Castelnau Group Regulatory News (CGL)

9 Mar 2007 07:02

Catlin Group Limited09 March 2007 PART 2 Catlin Group LimitedConsolidated Balance SheetsAs at 31 December 2006 and 2005(US dollars in thousands, except share amounts) 2006 2005 -------- ---------AssetsInvestmentsFixed maturities, available-for-sale, at fair value(amortised cost 2006: $2,685,960; 2005: $1,761,968) $2,669,437 $1,744,043Short-term investments, at fair value 27,565 14,666Investment in funds 326,208 -Investment in associate 2,617 2,794 -------- ---------Total investments 3,025,827 1,761,503 -------- --------- Cash and cash equivalents 1,987,882 609,857Securities lending collateral 130,854 -Accrued investment income 32,136 17,227Premiums and other receivables 987,768 565,500Reinsurance recoverable (net of allowance of 2006:$46,791; 2005: $24,511) 1,237,531 607,446 Deposit with reinsurer 1,321 21,823Reinsurers' share of unearned premiums 104,731 37,222Deferred policy acquisition costs 144,063 126,738Value of in-force business acquired 118,384 -Intangible assets and goodwill (accumulatedamortisation 2006: 868,026 63,639$29,789; 2005: $26,181)Derivatives, at fair value 46,037 -Other assets 121,758 49,028 -------- ---------Total assets $8,806,318 $3,859,983 -------- --------- Liabilities, Minority Interest and Stockholders'EquityLiabilities:Reserves for losses and loss expenses $4,005,133 $1,995,485Unearned premiums 1,290,379 663,659Deferred gain - 8,078Reinsurance payable 192,958 137,313Accounts payable and other liabilities 363,399 70,186Notes payable 550,290 50,000Subordinated debt 99,936 -Derivatives, at fair value 619 -Securities lending payable 130,854 -Deferred taxes 153,721 4,181 -------- ---------Total liabilities $6,787,289 $2,928,902 -------- --------- Minority interest 749 - 2006 2005 -------- --------Stockholders' equity:Ordinary common shares, par value $0.01 $2,383 $1,559Authorised 400,000,000; issued and outstanding 2006:238,283,281; 2005: 155,914,616) Additional paid-in capital 1,610,725 721,935Treasury stock (6,600) -Accumulated other comprehensive loss (26,090) (21,399)Retained earnings 437,862 228,986 -------- --------Total stockholders' equity 2,018,280 931,081 -------- --------Total liabilities, minority interest andstockholders' equity $8,806,318 $3,859,983 -------- -------- Approved by the Board of Directors on 8 March 2007Stephen Catlin, Director Christopher Stooke, Director Catlin Group LimitedConsolidated Statements of OperationsFor the years ended 31 December 2006 and 2005(US dollars in thousands, except share amounts) 2006 2005 ---------- ----------RevenuesGross premiums written $1,605,019 $1,386,600Reinsurance premiums ceded (194,896) (197,501) ---------- ----------Net premiums written 1,410,123 1,189,099Change in net unearned premiums (84,262) 27,343 ---------- ----------Net premiums earned 1,325,861 1,216,442 ---------- ----------Net investment income 105,287 82,147Net realised losses on investments (17,041) (1,520)Change in fair value of derivatives (619)Net realised gains/(losses) on foreign currencyexchange 38,746 (13,791)Other income 3,528 741 ---------- ----------Total revenues 1,455,762 1,284,019 ---------- ---------- ExpensesLosses and loss expenses 681,549 865,285Policy acquisition costs 341,531 305,539Administrative expenses 130,703 61,865Other expenses 26,562 23,665 ---------- ----------Total expenses 1,180,345 1,256,354 ---------- ----------Income before minority interest and income tax expense 275,417 27,665Minority interest (22) -Income tax expense (16,606) (8,003) ---------- ----------Net income $258,789 $19,662 ---------- ---------- Earnings per common shareBasic $1.59 $0.13Diluted $1.47 $0.12 Catlin Group LimitedConsolidated Statements of Changes in Stockholders' Equity andAccumulated Other Comprehensive IncomeFor the years ended 31 December 2006 and 2005(US dollars in thousands, except share amounts) Accumulated Additional other Total Common paid-in Treasury Retained comprehensive stockholders' stock capital stock earnings income (loss) equity ------- -------- -------- -------- --------- ---------Balance 1 January 2005 $1,541 $716,649 - $248,841 $4,156 $971,187Comprehensive income:Net income - - - 19,662 - 19,662Other comprehensiveloss - - - - (25,555) (25,555) ------- -------- -------- -------- --------- ---------Total comprehensiveincome/(loss) - - - 19,662 (25,555) (5,893) ------- -------- -------- -------- --------- --------- Stock compensationexpense - 4,246 - - - 4,246Dividends declared - - - (38,950) - (38,950)Deferred compensationobligation - 567 - (567) - -Adjustment toGlobal Offer expenses ------- -------- -------- -------- --------- --------- - 491 - - - 491 ------- -------- -------- -------- --------- ---------Balance 31 December 2005 $1,559 $721,935 - $228,986 $(21,399) $931,081 ------- -------- -------- -------- --------- --------- Comprehensive income:Net income - - - 258,789 - 258,789Other comprehensiveloss - - - - (4,691) (4,691) ------- -------- -------- -------- --------- ---------Total comprehensiveincome/(loss) - - - 258,789 (4,691) 254,098 ------- -------- -------- -------- --------- --------- Issuance