Castelnau Group Regulatory News (CGL)

9 Mar 2006 07:03

Catlin Group Limited09 March 2006 NOT FOR DISTRIBUTION IN THE UNITED STATES FOR IMMEDIATE RELEASE The shares to be issued in the proposed placing have not been registered underthe U.S. Securities Act of 1933 and may not be offered or sold in the UnitedStates absent registration or an applicable exemption from registration underthe Securities Act and applicable state securities laws. This announcement doesnot constitute an offer to sell or the solicitation of an offer to buy, norshall there be any sale of securities in any jurisdiction in which such offer,solicitation or sale would be unlawful. The shares to be issued in the proposedplacing will not be offered or sold to the public in the United States. 9 March 2006 CATLIN GROUP LIMITED ANNOUNCES PRELIMINARY RESULTS FOR YEAR ENDED 31 DECEMBER 2005 HAMILTON, Bermuda - Catlin Group Limited ('CGL': London Stock Exchange), theinternational property and casualty insurer and reinsurer, announces itsfinancial results for the year ended 31 December 2005. Financial highlights: • Income before tax amounted to US$27.7 million (2004: US$173.9 million) despite net incurred losses from the three major hurricanes of US$333.5 million (2004 major hurricanes: US$114.6 million); net income amounted to US$19.7 million (2004: US$154.1 million) • Return on average equity was 2.1% (2004: 19.1%) • Book value grew to £3.47 per share (2004: £3.28) in sterling terms; declined to US$5.97 (2004: US$6.30) in dollar terms • Gross premiums written decreased to US$1.39 billion (2004: US$1.43 billion) • Net premiums earned increased to US$1.22 billion (2004: US$1.16 billion) • Combined ratio was 103.1 per cent (2004: 89.4 per cent); net incurred losses from the three major hurricanes represent 27.4 percentage points of the combined ratio (2004 major hurricane losses amounted to 9.9%) • Proposed final dividend of 10.1 pence (17.6 US cents) per share (2004: 8.1 pence; 15.6 cents); proposed total dividend of 15.5 pence (27.5 US cents) per share (2004: 12.4 pence; 23.5 cents) • Five percent capital raise and debt restructuring during the first half of 2006 US$000 (except as indicated) 2005 2004 % change Gross premiums written 1,386,600 1,433,836 (3)Net premiums written 1,189,099 1,246,505 (5)Net premiums earned 1,216,442 1,161,110 5Income before income taxes 27,665 173,942 (84)Net income 19,662 154,056 (87)Earnings per share (US$)* 0.13 1.08 (88)Total dividend per share (pence) 15.5 12.4 25Total dividend per share (cents) 27.5 23.5 17Book value per share (US$) $5.97 $6.30 (5)Book value per share (sterling) £3.47 £3.28 6Tax rate 28.9% 11.4% --Loss ratio 71.1% 56.9% --Expense ratio 32.0% 32.5% --Combined ratio 103.1% 89.4% --Return on average equity 2.1% 19.1% -- * 2004 figure is pro forma Operational highlights: • Disciplined underwriting resulted in less than 1 per cent decrease in weighted average premium rates across all classes of business • Strong underlying business performance, distorted by record hurricane losses • US$94 million release of prior year reserves reflects underlying reserving strength and profitability • Establishment of fourth underwriting platform, Catlin US, to write admitted US business, subject to regulatory approval • Continued development of Catlin Bermuda and Catlin UK • Opened new offices in Antwerp, Toronto, Guernsey and San Francisco • Centralisation and strengthening of support infrastructure Outlook: • Premium levels are strong across entire risk portfolio • 9 per cent increase in average weighted premium rates across all classes for business incepting in January; (17 per cent increase for hurricane impacted classes; 1.5 per cent increase across balance of portfolio) • Exposure to potential catastrophe losses is being reduced as business renews during 2006 • Share placing of approximately 5% of capital and debt restructuring to maximise flexibility to respond to market opportunities in 2006, particularly in the United States Commenting on the Group's preliminary results, Sir Graham Hearne, Chairman ofCatlin Group Limited, said: "Catlin's operating performance during 2005 was very satisfactory,notwithstanding the unprecedented impact of the hurricanes. The proposed totaldividend of 15.5 pence per share, which represents an increase of 25 per cent,reflects our confidence in underlying trends and prospects for Catlin." Chief Executive Stephen Catlin said: "Catlin's performance during 2005 demonstrates the strength of the Group'sstrategy and the advantages offered by our operating structure and diversifiedportfolio of business. Our strong capital base has remained intact despite a very tough 2005; we arenow increasing our capital and improving our debt structure to take maximumadvantage of growth opportunities in 2006 and beyond." This summary should be read in conjunction with the detailed announcement whichfollows. - ends - For more information contact: Media Relations:James Burcke, Head of Communications Tel: +44 (0)20 7458 5710 Mobile: +44 (0)7958 767 738 E-mail: james.burcke@catlin.com Liz Morley, The Maitland Consultancy Tel: +44 (0)20 7379 5151 E-mail: emorley@maitland.co.ukInvestor Relations:William Spurgin, Head of InvestorRelations Tel: +44 (0)20 7458 5726 Mobile: +44 (0)7710 314 365 E-mail: william.spurgin@catlin.com Notes to editors: 1. The Catlin Group, headquartered in Bermuda, is an international specialistproperty/casualty insurer and reinsurer writing more than 30 classes of businessworldwide. Catlin wrote gross premiums of $1.4 billion in 2005. Catlin sharesare traded on the London Stock Exchange (ticker symbol: CGL). 2. Catlin management will make a presentation to investment analysts at 11.00amGMT today at its London office. The presentation will be broadcast live on theGroup's website (www.catlin.com). The webcast will be also be available on thewebsite following the presentation. 3. Catlin's financial statements are prepared in accordance with accountingprinciples generally accepted in the United States of America ('US GAAP'). TheGroup reports in US dollars. 4. Pro forma net income per share for 2004 has been calculated based on weightedaverage pro forma shares in issue of 142.8 million. 5. Rate of exchange at 31 December 2005: £1 = US$1.72 (balance sheet); £1 =US$1.82 (income statement); at 7 March 2006 £1 = US$1.74. 6. Detailed information regarding Catlin's financial results for the year ended31 December 2005 follow, including statements from the Chairman, Chief Executiveand Chief Financial Officer and unaudited financial statements. 7. Syndicate 2003 at Lloyd's (the Catlin Syndicate) and Catlin Insurance CompanyLtd. (Catlin Bermuda) and Catlin Insurance Company (UK) Limited (Catlin UK) havebeen assigned financial strength ratings of 'A' (Excellent) by A.M. BestCompany. Chairman's Statement The Catlin Group achieved a solid operating performance during 2005,notwithstanding the record level of catastrophe losses incurred during thesecond half of the year. Whilst net income decreased to US$19.7 million in 2005(2004: US$154.1 million), this reduction was mainly due to the impact ofHurricanes Katrina, Rita and Wilma. Together, the three hurricanes producedincurred losses of US$333.5 million, net of reinsurance recoveries. The Group performed well across all areas of the business in 2005,notwithstanding the hurricane losses. Prior to the hurricanes, premium ratesdecreased for many of the business classes underwritten by Catlin. As marketcompetition increased, our underwriting teams maintained strict discipline anddeclined to underwrite business when the rate was not considered to be adequatefor the risk. Catlin's multi-platform operating structure gives the Group advantages notshared by many of our competitors. During 2005, the Group announced it wouldestablish a fourth underwriting platform, Catlin US, to write speciality classesof insurance in the United States on an admitted basis. The establishment ofCatlin US in 2006, when approved, will further complement the business alreadywritten by the Catlin Syndicate at Lloyd's, Catlin Bermuda and Catlin UK, andwill provide new opportunities for targeted growth in the world's largestinsurance market. Dividend Catlin has established a dividend policy under which payments are linked to boththe recent trends in performance of the business as well as future prospects. Weanticipate that dividends will grow over time. The Board of Directors proposes a final dividend of 10.1 pence (17.6 cents) pershare, payable on 12 June 2006 to shareholders of record at the close ofbusiness on 12 May 2006. This dividend is in addition to the interim dividend of5.4 pence (9.9 cents) per share that was paid on 14 November 2005. The total2005 dividend of 15.5 pence (27.5 cents) per share is 25 per cent greater thanthe total 2004 dividend of 12.4 pence (23.5 cents) per share. Capital raise Catlin's capital base has withstood an unprecedented level of hurricane loss in2005 and our stockholders' equity has not been impaired and remains strong. 2006is likely to present good new underwriting opportunities across many parts ofour portfolio, and we expect growth in all of our platforms, not least at CatlinUS and in our network of overseas offices. To ensure that we are well positionedto develop these opportunities, we are increasing our capital by placing up to7,704,900 new common shares, approximately 5% of the Group's share capital. Wealso intend to improve our debt structure in the coming months, raising US$150million of subordinated debt, giving us further financial flexibility. Board of Directors A number of changes to the Board of Directors have been made in the past year.Michael Harper joined the Board in July 2005 as the Senior Independent Director,and Jean-Claude Damerval was appointed at the same time as an IndependentNon-Executive Director. They replaced Nicholas Paumgarten and John Marion, whoretired as Non-Executive Directors after the major shareholders who hadappointed them under the Group's Bye-Laws disposed of their shareholdings. InFebruary 2006 Gene Lee was appointed by one of the major shareholders as aNon-Executive Director, succeeding William Spiegel who retired from the Board. I would like to thank all of our Directors for their hard work during what hasproven to be a challenging year. Outlook The major catastrophes of 2005 have created new opportunities for Catlin, whichstarts 2006 with its capital base intact. Rates are rising in classes ofbusiness affected by the hurricanes, and rate adequacy in most other classesremains strong. The hurricanes have created new demand for many of the insuranceand reinsurance products underwritten by Catlin, and the strongly rated capacitythat the Group is able to offer is in short supply. We are optimistic about theGroup's prospects during 2006. Throughout 2005, Stephen Catlin and his team have diligently worked to buildvalue for shareholders. I thank them for their outstanding efforts and lookforward to working with them during the forthcoming year. Sir Graham HearneChairman8 March 2006 Chief Executive's Review The Catlin Group faced two critical challenges during 2005. During the first sixmonths of the year, premium rates declined for many classes of business. In thesecond half, Catlin and the rest of the global insurance and reinsuranceindustry were confronted with the most costly natural catastrophe on record,Hurricane Katrina, followed closely by Hurricanes Rita and Wilma. Catlin performed well in the face of both challenges. The Group reported recordnet income during the first half of 2005 despite softening market conditions,demonstrating Catlin's firm commitment to disciplined underwriting. Whilst thethree major hurricanes in the second half produced combined net incurred lossesto Catlin totalling US$333.5 million, representing 27.4 percentage points to thecombined ratio, the underlying book of business remained very profitable. Gross premiums written decreased by 3 per cent in 2005 to US$1.39 billion (2004:US$1.43 billion). The reduction would have been greater without the firming inpremium rates late in the year following the hurricanes and the impact ofreinstatement premiums. This reflects Catlin's strict underwriting discipline asthe Group refused to underwrite business at rates that were not considered to beadequate. Weighted average premium rates across all classes of businessdecreased by less than 1 percent during 2005 (2004: 1 per cent increase), anexcellent outcome considering that rates for most classes were under pressurefor most of the year. Underwriting prospects for 2006 and beyond are much improved from a year ago.Rates for business classes impacted by the hurricanes - including propertycatastrophe and marine reinsurance, energy coverages and facultative propertyrisks - rose significantly during the January 2006 renewal season. Rates andconditions for other classes not directly impacted by the storms have alsostrengthened and, as a result, rate adequacy remains strong across ourportfolio. The hurricane losses and the prospect of another active hurricane season in 2006underscore the importance of Catlin's strategy of underwriting a diverseportfolio of uncorrelated risk, by both class of business and source ofbusiness. Our multi-platform structure - including the Catlin Syndicate at Lloyd's, CatlinBermuda and Catlin UK - provides the Group access to the major world insurancemarkets, enhancing our spread of risk. The establishment of a fourthunderwriting platform, Catlin US, will further diversity our risk portfolio.Catlin US, which is planned to begin underwriting in 2006, will underwritespecialty insurance for policyholders that require coverage on an admittedbasis. US admitted business represents significant opportunities for Catlin,although the business to be underwritten by Catlin US will be consistent withthe classes in which the Group already specialises and underwrites on anon-admitted basis. With the formation of Catlin US, the main elements of our multi-platformstructure will be complete. However, the Group will continue to establish newoffices in areas where we see opportunities. These offices produce diversestreams of specialty business that would ordinarily not be accessible by ourunderwriting platforms. In the past year, we opened new offices in Antwerp,Guernsey, Toronto and San Francisco. In addition, Catlin UK opened new officesin Birmingham and Watford during 2005 as it targeted UK regional business tocomplement its existing, primarily London based portfolio. In the past year, we have strengthened the internal infrastructure that supportsour underwriting teams, including both our internal controls and ITcapabilities. In the past year the number of Catlin employees increased to 397(31 December 2004: 312), which includes additions to both underwriting andsupport staffs. Our employees work incredibly hard, and I am happy to compareCatlin's productivity to that of any other company in our sector. The Group'sresults reflect the tremendous effort by our employees, for which I express mysincerest gratitude and thanks. We see significant opportunity for Catlin in 2006 and beyond. Our optimism isbased on improved market conditions, strong premium levels across the portfolio,the advantages of our multi-platform structure and the prospects for newbusiness, including Catlin US. We cannot predict what Mother Nature has in storefor 2006, but we can promise to work diligently to capitalise on whateveropportunities arise whilst maintaining underwriting discipline. Stephen CatlinChief Executive8 March 2006 Business Segments/Operating Platforms For 2005 the Group amended its segmental reporting method to be aligned to itsmultiple platform structure. Whilst the Group previously reported itsnon-Lloyd's business through the Corporate Direct and Corporate Reinsurancesegments, this business is now divided into two new segments: Catlin UK andCatlin Bermuda: The four business segments used in 2005 are: • Catlin Syndicate Direct, which comprises direct insurance business written by the Catlin Syndicate at Lloyd's; • Catlin Syndicate Reinsurance, which comprises reinsurance business underwritten by the Catlin Syndicate; • Catlin Bermuda; and • Catlin UK. Catlin Bermuda primarily writes reinsurance business, including intra-Groupreinsurance; most of its business had previously been accounted for in theCorporate Reinsurance segment. Catlin UK primarily underwrites direct insurancebusiness; most of its business had previously been accounted for in theCorporate Direct segment. Comparative figures are presented on the new segmental reporting basis. Thechanges have no effect on the Catlin Syndicate Direct and Catlin SyndicateReinsurance segments. Comparisons of the premiums written and combined