connection with the trust preferred securities issued in December
2006. The investment book yield on our invested assets was 5.2% for the nine
months ended September 30, 2007 compared to 5.5% for the same period in 2006.
The decrease in yield is generally due to our investment in a limited
partnership, with respect to which we booked an unrealized loss of $1.3 million
offset by a realized gain of $0.4 million in net investment income partially
mitigated by an extension in the average duration of our fixed maturity
portfolio from 2.27 years at September 2006 to 2.63 years at September 2007, to
take advantage of a more normalized yield curve compared with a relatively flat
yield curve at September 2006. The partnership invests in highly rated municipal
bonds, which were negatively impacted by the recent "flight to quality" and lack
of liquidity. We believe this impairment to be temporary.
Realized losses were $0.1 million for the nine months ended September 30,
2007 compared with virtually zero for the nine months ended September 30, 2006.
Loss and loss adjustment expenses. Loss and loss adjustment expenses
increased 247.0% to $87.8 million, which produced a 52.5% loss ratio for the
nine months ended September 30, 2007 compared to $25.3 million which produced a
53.4% loss ratio for the same period in 2006. The reduction in the loss ratio is
primarily due to favorable experience to date on our brokerage business quota
share reinsurance agreement with Tower.
Operating expenses. Operating expenses increased 172.9% to $72.1 million
for the nine months ended September 30, 2007, from $26.4 million for the same
period in 2006. Operating expenses are comprised of commission expense and other
operating expenses, including corporate expenses (primarily, salaries, audit,
legal services and insurance expenses). The increase was due primarily to the
increase in commission and other acquisition expenses resulting from the growth
in premiums earned and, to a lesser extent, an increase in payroll and payroll
related expenses due to increase in staffing.
Interest expense. Interest expense was $6.6 million for the nine months
ended September 30, 2007 compared to zero for the nine months ended September
30, 2006. Interest expense resulted primarily from the $103.1 million of
subordinated debentures issued in connection with trust preferred securities
issued by us in December 2006 at an average fixed interest rate of 8.6%.
Income tax benefit. Our income tax benefit was $2.3 million for the nine
months ended September 30, 2007 compared to zero for the nine months ended 30,
2006. The effective income tax rate was negative 8.7% for the nine months ending
September 30, 2007 due to losses generated in our U.S. operations.
Net income and return on average equity. Our net income was $28.1 million
for the nine months ended September 30, 2007 compared to $3.8 million for the
same period in 2006. Our annualized return on average equity was 10.7% for the
nine months ended September 30, 2007. The annualized return was calculated by
dividing annualized net income of $37.5 million by weighted average
shareholders' equity of $349.1 million.
Consolidated combined ratio. One of our key measures of profitability is
what we refer to as our consolidated combined ratio, which is calculated by (i)
dividing the total expenses (excluding interest expenses) minus commission
income by (ii) net premiums earned. Our consolidated combined ratio for the nine
months ended September 30, 2007 was 93.3% compared to 106.2% for the same period
in 2006. Included in the 2006 ratio was the cost of the warrants we issued to
Tower of $4.6 million.
22
Insurance Segment Results of Operations
Three Months Ended Nine Months Ended
September 30, September 30,
2007 2006 2007 2006
---------------- -------------- ---------------- ---------------
($ in thousands)
Revenues
Premiums earned
Gross premiums earned $ 6,063 $ -- $ 7,394 $ --
Less: ceded premiums earned (1,419) -- (1,419) --
---------------- -------------- ---------------- ---------------
Net premiums earned 4,644 -- 5,975 --
---------------- -------------- ---------------- ---------------
Expenses
Loss and loss adjustment expenses
Gross loss and loss adjustment
expenses 3,312 -- 4,030 --
Less: ceded loss and loss
adjustment expenses (315) -- (315) --
---------------- -------------- ---------------- ---------------
Net loss and loss adjustment
expenses 2,997 -- 3,715 --
---------------- -------------- ---------------- ---------------
Underwriting expenses
Commission expense 1,997 -- 2,546 --
Other underwriting expenses 130 -- 151 --
---------------- -------------- ---------------- ---------------
Total underwriting expenses 2,127 -- 2,697 --
---------------- -------------- ---------------- ---------------
Underwriting Loss $ (480) $ -- $ (437) $ --
================ ============== ================ ===============
Key Measures
Premiums written
Gross premiums written $ 28,696 $ -- $ 42,228 $ --
Less: ceded premiums written (7,096) -- (7,096) --
---------------- -------------- ---------------- ---------------
Net premiums written $ 21,600 $ -- $ 35,132 $ --
================ ============== ================ ===============
Loss Ratios
Gross 54.6% n/a 54.5% n/a
Net 64.5% n/a 62.2% n/a
Accident Year Loss Ratios
Gross 54.6% n/a 54.5% n/a
Net 64.5% n/a 62.2% n/a
Underwriting Expense Ratios
Gross 35.1% n/a 36.5% n/a
Net 45.8% n/a 45.1% n/a
Combined Ratios
Gross 89.7% n/a 91.0% n/a
Net 110.3% n/a 107.3% n/a
|
23
Insurance Segment Results of Operations for the Three Months Ended
September 30, 2007 and 2006
The insurance segment did not conduct any business and did not have any
premium income, obligations relating to insurance policies, employees and
operations for the three months ended September 30, 2006.