of common sharesin connection withacquisition of Wellington 744 811,683 - - - 812,427Equity raise 77 64,804 - - - 64,881Stock compensationexpense - 11,000 - - - 11,000Stock options and warrantsexercised 3 (3) - - - -Dividends declared - - - (48,607) - (48,607)Deferred compensationobligation - 1,306 - (1,306) - -Treasury stock purchase - - (6,600) - - (6,600) ------- -------- -------- -------- --------- ---------Balance 31 December 2006 $2,383 $1,610,725 $(6,600) $437,862 $(26,090) $2,018,280 ------- -------- -------- -------- --------- --------- Catlin Group LimitedConsolidated Statements of Cash FlowsFor the years ended 31 December 2006 and 2005(US dollars in thousands, except share amounts) 2006 2005 --------- --------- Cash flows provided by operating activitiesNet income $258,789 $19,662Adjustments to reconcile net income to net cashprovided by operations:Amortisation and depreciation 11,379 9,631Amortisation of premiums/discounts of fixedmaturities (6,185) (12,371)Net realised losses on investments 17,040 1,520Changes in operating assets and liabilities, net ofeffect of businesscombinationReserves for losses and loss expenses (258,017) 700,895Unearned premiums 52,587 7,810Premiums and other receivables (7,346) (10,087)Deferred policy acquisition costs (1,639) 2,577Reinsurance payable (175,687) 166,576Reinsurance recoverable 292,176 (305,930)Reinsurers' share of unearned premiums 4,016 (14,334)Deposit with reinsurer 21,823 36,007Deferred gain (8,078) (11,470)Accounts payable and other liabilities 60,894 (2,174)Investment in funds (89,925) -Deferred tax - 6,855Other (50,635) (129,933) --------- ---------Net cash flows provided by operating activities 121,192 465,234 --------- --------- Cash flows provided by/(used in) investingactivitiesPurchases of fixed maturities (2,138,862) (1,817,889)Purchases of short-term investments (97,088) (258,048)Proceeds from sales of fixed maturities 2,104,900 1,445,990Proceeds from maturities of fixed maturities 17,397 77,864Proceeds from sales of short-term investments 102,219 429,616Cash flows arising from investment in associate 1,452 -Purchases of subsidiaries, net of cash acquired 933,042 -Purchase of intangible assets (223,257) (51)Purchases of property and equipment (16,484) (11,174)Proceeds from sales of property and equipment 340 21Investment of securities lending collateral (130,854) - --------- ---------Net cash flows provided by/(used in) investingactivities $552,805 $(133,671) --------- --------- 2006 2005 --------- ---------Cash flows provided by/(used in) financing activitiesNet proceeds from issue of common shares $65,436 -Dividends paid on common shares (48,751) (38,291)Proceeds from notes payable 500,000 250,000Repayment of notes payable - (250,000)Securities lending collateral received 130,854 -Purchase of treasury stock (1,352) - --------- ---------Net cash flows provided by/(used in) financingactivities 646,187 (38,291) --------- ---------Net increase in cash and cash equivalents 1,320,184 293,272Cash and cash equivalents - beginning of year 609,857 354,608Effect of exchange rate changes 57,841 (38,023) --------- ---------Cash and cash equivalents - end of year $1,987,882 $609,857 --------- --------- Supplemental cash flow informationTaxes paid $16,135 $223Interest paid $2,655 $2,113 Cash and cash equivalents comprise the following:Cash at bank and in hand $1,040,079 $480,014Cash equivalents $947,803 $129,843 --------- --------- The accompanying notes are an integral part of the consolidated financial statements Catlin Group LimitedNotes to the Consolidated Financial StatementsFor the years ended 31 December 2006 and 2005(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'), a member of Lloyd's Syndicate 2003and Syndicate 2600. As well as Syndicates 2003 and 2600, CUAL also managedSyndicate 1003, the capital of which was provided by third parties for 2002 andprior years. With effect from the 2003 underwriting year through 31 December2006, CSL was the sole capital provider to all CUAL-managed syndicates; witheffect from the 2007 underwriting year, certain Wellington companies alsoprovide capital to support Syndicate 2003's underwriting. In December 2000, the Company established Catlin Insurance Company Ltd. ('CatlinBermuda') as a Bermuda licensed insurer. Catlin Bermuda remained dormant untilJuly 2002 when, in conjunction with a private equity capital raise, CatlinBermuda was capitalised, activated and licensed as a Class 4 insurer under thelaws and regulations of Bermuda. In December 2003, Catlin Bermuda receivedauthorisation from the Financial Services Authority ('FSA') to commenceunderwriting in the UK through its UK Branch operations. In March 2005, CatlinInsurance Company (UK) Limited ('Catlin UK') was authorised by the FSA and inJune 2005, all of the business written by the UK Branch of Catlin Bermuda wasnovated into this new company, Catlin UK, a subsidiary of Catlin Bermuda. In May 2006, the Group, through its wholly owned subsidiary Catlin Inc.,acquired 100 per cent of the outstanding common shares of American IndemnityCompany. That