ratios of the segments in 2005and 2004 are shown in the table below: Premiums Premiums Combined Combined written written ratio ratio including excluding including excluding intra-Group Intra-Group intra-Group intra-Group intra-Group2005 US$m reinsurance reinsurance reinsurance reinsurance reinsurance CatlinSyndicateDirect 698,841 - 698,841 85.6% 87.2%CatlinSyndicateReinsurance 278,450 - 278,450 136.4% 143.9%Catlin Bermuda 566,805 (389,625) 177,180 114.1% 109.7%Catlin UK 232,129 - 232,129 88.8% 88.7%Intra-GroupReinsurance (389,625) 389,625 - - - ---------- -------- ---------- -------- --------Total 1,386,600 - 1,386,600 103.1% 103.1% ---------- -------- ---------- -------- -------- Premiums Premiums Combined Combined written written ratio ratio including excluding including excluding intra-Group Intra-Group intra-Group intra-Group intra-Group2004 US$m reinsurance reinsurance reinsurance reinsurance reinsurance CatlinSyndicateDirect 870,363 - 870,363 93.4% 90.6%CatlinSyndicateReinsurance 211,185 - 211,185 86.1% 83.1%Catlin Bermuda 242,814 (90,236) 152,578 80.7% 90.1%Catlin UK 199,710 - 199,710 92.6% 93.8%Intra-GroupReinsurance (90,236) 90,236 - - - ---------- -------- ---------- -------- --------Total 1,433,836 - 1,433,836 89.4% 89.4% ---------- -------- ---------- -------- -------- Gross premiums written by Catlin's two 'Corporate' segments - Catlin Bermuda andCatlin UK -represented 53 per cent of the Group's 2005 premium volume includingintra-Group reinsurance (2004: 31 per cent). Gross premiums written by CatlinBermuda and Catlin UK during 2005 excluding intra-Group reinsurance represented30 per cent of the Group's total volume (2004: 25 per cent). Gross premiums written including intra-Group reinsurance increased in allsegments during 2005 with the exception of Catlin Syndicate Direct. The decreasereflects Catlin's strict underwriting discipline as business for which rateswere not totally adequate was not written or renewed. Commentary pertaining toeach business segment can be found in the underwriting platform reports.Financial commentary on Catlin's overall operations can be found in theFinancial Review. The Group's underlying portfolio of business, excluding the hurricanes thatmainly affected the Catlin Syndicate Reinsurance and Catlin Bermuda segments,performed better in 2005 than in 2004. Catlin Syndicate The Catlin Syndicate at Lloyd's (Syndicate 2003), the oldest and largest of theGroup's underwriting platforms, is a recognised leader of numerous classes ofspeciality insurance and reinsurance business. Gross premiums written by the Catlin Syndicate during 2005 decreased by 10 percent to US$977.3 million (2004: US$1.08 billion). The reduction reflects thecompetitive market conditions in many classes of business, particularly directinsurance business, in the first half of the year. The Syndicate declined tounderwrite or renew significant amounts of business at rates that we did notbelieve were fully adequate. Substantial reductions in exposure weresubsequently implemented in several key areas of the portfolio, includingproperty facultative, energy, non-marine binding authorities and generalliability. Offsetting these reductions, premium volume increased in several classes ofbusiness, notably catastrophe reinsurance and marine excess of loss classeswhich benefited from stronger rates and reinstatement premiums following thehurricanes in the second half of the year. The establishment of Catlin Group offices in Antwerp, Guernsey, San Franciscoand Toronto during 2005 led to increased underwriting in several classes ofbusiness, including specie and aviation. In addition, the Syndicate continued toexplore new specialty niches during the year. For example, an additionalunderwriter was recruited with experience in US errors' and omissions'insurance, adding to the Syndicate's existing expertise in this class ofbusiness. The improvement in the combined ratio for the Catlin Syndicate Direct segment in2005 reflects a relatively benign loss experience during the year. The hurricanelosses mainly impacted the Catlin Syndicate Reinsurance segment. The Syndicate's stamp capacity was reduced to £450 million for the 2006underwriting year (2005 and 2004: £500 million). This decision was taken priorto the US hurricanes and was based on the expectation at that time that ratesfor most classes of business would be competitive during 2006. The Syndicate'scapacity can be effectively increased at any time during the year since theCatlin Group supplies 100 per cent of the Syndicate's capital. The Group iscarefully monitoring the Syndicate's premium volume against capacity and ispoised to increase capacity, if necessary, to take advantage of favourableunderwriting opportunities as they arise. Under Lloyd's accounting rules, the Catlin Syndicate's 2003 year of account wasclosed at the end of 2005 with a return equal to 19.6 per cent of capacity. Nicolas Burkinshaw was appointed as Active Underwriter of the Catlin Syndicate,effective 1 January 2006, replacing Paul Brand. The appointment recognisesNick's achievements as a Catlin Group Underwriting Director and allows Paul tofocus exclusively on his duties as the Group's Chief Underwriting Officer.Andrew McMellin, another Underwriting Director, was appointed Deputy Underwriterof the Syndicate. Catlin Bermuda Since it began underwriting in November 2002, Catlin Bermuda has steadily builta diversified portfolio of property and casualty business. The company isrecognised by brokers as a leading underwriter in the rapidly growing Bermudamarket and as a provider of stable, secure long-term capacity. Excluding intra-Group reinsurance, gross premiums underwritten by Catlin Bermudaincreased by 16 per cent to US$177.2 million in 2005 (2004: US$152.6 million).This was primarily attributable to growth in the property catastrophe portfolio,both as a result of increased demand following the 2004 hurricanes andreinstatement premiums received following the 2005 hurricanes. Catlin Bermuda underwrites a diversified portfolio of both property treaty andcasualty treaty reinsurance as a lead or quoting market. Property treatyunderwriting is weighted towards US and international catastrophe business,including workers compensation catastrophe excess of loss, but also includingrisk excess of loss and proportional treaty, both USA and internationally. The casualty reinsurance team underwrites almost all lines of US casualtybusiness including medical malpractice, lawyers' malpractice, nursing homeliability, municipal liability, auto liability and general liability on a perrisk and clash basis. The team is a lead and quoting market for professional andmunicipal liability risks and is a known lead market in providing protection tomutual insurers, captives and other risk financing mechanisms. Catlin Bermuda also underwrites a number of specialist classes of insurance.Capitalising on the Group's longstanding expertise in healthcare relatedcoverages, a book of medical malpractice business for US healthcare providers isunderwritten on a non-admitted basis on behalf of Catlin Bermuda by the Group'sHouston office. A political risk and terrorism insurance underwriter joined Catlin Bermuda inlate 2005, and the company has joined several other Bermuda companies in writingthese classes of business, creating a significant level of market capacity. Catlin Bermuda also offers multi-year structured risk contracts to largecorporate clients and insurers seeking protection against loss volatility withinretained exposures. Catlin Bermuda holds a significant amount of the Group's capital and providedreinsurance support to the Group's other underwriting platforms. Catlin Bermuda continued to build its professional staff during 2005, recruitingnot only additional underwriting staff but also strengthening its finance,compliance and operational support capabilities. This investment not only willsupport further growth at Catlin Bermuda, but also will support theadministrative functions of Catlin UK and Catlin US, which are subsidiaries ofCatlin Insurance Company Ltd., as well as the increased amount of intra-Groupreinsurance premiums ceded to Catlin Bermuda. Catlin UK Catlin UK completed its second year of operations with a 16 per cent increase ingross written premiums and a reduced combined ratio. Catlin UK's business is derived from two sources: • Specialty classes of insurance that are also underwritten by the Catlin Syndicate; and • Selected classes of property and casualty insurance underwritten for commercial clients in the UK and Europe. Gross premiums written by Catlin UK during 2005 rose by 16 per cent to US$232.1million (2004: US$199.7 million). Catlin UK's combined ratio includingintra-Group reinsurance decreased to 88.8 per cent (2004: 92.6 per cent). Thisreflects the elimination of start-up costs which Catlin UK incurred in 2004, itsfirst year of operations. As Catlin UK focuses on UK and European business, ithad little exposure to claims arising from the 2005 US hurricanes. Apart from the classes of business also written by the Catlin Syndicate, CatlinUK focuses on five classes of business: • Professional indemnity;• Commercial property;• General liability;• Commercial crime; and• Directors' and officers' liability. During its initial year of operations, this business was primarily produced bythe London based brokers which the Catlin Syndicate has traditionally served,with modest amounts of business produced by existing Catlin offices in Glasgow,Leeds and Derby. Whilst Catlin UK further developed its London market book ofbusiness in 2005, it also further developed its UK regional strategy, underwhich business was sourced from regional brokers. The majority of UK domesticinsurance business - particularly small to medium size enterprise (SME) business- is placed outside of the London market. The regional strategy was carefully implemented during 2005 and will continue tobe developed during 2006. New offices were opened in Birmingham and Watford inthe second half of the year. Another regional office is scheduled to open in thespring of 2006. Each office has been staffed with experienced underwriters. Serving these regional accounts necessitated substantial development work toensure that internal systems could process business outside of the traditionalLloyd's and London Market processing bureaux. The work was essentially completedby year-end. Development of Catlin UK's online quotation system, 'CatLink',continued, both to further integrate it with Catlin's existing systems and totransact additional classes of business. Catlin UK was originally established as the UK Branch of Catlin InsuranceCompany Ltd. of Bermuda. In April 2005, the UK Financial Services Authorityapproved the formation of Catlin Insurance Company (UK) Ltd. as a subsidiary ofthe Bermuda company and subsequently approved the novation of the liabilities ofthe UK Branch to the new company. Converting Catlin UK to subsidiary statusallows it to underwrite business within all nations within the European EconomicArea. Catlin UK is also in the process of becoming an eligible surplus linesinsurer in many US states. Upon its establishment, Catlin Insurance Company (UK) Ltd. received a financialstrength rating of 'A' (Excellent) from A.M. Best. Financial Review The following pages contain commentary on Catlin's consolidated financialstatements for the year ended 31 December 2005, which are prepared in accordancewith US Generally Accepted Accounting Principles ('US GAAP'). Consolidated results of operations US$000 2005 2004 % changeRevenuesGross premiums written 1,386,600 1,433,836 (3)Reinsurance premiums ceded (197,501) (187,331) 5 ---------- ---------- ----------Net premiums written 1,189,099 1,246,505 (5)Change in unearned premiums 27,343 (85,395) 132 ---------- ---------- ----------Net premiums earned 1,216,442 1,161,110 5 Net investment income 82,147 46,974 75Net realised (losses)/gains on (1,520) 3,358 (145)investmentsNet realised (losses)/gains on (13,791) 8,865 (256)foreign currencyOther income 741 759 (2) ---------- ---------- ----------Total revenues 1,284,019 1,221,066 5 ---------- ---------- ---------- ExpensesLosses and loss expenses 865,285 660,437 31Policy acquisition costs 305,539 302,791 1Administrative expenses 61,865 57,294 8Other expenses 23,665 26,602 (11) ---------- ---------- ----------Total expenses 1,256,354 1,047,124 20 ---------- ---------- ---------- Income before income taxes 27,665 173,942 (84)Income tax expense (8,003) (19,886) 60 ---------- ---------- ----------Net income 19,662 154,056 (87) ---------- ---------- ---------- 2005 2004 Loss ratio (1) 71.1% 56.9%Expense ratio (2) 32.0% 32.5%Combined ratio (3) 103.1% 89.4%Tax rate 28.9% 11.4%Return on average equity 2.1% 19.1% 1. Calculated as losses and loss expenses divided by net premiums earned 2. Calculated as the total of policy acquisition costs, administrative expensesand other expenses, less financing and amortisation expenses, divided by netpremiums earned 3. Total of loss ratio plus expense ratio Gross premiums written Gross premiums written in 2005 decreased 3 per cent to US$1.39 billion (2004:US$1.43 billion), driven by a decline of nearly 20 per cent in gross premiumswritten by the Catlin Syndicate Direct segment. This reflects the Group's strictunderwriting discipline as business whose rates were not wholly adequate was notwritten or renewed. The decrease in gross written premiums would have beengreater without the firming in premium rates late in the year following thehurricanes and the collection of reinstatement premiums. Partially offsetting this decreased volume, gross premiums written in the CatlinSyndicate Reinsurance segment increased by 32 per cent as the Group tookadvantage of underwriting opportunities created by the past two active hurricaneseasons and reinstatement premiums. Reinsurance The 5 per cent increase in reinsurance premiums ceded in 2005, and the increasedproportion of gross premiums written which are ceded to reinsurers, is entirelydue to reinstatement costs triggered by actual and anticipated collections fromreinsurers following the large losses in 2005. If reinstatements are excluded,reinsurance costs for 2005 would have been lower than 2004. Net premiums earned Net premiums earned increased by 5 per cent to US$1.22 billion (2004: US$1.16billion). Gross premiums written grew by 20 per cent in 2004, and a significantelement of this increased volume was earned in 2005. Losses and loss expenses Losses and loss expenses have increased 31 per cent to US$865.3 million (2004:US$660.4 million). The Group's loss ratio increased by 14.2 percentage points to71.1 per cent (2004: 56.9 per cent). Included in losses and loss expenses are net losses incurred in respect of thethree major hurricanes (Katrina, Rita and Wilma) that caused extensive damage inthe Gulf of Mexico and the Southeastern United States during the second half of2005. The Group's incurred loss from these hurricanes amounted to US$333.5million, which added 27.4 percentage points to the Group's loss ratio, excludingthe impact of reinstatement premiums (2004 major hurricanes: US$114.6 million). Also included in losses and loss expenses is a release of reserves relating toprior year losses amounting to US$94.2 million (2004: US$38.3 million). Theimpact of both of these items on losses and loss expenses as well as the lossratio is outlined in the table below: 2005 2004 US$000 Loss ratio US$000 Loss ratioLosses and lossexpenses, as 865,285 71.1% 660,437 56.9%reportedLess: hurricane large (333,506) (27.4%) (114,616) (9.9%)lossesAdd: release of prior 94,207 7.8% 38,269 3.3%year reserves --------- --------- --------- --------- 625,986 51.5% 584,090 50.3% --------- --------- --------- --------- Expense ratio Total expenses increased 1 per cent to US$391.1 million (2004: US$386.7million). The expense ratio improved by 0.5 percentage points to 32.0 per cent(2004: 32.5 per cent). Acquisition costs are the single largest element of expense. These increased byUS$2.7 million to US$305.5 million (2004: US$302.8 million), and the acquisitionexpense ratio fell by 1 percentage point to 25.1 per cent (2004: 26.1 per cent).This reduction was driven by the mix of business underwritten and particularlythe effect on earned premium of reinsurance accounts which attract relativelylower acquisition costs. The increase in administration and other expenses was primarily due to greateremployee numbers across the Group, combined with the expense involved inestablishing new offices in the United Kingdom, United States, Belgium, Canadaand Guernsey. In addition, significant professional fees were incurred in 2005related to due diligence for the acquisition of Catlin US and the restructuringof Catlin UK