Summary. The Insurance segment had an underwriting loss for the three
months ended September 30, 2007 due to the cost of purchasing property
catastrophe reinsurance. However, on a gross of reinsurance basis, the combined
ratio was 89.7% which reflects solid underlying profitability, and when the
premiums earned increase relative to premiums written the net combined ratio is
expected to decrease and be closer to the gross combined ratio. Premiums written
in the three month period ended September 30, 2007 increased significantly based
upon implementation of the alternative insurance risk-sharing solutions with
Tower which generated $23.4 million in premiums written during the period, as
well as premiums written of $5.7 million on another risk sharing arrangement
with a client other than Tower.
Gross premiums and net premiums. Gross and net premiums written were $28.7
million and $21.6 million, respectively, for the three months ended September
30, 2007. Gross and net premium earned were $6.1 and $4.6 respectively, for the
three months ended September 30, 2007. CastlePoint Insurance assumed $5.7
million through a new program managed by CastlePoint Management and wrote
approximately $23.4 million of direct business that was produced by Tower Risk
Management Corp., a subsidiary of Tower. The ceded premium consisted of excess
of loss and catastrophe premium of which approximately 49% was ceded to third
party reinsurers and 51% to CastlePoint Re.
Gross and net loss and loss adjustment expenses and loss ratio. Gross loss
and loss adjustment expenses were $3.3 million, which produced a 54.6% gross
loss ratio for the three months ended September 30, 2007. Net loss and loss
adjustment expenses were $3.0 million, which produced a 64.5% net loss ratio for
the three months ended September 30, 2007. The net loss ratio was negatively
impacted by $0.9 million of ceded catastrophe premium written and earned with a
zero percent loss ratio.
Underwriting expenses and underwriting expense ratio. Underwriting
expenses for the insurance segment are comprised of commission and other
underwriting expenses. Commission expense was $2.0 million and other
underwriting expenses were minimal for the three months ended September 30,
2007. The gross underwriting expense ratio was 35.1% and the net underwriting
expense ratio was 45.8% for the three months ended September 30, 2007.
Underwriting loss and net combined ratio. The underwriting loss and net
combined ratio from the insurance segment was $480,000 and 110.3%, respectively,
for the three months ended September 30, 2007.
Insurance Segment Results of Operations for the Nine Months Ended September 30,
2007 and 2006
The insurance segment did not conduct any business and did not have any
premium income, obligations relating to insurance policies, employees and
operations for the nine months ended September 30, 2006.
Gross premiums and net premiums. Gross and net premiums written were $42.2
million and $35.1 million, respectively, for the nine months ended September 30,
2007. Gross and net premium earned were $7.4 and $6.0 respectively, for the nine
months ended September 30, 2007. CastlePoint Insurance assumed $5.7 million
through a new program managed by CastlePoint Management, and wrote approximately
$23.9 million of direct business that was produced by Tower Risk Management
Corp., a subsidiary of Tower, which incepted in the third quarter; CastlePoint
Insurance also assumed $12.6 million of Tower's brokerage business during the
second quarter. The ceded premium consisted of excess of loss and catastrophe
premium, of which approximately 49% was ceded to third party reinsurers and 51%
to CastlePoint Re.
Gross and net loss and loss adjustment expenses and loss ratio. Gross loss
and loss adjustment expenses were $4.0 million, which produced a 54.5% gross
loss ratio for the nine months ended September 30, 2007. Net loss and loss
adjustment expenses were $3.7 million, which produced a 62.2% net loss ratio for
the nine months ended September 30, 2007. The net loss ratio was negatively
impacted by $0.9 million of ceded catastrophe premium written and earned with a
zero percent loss ratio.