company, now renamed Catlin Insurance Company Inc. ('Catlin US'),is expected to become a key part of the Company's US operations. On 18 December 2006, the Group declared unconditional its offer to acquire allof the issued and to be issued share capital of Wellington Underwriting plc ('Wellington'). The core of Wellington's business was in the Lloyd's insurancemarket. Wellington also owned a managing general agent in the United States,Wellington Underwriting Inc. ('WU Inc.') and a US-based specialist insurancecompany, Wellington Specialty Insurance Company ('WSIC'). This acquisition isdescribed in Note 3. At 31 December 2006, the Company was also the sole shareholder (directly orthrough intermediate holding companies) of companies in Canada (Toronto andCalgary), Australia (Sydney), Singapore, Malaysia (Kuala Lumpur), Hong Kong,Germany (Cologne), Belgium (Antwerp) and Guernsey. Catlin UK operates regionaloffices in Glasgow, Leeds, Derby, Birmingham, Watford and Tonbridge. Thesecompanies all act as underwriting agents for Catlin underwriting platforms.During early 2007, the Company established (directly or through intermediateholding companies) companies in France (Paris), Spain (Barcelona), Austria (Innsbruck) and Switzerland (Zurich). 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 United States predominates. TheCompany and its subsidiaries are together referred to as the 'Group'. 2 Significant accounting policies Basis of presentation The accompanying consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the United States ofAmerica ('US GAAP'). The preparation of financial statements in conformity withUS GAAP requires management to make estimates when recording transactionsresulting from business operations based on information currently available. Themost significant items on the Group's balance sheet that involve accountingestimates and actuarial determinations are reserves for losses and lossexpenses, deferred policy acquisition costs, reinsurance recoverables, valuationof investments, intangible assets and goodwill. The accounting estimates andactuarial determinations are sensitive to market conditions, investment yields,commissions and other policy acquisition costs. As additional informationbecomes available, or actual amounts are determinable, the recorded estimateswill be revised and reflected in operating results. Although some variability isinherent in these estimates and actual results may differ from the estimatesused in preparing the consolidated financial statements, management believes theamounts recorded 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 '$'). Investment in fixed maturities The Group's investments in fixed maturities are considered to beavailable-for-sale and are carried at fair value. The fair value is based on thequoted market price of these securities provided by either independent pricingservices, or, when such prices are not available, by reference to broker orunderwriter bid indications. Net investment income includes interest income together with amortisation ofmarket premiums and discounts and is net of investment management and custodyfees. Interest income is recognised when earned. Premiums and discounts areamortised or accreted over the lives of the related fixed maturities as anadjustment to yield using the effective-interest method and is recorded incurrent period income. For mortgage-backed securities and any other holdings forwhich there is a prepayment risk, prepayment assumptions are evaluated andrevised as necessary. Any adjustments required due to the resultant change ineffective yields and maturities are recognised prospectively. Realised gains or losses are included in earnings and are derived using thespecific-identification method. Net unrealised gains or losses on investments, net of deferred income taxes, areincluded in accumulated other comprehensive income in stockholders' equity. 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 decision to make an impairment provision is basedon regular objective reviews of the issuer's current financial position andfuture prospects, its financial strength rating and an assessment of theprobability that the current market value will recover to former levels andrequires the judgment of management. 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 stockholders' equity is removed and charged to earnings. Inherently, thereare risks 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 amortised cost, which approximates fairvalue, and are composed of securities due to mature between 90 days and one yearfrom the date of purchase. Investment in funds The Group's investment in funds is considered to be trading and is carried atfair value. The fair value is based on the quoted market price of these fundsprovided by independent pricing services. Realised and unrealised gains and losses are included in earnings and arederived using the specific-identification method. Investment in associate Investment in associate comprises an investment in a limited liabilitycorporation. This investment is accounted for using the