from a branch to a subsidiary of Catlin Bermuda. The increase in administration and other expenses was partially offset by amaterial decrease in Central Fund contributions levied by Lloyd's (2005: 0.5 percent of stamp capacity; 2004: 1.25 per cent). In addition, the Group did notmake sufficient returns in 2005 under the profit related bonus calculation andtherefore no such bonus will be payable to management relating to the 2005 year. Finally, in 2005 the Group ceased amortising its purchased syndicate capacityintangible asset. This intangible asset has a balance sheet value of US$48.7million at 31 December 2005. Amortisation of this asset reported in 2004 wasUS$4.0 million. Net investment income and net realised gains/(losses) on investments US$000 2005 2004 Total investments, as at 31 December 2,371,360 1,982,712 Net investment income 82,147 46,974Net realised (losses)/gains on investments (1,520) 3,358Net unrealised (losses)/gains on (29,015) 5,254investments ---------- ---------- 51,612 55,586 ---------- ----------Realised return on average investments 3.6% 3.1% ---------- ----------Total return on average investments 2.3% 3.4% ---------- ---------- Net investment income and net realised gains/(losses) on investments increasedby 60 per cent to US$80.6 million (2004: US$50.3 million). The realised returnon average investments increased to 3.6 per cent (2004: 3.1 per cent). Total return on average investments decreased to 2.3 per cent (2004: 3.4 percent) as a result of significant unrealised losses. During the year, short terminterest rates rose and yield curves flattened dramatically, significantlyimpacting fixed income securities with maturities of less than three years. As aresult of the relatively short term nature of the Group's liabilities and itsmatched asset position, the rise in short term interest rates createdsubstantial unrealised losses on the Group's investment portfolios. Net realised gain/(loss) on foreign currency exchange The Group reports its financial results in US dollars. During the year ended 31December 2005, the Group realised a loss on foreign exchange of US$13.8 million(2004: US$8.9 million gain). The US dollar strengthened by 10 per cent againststerling during 2005, triggering foreign exchange losses on the valuation ofsterling denominated net assets carried in US dollar balance sheets. The Group seeks to maintain matched portfolios of assets and liabilities by maincurrency to avoid economic exposure to foreign exchange movements. However,accounting effects arise largely as a result of intra-Group trading. Inparticular, Catlin Bermuda has provided substantial sterling funding andreinsurance to Catlin Syndicate and Catlin UK. Losses realised in Bermuda areoffset by gains arising on translation of the balance sheets of these UKentities; such gains are taken directly to stockholders' equity. Income tax expense The Group's effective tax rate increased to 28.9 per cent (2004: 11.4 per cent).This is higher than the anticipated long term tax rate, partly due to the highincidence of losses incurred in and ceded to Catlin Bermuda, a zero-taxjurisdiction. 2005 was a year of exceptional loss; the effective tax rate willdecrease during years of higher profitability. Balance sheet US$000 (except share amounts) 2005 2004 % change Investments and cash 2,371,360 1,982,712 20Intangibles and goodwill 63,639 71,238 (11)Premiums and other receivables 565,500 629,544 (10)Reinsurance recoverable 629,269 448,775 40Deferred acquisition costs 126,738 142,511 (11)Other assets 103,477 98,346 5 Loss reserves (1,995,485) (1,472,819) 35Unearned premiums (663,659) (722,891) (8)Notes payable (50,000) (50,187) -Other liabilities (219,758) (156,042) 41 ---------- ---------- ---------Stockholders' equity 931,081 971,187 (4) ---------- ---------- ---------Stockholders' equity per share (US$) US$5.97 US$6.30 (5) ---------- ---------- ---------Stockholders' equity per share £3.47 £3.28 6(sterling) ---------- ---------- --------- The chart below shows the principal components of the change in stockholders'equity during the year: US$000Stockholders' equity, 1 January 2005 971,187Net income 19,662Stock compensation and other 4,737Dividends declared (38,950)Change in other comprehensive income (25,555) ------------Stockholders' equity, 31 December 2005 931,081 ------------ Investments and cash Investments and cash increased by 20 per cent to US$2.37 billion (2004:US$1.98billion). There was no capital activity during 2005; the increase was generatedby operations, offset by dividend payments of US$38.3 million (2004: US$12.1million). The Group continued to maintain a conservative investment philosophy,with assets invested in a portfolio of fixed maturities, short term investmentsand cash. At 31 December 2005, the fixed maturities were all high quality,primarily with ratings of AA or higher. Reinsurance recoverable Reinsurance recoverable, including deposit with reinsurer, increased by 40 percent to US$629.3 million (US$448.8 million), largely reflecting the anticipatedrecoveries from reinsurers due to the hurricane losses incurred in the secondhalf of the year. Recoveries for these losses at year end were estimated to beUS$282 million. More than 95 per cent of the Group's overall recoveries is due from reinsurersrated 'A-' or better, and US$135.0 million of the amount recoverable is securedthrough segregated trust funds held for the account of Catlin (2004: US$169.4million). The Group maintains provisions to cover balances due, or anticipatedto be due, from reinsurers that are now expected not to be able to pay amountsdue or where there are specific contractual disputes. Loss reserves Gross loss reserves increased 35 per cent to US$2.00 billion (2004: US$1.47billion). Net loss reserves as a proportion of stockholders' equity increased to152.5 per cent at 31 December 2005 (31 December 2004: 114.7 per cent),reflecting the large hurricane losses incurred during the year. These largelosses remain mostly unpaid, resulting in a high level of unsettled claims atthe year-end. Loss reserves continue to be held at levels which are conservativerelative to the range of estimates of both internal actuaries and independentadvisors. Unearned premiums Unearned premiums decreased 8 per cent to US$663.7 million at 31 December 2005(31 December 2004: US$722.9 million). Gross premiums written declined 3 per centcompared with the prior period. Within gross premiums written there is a largerelement of reinstatement premiums in 2005 compared with 2004, the majority ofwhich were earned by the end of the year. Cash and capital management Intra-Group reinsurance The use of intra-Group reinsurance is central to the management of the Group'scapital. The Group seeks to maintain economic capital within Catlin Bermuda tothe maximum extent possible and to manage the insurance risk portfolio on aGroup basis, regardless of the underwriting platform which originallyunderwrites the risk. At the end of 2004, the Group put into place a quota share contract, whicheffectively resulted in the cession of 50 per cent of Catlin Syndicate'sbusiness to Catlin Bermuda. This contract was deposit accounted in the 2004financial statements due to its retroactive nature. In 2005, this contract isaccounted for as reinsurance and its impact on the segmental reporting can beseen. During 2005, the Group put into place another quota share contract, whichresults in the cession of 60 per cent of Catlin UK's business to Catlin Bermuda.This is also accounted for as reinsurance. Cash and liquidity A summary of the growth in cash and invested assets is shown in the table below. US$000Total cash and investments, 1 January 2005 1,982,712Operating cash 465,234Dividends paid (38,291)Non-operating cash and other (38,295) --------------Total cash and investments, 31 December 2005 2,371,360 -------------- Gearing and banking facility During December 2005 the Group renewed its bank facility with a club of threelending banks. The structure of the facility is largely unchanged from the prioryear although the amounts have increased, in particular relating to the standbyletter of credit facility: • A US$50 million revolving credit facility fully drawn by the Group and used to subscribe capital to Catlin Bermuda. • A £150 million (US$258 million) unsecured letter of credit facility. £125 million (US$215 million) of this facility is drawn and used to provide part of the Funds at Lloyd's supporting the underwriting of Catlin Syndicate. • A US$200 million standby letter of credit facility which is used by Catlin Bermuda and Catlin UK to secure outstanding claim and unearned premium balances as necessary. The gearing reflected on the balance sheet resulting from usage of this facilityis represented by the $50 million of notes payable, unchanged from 2004, whichrepresents 5.4% (2004: 5.2%) of stockholders' equity. The Funds at Lloyd's unsecured letter of credit facility is used to provide partof the regulatory capital for Catlin Syndicate, the balance being provided byCatlin Bermuda funds which are held in trust by Lloyd's. In addition, at 31December 2005 letters of credit with a value of $122 million, half of which areunsecured, had been issued under the standby facility, almost all in respect ofCatlin Bermuda policies. Foreign currency management US dollars account for the majority of the Group's cash flow. A significant partof the remaining cash flow is in sterling; the Group also maintains euro andCanadian dollar funds. Management of foreign currency exposures is primarilyfocussed on analysis and matching of expected cash flows; derivatives or otherfinancial instruments have not been utilised. Forward purchases and sales ofcurrency are used when currency needs are identified. Whilst the Group typically realises exchange losses during periods ofappreciating US dollar values, sterling shareholders can achieve substantialgains. During 2005 the value of the US dollar against sterling moved from 1.92at 1 January to 1.72 at 31 December, a rise of more than 10 per cent. Althoughstockholders' equity per share in US dollar terms has fallen by 5 per centduring the year to US$5.97 (2004: US$6.30), in sterling terms this represents a6 per cent gain to £3.47 per share (2004:£3.28). Other capital management Group capital adequacy is measured against Catlin's economic capital model whichmeasures required capital against a series of 1 in 200 year scenarios. Thiscomplies with European and US regulatory requirements, although the Group holdscapital in excess of regulatory minima. The model calculates capitalrequirements having regard to underwriting, reserving, credit, market,investment and operational risk. The model is regularly updated as part of ourplanning process. Catlin Bermuda, Catlin UK and Catlin Syndicate are each rated 'A' (Excellent) byA.M. Best. Christopher StookeChief Financial Officer8 March 2006 Catlin Group LimitedConsolidated Balance SheetsAs at 31 December 2005 and 2004(US dollars in thousands, except share amounts) 2005 2004AssetsInvestmentsFixed maturities, available-for-sale, at fairvalue(amortised cost 2005: $1,761,968; 2004: $1,744,043 $1,452,198$1,441,014)Short-term investments, at fair value 14,666 173,037Cash and cash equivalents, at fair value 609,857 354,608Investment in associate 2,794 2,869 ---------- ----------Total investments 2,371,360 1,982,712 ---------- ---------- Accrued investment income 17,227 15,925Premiums and other receivables 565,500 629,544Reinsurance recoverable (net of allowance of2005: $24,511; 2004: $18,864) 607,446 390,945Deposit with reinsurer 21,823 57,830Reinsurers' share of unearned premiums 37,222 51,748Deferred acquisition costs 126,738 142,511Intangible assets and goodwill (accumulatedamortisation 2005: $26,181; 2004: $29,163) 63,639 71,238Other assets 49,028 30,673 ---------- ----------Total assets $3,859,983 $3,373,126 ---------- ----------Liabilities and Stockholders' EquityLiabilities:Unpaid losses and loss expenses $1,995,485 $1,472,819Unearned premiums 663,659 722,891Deferred gain 8,078 19,548Reinsurance payable 137,313 59,137Notes payable 50,000 50,187Accounts payable and other liabilities 70,186 70,138Deferred taxes 4,181 7,219 ---------- ----------Total liabilities $2,928,902 $2,401,939 ---------- ---------- The accompanying notes are an integral part of the consolidated financialstatements Catlin Group LimitedConsolidated Balance SheetsAs at 31 December 2005 and 2004(US dollars in thousands, except share amounts) 2005 2004Stockholders' equity:Ordinary common shares, par value $0.01 1,559 1,541Authorised 250,000,000; issued and outstanding2005: 155,914,616; 2004: 154,097,989) Additional paid-in capital 721,935 716,649Accumulated other comprehensive income/(loss) (21,399) 4,156Retained earnings 228,986 248,841 ---------- ----------Total stockholders' equity 931,081 971,187 ---------- ----------Total liabilities and stockholders' equity $3,859,983 $3,373,126 ---------- ---------- The accompanying notes are an integral part of the consolidated financialstatements Approved by the Board of Directors on 8 March 2006Stephen Catlin, DirectorChristopher Stooke, Director Catlin Group LimitedConsolidated Statements of OperationsFor the years ended 31 December 2005 and 2004(US dollars in thousands, except share amounts) 2005 2004RevenuesGross premiums written $1,386,600 $1,433,836Reinsurance premiums ceded (197,501) (187,331) ---------- ----------Net premiums written 1,189,099 1,246,505Change in net unearned premiums 27,343 (85,395) ---------- ----------Net premiums earned 1,216,442 1,161,110 ---------- ----------Net investment income 82,147 46,974Net realised (losses)/gains on investments (1,520) 3,358Net realised (losses)/gains on foreign currencyexchange (13,791) 8,865Other income 741 759 ---------- ----------Total revenues 1,284,019 1,221,066 ---------- ---------- ExpensesLosses and loss expenses 865,285 660,437Policy acquisition costs 305,539 302,791Administrative expenses 61,865 57,294Other expenses 23,665 26,602 ---------- ----------Total expenses 1,256,354 1,047,124 ---------- ----------Income before income tax expense 27,665 173,942Income tax expense (8,003) (19,886) ---------- ----------Net income $19,662 $154,056 ---------- ---------- Earnings per common shareBasic $0.13 $1.31Diluted $0.12 $1.00 ---------- ---------- The accompanying notes are an integral part of the consolidated financialstatements Catlin Group LimitedConsolidated Statements of Changes in Stockholders' Equity andAccumulated Other Comprehensive IncomeFor the years ended 31 December 2005 and 2004(US dollars in thousands, except share amounts) Accumulated Total Additional Retained other stock- Common Preference paid-in earnings comprehensive holders' stock shares capital (deficit) income (loss) equityBalance 1January 2004 $8 $50 $533,276 $106,709 $(1,406) $638,637Comprehensiveincome:Net income - - - 154,056 - 154,056Othercomprehensiveincome - - - - 5,562 5,562 ------- ------- -------- ------- --------- --------Totalcomprehensiveincome - - - 154,056 5,562 159,618 ------- ------- -------- ------- --------- -------- Payment of PIKdividend 4 - (4) - - -Redesignationof preferenceshares 50 (50) - - - -19-1 bonusissue 1,167 - (1,167) - - -Global Offer 312 - 182,315 - - 182,627Stockcompensationexpense - - 2,099 - - 2,099Stock optionsexercised - - 130 - - 130Dividendsdeclared - - - (11,924) - (11,924) ------- ------- -------- ------- --------- --------Balance 31December 2004 $1,541 $- $716,649 $248,841 $4,156 $971,187 ------- ------- -------- ------- --------- -------- Comprehensiveincome:Net income - - - 19,662 - 19,662Othercomprehensiveloss - - - - (25,555) (25,555) ------- ------- -------- ------- --------- --------Totalcomprehensiveloss - - - 19,662 (25,555) (5,893) ------- ------- -------- ------- --------- -------- Stockcompensationexpense - - 4,246 - - 4,246Stock optionsand warrantsexercised 18 - (18) - - -Dividendsdeclared - - - (38,950) - (38,950)Deferredcompensationobligation - - 567 (567) - -Adjustment toGlobal Offerexpenses - - 491 - - 491 ------- ------- -------- ------- --------- --------Balance 31December 2005 $1,559 $- $721,935 $228,986 $(21,399) $931,081 ------- ------- -------- ------- --------- -------- The accompanying notes are an integral part of the consolidated financialstatements Catlin Group LimitedConsolidated Statements of Cash FlowsFor the years ended 31 December 2005 and 2004(US dollars in thousands, except share amounts) 2005 2004 Cash flows provided by operating activitiesNet income $19,662 $154,056Adjustments to reconcile net income to net cashprovided by operations:Amortisation and depreciation 9,631 10,742Amortisation of discounts of fixed maturities (12,371) (2,317)Net realised losses/(gains) on investments 1,520 (3,358)Unpaid losses