24
Underwriting expenses and underwriting expense ratio. Underwriting
expenses for the insurance segment are comprised of commission and other
underwriting expenses. Commission expense was $2.5 million and other
underwriting expenses were minimal for the nine months ended September 30, 2007.
The gross underwriting expense ratio was 36.5% and the net underwriting expense
ratio were 45.1% for the nine months ended September 30, 2007. The gross
commission rate paid on direct business that was produced by Tower Risk
Management Corp. and the business assumed from Tower's brokerage business was
36%, which includes a commission slide of 2% based upon profitable loss ratio
results.
Underwriting loss and net combined ratio. The underwriting loss and net
combined ratio from the insurance segment were $437,000 and 107.3%,
respectively, for the nine months ended September 30, 2007.
Reinsurance Segment Results of Operations
Three Months Ended September 30, Nine Months Ended September 30,
2007 2006 2007 2006
----------------- ----------------- ----------------- -----------------
($ in thousands)
Revenues
Premiums earned
Gross premiums earned $ 60,965 $ 27,003 $ 161,171 $ 47,390
Less: ceded premiums earned -- -- -- --
----------------- ----------------- ----------------- -----------------
Net premiums earned 60,965 27,003 161,171 47,390
----------------- ----------------- ----------------- -----------------
Expenses
Loss and loss adjustment expenses
Gross loss and loss adjustment expenses 31,485 13,919 84,075 25,297
Less: ceded loss and loss adjustment expenses -- -- -- --
----------------- ----------------- ----------------- -----------------
Net loss and loss adjustment expenses 31,485 13,919 84,075 25,297
----------------- ----------------- ----------------- -----------------
Underwriting expenses
Ceding commission expense 20,929 9,286 54,634 16,405
Other underwriting expenses 1,125 331 2,614 535
----------------- ----------------- ----------------- -----------------
Total underwriting expenses 22,054 9,618 57,248 16,940
----------------- ----------------- ----------------- -----------------
Underwriting Profit $ 7,426 $ 3,465 $ 19,848 $ 5,153
================= ================= ================= =================
Key Measures
Premiums written
Gross premiums written $ 68,975 $ 43,664 $ 207,849 $ 116,406
Less: ceded premiums written -- -- -- --
----------------- ----------------- ----------------- -----------------
Net premiums written $ 68,975 $ 43,664 $ 207,849 $ 116,406
================= ================= ================= =================
Loss Ratios
Gross 51.6% 51.5% 52.2% 53.4%
Net 51.6% 51.5% 52.2% 53.4%
Accident Year Loss Ratios
Gross 52.3% 51.5% 52.5% 53.4%
Net 52.3% 51.5% 52.5% 53.4%
Underwriting Expense Ratios
Gross 36.2% 35.6% 35.5% 35.7%
Net 36.2% 35.6% 35.5% 35.7%
Combined Ratios
Gross 87.8% 87.1% 87.7% 89.1%
Net 87.8% 87.1% 87.7% 89.1%
|
25
Reinsurance Segment Results of Operations for the Three Months Ended
September 30, 2007 and 2006
Summary. The Reinsurance segment is predominantly quota share reinsurance.
The segment had excellent results driven by a significant increase in premiums
written and earned and a combined ratio of 87.8%. CastlePoint Re assumed 40% of
Tower's brokerage business during the period, and premiums from clients other
than Tower were 27% of total premiums written. The loss ratio of 51.6% benefited
by 0.7 points from favorable loss development on prior accident years. The
expense ratio of 36.2% reflects 36.0% ceding commissions to Tower, which
includes 2 points of profit sharing commission to Tower based upon its loss
ratios. Ceding commissions to clients other than Tower also included profit
sharing commissions.
Gross premiums and net premiums. Gross and net written premiums increased
58.0% to $69.0 million for the three months ended September 30, 2007 from $43.7
million for the three months ended September 30, 2006. Business not originated
from Tower and CastlePoint Insurance represents 26.6% or $18.3 million of the
total written premiums compared to 9.3% or $4.1 million during the same period
last year. The quota share reinsurance agreements originated from third-party
clients included a new non-standard automobile U.S. regional insurance company
and a U.S. regional insurance company specializing in small workers compensation
and commercial automobile. Gross and net premiums earned increased by 125.8% to
$61.0 million for the three months ended September 30, 2007 from $27.0 million
for the same period in 2006. The increase is attributable to the fact we have a
full year of written premium included in our earned premium for the three months
ended September 30, 2007 compared to only two quarters of written premium
included for the same period in 2006. Further, during the three months ended
September 30, 2007, CastlePoint Re added four new quota share reinsurance
agreements (resulting in earned premium of $0.7 million) and one new excess of
loss reinsurance agreement (resulting in earned premium of $0.2 million).