equity method. Derivatives In accordance with FASB Statement No. 133, Accounting for Derivative Instrumentsand Hedging Activities (FAS 133), the Group recognises derivative financialinstruments as either assets or liabilities measured at fair value. Gains andlosses resulting from changes in fair value are included in earnings. The fair value of the catastrophe swap agreement described in Note 9 isdetermined by management using internal models based on the valuation of theunderlying notes issued by the counterparty, which are publicly quoted. The fairvalue model takes into account changes in the market for catastrophe reinsurancecontracts with similar economic characteristics and the potential for recoveriesfrom events preceding the valuation date. The fair value of the Aspen shareoptions is estimated using the Black-Scholes valuation model. The fair value ofall other derivative financial instruments is obtained from independentvaluation sources. 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. Securities lending Certain entities within the Group participate in securities lending arrangementswhereby specific securities are loaned to other institutions, primarily banksand brokerage firms, for short periods of time. Under the terms of thesecurities lending agreements, the loaned securities remain under the Group'scontrol and therefore remain on the Group's balance sheet. Collateral in theform of cash, government securities and letters of credit is required and ismonitored and maintained by the lending agent. The Group receives interestincome on the invested collateral, which is included in net investment income. Premiums Premiums written are primarily earned on a daily pro rata basis over the termsof the policies to which they relate. Accordingly, unearned premiums representthe portion of premiums written which is applicable to the unexpired riskportion 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 policy 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 earnings to theextent that future policy premiums, including anticipation of interest income,are not adequate to recover all deferred policy acquisition costs ('DPAC') andrelated losses and loss expenses. If the premium deficiency is greater thanunamortised DPAC, a liability will be accrued for the excess deficiency. Value of in-force business acquired Upon the Group's acquisition of Wellington, an asset representing the presentvalue of future profits associated with unearned premiums was recorded. Thevalue of in-force insurance contracts is amortised over the period in which therelated premiums are earned, and is expected to be fully amortised approximatelytwo years from the date of acquisition. Reserves for 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 reserve for losses and loss expenses includes: (1) case reservesfor known but unpaid claims as at the balance sheet date; (2) incurred but notreported ('IBNR') reserves for claims where the insured event has occurred buthas not been reported to the Group as at the balance sheet date; and (3) lossadjustment expense reserves for the expected handling costs of settling theclaims. Reserves for losses and loss expenses are established based on amounts reportedfrom insureds or ceding companies and according to generally accepted actuarialprinciples. Reserves are based on a number of factors, including experiencederived from historical claim payments and actuarial assumptions to arrive atloss development factors. Such assumptions and other factors include trends, theincidence of incurred claims, the extent to which all claims have been reported,and internal claims processing charges. The process used in establishingreserves cannot be exact, particularly for liability coverages, since actualclaim costs are dependent upon such complex factors as inflation, changes indoctrines of legal liability and damage awards. The methods of making suchestimates and establishing the related liabilities are periodically reviewed andupdated. 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. Returnpremiums due from reinsurers are included in premiums and other receivables. Reinsurers' share of unearned premiums represent the portion of premiums cededto reinsurers applicable to the unexpired terms of the reinsurance contracts inforce. 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. 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 is not amortised, but rather tested at least annually for impairment. 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 would be recorded. The measurement of fair value of the reporting unitwas determined 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, thedistribution network and admitted as well as surplus lines 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 insteadassesses its recoverability at least annually.Admitted licenses are considered to have an indefinite life and as such aresubject to annual impairment testing. Surplus lines authorisations areconsidered to have a finite life and are amortised over their estimated usefullives of five years. Distribution channels are amortised over their useful livesof five years. The Group evaluates the recoverability of its intangible assetswhenever changes in circumstances indicate that an intangible asset may not berecoverable. If it is determined that an impairment exists, the excess of theunamortised balance over the fair value of the intangible asset is charged toearnings. Other assets Other assets are principally composed of prepaid items and property andequipment. 