and loss expenses 700,895 423,817Unearned premiums 7,810 67,485Premiums and other receivables (10,087) (187,251)Deferred acquisition costs 2,577 (3,518)Reinsurance payable 166,576 42,358Reinsurance recoverable (305,930) (63,542)Reinsurers' share of unearned premiums (14,334) 2,211Deposit with reinsurer 36,007 36,640Deferred gain (11,470) (3,893)Accounts payable and other liabilities (2,174) 7,869Deferred tax 6,855 3,035Other (129,933) 66,396 --------- ---------Net cash flows provided by operating activities 465,234 550,730 --------- --------- Cash flows used in investing activitiesPurchases of fixed maturities (1,817,889) (1,370,658)Purchases of short-term investments (258,048) (738,956)Proceeds from sales of fixed maturities 1,445,990 672,950Proceeds from maturities of fixed maturities 77,864 11,670Proceeds from sales of short-term investments 429,616 727,563Purchase of intangible assets (51) (161)Purchases of property and equipment (11,174) (12,233)Proceeds from sales of property and equipment 21 85 --------- ---------Net cash flows used in investing activities (133,671) (709,740) --------- --------- The accompanying notes are an integral part of the consolidated financialstatements Catlin Group LimitedConsolidated Statements of Cash FlowsFor the years ended 31 December 2005 and 2004(US dollars in thousands, except share amounts) 2005 2004Cash flows provided by financing activitiesProceeds from issue of common shares - 183,127Dividends paid on common shares (38,291) (12,085)Proceeds from notes payable 250,000 200,000Repayment of notes payable (250,000) (200,000)Proceeds from exercise of stock options - 130 --------- ---------Net cash flows (used in)/provided by financing (38,291) 171,172activities --------- ---------Net increase in cash and cash equivalents 293,272 12,162Cash and cash equivalents - beginning of year 354,608 325,667Effect of exchange rate changes (38,023) 16,779 --------- ---------Cash and cash equivalents - end of year $609,857 $354,608 --------- --------- Supplemental cash flow informationTaxes paid $223 $306Interest paid $2,113 $1,176 Cash and cash equivalents comprise the following:Cash at bank and in hand $480,014 $349,815Cash equivalents $129,843 $4,793 --------- --------- The accompanying notes are an integral part of the consolidated financialstatements Catlin Group LimitedNotes to the Consolidated Financial StatementsFor the years ended 31 December 2005 and 2004(US dollars in thousands, except share amounts) 1. Nature of operations Catlin Group Limited ('Catlin' or the 'Company') is a holding companyincorporated on 25 June 1999 under the laws of Bermuda. Through intermediateholding companies in the United Kingdom ('UK'), the Company is the soleshareholder of Catlin Underwriting Agencies Limited ('CUAL'), a Lloyd's managingagent, and Catlin Syndicate Limited ('CSL'), the sole member of Lloyd'sSyndicate 2003 and Syndicate 2600. As well as Syndicates 2003 and 2600, CUALalso managed Syndicate 1003, the capital of which was provided by third partiesfor 2002 and prior years. With effect from the 2003 underwriting year, CSL isthe sole capital provider to all CUAL-managed syndicates. In December 2000, the Company established Catlin Insurance Company Limited('CICL') as a Bermuda licensed insurer. CICL remained dormant until July 2002when, in conjunction with a private equity capital raise, CICL was capitalised,activated and licensed as a Class 4 insurer under the laws and regulations ofBermuda. In December 2003, CICL received authorisation from the FinancialServices Authority ('FSA') to commence underwriting in the UK through its UKBranch operations. In March 2005, Catlin Insurance Company (UK) Limited wasauthorised by the FSA and in June 2005, all of the business written by the UKBranch of CICL was novated into this new company, a subsidiary of CICL. The Company is also the sole shareholder (directly or through intermediateholding companies) of companies in Singapore, Malaysia, Germany, Australia,Guernsey, Canada, the United States of America ('US') and the UK. Thesecompanies all act as underwriting agents for Catlin underwriting platforms. Through its subsidiaries, the Company writes a broad range of products,including property, casualty, energy, marine and aerospace insurance productsand property, catastrophe and per-risk excess, non-proportional treaty,aviation, marine, casualty and motor reinsurance business. Business is writtenfrom many countries, although business from the US predominates. The Company andits subsidiaries are together referred to as the 'Group'. On 6 April 2004, the Company completed its initial public offering and wasadmitted to the London Stock Exchange. The Company raised $182,627 net ofexpenses through the issuance of new common shares. 2. Significant accounting policies Basis of presentation The accompanying consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the US ('US GAAP').The preparation of financial statements in conformity with US GAAP requiresmanagement to make estimates when recording transactions resulting from businessoperations based on information currently available. The most significant itemson the Group's balance sheet that involve accounting estimates and actuarialdeterminations are reserves for loss and loss expenses, deferred acquisitioncosts, reinsurance recoverables, valuation of investments and goodwill. Theaccounting estimates and actuarial determinations are sensitive to marketconditions, investment yields, commissions and other acquisition expenses. Asadditional information becomes available, or actual amounts are determinable,the recorded estimates will be revised and reflected in operating results.Although some variability is inherent in these estimates and actual results maydiffer from the estimates used in preparing the consolidated financialstatements, the Group believes the amounts provided are reasonable. Principles of consolidation The consolidated financial statements include the accounts of the Company andall of its wholly owned subsidiaries. All significant inter-company transactionsand balances are eliminated on consolidation. Reporting currency The financial information is reported in US dollars ('US dollars' or '$'). Investments The Group's investments are considered to be available-for-sale and are carriedat fair value. The fair value is based on the quoted market price of thesesecurities provided by either independent pricing services, or, when such pricesare not available, by reference to broker or underwriter bid indications. Net unrealised gains or losses on investments, net of deferred income taxes, areincluded in accumulated other comprehensive income in stockholders' equity. Premiums and discounts are amortised or accreted over the lives of the relatedfixed maturities as an adjustment to yield using the effective-interest methodand is recorded in current period income. Interest income is recognised whenearned. Realised gains or losses are included in earnings and are derived usingthe specific-identification method. Net investment income includes interest income together with amortisation ofmarket premiums and discounts and is net of investment management and custodyfees. For mortgage-backed securities and any other holdings for which there is aprepayment risk, prepayment assumptions are evaluated and revised as necessary.Any adjustments required due to the resultant change in effective yields andmaturities are recognised prospectively. Other than temporary impairments The Group regularly monitors its investment portfolio to ensure that investmentsthat may be other than temporarily impaired are identified in a timely fashionand properly valued, and that any impairments are charged against earnings inthe proper period. The Group's methodology to identify potential impairmentsrequires professional judgment. Changes in individual security values aremonitored on a monthly basis in order to identify potential problem credits. TheGroup's decision to make an impairment provision is based on an objective reviewof the issuer's current financial position and future prospects, its financialstrength rating and an assessment of the probability that the current marketvalue will recover to former levels. In assessing the recovery of market valuefor debt securities, the Group also takes into account the timing of suchrecovery by considering whether it has the ability and intent to hold theinvestment to the earlier of (a) settlement or (b) market price recovery. Anysecurity whose price decrease is deemed other-than-temporary is written down toits then current market level and the cumulative net loss previously recognisedin equity is removed from equity and charged to earnings. Inherently, there arerisks and uncertainties involved in making these judgments. Changes incircumstances and critical assumptions such as a continued weak economy, a morepronounced economic downturn or unforeseen events which affect one or morecompanies, industry sectors or countries could result in additional writedownsin future periods for impairments that are deemed to be other-than-temporary.Additionally, unforeseen catastrophic events may require us to sell investmentsprior to the forecast market price recovery. Short-term investments Short-term investments are carried at fair value and are composed of securitiesdue to mature between 90 days and one year of date of purchase. Investment in associate Investment in associate is composed of an investment in a limited liabilitycorporation. This investment is accounted for using the equity method. Cash and cash equivalents Cash equivalents are carried at cost, which approximates fair value, and includeall investments with original maturities of 90 days or less. Premiums Premiums written are generally recognised in accordance with the terms of theunderlying policy. Premiums written are primarily earned on a daily pro ratabasis over the terms of the policies to which they relate. Accordingly, unearnedpremiums represent the portion of premiums written which is applicable to theunexpired risk portion of the policies in force. Reinsurance premiums assumed are recorded at the inception of the policy and areestimated based on information provided by ceding companies. The informationused in establishing these estimates is reviewed and subsequent adjustments arerecorded in the period in which they are determined. These premiums are earnedover the terms of the related reinsurance contracts. For multi-year policies written which are payable in annual instalments, due tothe ability of the insured or reinsured to commute or cancel coverage within theterm of the policy, only the annual premium is included as written premium atpolicy inception. Annual instalments are included as written premium at eachsuccessive anniversary date within the multi-year term. Reinstatement premiums are recognised and fully earned as they fall due. Deferred acquisition costs Certain policy acquisition costs, consisting primarily of commissions andpremium taxes, that vary with and are primarily related to the production ofpremium, are deferred and amortised over the period in which the relatedpremiums are earned. A premium deficiency is recognised immediately by a charge to the Statement ofOperations as a reduction of deferred acquisition costs ('DAC') to the extentthat future policy premiums, including anticipation of interest income, are notadequate to recover all DAC and related losses and loss expenses. If the premiumdeficiency is greater than unamortised DAC, a liability will be accrued for theexcess deficiency. Unpaid losses and loss expenses A liability is established for unpaid losses and loss expenses when insuredevents occur. The liability is based on the expected ultimate cost of settlingthe claims. The unpaid losses and loss expenses reserve includes: (1) casereserves for known but unpaid claims as of the balance sheet date; (2) incurredbut not reported ('IBNR') reserves for claims where the insured event hasoccurred but has not been reported to the Group as of the balance sheet date;and (3) loss adjustment expense reserves for the expected handling costs ofsettling the claims. Unpaid losses and loss expenses reserves are established based on amountsreported from insureds or ceding companies and according to generally acceptedactuarial principles. Reserves are based on a number of factors, includingexperience derived from historical claim payments and actuarial assumptions toarrive at loss development factors. Such assumptions and other factors includetrends, the incidence of incurred claims, the extent to which all claims havebeen reported, and internal claims processing charges. The process used inestablishing reserves cannot be exact, particularly for liability coverages,since actual claim costs are dependent upon such complex factors as inflation,changes in doctrines of legal liability and damage awards. The methods of makingsuch estimates and establishing the related liabilities are periodicallyreviewed and updated. Deferred gain The Group may enter into retroactive reinsurance contracts, which are contractswhere an assuming company agrees to reimburse a ceding company for liabilitiesincurred as a result of past insurable events. Any initial gain and any benefitdue from a reinsurer as a result of subsequent covered adverse development isdeferred and amortised into income over the settlement period of the recoveriesunder the relevant contract. Contract deposits Contracts written by the Group which are not deemed to transfer significantunderwriting and/or timing risk are accounted for as contract deposits and areincluded in premiums and other receivables. Liabilities are initially recordedat an amount equal to the assets received and are included in accounts payableand other liabilities. The Group uses the risk-free rate of return of equivalent duration to theliabilities in determining risk transfer and records the transactions using theinterest method. The Group periodically reassesses the estimated ultimateliability. Any changes to this liability are reflected as an adjustment tointerest expense to reflect the cumulative effect of the period the contract hasbeen in force, and by an adjustment to the future internal rate of return of theliability over the remaining estimated contract term. Goodwill and intangible assets Goodwill represents the excess of acquisition costs over the net fair values ofidentifiable assets acquired and liabilities assumed in a business combination.Pursuant to Statement of Financial Accounting Standards No. 142, Goodwill andOther Intangible Assets ('FAS 142'), goodwill is deemed to have an indefinitelife and should not be amortised, but rather tested at least annually forimpairment. The goodwill impairment test has two steps. The first step identifies potentialimpairments by comparing the fair value of a reporting unit with its book value,including goodwill. If the fair value of the reporting unit exceeds the carryingamount, goodwill is not impaired and the second step is not required. If thecarrying value exceeds the fair value, the second step calculates the possibleimpairment loss by comparing the implied fair value of goodwill with thecarrying amount. If the implied goodwill is less than the carrying amount, awritedown is recorded. The measurement of fair value of the reporting unit wasdetermined based on an evaluation of ranges of future discounted earnings.Certain key assumptions considered include forecasted trends in revenues,operating expenses and effective tax rates. Intangible assets are valued at their fair value at the time of acquisition. TheGroup's intangibles relate to the purchase of syndicate capacity and surpluslines licenses. During 2005, the Group reassessed its estimate of the useful life of syndicatecapacity purchased during 2002 and determined that it was indefinite. As aresult, the Group has ceased amortising this intangible asset and instead willassess its recoverability at least annually. Surplus lines authorisations are considered to have a finite life and areamortised over their estimated useful lives of 5 years. The Group evaluates therecoverability of its intangible assets whenever changes in circumstancesindicate that an intangible asset may not be recoverable. If it is determinedthat an impairment exists, the excess of the unamortised balance over the fairvalue of the intangible asset is charged to earnings. Other assets Other assets are principally composed of prepaid items and property andequipment. Property and equipment Property and equipment are stated at cost less accumulated depreciation.Depreciation of property and equipment is calculated using the straight-linemethod over the estimated useful lives of four to ten years for fixtures