Loss and loss adjustment expenses and loss ratio. Loss and loss adjustment
expenses increased by 126.2% to $31.5 million, which produced a 51.6% loss ratio
for the three months ended September 30, 2007 compared to $13.9 million, which
produced a 51.5% loss ratio for the same period in 2006.
Underwriting expenses and underwriting expense ratio. Underwriting
expenses for the reinsurance segment are comprised of ceding commission paid to
insurance companies, which cede business to CastlePoint Re, and other
underwriting expenses. Ceding commission expense was $20.9 million and other
underwriting expenses were $1.1 million for the three months ended September 30,
2007 compared to $9.3 million and $0.3 million, respectively, for the same
period in 2006. Both the gross underwriting expense ratio and the net
underwriting expense ratio were 36.2% for the three months ended September 30,
2007 compared to 35.6% for the same period in 2006.
Underwriting profit and combined ratio. The underwriting profit and
combined ratio from the reinsurance segment was $7.4 million and 87.8%,
respectively, for the three months ended September 30, 2007 compared to $3.5
million and 87.1% for the same period in 2006. The combined ratio increased
slightly as a result of higher profit sharing commission due to favorable loss
ratios on several treaties.
Reinsurance Segment Results of Operations for the Nine Months Ended
September 30, 2007 and 2006
Gross premiums and net premiums. Gross and net written premiums increased
78.6% to $207.8 million for the nine months ended September 30, 2007 from $116.4
million for the nine months ended September 30, 2006. Included in the gross and
net premiums of $116.4 million in 2006 was a transfer of unearned written
premiums in the amount of $40.9 million. The total amount of net written
premiums originated by and assumed from Tower and CastlePoint Insurance by
CastlePoint Re for the nine months ended September 30, 2007 was $157.6 million
or 75.8% of total written premium compared to $111.1 million or 95% during the
same period last year. Gross and net premiums earned increased by 240.1% to
$161.2 million for the nine months ended September 30, 2007 from $47.4 million
for the same period in 2006. The increase is attributable to the fact we have a
full year of written premium included in our earned premium for the three months
ended September 30, 2007 compared to only two quarters of written premium
included for the same period in 2006. Further, during the third quarter 2007
CastlePoint Re entered into four new quota share reinsurance agreements
(resulting in earned premium of $0.7 million) and one new excess of loss
reinsurance agreement (resulting in earned premium of $0.2 million). Three
reinsurance agreements, out of the five new reinsurance agreements that
CastlePoint Re entered into during the third quarter 2007, represent business
from clients other than Tower and CastlePoint Insurance.
26
Loss and loss adjustment expenses and loss ratio. Loss and loss adjustment
expenses increased by 232.3% to $84.1 million, which produced a 52.2% loss ratio
for the nine months ended September 30, 2007 compared to $25.3 million, which
produced a 53.4% loss ratio for the same period in 2006, primarily reflecting
favorable development on our brokerage business quota share reinsurance
agreement with Tower.
Underwriting expenses and underwriting expense ratio. Underwriting
expenses for the reinsurance segment are comprised of ceding commission paid to
insurance companies, which cede business to CastlePoint Re, and other
underwriting expenses. Ceding commission expense was $54.6 million and other
underwriting expenses were $2.6 million for the nine months ended September 30,
2007 compared to $16.4 million and $0.5 million, respectively, for the same
period in 2006. Both the gross underwriting expense ratio and the net
underwriting expense ratio were 35.5% for the nine months ended September 30,
2007 compared to 35.7% for the nine months ended September 30, 2006.
Underwriting profit and combined ratio. The underwriting profit and
combined ratio from the reinsurance segment was $19.9 million and 87.7%,
respectively, for the nine months ended September 30, 2007 compared to $5.2
million and 89.1%, respectively, for the nine months ended September 30, 2006.
The principal factor that led to the improvement in the underwriting profit and
combined ratio for the reinsurance segment was a reduction in the loss ratio
attributable to the Tower brokerage quota business.