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. 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 currencies other than thefunctional currency are revalued at period end rates of exchange, with theresulting gains and losses included in income. Revenues and expenses denominatedin foreign currencies are translated at average rates of exchange for theperiod. Income taxes Income taxes have been provided for those operations that are subject to incometaxes. Deferred tax assets and liabilities result from temporary differencesbetween the amounts recorded in the consolidated financial statements and thetax basis of the Group's assets and liabilities. Such temporary differences areprimarily due to the tax basis discount on unpaid losses, adjustment forunearned premiums, the accounting treatment of reinsurance contracts, and taxbenefits of net operating loss carry-forwards. The effect on deferred tax assetsand liabilities of a change in tax rates is recognised in income in the periodthat includes the enactment date. A valuation allowance against deferred taxassets is recorded if it is more likely than not that all or some portion of thebenefits related to deferred tax assets will not be realised. 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 requisite service 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. Pensions The Group operates defined contribution pension schemes for eligible employees,the costs of which are expensed as incurred. The Group also sponsors a defined benefit pension scheme which was closed to newmembers in 1993. In accordance with Statement of Financial Accounting StandardNo 87, Employers' Accounting for Pensions, the recorded asset related to theplan was set equal to the value of plan assets in excess of the defined benefitobligation at the date of the business combination. Risks and uncertainties In addition to the risks and uncertainties associated with unpaid losses andloss expenses described above and in Note 7, cash balances, investmentsecurities and reinsurance recoveries are exposed to various risks, such asinterest rate, market, foreign exchange and credit risks. Due to the level ofrisk associated with investment securities and the level of uncertainty relatedto changes in the value of investment securities, it is at least reasonablypossible that changes in risks in the near term would materially affect theamounts reported in the financial statements. The cash balances and investmentportfolio are managed following prudent standards of diversification. Specificprovisions limit the allowable holdings of a single institution issue andissuers. Similar diversification provisions are in place governing the Group'sreinsurance programme. Management believes that there are no significantconcentrations of credit risk associated with its investments and itsreinsurance 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 adopted the provisions of FAS 123R in the 2005consolidated financial statements using modified prospective application, suchthat the new Performance Share Plan described in Note 14 has been accounted forin accordance with FAS 123R. The Group's existing stock option plan washistorically accounted for at fair value and therefore the adoption of FAS 123Rhad no impact on the Group's financial position 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 did nothave an impact on the Group's financial position or results of operations. In February 2006, the FASB issued Financial Accounting Standard 155, ('FAS 155')Accounting for Certain Financial Instruments, an amendment Financial AccountingStandard 133 ('FAS 133'), Accounting for Derivative Instruments and HedgingActivities, and Financial Accounting Standard 140, Accounting for Transfers andServicing of Financial Assets and Extinguishments of Liabilities. ThisStatement resolves issues addressed in FAS 133 Implementation Issue No.D1,'Application of Statement 133 to Beneficial Interests in SecuritizedFinancial Assets.' FAS 155 is effective for reporting periods beginning after 15September 2006, although early adoption is permitted. The adoption of FAS 155 isnot expected to have a material effect on the Group's financial position orresults of operations. In July 2006, the FASB issued FIN 48, Accounting for Uncertainty in IncomeTaxes-an interpretation of FASB Statement No. 109 ('FIN 48'). FIN 48 clarifiesthe accounting for income taxes by prescribing the minimum recognition thresholda tax position is required to meet before recognition in the financialstatements. It also provides guidance on derecognition, measurement,classification, interest and penalties, accounting in