andfittings, four years for automobiles and two years for computer equipment.Leasehold improvements are amortised over the life of the lease or the life ofthe improvement, whichever is shorter. Computer software development costs arecapitalised when incurred and depreciated over their estimated useful lives offive years. Reinsurance In the ordinary course of business, the Company's insurance subsidiaries cedereinsurance to other insurance companies. These arrangements allow for greaterdiversification of business and minimise the net loss potential arising fromlarge risks. Ceded reinsurance contracts do not relieve the Group of itsobligation to its insureds. Reinsurance premiums ceded are recognised andcommissions thereon are earned over the period that the reinsurance coverage isprovided. Reinstatement premiums are recorded and fully expensed as they fall due. Reinsurance recoverable includes the balances due from reinsurance companies forpaid and unpaid losses and loss expenses that will be recovered from reinsurers,based on contracts in force. A reserve for uncollectible reinsurance has beendetermined based upon a review of the financial condition of the reinsurers andan assessment of other available information. Reinsurers' share of unearned premiums represent the portion of premiums cededto reinsurers applicable to the unexpired terms of the reinsurance contracts inforce. Return premiums due from reinsurers are included in premiums and otherreceivables. Comprehensive income/(loss) Comprehensive income/(loss) represents all changes in equity that result fromrecognised transactions and other economic events during the period. Othercomprehensive income/(loss) refers to revenues, expenses, gains and losses thatare included in comprehensive income/(loss) but excluded from net income/(loss),such as unrealised gains or losses on available for sale investments and foreigncurrency translation adjustments. Foreign currency translation and transactions Foreign currency translation The Group has more than one functional currency, generally the currency of thelocal operating environments, consistent with its operating environment andunderlying cash flows. The presentation currency of the Group has beendetermined to be US dollars. For subsidiaries with a functional currency otherthan US dollars, foreign currency assets and liabilities are translated into USdollars using period end rates of exchange, while statements of operations aretranslated at average rates of exchange for the period. The resultingtranslation differences are recorded as a separate component of accumulatedother comprehensive income/(loss) within stockholders' equity. Foreign currency transactions Monetary assets and liabilities denominated in foreign currencies are revaluedat period end rates of exchange, with the resulting gains and losses included inincome. Revenues and expenses denominated in foreign currencies are translatedat average rates of exchange for the period. Income taxes Income taxes have been provided for on those operations that are subject toincome taxes. Deferred tax assets and liabilities result from temporarydifferences between the amounts recorded in the consolidated financialstatements and the tax basis of the Group's assets and liabilities. Suchtemporary differences are primarily due to the tax basis discount on unpaidlosses, adjustment for unearned premiums, the accounting treatment ofreinsurance contracts, and tax benefits of net operating loss carry-forwards.The effect on deferred tax assets and liabilities of a change in tax rates isrecognised in income in the period that includes the enactment date. A valuationallowance against deferred tax assets is recorded if it is more likely than notthat all or some portion of the benefits related to deferred tax assets will notbe realised. Preference shares Convertible preference shares are recorded at fair value at the time ofissuance. At the time of issuance, the fair value in excess of the shares' parvalue is credited to additional paid-in capital. Dividends are recognised whendeclared by the Company. Stock compensation The Group accounts for stock-based compensation arrangements under theprovisions of Statement of Financial Accounting Standards No. 123 (Revised2004), Accounting for Stock-Based Compensation ('FAS 123R'). The fair value of options is calculated at the date of grant based on theBlack-Scholes Option Pricing Model. The corresponding compensation charge isrecognised on a straight-line basis over the option-vesting period. The fair value of non-vested shares is calculated on the grant date based on theshare price and the exchange rate in effect on that date and is recognised on astraight-line basis over the vesting period. This calculation is updated on aregular basis to reflect revised expectations and/or actual experience. Warrants For convertible preference shares issued with detachable stock purchasewarrants, the portion of the proceeds that is allocable to the warrants, isaccounted for as additional paid-in capital. This allocation is based on therelative fair values of the two securities at the time of issuance. Warrantcontracts are classified as equity so long as they meet all the conditions ofequity outlined in EITF 00-19, Accounting for Derivative Financial InstrumentsIndexed to, and Potentially Settled in, a Company's Own Stock. Subsequentchanges in fair value are not recognised in the Statement of Operations as longas the warrant contracts continue to be classified as equity. Other income Other income consists of managing agency fees and profit commission in respectof the Group's management of Syndicate 1003. Managing agency fees are creditedin the year to which they relate. Profit commissions are earned as the relatedunderwriting profits are recognised on an annual basis. Pensions The Group operates defined contribution pension schemes for eligible employees,the costs of which are expensed as incurred. Risks and uncertainties In addition to the risks and uncertainties associated with unpaid losses andloss expenses described above and in Note 6, cash balances, investmentsecurities and reinsurance recoveries are exposed to various risks, such asinterest rate, market, and credit risks. Due to the level of risk associatedwith investment securities and the level of uncertainty related to changes inthe value of investment securities, it is at least reasonably possible thatchanges in risks in the near term would materially affect the amounts reportedin the financial statements. The cash balances and investment portfolio aremanaged following prudent standards of diversification. Specific provisionslimit the allowable holdings of a single institution issue and issuers. TheGroup believes that there are no significant concentrations of credit riskassociated with its investments. Similar diversification provisions are in placegoverning the Group's reinsurance programme. New accounting pronouncements In April 2005, the Financial Accounting Standards Board ('FASB') issued FAS123R, which is a revision of FAS 123, 'Accounting for Stock-based Compensation.'FAS 123R focuses primarily on accounting for transactions in which an entityobtains employee services for share-based payment transactions, and requiresthat all share-based payment transactions are recorded at fair value. FAS 123Ris effective for reporting periods beginning after 15 December 2005, but earlyadoption is permitted. The Group has adopted the provisions of FAS 123R in these2005 consolidated financial statements, such that new Performance Share Plandescribed in Note 14 has been accounted for in accordance with FAS 123R. TheGroup's existing stock option plan was historically accounted for at fair valueand therefore the adoption of FAS 123R had no impact on the Group's financialposition or results of operations. In June 2005, the FASB issued Financial Accounting Standard 154, ('FAS 154')Accounting Changes and Error Corrections, a replacement of APB No. 20 and FAS No3. FAS 154 changes the requirements for the accounting and reporting of a changein accounting principle. FAS 154 requires retrospective application to priorperiods' financial statements of changes in accounting principle and requiresthat a change in depreciation, amortisation, or depletion method for long-lived,non-financial assets be accounted for as a change in accounting estimateeffected by a change in accounting principle. The provisions of FAS 154 areeffective for accounting changes made in fiscal years beginning after 15December 2005, but early adoption is permitted. The adoption of FAS 154 willnot have an impact on the Group's financial position or results of operations. In January 2003, the Financial Accounting Standards Board issued Interpretation46 ('FIN 46'), Consolidation of Variable Interest Entities, an Interpretation ofAccounting Research Bulletin No. 51, Consolidated Financial Statements ('ARB51'). FIN 46 was subsequently reissued as FIN 46-R in December 2003, with FIN46-R providing additional interpretation of standards on consolidation. FIN 46-Rclarifies the consolidation accounting guidance in ARB 51 as it applies tocertain entities in which equity investors who do not have the characteristicsof a controlling financial interest or do not have sufficient equity at risk forthe entities to finance their activities without additional subordinatedfinancial support from other parties. Such entities are known as variableinterest entities ('VIEs'). FIN 46-R requires that the primary beneficiary of aVIE consolidates the VIE. FIN 46-R also requires new disclosures for significantrelationships with VIEs, whether or not consolidation accounting is used oranticipated. The requirements of FIN 46-R had various implementation datesduring financial years 2003 and 2004. The adoption of certain FIN 46-Rrequirements did not have an impact on the Group's financial position or resultsof operations. 3. Segmental information In 2005, the Group has adjusted its segmental reporting method to respond tochanges in the operational management and reporting of the Group. The Group nowreports four segments aligned to its three operating platforms as follows:Catlin Syndicate Direct, Catlin Syndicate Reinsurance, Catlin UK and CatlinBermuda. The former segments Lloyd's Direct and Lloyd's Reinsurance have beenrenamed as Catlin Syndicate Direct and Catlin Syndicate Reinsurance,respectively. The former segments Corporate Direct and Corporate Reinsurancewere each a combination of business written by Catlin UK and Catlin Bermuda.Comparative segmental information for the year ended 31 December 2004 has beenreclassified to conform to this new presentation. At 31 December 2005, there were four intra-Group reinsurance contracts in place:a 30% Qualifying Quota Share ('QQS') contract on the 2003 Year of Account and a10% QQS contract on the 2004 Year of Account; a Long Tail Stop Loss ('LTSL');and a 50% Corporate Quota Share ('CQS'), all of which cede Catlin Syndicate riskto Catlin Bermuda, as well as the 60% Quota Share contract that cedes Catlin UKrisk to Catlin Bermuda ('CUK QS'). At 31 December 2004, the CUK QS was not yetin place, and the CQS was deposit accounted for as a retrospective reinsurancecontract, as it was entered into at the end of the year. The effects of each ofthese reinsurance contracts are initially included within each of the operatingsegments and are then eliminated to reconcile to the Group position. For the years ended 31 December 2005 and 2004, these segments correspond to thelocation of where the business was written, with Catlin Syndicate Direct, CatlinSyndicate Reinsurance and Catlin UK business being written in the UK and CatlinBermuda business being written in Bermuda. Net income before tax by operating segment before intra-Group reinsuranceeliminations for the year ended 31 December 2005 is as follows: Catlin Catlin Syndicate Syndicate Catlin Catlin Intra Direct Reinsurance Bermuda UK -Group Total Gross premiumswritten $698,841 $278,450 $566,805 $232,129 $(389,625) $1,386,600 Reinsurancepremiums ceded (360,037) (122,814) (8,341) (95,934) 389,625 (197,501) --------- --------- -------- -------- --------- ---------Net premiumswritten 338,804 155,636 558,464 136,195 - 1,189,099 --------- --------- -------- -------- --------- ---------Net premiumsearned 478,670 186,191 395,727 155,854 - 1,216,442Losses andloss expenses (205,042) (184,556) 382,577) (93,110) - (865,285)Policyacquisitioncosts (176,886) (58,495) (45,513) (36,203) 11,558 (305,539)Administrativeexpenses (24,344) (9,469) (20,126) (7,926) - (61,865)Other expenses (4,765) (1,853) (3,938) (1,551) (11,558) (23,665) --------- --------- -------- -------- --------- ---------Netunderwritingresult 67,633 (68,182) (56,427) 17,064 - (39,912) --------- --------- -------- -------- --------- ---------Net investmentincome and netrealisedlosses oninvestments 31,727 12,341 26,229 10,330 - 80,627Net realisedlosses onforeigncurrencyexchange (5,426) (2,111) (4,487) (1,767) - (13,791)Other income 291 113 242 95 - 741Income/(loss)before incometax expense $94,225 $(57,839) $(34,443) $25,722 $- $27,665 --------- --------- -------- -------- --------- ---------Total revenue $505,262 $196,534 $417,711 $164,512 $- $1,284,019 --------- --------- -------- -------- --------- --------- Net income before tax by operating segment before intra-Group reinsuranceeliminations for the year ended 31 December 2004 is as follows: Catlin Catlin Syndicate Syndicate Catlin Catlin Intra Direct Reinsurance Bermuda UK Group Total Gross premiumswritten $870,363 $211,185 $242,814 $199,710 $(90,236) $1,433,836 Reinsurancepremiums ceded (209,779) (28,911) (4,376) (34,501) 90,236 (187,331) --------- --------- -------- -------- --------- ---------Net premiumswritten 660,584 182,274 238,438 165,209 - 1,246,505 --------- --------- -------- -------- --------- ---------Net premiumsearned 644,367 181,805 252,731 82,207 - 1,161,110Losses andloss expenses (354,783) (105,623) (150,161) (49,870) - (660,437)Policy acquisitioncosts (213,495) (41,503) (40,717) (21,969) 14,893 (302,791)Administrativeexpenses (31,796) (8,971) (12,471) (4,056) (57,294)Other expenses (6,499) (1,833) (2,549) (828) (14,893) (26,602) --------- --------- -------- -------- --------- ---------Netunderwritingresult 37,794 23,875 46,833 5,484 - 113,986 --------- --------- -------- -------- --------- ---------Net investmentincome and netrealised gainson investments 27,932 7,881 10,955 3,564 - 50,332Net realisedgains onforeigncurrencyexchange 4,920 1,388 1,930 627 - 8,865Other income 421 119 165 54 - 759Income beforeincome taxexpense $71,067 $33,263 $59,883 $9,729 - $173,942 --------- --------- -------- -------- --------- ---------Total revenue $677,640 $191,193 $265,781 $86,452 $- $1,221,066 --------- --------- -------- -------- --------- --------- Total revenue is the total of net premiums earned, net investment income and netrealised gain/(loss) on investments, net realised gain/(loss) on foreigncurrency exchange, and other income. Total assets by segment at 31 December 2005 and 2004 are as follows: 2005 2004 Catlin Syndicate Direct $2,190,303 $1,936,595Catlin Syndicate Reinsurance 749,162 480,643Catlin Bermuda 1,913,467 1,379,067Catlin UK 509,869 309,525Other 860,990 809,980Consolidation adjustments (2,363,808) (1,542,684) ------------ ------------Total assets $3,859,983 $3,373,126 ------------ ------------ 'Other' in the table above includes assets such as investments in Groupcompanies which are not allocated to individual segments. Goodwill has been allocated to the relevant segments, being Catlin SyndicateDirect and Catlin Syndicate Reinsurance. The amount of goodwill allocated as at31 December 2005 was $11,740 (2004: $13,447) for Catlin Syndicate Direct and $3,173 (2004: $2,783) for Catlin Syndicate Reinsurance. Property and equipment, net of accumulated amortisation, held in the UK was $17,504 (2004: $18,148), held in Bermuda was $3,570 (2004: $4,140) and held inall other territories was $1,361 (2004: $574). 