Insurance Services Segment Results of Operations
Three Months Ended September 30, Nine Months Ended September 30,
2007 2006 2007 2006
----------------- ----------------- ------------------ -----------------
($ in thousands)
Revenues
Direct commission revenue from programs $ 1,667 $ 854 $ 3,902 $ 1,392
----------------- ----------------- ------------------ -----------------
Total Revenues 1,667 854 3,902 1,392
----------------- ----------------- ------------------ -----------------
Expenses
Direct commissions expense for programs 1,222 617 2,930 1,016
Other insurance services expenses 1,435 1,032 4,567 1,757
----------------- ----------------- ------------------ -----------------
Total Expenses 2,657 1,649 7,496 2,773
----------------- ----------------- ------------------ -----------------
Insurance Services Loss $ (990) $ (795) $ (3,594) $ (1,381)
================= ================= ================== =================
|
Insurance Services Segment Results of Operations for the Three Months
Ended September 30, 2007 and 2006
Direct commission revenue from programs. Direct commission revenue is
dependent upon the premiums written during the year with respect to the program
business managed by CastlePoint Management. CastlePoint Management receives a
30% commission from CastlePoint Insurance and Tower's insurance companies for
program business placed by CastlePoint Management with these companies less
boards, bureaus and premium taxes (which we refer to as "BB&T") and less direct
commission expenses that are incurred by Tower and CastlePoint Insurance. Direct
commission revenue increased 95.2% to $1.7 million for the three months ended
September 30, 2007 compared to $0.9 million for the three months ended September
30, 2006. These commission revenues were received for the specialty programs and
traditional programs. We also bound two additional programs, which contributed
approximately $0.5 million to revenues in the third quarter of 2007.
Direct commission expense for programs. Direct commission expense
increased 98.1% to $1.2 million for the three months ended September 30, 2007
from $0.6 million for the three months ended September 30, 2006. Direct
commission expense consisted of the commission fees paid by us to producing
agents for the placement of program business.
27
Other insurance services expenses. Other insurance services expenses were
$1.4 million for the three months ended September 30, 2007 compared to $1.0
million for the same period in 2006. This amount includes $0.3 million for the
three months ended September 30, 2007 and $0.2 million for the three months
ended September 30, 2006 of costs incurred and charged by Tower's insurance
companies for services provided to us.
Insurance services loss. Insurance services loss was $1.0 million for the
three months ended September 30, 2007 compared to $0.8 million for the same
period in 2006 due to CastlePoint Management's current incurrence of costs to
produce programs that are expected to generate commission revenue in future
periods due in part to the lag time associated with launching new programs that
require rates and forms to be filed and approved, as well as systems to be
implemented.
Insurance Services Segment Results of Operations for the Nine Months
Ended September 30, 2007 and 2006
Direct commission revenue from programs. Direct commission revenue is
dependent upon the premiums written during the year with respect to the program
business managed by CastlePoint Management. CastlePoint Management receives a
30% commission from CastlePoint Insurance and Tower's insurance companies for
program business placed by CastlePoint Management with these companies less BB&T
and less direct commission expenses that are incurred by these companies.
Commission income increased 180.3% to $3.9 million for the nine months ended
September 30, 2007 compared to $1.4 million for the nine months ended September
30, 2006. These commission revenues were received for the specialty programs and
traditional programs. We also bound two additional programs that began producing
revenues in the third quarter of 2007.
Direct commission expense for programs. Direct commission expense
increased 188.4% to $2.9 million for the nine months ended September 30, 2007
from $1.0 million for the nine months ended September 30, 2006. Direct
commission expense consisted of the commission fees paid by us to producing
agents for placement of program business.
Other insurance services expenses. Other insurance services expenses were
$4.6 million for the nine months ended September 30, 2007 compared to $1.8
million for the same period in 2006. This amount includes $0.8 million for the
nine months ended September 30, 2007 and $0.5 million for the nine months ended
September 30, 2006 of costs incurred and charged by Tower's insurance companies
for services provided to us. The increase in expenses over the two periods was
due in part to the fact we did not start our operations until April of 2006. In
addition, the increase in staffing increased the salary and salary related items
by approximately $1.9 million.
Insurance services loss. Insurance services loss was $3.6 million for the
nine months ended September 30, 2007 compared to $1.4 million for the same
period in 2006 primarily due to CastlePoint Management's current incurrence of
costs to produce programs that are expected to generate commission revenue in
future periods due in part to the lag time associated with launching new
programs that require rates and forms to be filed and approved, as well as
systems to be implemented.
Liquidity and Capital Resources
CastlePoint Holdings is organized as a Bermuda holding company, and as
such, has no direct operations of its own. We expect substantially all of our
operations to be conducted by our insurance, reinsurance, and management company
subsidiaries. Accordingly, we expect to have continuing cash needs for
administrative expenses and the payment of principal and interest on existing
and any future borrowings, taxes and dividends. Funds to meet these obligations
will come primarily from dividend payments from our operating subsidiaries.
There are restrictions on the payment of dividends by our insurance
subsidiaries. These restrictions, as well as our liquidity, principal capital
requirements and related matters are described in more detail in the section
entitled "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included in our Registration Statement filed with the
SEC.
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Our ongoing principal cash requirements for the Company and its wholly
owned subsidiaries are expected to be the capitalization of our existing
operating subsidiaries, operating expenses, our acquisition of at least one
additional U.S. licensed insurance company in connection with our insurance
risk-sharing and program business within the next nine months, subject to
receipt of regulatory approvals, net cash settlements under the reinsurance
agreements, payment of losses and loss adjustment expenses, commissions paid to
program underwriting agents, ceding commissions to insurance companies including
Tower, excise taxes, operating expenses, purchases of marketable securities and
payments under our service and expense sharing agreements with Tower and certain
of its subsidiaries. In addition, we will need cash to enable us to make
strategic investments in some of our clients and potential clients, including
Tower, as well as to pay dividends to our shareholders and to service the debt
on the subordinated debentures of $103.1 million issued by CastlePoint
Management in December 2006 and an additional $30.9 million issued by
CastlePoint Bermuda Holdings in September 2007. Further, while insurance
regulations differ by location, insurers and reinsurers are generally required
to maintain certain minimum levels of capital and/or risk-based capital, the
calculation of which typically includes numerous factors specified by the
respective insurance regulatory authorities and the related insurance
regulations. In order to maintain these capital requirements our insurance
subsidiaries may need additional capital. In addition, we maintain levels of
capital commensurate with standards expected by rating agencies.
On March 28, 2007, we completed the sale of 8,697,148 common shares at
$14.50 per share in an initial public offering. In addition, 119,500 shares were
sold in that offering by selling shareholders who previously purchased such
shares in the private offering of our common shares we completed in April 2006.
Included in the 8,697,148 shares sold by us were 1,134,410 shares purchased by
the underwriters to cover over-allotments. The net proceeds to the Company of
the initial public offering were approximately $114 million after the deduction
of underwriting discounts and other offering expenses. We have used
approximately $70.0 million of these net proceeds to further capitalize
CastlePoint Re, and we intend to use the remaining proceeds of the initial
public offering to either further capitalize CastlePoint Re or capitalize any
U.S. licensed insurance companies we may acquire in the future, and for general
corporate purposes.
As previously reported in the Company's current report on Form 8-K filed
with the SEC on October 1, 2007, which is incorporated herein by reference (the
"October 2007 Current Report"), in September 2007, our subsidiary CastlePoint
Bermuda Holdings borrowed $30.9 million in a trust preferred securities
transaction, the proceeds of which are intended to be used for general corporate
purposes, including acquisitions. In connection with this transaction,
CastlePoint Bermuda Holdings formed a Delaware statutory trust in September
2007.
Sources of Cash
We expect to receive cash from direct and assumed premiums collected, net
cash settlements under our reinsurance agreements, fee income for services
provided, investment income and proceeds from sales and redemptions of
investments. We also expect that we may raise additional funds in the future
through additional equity and/or additional debt financings. However there are
no assurances that such equity/debt financing will be available on terms
acceptable to us or at all.
We, or one or more of our subsidiaries, may also enter into one or more
unsecured revolving credit facilities and/or term loan facilities with one or
more syndicates of lenders, and we may use any such facilities for strategic
acquisitions, general corporate purposes and working capital requirements. We
believe that any debt financing or credit facility will require compliance with
financial covenants, such as a leverage ratio, a consolidated tangible net worth
ratio and maintenance of ratings. Any debt financing or credit facility will
likely contain additional covenants that restrict the activities of our
operating subsidiaries, such as the incurrence of additional indebtedness and
liens and the payment of dividends and other payments. In addition, the terms of
any debt financings may require guarantees by CastlePoint Holdings or any of our
subsidiaries. We are currently in discussions with a major lender with respect
to a credit facility. We cannot assure you that we will be able to obtain a
credit facility on terms acceptable to us.
Cash Flows
For the nine months ended September 30, 2007, net cash provided by
operating activities was approximately $95.8 million compared to $45.0 million
for the nine months ended September 30, 2006. The increase in net cash provided
by operations resulted primarily from the increase in collected premiums as a
result of the growth in premiums written.
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For the nine months ended September 30, 2007 net cash flows used in
investing activities was approximately $144.0 million compared to $285.8 million
for the same period in 2006, which consisted of purchases and sales of
investments.