4. Investments Fixed maturities The fair values and amortised costs of fixed maturities at 31 December 2005 and2004 are as follows: 2005 2004 Fair Amortised Fair Amortised Value Cost Value Cost US government and agencies $860,839 $869,655 $741,900 $728,857Non-US governments 378,339 381,449 140,768 140,737Corporate securities 277,575 281,500 301,601 302,889Asset-backed securities 227,290 229,364 267,929 268,531 ---------- ---------- ---------- ----------Total fixed maturities $1,744,043 $1,761,968 $1,452,198 $1,441,014 ---------- ---------- ---------- ---------- The carrying value of fixed maturities at 31 December 2005 and 2004 was the sameas their fair value. The composition of the amortised cost of fixed maturities by ratings assigned byratings agencies are as follows: 2005 2004 Amortised Amortised Cost % Cost % US government and agencies $869,655 49% $764,867 53%Non-US governments 381,449 22% 102,879 7%AAA 337,923 19% 375,386 26%AA 74,210 4% 78,914 6%A 98,731 6% 117,562 8%BBB - -% 1,406 -% --------- ---------- --------- ---------Total fixed maturities $1,761,968 100% $1,441,014 100% --------- ---------- --------- --------- The gross unrealised gains and losses related to fixed maturities at 31 December2005 and 2004 are as follows: 2005 2004 Gross Gross Gross Gross unrealised unrealised unrealised unrealised gains losses gains losses US government and agencies $925 $9,742 $13,786 $743Non-US governments 315 3,425 418 387Corporate securities 33 3,958 316 1,604Asset-backed securities 101 2,174 189 791 ---------- ---------- ---------- ----------Total fixed maturities $1,374 $19,299 $14,709 $3,525 ---------- ---------- ---------- ---------- There were no other than temporary declines in the value of investments in theyear to 31 December 2005 or 2004. The net realised losses on fixed maturitiesfor the year ended 31 December 2005 were $1,314 (2004: net realised gain of$3,429). The following is an analysis of how long each of the fixed maturities that werein an unrealised loss position as at 31 December 2005 had been in a continualloss position. This information concerns the potential effect upon futureearnings and financial position should management later conclude that some ofthese current unrealised losses represent other than temporary declines in thevalue of the securities. Less than 12 months Equal to or greater than 12 months Gross Gross Market unrealised Market unrealised value losses value losses US government and agencies $698,842 $8,593 $25,438 $576Non-US governments 202,455 2,324 35,177 1,030Corporate securities 222,947 3,163 37,387 819Asset-backed securities 117,681 1,989 6,433 111 ---------- ---------- ---------- ----------Total fixed maturities $1,241,925 $16,069 $104,435 $2,536 ---------- ---------- ---------- ---------- Proceeds from the sales and maturities of fixed maturities during 2005 were $1,523,854 (2004: $684,620). Proceeds from the sales and maturities of short-terminvestments during 2005 were $429,616 (2004: $727,563). Gross gains of $5,962(2004: $3,925) and gross losses of $7,469 (2004: $567) were realised on sales offixed maturities and short-term investments in 2005. Mortgage-backed securities issued by US government agencies are combined withall other asset-backed securities and are included in the category 'asset-backedsecurities'. Approximately 8 per cent (2004: 18 per cent) of the totalasset-backed holdings at December 31, 2005 are represented by investments inSallieMae, Government National Mortgage Association, Federal National MortgageAssociation, Federal Home Loan Bank and Federal Home Loan Mortgage Corporationbonds. The remainder of the asset-backed exposure consists of non-governmentasset-backed securities, the majority of which provide a planned structure forprincipal and interest payments and carry a 'AAA' rating by the major creditrating agencies. The Group did not have an aggregate investment in a single entity, other thanthe US government securities, in excess of 10 per cent of total investments at31 December 2005 and 2004. Fixed maturities at 31 December 2005, by contractual maturity, are shown below.Expected maturities could differ from contractual maturities because borrowersmay have the right to call or prepay obligations, with or without call orprepayment penalties. Fair Amortised value cost Due in one year or less $104,323 $105,281Due after one through five years 905,707 914,919Due after five years through ten years 503,939 509,625Due after ten years 2,783 2,779 --------- --------- 1,516,752 1,532,604Asset-backed securities 227,291 229,364 --------- ---------Total $1,744,043 $1,761,968 --------- --------- Net investment income The components of net investment income for the years ended 31 December 2005 and2004 are as follows: 2005 2004 Interest income $71,153 $45,062Amortisation of premium/discount 12,371 2,320Equity in income of investment in associate 1,343 1,400 --------- ---------Gross investment income 84,867 48,782Investment expenses (2,720) (1,808) --------- ---------Net investment income $82,147 $46,974 --------- --------- Restricted assets The Group is required to maintain assets on deposit with various regulatoryauthorities to support its insurance and reinsurance operations. Theserequirements are generally promulgated in the statutory regulations of theindividual jurisdictions. These funds on deposit are available to settleinsurance and reinsurance liabilities. The Group also has investments insegregated portfolios primarily to provide collateral or guarantees for Lettersof Credit ('LOC'), as described in Note 9. Finally, the Group also utilisestrust funds where the trust funds are set up for the benefit of the cedingcompanies, and generally take the place of LOC requirements. The total value of these restricted assets by category at 31 December 2005 and2004 are as follows: 2005 2004 Fixed maturities, available for sale $741,281 $607,571Short term investments 6,957 19,146Cash and cash equivalents 98,873 119,401 --------- ---------Total restricted assets $847,111 $746,118 --------- --------- 5. Investment in associate The Group, through Catlin Inc., its US subsidiary, has a 25 per cent membershipinterest in Southern Risk Operations, L.L.C. ('SRO') which is accounted forusing the equity method. The Group received cash distributions from SRO duringthe year ended 31 December 2005 of $1,418 (2004: $1,073). The share of SRO'sprofit included within the Consolidated Statement of Operations during 2005 was$1,343 (2004: $1,400). In management's opinion, the fair value of SRO is notless than its carrying value. 6. Unpaid losses and loss expenses The Group establishes reserves for losses and loss adjustment expenses, whichare estimates of future payments of reported and unreported claims for lossesand related expenses, with respect to insured events that have occurred. Theprocess of establishing reserves is complex and imprecise, requiring the use ofinformed estimates and judgments. The Group's estimates and judgments may berevised as additional experience and other data become available and arereviewed, as new or improved methodologies are developed or as current lawschange. Any such revisions could result in future changes in estimates of lossesor reinsurance recoverable, and would be reflected in the Group's results ofoperations in the period in which the estimates are changed. Management believesthey have made a reasonable estimate of the level of reserves at 31 December2005 and 2004. The reconciliation of unpaid losses and loss expenses for the years ended 31December 2005 and 2004 is as follows: 2005 2004 Gross unpaid losses and loss expenses, beginningof year $1,472,819 $962,535Reinsurance recoverable on unpaid loss and lossexpenses (359,154) (242,187) ---------- ----------Net unpaid losses and loss expenses beginning of year 1,113,665 720,348 ---------- ----------Net incurred losses and loss expenses for claimsrelated to:Current year 959,492 698,706Prior years (94,207) (38,269) ---------- ----------Total incurred losses and loss expenses 865,285 660,437 ---------- ----------Net paid losses and loss expenses for claimsrelated to:Current year (115,128) (94,432)Prior year (363,449) (281,483) ---------- ----------Total paid losses and loss expenses (478,577) (375,915) ---------- ----------Loss portfolio transfer of remaining net liability - 66,926in Syndicate 1003Foreign exchange adjustment (80,410) 41,869 ---------- ----------Net unpaid losses and loss expenses end of year 1,419,963 1,113,665Reinsurance recoverable on unpaid loss and lossexpenses 575,522 359,154 ---------- ----------Gross unpaid losses and loss expenses, end of year $1,995,485 $1,472,819 ---------- ---------- As a result of the changes in estimates of insured events in prior years, the2005 provision for losses and loss expenses net of reinsurance recoveriesdecreased by $94,207 (2004: decrease of $38,269). In 2005 and 2004, the decreasewas due to changes in estimates of insured events in previous years resultingfrom reductions of expected ultimate loss costs, settlement of losses at amountsbelow previously estimated loss costs and reduction in uncertainty surroundingthe quantification of the net cost of claim events. 2005 hurricanes Net incurred losses and loss expenses for claims related to the current yearinclude $ 333,506 of net losses incurred (prior to reinstatement costs) inrespect of the three hurricanes (Katrina, Rita and Wilma) that caused extensivedamage in the Gulf of Mexico and southeastern United States during the secondhalf of 2005. The following table summarises the gross to net position. Gross losses $615,097Reinsurance recoveries (281,591) ---------Net loss prior to reinsurance costs 333,506Net reinstatements due on ceded business 48,258Reinsurance restatements on assumed business (31,540) ----------Net loss $350,224 ---------- The figures above represent management's best estimate of the likely finallosses to the Group from the three hurricanes. In making this estimate,management has used the best information available, including estimatesperformed by Catlin's underwriters, actuarial and claims staff, retainedexternal actuaries, outside agencies and market studies. Hurricane Katrina isthe largest insured loss in history and is still subject to particularuncertainty both in respect of the original loss and the impact on thereinsurance market. Management's best estimate is based on an assessment ofindividual contracts in which the Group has a participation. Where affectedclasses of business underwritten by Catlin are covered by reinsurance,management's best estimate of losses is within the limits of reinsuranceprotections in respect of all three hurricanes. Where affected classes ofbusiness are not covered by reinsurance, any changes to management's bestestimate will be fully reflected in net losses and loss expenses in that period. Allowance is made in the overall management best estimate of net unpaid lossesfor an appropriate level of sensitivity, for both individual large losses andthe overall portfolio of business. In respect of the 2005 hurricanes, managementhave particularly considered sensitivities relating to gross losses on directand reinsurance accounts, underlying loss experience of cedants and reinsurancecoverage and security issues. 11 September 2001 event The Group's ultimate gross loss is estimated to be $153,357 (2004: $163,686),and its ultimate net loss after reinstatement premiums is estimated to be$28,079 (2004: $29,512). These ultimate losses are calculated on the basis of asingle occurrence. While these figures represent management's best estimate ofthe likely final loss, a series of sensitivity analyses for contingent scenariosare conducted on a regular basis to quantify potential variability in theforecasting. Sensitivity analysis indicates that the net loss is relativelyinsensitive to most modeled scenarios because unexhausted coverage remains onthe Group's outwards reinsurance programmes, which would be available to protectagainst any gross loss deterioration, including a two-event scenario. Closure of Lloyd's Syndicate 1003 Syndicate 1003, which was capitalised by external Names and managed by CatlinUnderwriting Agencies Limited, ceased underwriting new business with the 2002underwriting year. The remaining net liability in Syndicate 1003, calculated as$66,926 at 31 December 2004, was assumed by Syndicate 2003 at 31 December 2004.This was settled through a payment in the form of cash and investments in thesame amount, which was carried in premiums and other receivables at 31 December2004. The transaction has been treated as a loss portfolio transfer, recorded asan increase in loss reserves with no impact on the Consolidated Statement ofOperations. To the extent that the future run-off of this portfolio differs fromthe recorded amount, that development will be recorded in the ConsolidatedStatement of Operations in the period that it is incurred. 7. Reinsurance The Group purchases reinsurance to limit various exposures including catastropherisks. Although reinsurance agreements contractually obligate the Group'sreinsurers to reimburse it for the agreed upon portion of its gross paid losses,they do not discharge the primary liability of the Group. The effect ofreinsurance and retrocessional activity on premiums written and earned is asfollows: 2005 2004 Premiums Premiums Premiums Premiums written earned written earned Direct $953,172 $992,181 $1,095,619 $1,011,421Assumed 433,428 427,515 338,217 326,889Ceded (197,501) (203,254) (187,331) (177,200) ---------- ---------- ---------- ----------Net premiums $1,189,099 $1,216,442 $1,246,505 $1,161,110 ---------- ---------- ---------- ---------- The Group's provision for reinsurance recoverable as of the years ended December31, 2005 and 2004 is as follows: 2005 2004 Gross reinsurance recoverable $631,957 $409,809Provision for uncollectible balances (24,511) (18,864) --------- ---------Net reinsurance recoverable $607,446 $390,945 --------- --------- The Group evaluates the financial condition of its reinsurers and potentialreinsurers on a regular basis and also monitors concentrations of credit riskwith reinsurers. All reinsurers must maintain a minimum financial strengthrating of 'A' from Standard & Poor's or 'A-' from A M Best. At 31 December 2005,there were four reinsurers which accounted for more than 5 per cent of the totalreinsurance recoverable. % of reinsurance AM Best recoverable RatingNational Indemnity Company 14 A++ERC Frankona Ruckversicherungs AG 11 AHannover Ruck AG 8 AMunich Re 8 A+ At 31 December 2005, the Group has a deposit with reinsurer of $21,823 (2004:$57,830) with Max Re, which is rated A- by A M Best. This relates to a wholeaccount stop loss contract that covers the Group's underwriting at Lloyd's forthe 2001 and prior underwriting years. The reinsurance contract is retroactivein nature and as a result, premiums paid are accounted as a deposit. Theanticipated gain under the contract of $6,898 (2004: $18,278) is deferred and isrecognised in income as recoveries are made. During 2005, $11,380 of thedeferred gain was recognised in income (2004: $10,811). Assets equivalent invalue to the amount accounted as a deposit are held by an independent trusteefor the benefit of the reinsured syndicates. 8. Property and equipment Property and equipment is included within other assets on the balance sheet.Following are the components of property and equipment: 2005 2004 Property $1,708 $1,012Automobiles 526 543Leasehold improvement 3,387 2,939Furniture and equipment 39,609 38,413 --------- ---------Total property and equipment 45,230 42,907Less: accumulated depreciation (22,795) (20,048) --------- ---------Net property and equipment $22,435 $22,859 --------- --------- Depreciation expense relating to property and equipment for the year ended 31December 2005 was $9,631 (2004: $6,913). Included in the furniture and equipment category above are unamortised softwarecosts of $12,885 (2004: $15,161). Depreciation expense relating to softwarecosts for the year ended December 31, 2005 was $4,385 (2004: $5,613). The Group leases office space and equipment under non-cancellable operatinglease agreements, which expire at various times. Future minimum annual leasecommitments for non-cancellable operating leases as at 31 December 2005 are asfollows: 2006 $3,9162007 3,8532008 2,366 2009 4392010 and thereafter 462 --------Total $11,036 -------- Total rent expense for the year ended 31 December 2005 was $3,952 (2004:$3,692). 9. Notes payable, debt and financing arrangements Notes payable as at 31 December 2005 and 2004 consisted of the following: 2005 2004 Drawdown under 364-day revolving bank facility, atthree-month Libor plus 65 basis points, due 31 March $50,000 $50,1872006 Future interest payments on notes payable as of 31 December 2005 are $667, duein 2006. The Group paid $2,113 in interest during the year ended 31 December 2005 (2004:$1,176). Bank facilities Since November 2003, the Group has participated in a Letter of Credit/ RevolvingLoan Facility (the 'Club Facility') with three banks. Each bank participatesequally in the Club Facility. The Club Facility is comprised of three tranchesas detailed below. The Club Facility been varied, amended and restated since itwas originally entered into, most recently on 22 December 2005 when the creditavailable under the Club Facility increased from $150,000 and £125,000 to$250,000 and £150,000 respectively. The following amounts were outstanding underthe Club Facility as at 31 December 2005: • Debt outstanding was $50,000, in the form of a 364-day $50,000 revolving facility with a one year term-out option ('Facility A'). Facility A, while not directly collateralised, is secured by floating charges on Group assets and cross guarantees from material subsidiaries. This debt bears interest at three-month Libor plus 65 basis points, and the Group is required to maintain free and unencumbered assets consisting of OECD Government Bonds, US Agencies and Corporate Bonds, discounted by 10%, sufficient to repay the loan at any time. The undrawn portion of Facility A costs 25 basis points per annum. This loan, which is available under one, two or three month renewal periods, can be repaid at any time at the discretion of the Group in increments of $10 million. The Group has the option to extend the revolving facility for 364 days, or to convert all cash advances into a term loan. • A clean, irrevocable standby LOC of $258,000 (£150,000) is provided to support CSL's underwriting at Lloyd's ('Facility B'). As at 31 December 2005, CSL has utilised Facility B and deposited with Lloyd's an LOC in the amount of $215,000 (£125,000). In the event that CSL failed to meet its obligations under policies of insurance written on its behalf, Lloyd's could draw down this letter of credit. This LOC became effective on 24 November 2005 and has an initial expiry date of 27 November 2009. Collateral of $ 68,800 (£40,000) must be provided by 1 August 2006 and a further $34,400 (£20,000) must be provided by 1 August 2007. • A two-year $200 million standby LOC facility is available for utilisation by CICL Bermuda and CICL UK ('Facility C'). At 31 December 2005, $121,689 in LOC's were outstanding, of which $119,855 are issued for the benefit of CICL Bermuda, with a single LOC of $1,834 (£1,066) being for the benefit of Catlin UK. Collateral of 110% of 50% of the face value of the utilised portion of the LOCs under the Standby facility must be provided. The terms of the Club Facility require that certain financial covenants be meton a quarterly basis through the filing of Compliance Certificates. Theseinclude maximum levels of possible exposures to realistic disaster scenarios forthe Group, as well as requirements to maintain minimum Tangible Net Worth andAdjusted Tangible Net Worth levels, the calculations of which are based uponfixed amounts in 2005 and increase over time, for items such as consolidated netincome in future accounting periods. The Group was in compliance with allcovenants during 2005. 10. Intangible assets and goodwill Net intangible assets and goodwill as at 31 December 2005 and 2004 consist ofthe following: Indefinite Finite life life Goodwill intangibles intangibles Total Gross value at 1 January $33,957 $- $59,831 $93,7882004Accumulated amortisation (18,583) - (4,674) (23,257) --------- --------- --------- ---------Net value at 1 January 2004 15,374 - 55,157 70,531 --------- --------- --------- ---------Movements during 2004:Additions - - 167 167Foreign exchange adjustment 856 - 3,766 4,622Amortisation charge - - (4,082) (4,082) --------- --------- --------- ---------Total movements during 2004 856 - (149) 707 --------- --------- --------- ---------Gross value at 31 December 36,099 - 64,302 100,4012004Accumulated amortisation (19,869) - (9,294) (29,163) --------- --------- --------- ---------Net value at 31 December 16,230 - 55,008 71,2382004 --------- --------- --------- ---------Movements during 2005:Reclassification ofintangible asset - 54,337 (54,337) -Additions - - 51 51Foreign exchange adjustment (1,317) (5,660) (2) (6,979)Amortisation charge - - - -Write off - - (671) (671) --------- --------- --------- ---------Total movements during 2005 (1,317) 48,677 (54,959) (7,599) --------- --------- --------- ---------Gross value at 31 December 32,805 56,966 49 89,8202005Accumulated amortisation (17,892) (8,289) - (26,181) --------- --------- --------- ---------Net value at 31 December $14,913 $48,677 $49 $63,6392005 --------- --------- --------- --------- Neither goodwill nor intangibles were impaired in 2005 or 2004. The Group's intangibles relate to the purchase of syndicate capacity and surpluslines licenses. Surplus lines licenses are considered to have a finite life and are amortisedover their estimated useful life of 5 years. Amortisation of intangible assetsfor the next 5 years at current exchange rates will amount to approximately $10per annum. Lloyd's syndicate capacity purchased in 2002 amounted to $50,959. Theacquisition of the syndicate capacity gives the Group benefits that relate tothe value of future income streams estimated to arise from business originallyunderwritten by members of Syndicate 1003, which was assumed by Syndicate 2003,and which was capitalised by CSL in the 2003 Lloyd's underwriting year. Theacquisition also gives the Group a valuable ability to generate additionalprofits as a consequence of the underwriting capital and management flexibility,which results from the acquisition of the third party capacity. The whole of theconsideration has been allocated to these intangible assets. During 2005, the Group reassessed its estimate of the useful life of syndicatecapacity purchased during 2002 and determined that it was indefinite. As aresult, the Group has ceased amortising this intangible asset and instead willassess its recoverability at least annually. This change in accounting estimateis applied prospectively. The effect of this change in accounting estimate on current periodadministrative expenses, income before income tax expense and net income, aswell as on basic and diluted earnings per share, is presented below. Before change in accounting Effect estimate($) of change As reported Administrative expenses $65,884 $(4,019) $61,865 Income before income tax expense 23,646 4,019 27,665Income tax expense (6,840) (1,163) (8,003) --------- --------- ---------Net income $16,806 $2,856 $19,662 --------- --------- ---------Earnings per common shareBasic $0.11 $0.02 $0.13Diluted $0.10 $0.02 $0.12 --------- --------- --------- 11. Taxation Under current Bermuda law, the Company and its Bermuda subsidiary, CICL, are notrequired to pay any taxes in Bermuda on their income or capital gains. TheCompany and CICL have received an undertaking from the Minister of Finance inBermuda that, in the event of any taxes being imposed, the Company and CICL willbe exempt from taxation in Bermuda until March 2016. The Group also operates in the UK through its UK subsidiaries. The income of theUK subsidiaries is subject to UK corporation taxes. Income from the Group's operations at Lloyd's is also subject to US corporationtaxes. Lloyd's is required to pay US income tax on US connected income ('USincome') written by Lloyd's syndicates. Lloyd's has a closing agreement with theIRS whereby the amount of tax due on this business is calculated by Lloyd's andremitted directly to the Internal Revenue Service. These amounts are thencharged to the personal accounts of the Names and Corporate Members inproportion to their participation in the relevant syndicates. The Group'sCorporate Member is also subject to this arrangement but, as a UK domiciledcompany, will receive UK corporation tax credits for any US income tax incurredup to the value of the equivalent UK corporation income tax charge on the USincome. The UK tax authorities are currently reviewing legislation on thetaxation of insurance company technical reserves. The outcome of this review isnot yet known, but it remains a possibility that recoverability of foreign taxesby Catlin Syndicate may be prejudiced in whole or in part by any changes in afuture year. The Group, through its US operations, is subject to income taxes imposed by USauthorities and is required to file US tax returns. Certain internationaloperations of the Group are also subject to income taxes imposed by thejurisdictions in which they operate. The Group is not subject to taxation other than as stated above. There can be noassurance that there will not be changes in applicable laws, regulations ortreaties, which might require the Group to change the way it operates or becomesubject to taxation. The income tax expense for the years ended 31 December 2005 and 2004 is asfollows: 2005 2004 Current tax expense $6,477 $69Deferred tax expense 1,526 19,817 --------- ---------Expense for income taxes $8,003 $19,886 --------- --------- The weighted average expected tax expense has been calculated using pre-taxaccounting income/(loss) in each jurisdiction multiplied by that jurisdiction'sapplicable statutory tax rate. The weighted average tax rate for the Group is29.9 per cent (2004: 9.6 per cent), which has increased in 2005 because of achange in the balance of the geographical distribution of profits. Areconciliation of the difference between the expense for income taxes and theexpected tax expense at the weighted average tax rate for the years ended 31December 2005 and 2004 is provided below. 2005 2004 Expected tax expense at weighted average rate $8,307 $16,704Permanent differences:Disallowed expenses 1,149 2,692Under/(over) accrual of tax in prior periods 262 490Items taxed in previous years (1,212) -Other (503) - --------- ---------Expense for income taxes $8,003 $19,886 --------- --------- The components of the Group's net deferred tax asset/(liability) as of 31December 2005 and 2004 are as follows: 2005 2004Deferred tax assets:Net operating loss carryforwards $7,462 $29,886Future UK double tax relief 7,507 -Whole account stop loss 2,069 5,483Deep discount security unwind 1,201 3,029Accelerated capital allowances 488 -Cumulative translation adjustment 4,447 -Syndicate capacity amortisation and other 2,022 1,232 --------- ---------Total deferred tax assets 25,196 39,630 --------- ---------Deferred tax liabilitiesCumulative translation adjustment - (1,061)Untaxed profits (29,377) (45,788) --------- ---------Net deferred tax liability $(4,181) $(7,219) --------- --------- No valuation allowance was necessary as at 31 December 2005 and 2004. As of 31 December 2005, the Group has net operating loss carryforwards ofapproximately $24,873, which are available to offset future taxable income(2004: $99,619). The net operating loss carry forwards arise in the UKsubsidiaries where they are expected to be fully utilised. There are no timerestrictions on the utilisation of these losses. 12. Stockholders' equity The following is a detail of the number and par value of common sharesauthorised, issued and outstanding as of 31 December 2005 and 2004: 2005 Authorised Issued and outstanding Par Par Number value Number value of shares $000 of shares $000Ordinary commonshares, par 250,000,000 $2,500 155,914,616 $1,559value $0.01 per share ----------- ---------- ----------- ---------Total 250,000,000 $2,500 155,914,616 $1,559 ----------- ---------- ----------- --------- 2004 Authorised Issued and outstanding Par Par Number value Number value of shares $000 of shares $000Ordinary commonshares, par 250,000,000 $2,500 154,097,989 $1,541value $0.01 per share ------------- ---------- ------------ ----------Total 250,000,000 $2,500 154,097,989 $1,541 ------------- ---------- ------------ ---------- The following table outlines the changes in common shares issued and outstandingduring 2005 and 2004: 2005 2004 Balance, 1 January 154,097,989 75,109,082Movements pre-IPO:Payment of payment-in-kind ('PIK') dividend - 42,195,965Redesignation of preference shares - 497,000,000Cancellation of options and replacement withordinary common shares - 154,576 ------------ ------------Total ordinary common shares before theeffect of both the 19-1 bonus issue and - 614,459,623the subsequent 100-1 consolidation ------------ ------------ Total ordinary common shares after effect ofboth the 19-1 bonus issue and the subsequent100-1 consolidation - 122,891,925 New ordinary common shares issued in the IPO - 31,180,000Ordinary common shares issued after the IPO(exercise of stock options and warrants) 1,816,627 26,064 ------------ ------------Balance, 31 December 155,914,616 154,097,989 ------------ ------------ On 6 April 2004, the Group completed its IPO and was admitted to the OfficialList of the London Stock Exchange plc. Immediately prior to admission, certainchanges to the Company's capital structure took place. Accrued dividends onconvertible preference shares were settled through the issuance of additionalcommon shares and a small number of share options were cancelled and replacedwith common shares. All convertible preference shares were then converted intocommon shares and were consolidated on a five-to-one basis, achieved through a19-to-1 bonus issuance and a 100-to-1 share consolidation. The Group raised $200,472 ($182,627 net of expenses) through the issuance of31,180,000 new shares. In addition, as part of the IPO, existing shareholderssold a further 23,380,000 shares. As a result, immediately following the capital changes and the IPO, the Companyhad 154,071,925 common shares issued and outstanding. To maintain economicequivalence, the warrants and stock options that were outstanding at the time ofthe IPO were also consolidated on a five-to-one basis and their exercise pricesincreased by a factor of five. Dividends On 31 May 2005, the Group paid a final dividend relating to the 2004 financialyear of $0.156 (£0.081) per share to shareholders of record at the close ofbusiness on 29 April 2005. The total dividend paid for the 2004 financial yearwas $0.235 (£0.124) per share. On 14 November 2005, the Group paid an interim dividend relating to the 2005financial year of $0.099 per share (£0.054 per share) to shareholders of recordas of 14 October 2005. 13. Employee stock compensation schemes The Group has two stock compensation schemes in place: a Performance Share Plan,which was adopted in 2004, and a Long Term Incentive Plan, adopted in 2002.These financial statements include the total cost of stock compensation for bothplans, calculated using the fair value method of accounting for stock-basedemployee compensation. The total cost of the plans expensed in the year ended 31December 2005 was $4,246 (2004: $2,099). Performance Share Plan ('PSP') The first awards were made to employees under the PSP on 11 March 2005. Optionswith a nil exercise price over 2,056,977 shares and 166,982 non-vested shares(total of 2,223,959 securities) were granted to Group employees. Up to half ofthe securities will vest on 11 March 2008 and up to half will vest on 11 March2009, subject to certain performance conditions calibrated to stockholderreturns. These securities have been treated as non-vested shares and as suchhave been measured at their fair value as if they were vested and issued on thegrant date, excluding the impact of performance vesting conditions. Performancevesting conditions are included in assumptions about the number of non-vestedshares that employees will ultimately receive. This estimate is revised at eachbalance sheet date and the difference is charged or credited to the incomestatement, with a corresponding adjustment to equity. The total number of PSPsecurities outstanding at 31 December 2005 was 2,203,786 and the totalcompensation expense relating to the PSP for the year ended 31 December 2005 was$2,221. In addition, at each dividend payment date, an amount equal to the dividend thatwould be payable in respect of the shares to be issued under the PSP, is to bepaid into an Employee Benefit Trust. This amount, totalling $567 in 2005, istreated as a deferred compensation obligation and as such is taken directly toretained earnings and capitalised in stockholders' equity within additionalpaid-in capital. Long Term Incentive Plan ('LTIP') After adjusting for the effects of the bonus issuance and share consolidation asdescribed in Note 12, interests in shares equivalent to 10 per cent of theCompany's fully diluted share capital as at 4 July 2002, (a total of 16,051,613ordinary common shares) were granted to eligible employees. The individualawards were divided into options with an exercise price of $5.00 and exercisablein four equal annual tranches, and options with exercise prices of $10.00,$12.50 and $15.00, exercisable on 1 July 2007. During 2002, the Company granted options over 14,624,099 shares, which had beenallocated to employees based on the fair value as at July 4, 2002, being $5.20per share. During 2003, the Company granted options over a further 1,427,514 shares toemployees, based on the fair value as at 31 December 2003, being $7.60 pershare. Immediately prior to the IPO on 6 April 2004, the Board approved the grant ofoptions over an additional 739,979 shares, with exercise prices of $6.40(£3.50), $10.00, $12.50 and $15.00. The weighted average exercise price ofinterests allocated is $10.06 per share (2003: $9.50 per share). At the sametime, the Board also approved the acceleration of the vesting date of one halfof the options with exercise prices of $10.00, $12.50 and $15.00, from 1 July2007 to 6 April 2004 (date of Admission). The impact of the acceleration of thevesting date is to shorten the remaining expected life of the modified optionsfrom 3.625 years to 1.875 years. This modification has resulted in no additionalcompensation expense. The options vest on various dates as prescribed under LTIP plan documentation,but in any event all will have vested and will expire by 4 July 2012. 