The net cash flows provided by financing activities for the nine months
ended September 30, 2007 were approximately $141.2 million, which primarily
consisted of approximately $114.5 million in net proceeds from the IPO after all
offering expenses and net proceeds from the issuance of subordinated debentures
of approximately $30 million by CastlePoint Bermuda Holdings, less dividends
paid to shareholders of $2.7 million, as compared to $262.4 for the same period
in 2006, which primarily consisted of approximately $248.9 million in net
proceeds from the private offering and $15 million in net proceeds from Tower
Group's initial investment in the Company in early 2006, less dividends paid to
shareholders of $1.5 million.
The primary sources of cash of our operating subsidiaries are net premiums
received, commission income and investment income. Cash is used by our operating
subsidiaries to pay dividends to their parent, commissions, claims and operating
expenses, as well as to purchase investments and fixed assets, subject to
regulatory, contractual, rating agencies and other constraints applicable to us.
Security Requirements
Under the terms of the quota share reinsurance agreements between
CastlePoint Re and Tower's insurance companies, CastlePoint Re is required to
provide security to Tower's insurance companies to support reinsurance
recoverables owed to these reinsureds in a form acceptable to the insurance
commissioners of the State of New York and Commonwealth of Massachusetts, the
domiciliary states of Tower's insurance companies. The security is provided in
the form of trust accounts. These trust arrangements permit Tower's insurance
companies to take credit on their statutory financial statements for the
reinsurance ceded to CastlePoint Re, either as an additional asset or as a
reduction in liability. CastlePoint Re is also required by its reinsurance
agreements with its other cedents to collateralize amounts through a letter of
credit, cash advance, funds held or a trust account meeting the requirements of
the applicable state insurance regulations.
As of September 30, 2007, CastlePoint Re had trust accounts for the
benefit of its reinsureds totaling approximately $181.9 million, an increase of
approximately $84.1 million since December 31, 2006. The increase is due to
larger assumed loss reserves and unearned premium reserves due to the growth in
written and earned premiums. CastlePoint Re earns and collects the interest on
the trust funds. CastlePoint Insurance had no trust accounts for the benefit of
its clients as of September 30, 2007.
Investments
The Company has developed specific investment objectives and guidelines
for the management of its investment portfolio. These investment guidelines
stress capital preservation and maximization of after tax investment income
through the maintenance of liquidity, risk diversification and credit quality.
Generally, we invest our assets in relatively liquid, high-grade fixed maturity
securities of relatively short duration. We seek to manage our credit risk
through issuer and industry diversification and interest rate risk by monitoring
the duration and structure of the portfolio. Despite the prudent focus of these
objectives and guidelines, the Company's investments are subject to general
market risk, as well as to risks inherent to particular securities.
The aggregate fair market value of our available-for-sale investments as
of September 30, 2007 was $534.4 million, which excludes our investment in
common trust securities of the three statutory business trusts described under
"--Off-Balance Sheet Transactions" below and under Note 1
"Investments--Investments in partnerships and other funds" above. Our fixed
maturity securities as of this date had a fair market value of $494.3 million
and an amortized cost of $494.8 million. Short term investments were carried at
fair value of $0 as of September 30, 2007 compared to $51.6 million as of
December 31, 2006.
The portfolio duration of the fixed maturity securities at September 30,
2007 was approximately 2.63 years (2.0 years at December 31, 2006) and the
average credit rating was AA+ (AA+ at December 31, 2006).
30
Included in the "Fixed maturity securities" on the balance sheet at
September 30, 2007, the Company held $337.6 million ($187.7 million at December
31, 2006), at fair value in mortgage-backed, commercial mortgage-backed and
asset backed securities (reflecting primarily assets backed by automobile loans
and credit card receivables, with approximately $3.0 million of the asset backed
securities being backed by home equity loans at September 30, 2007). Our total
exposure to mortgage and asset backed securities at September 30, 2007
represented 50.0% (44.2% at December 31, 2006) of cash and invested assets. Of
the total $337.6 million exposure to mortgage and asset backed securities,
$159.3 million (47%) was rated Agency and $169.7 million (50%) was rated AAA.
The remaining 3% was rated above investment grade. The $3.0 million of assets
backed by home equity loans represents subprime exposure and is rated AAA. The
remaining asset class at September 30, 2007 and December 31, 2006 consisted
primarily of highly rated corporate securities.