1,576,110interests vested on 4 July 2003. Upon the IPO on 6 April 2004, 4,815,484interests vested and on 4 July 2004, a further 1,668,261 interests vested.1,655,158 interests vested on 4 July 2005. The table below shows the status ofthe interests in shares as at 31 December 2005: 2005 2004 Weighted Weighted average average exercise exercise Number price ($) Number price ($)Outstanding,beeginning of period 16,440,660 9.60 15,829,797 9.56Granted during year - - 739,979 10.06Exercised during year (322,877) 5.05 (129,116) 5.00Forfeited during year (137,868) 11.27 - - --------- ---------- ---------- ----------Outstanding, end 15,979,915 9.68 16,440,660 9.60of period --------- ---------- ---------- ----------Exercisable,end of period 9,005,511 8.94 7,735,225 9.62 --------- ---------- ---------- ---------- Average Number of remaining Number options contractual of optionsExercise price outstanding life exercisable $5.00 5,741,231 6.5 4,160,927£3.50 334,835 6.5 150,727$10.00 3,301,281 2.0 1,564,619$12.50 3,301,281 2.0 1,564,619$15.00 3,301,287 2.0 1,564,619 ---------- ---------- ----------Total 15,979,915 3.7 9,005,511 ---------- ---------- ---------- As at year end, there was no amount receivable from shareholders on the exerciseof interests in shares. The fair value of the options granted during 2004 was calculated using theBlack-Scholes valuation model and is being amortised over the expected vestingperiod of the options, being 4 years for the £3.50 tranche, 1.875 years for theperformance based tranche that vested on admission and 3.625 for the performancebased tranche that vests on 4 July 2007. The valuation has assumed an averagevolatility of 40 per cent, no expected dividends and a risk free rate using USdollar swap rates appropriate for the expected life assumptions: 2.8 per centfor four years; 1.79 per cent for 1.875 years; and 2.64 per cent for 3.625years. The fair value of the options granted prior to 2004 was calculated using theBlack-Scholes valuation model and is being amortised over the expected vestingperiod of the options, being 4.5 years from the date of the subscriptionagreement. The valuation has assumed a risk free rate of return at the averageof the four- and five-year US dollar swap rates of 3.39 per cent and no expectedvolatility (as the minimum value method was utilised because the Company was notlisted on the date the options were issued). Warrants In 2002, the Company issued warrants to shareholders to purchase 20,064,516common shares (after adjusting for the effects of the bonus issuance and shareconsolidation as described in Note 12). Warrants may be exercised in whole or inpart, at any time, until 4 July 2012 and are exercisable at a price per share of$5.00. During the year warrants to purchase 5,120,465 common shares wereexercised and settled net for 1,703,386 common shares, leaving warrantsentitling the purchase of 14,944,051 common shares outstanding. 14. Earnings per share Basic earnings per share is calculated by dividing the earnings attributable tocommon shareholders by the weighted average number of common shares in issueduring the year. Diluted earnings per share is calculated by dividing the earnings attributableto all shareholders by the weighted average number of common shares in issueadjusted to assume conversion of all dilutive potential common shares. Thecompany has the following potentially dilutive instruments outstanding duringthe periods presented: (i) Class A cumulative redeemable preference shares; (ii) Class B-1 cumulative redeemable preference shares; (iii) Class B-2 cumulative redeemable preference shares; (iv) Employee stock option plan; and (v) Warrants Reconciliation of the earnings used in the calculations are set out below: 31 December 30 June 31 December 2005 2004 2004 Net income attributable to $19,662 $111,175 $154,056stockholders --------- --------- ---------Diluted earnings attributable toordinary stockholders $19,622 $111,175 $154,056 --------- --------- --------- Reconciliations of the number of shares used in the calculations are set outbelow. 31 December 30 June 31 December 2005 2005 2004 Weighted average number of shares 154,984,097 154,116,555 117,379,304Dilution effect of warrants 5,101,067 4,125,308 4,665,336Dilution effect of stock optionsand non-vested shares 2,013,603 3,890,747 1,460,615Dilution effect of stock optionsand warrants exercised in the period 930,519 1,726,515 -Dilution effect of convertibleparticipating preference shares - - 29,092,521Dilution effect of accrued dividendson convertible participatingpreference shares, to be paid in - - 1,561,009common stock ---------- --------- ---------Weighted average number of shareson a diluted basis 163,029,285 163,859,125 154,158,785 ---------- --------- ---------Earnings per common shareBasic $0.13 $0.72 $1.31Diluted $0.12 $0.68 $1.00 ---------- --------- --------- Options to purchase 9,903,849 shares under the LTIP were outstanding during theyear but were not included in the computation of diluted earnings per sharebecause the options' exercise price was greater than the average market price ofthe common shares. Similarly, 2,203,786 securities awarded under the PSP werenot included in the computation of diluted earnings per share because theperformance conditions necessary for these securities to vest were not met as at31 December 2005. 15. Other comprehensive income/(loss) The following table details the tax effect of the individual components of othercomprehensive income/(loss) for 2005 and 2004: Before tax Tax Net of tax2005 amount benefit/ amount (loss) Unrealised losses arising during year $(27,495) $2,400 $(25,095)Less reclassification for lossesrealised in income (1,520) 582 (938) --------- --------- ---------Net unrealised losses on investments (29,015) 2,982 (26,033)Cumulative translation adjustments 1,361 (883) 478 --------- --------- ---------Change in accumulated othercomprehensive $(27,654) $2,099 $(25,555)income --------- --------- --------- Before tax Tax Net of tax2004 amount benefit amount Unrealised gains arising during year $8,612 $176 $8,788Less reclassification for gainsrealised in income (3,358) 202 (3,156) --------- --------- ---------Net unrealised gains on investments 5,254 378 5,632Cumulative translation adjustments (1,245) 1,175 (70) --------- --------- ---------Change in accumulated othercomprehensive $4,009 $1,553 $5,562income --------- --------- --------- 16. Pension commitments In the UK, the Group operates defined contribution schemes for certain directorsand employees, which are administered by third party insurance companies. Thepension cost for the UK scheme was $3,265 for the year ended 31 December 2005(2004: $2,498). In Bermuda, the Group operates a defined contribution scheme, under which theGroup contributes a specified percentage of each employee's earnings. Thepension cost for the Bermuda scheme was $470 for the year ended 31 December 2005(2004: $477). In the US, Catlin Inc. has adopted a Profit Sharing Plan (the Plan) qualifiedunder the Internal Revenue Code in which all employees meeting specified minimumage and service requirements are eligible to participate. Contributions are madeto the Plan as determined by the Board of Directors of Catlin Inc on an annualbasis and are allocated on a pro rata basis to individual employees based uponeligible compensation. The pension cost for the Plan was $303 for the year ended31 December 2005 (2004: $126). 17. Statutory financial data The Group's ability to pay dividends is subject to certain regulatoryrestrictions on the payment of dividends by its subsidiaries. The payment ofsuch dividends is limited by applicable laws and statutory requirements of thejurisdictions in which the Group operates. Statutory capital and surplus asreported to relevant regulatory authorities for the principal operatingsubsidiaries of the Company was as follows: CICL Catlin UK CUAL 2005 2004 2005 2004 2005 2004Required statutorycapital andsurplus $284,676 $369,631 $36,992 $41,267 $2,580 $2,880Actual statutorycapital andsurplus $745,157 $603,003 $139,284 $119,084 $24,693 $11,876 The Group is also subject to restrictions on some of its assets to support itsinsurance and reinsurance operations, as described in Note 4. 18. Commitments and contingencies Legal proceedings The Group is party to a number of legal proceedings arising in the ordinarycourse of the Group's business which have not been finally adjudicated. Whilethe results of the litigation cannot be predicted with certainty, managementbelieves that the outcome of these matters will not have a material impact onthe results of operations or financial condition of the Group. Concentrations of credit risk Areas where significant concentration of risk may exist include investments,reinsurance recoverable and cash and cash equivalent balances. The cash balances and investment portfolio are managed following prudentstandards of diversification. Specific provisions limit the allowable holdingsof a single institution issue and issuers. Similar principles are followed forthe purchase of reinsurance. The Group believes that there are no significantconcentrations of credit risk associated with its investments or its reinsurers.Note 7 describes concentrations of more than 5 per cent of the Group's totalreinsurance recoverable asset. Letters of credit The Group provides finance under its Club Facility to enable its subsidiaries tocontinue trading and to meet its liabilities as they fall due, as described inNote 9. 19. Related parties The Group purchased services from Catlin Estates Limited and Burnhope Lodge,both of which are controlled by a Director of the Group. All transactions wereentered into on normal commercial terms. The cost of services purchased fromCatlin Estates Limited during 2005 was $201 (2004: $111) and from Burnhope Lodgewas $23 (2004: $39). Club Facility During 2005, Barclays Plc became interested in more than 10% of the issued sharecapital of the Company. An affiliate of Barclays Plc, Barclays Bank plc('Barclays'), is one of the banks participating in the Club Facility, describedin Note 9. Barclays participates equally with the other two banks in the ClubFacility and, following the amendment and restatement of the Club Facility(completed after Barclays Plc became interested as set forth above), receivesfees as follows: • A participation fee of one third of 0.085% on the total amount of the Club Facility; • A fronting fee of 0.125% per annum on the maximum actual and contingent liabilities of the other two banks under Facility C; • A fronting agent/security trustee fee of $75 per annum plus $0.5 for each LOC issued, payable on a quarterly basis, once more than 75 LOCs are issued; • A commitment fee of one third of 0.25% per annum on Facility A, one third of 0.25% per annum on Facility B and one third of 0.135% per annum on Facility C, in each case payable on the undrawn portion of the relevant Facility; • Interest of one third of LIBOR plus 0.65% per annum plus mandatory costs on Facility A; • Commission of one third of 1.2% per annum, reducing to 0.3% per annum in respect of securitised outstandings, on Facility B; and • Commission of one third of 0.6% per annum, reducing to 0.3% per annum in respect of securitised outstandings, on Facility C. In addition, Barclays was the Arranger for the Club Facility, and was paid acoordination fee of $150 for acting in that capacity. Various subsidiaries of the Group also hold bank accounts with Barclays and itsaffilitiates, in the normal course of business. Management believes that alltransactions with Barclays were conducted under normal commercial terms. 20. Subsequent events Proposed dividend On 8 March 2006, the Board approved a proposed final dividend of $0.176 pershare (£0.101 per share), payable on 12 June 2006 to shareholders of record atthe close of business on 12 May 2006. The final dividend is determined in USdollars but payable in sterling based on the exchange rate of £1=$1.74 on 7March 2006. Placing of common shares On 8 March 2006, the Board approved a placing of up to 7,704,900 new ordinarycommon shares, representing approximately 5 per cent of stockholders' equity.These shares will be placed through an accelerated bookbuilding process expectedto be completed on 9 March 2006, with settlement expected to take place on 14March 2006. 21. Reconciliation to IFRS The Group's consolidated financial statements are prepared in accordance with USGAAP, which differs in certain respects from International Financial ReportingStandards ("IFRS"). The following statements summarise the material adjustments, gross of their taxeffect, which reconcile the net income and stockholders' equity under US GAAP tothe amounts which would have been reported had IFRS been applied. Certain companies considered by management to be the Group's peers have adoptedIFRS as their primary reporting basis, beginning with the 2005 InterimReporting. As a result, this is the first year that a reconciliation to IFRS hasbeen included in the Group's consolidated financial statements; in previousperiods, a reconciliation to UK GAAP was presented. Net income Year ended 31 December Note 2005 2004 Net income under US GAAP $19,662 $154,056Adjustment for:Change to single functional currency (a) 5,275 -Exchange gains/(losses) on foreign currencybond portfolios (b) 3,662 (8,048)Fair value of employee stock compensation (c) (99) (99)Recognition of payroll taxes on employeestock compensation (d) (1,826) (633) --------- ---------Taxation (e) (2,319) 2,419 --------- ---------Net income under IFRS $24,355 $147,695 --------- --------- Stockholders' equity Year ended 31 December Note 2005 2004 Stockholders' equity under US GAAP $931,081 $971,187Adjustment for:Change to single functional currency (a) (9,387) -Fair value of employee stock compensation (c) (241) (161)Recognition of payroll taxes on employeestock compensation (d) (1,721) (443)Stockholders' equity under IFRS $919,732 $970,583 (a) Under US GAAP, an entity is permitted to have more than one functionalcurrency, if certain criteria are met. The Catlin Syndicate meets these criteriaand therefore operates with four functional currencies. Under IFRS, the revisedIAS 21 became effective on 1 January 2005. Although multiple functionalcurrencies were allowed under the former IAS 21, the revised standard prohibitsmultiple functional currencies within an entity. The new IAS 21 has been appliedprospectively, and this reconciling item shows the net effect of moving theCatlin Syndicate from four functional currencies to sterling as the solefunctional currency. (b) Certain of the Group companies hold fixed income investments in foreigncurrencies, which are intended to mitigate exposures to foreign currencyfluctuations in net liabilities. Under US GAAP, changes in the value of suchinvestments due to foreign currency rate movements are reflected as a directincrease or decrease to stockholders' equity. Under IFRS, such changes areincluded in the statement of operations. (c) Under US GAAP, options issued under an employee stock compensation schemewhen the Company is privately-held may be valued assuming no expected volatility(the minimum value method). Under IFRS, a volatility assumption must be made invaluing stock-based compensation issued after 7 November 2002, even if theCompany is privately-held. This reconciling item represents the fair value ofemployee stock options issued after 7 November 2002, recalculated with anexpected volatility assumption reflecting the historical volatility of theGroup's listed peers. (d) Under US GAAP, a liability for payroll taxes arising from stock compensationis recognised when the amount is due to the taxing authority, for example on theexercise of stock options. Under IFRS, a liability must be recorded at the dateof grant, based on the market value of the underlying security. This liabilityshould be subsequently adjusted for movements in the market value of theunderlying security. (e) All of the reconciling items are presented before tax. This line itemrepresents the tax effect of all the reconciling items. This information is provided by RNS The company news service from the London Stock Exchange