Included in "Equity securities" on the balance sheet at September 30,
2007, the Company held an investment in a fund that has subprime mortgage
exposure. Our proportional share of the total exposure to subprime mortgages in
this fund is approximately $8.0 million. Of this amount, approximately $4.0
million is from mortgages originating in years 2006 and 2007 and all the
exposure from mortgages issued in these years is rated investment grade. Of the
$4.0 million originating in years 2005 and prior, only $126,000 is rated below
investment grade. Of our total exposure of $8.0 million, $6.0 million is rated A
or better. We do not believe these securities have suffered significant credit
impairment and we believe the lower market prices at September 30, 2007 for
these securities are based primarily on the lack of liquidity in this sector of
the mortgage backed securities market. Additionally, we have no Alternative A
(defined as risks falling between prime and subprime) mortgage exposure in our
portfolio or in any of the funds in which we have invested.
At September 30, 2007, we had gross unrealized gains of $2.5 million and
gross unrealized losses of $9.1 million. Of the $9.1 million of gross unrealized
losses, the majority is attributable to the liquidity problems affecting
mortgage and mortgage related securities. The gross unrealized losses are
generally attributed to the funds in which we have invested ($3.6 million
relates to our investment in a fund consisting of primarily floating rate asset
backed securities and mortgage backed securities and $1.4 million relates to
publicly traded mortgage real estate investment trusts).
At September 30, 2007, we held $127.6 million of cash and cash
equivalents, which include all securities that, at their purchase date, have a
maturity of less than 90 days, of which $30 million was uninvested cash
resulting from the proceeds from the offering by CastlePoint Bermuda Holdings of
trust preferred securities, which we received at the end of September 2007. Of
the remaining cash and cash equivalents, the majority is invested in 90 day
commercial paper. The average yield on commercial paper purchased during the
third quarter was approximately 5.5%. During the third quarter of 2007, our
investment manager recommended overweight positions in mortgages, favoring
pass-through instruments and high quality collateralized mortgage obligations
and commercial mortgage backed securities. Our investment manager recommended
underweight positions in virtually all other sectors. However, since we did not
wish to increase our exposure to mortgages at this time, we decided to maintain
a relatively high amount of cash and cash equivalent balances without
sacrificing yield.
The fair value pricing of our fixed maturity securities at September 30,
2007 is generally based on current marks provided by indices and reputable
pricing services and, to a lesser extent, established broker-dealers who
routinely make a market in the securities being priced. Approximately 77% of the
portfolio is priced by indices or pricing services and 23% is priced by broker
dealers. To the best of our management's knowledge, substantially all of the
prices represent identical or similar securities priced in actively traded
markets. No securities have been priced utilizing inputs from unobservable
inputs. Our investment in equity securities primarily represents funds in which
we have invested and substantially all of the pricing also comes from pricing
services and broker-dealers.
Contractual Obligations
There have been no material changes during the period covered by this
quarterly report on Form 10-Q, outside of our ordinary course of business, to
the contractual obligations specified in the table of contractual obligations in
the section "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included in the Registration Statement, except as
described below.
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As reported in more detail in the October 2007 Current Report, in
September 2007, CastlePoint Bermuda Holdings issued $30.9 million in
subordinated debentures, which mature on December 15, 2037 and represent payment
obligations due more than five years after the end of the period covered by this
quarterly report.
Off-Balance Sheet Transactions
We formed two Delaware statutory business trusts of which CastlePoint
Management owns all of the common trust securities, in connection with the trust
preferred financing completed in December 2006. We also formed another Delaware
statutory business trust of which CastlePoint Bermuda Holdings owns all of the
common trust securities, in connection with the trust preferred financing
completed in September 2007.
Ratings
During the first quarter of 2007, CastlePoint Insurance received a
Financial Strength rating of "A-" (Excellent) from A.M. Best Company, Inc., an
insurance rating agency, which is the fourth highest of fifteen rating levels
and indicates A.M. Best's opinion of our financial strength and ability to meet
ongoing obligations to our policyholders. A.M. Best also confirmed the "A-"
(Excellent) rating it previously assigned to CastlePoint Re. In June 2007,
following the Company's press release announcing a risk sharing arrangement with
AequiCap Program Administrators and certain of its subsidiaries, A.M. Best
placed the ratings of CastlePoint Re and CastlePoint Insurance, and the issuer
credit rating of "bbb-" of CastlePoint Holdings, under review with negative
implications. However, the ratings of CastlePoint Re and CastlePoint Insurance
were affirmed by A.M. Best in July 2007. The maintenance of the assigned ratings
depends, in part, upon CastlePoint Re and CastlePoint Insurance operating in a
manner consistent with the business plan presented to A.M. Best. A.M. Best
formally evaluates its Financial Strength ratings of insurance companies at
least once every twelve months and monitors the performance of rated companies
throughout the year.