interim periods,disclosure, and transition. FIN 48 is effective for fiscal years beginning after15 December 2006. Management has reviewed its tax positions and does notanticipate that the adoption of FIN 48 will have a significant impact on thereporting of those positions. In September 2006, the FASB issued Financial Accounting Standard 157 ('FAS157'), Fair Value Measurements. FAS 157 provides a common definition of fairvalue and establishes a framework to make the measurement of fair value ingenerally accepted accounting principles more consistent and comparable. FAS 157also requires expanded disclosures to provide information about the extent towhich fair value is used to measure assets and liabilities, the methods andassumptions used to measure fair value, and the effect of fair value measures onearnings. FAS 157 is effective for reporting periods beginning after 15 November2007, although early adoption is permitted. The adoption of FAS 157 is notexpected to have a material effect on the Company's financial position orresults of operations. In September 2006, the FASB issued Financial Accounting Standard No. 158,Employers' Accounting for Defined Benefit Pension and Other PostretirementPlans, an amendment of FASB Statements No. 87, 88, 106, and 132(R) ('FAS 158').This statement requires recognition of the overfunded or underfunded status ofdefined benefit pension and other postretirement plans as an asset or liabilityin the balance sheet and changes in that funded status to be recognised incomprehensive income in the year in which the changes occur. FAS 158 alsorequires measurement of the funded status of a plan as at the balance sheetdate. The recognition provisions of FAS 158 are effective for reporting periodsending after 15 December 2006, while the measurement date provisions areeffective for reporting periods ending after 15 December 2008. The adoption ofFAS 158 will not have a material effect on the Company's financial position orresults of operations. 3 Business Combination On 18 December 2006, the Group declared unconditional its offer to acquireWellington, which was announced on 30 October 2006 (the 'Offer'). The businesscombination was deemed effective 31 December 2006 for accounting purposes;accordingly the net assets acquired are valued as at that date and the operatingresults of Wellington will be included in the Group's consolidated financialstatements in periods following 31 December 2006. Prior to the acquisition, Wellington managed and underwrote a diversified bookof insurance and reinsurance business at Lloyd's and in the US. As a result ofthe acquisition, the enlarged Group will be a major international specialtyinsurance and reinsurance business with well established underwriting platformsin the United Kingdom and Bermuda and a significantly enhanced underwriting anddistribution platform in the United States. Under the terms of the Offer, Wellington shareholders received 0.17 shares ofthe Company's common stock and 35 pence in cash for each Wellington sharesurrendered. Total consideration paid by the Group was $1,184,934, including $347,431 of cash and 86,094,294 shares of the Company's common stock valued at $812,427. The value of the common shares issued was determined based on theaverage market price of the Company's common shares for the period from 20October to 2 November 2006, inclusive, which commenced two business days beforethe announcement that the Company and Wellington were in discussions regarding apossible combination and ended two business days after the terms of the Offerwere announced. As at 31 December 2006, acceptances representing 93 per cent of Wellington'sissued share capital had been received, and acceptances representing 88 per centof Wellington's issued share capital had been settled in the form of $300,286 ofcash and 74,414,657 shares. The remaining 12 per cent has been accrued in theyear end balance sheet as a liability for the cash consideration and withinadditional paid-in capital for the equity consideration, and has been acquiredin early 2007 as described in Note 21. The following table summarises the estimated fair values of the assets acquiredand liabilities assumed at the date of acquisition. The fair values willcontinue to be refined as further relevant information is obtained. Investments and cash $2,288,886Premiums and other receivables 339,366Reinsurance recoverable 804,787Value of in-force business acquired 118,384Intangible assets and goodwill 472,556Other assets 119,676 --------------Total assets acquired 4,143,655 --------------Reserves for losses and loss expenses 2,026,268Unearned premiums 491,756Reinsurance payable 65,306Subordinated debt 99,936Deferred tax 134,739Other liabilities 217,176 --------------Total liabilities assumed 3,035,181 --------------Net assets acquired $1,108,474 -------------- The table below summarises the calculation of goodwill arising on theacquisition. Cash consideration $347,431Catlin share consideration 812,427Acquisition expenses 25,076 --------------Total consideration $1,184,934 --------------Net assets acquired 1,108,474Treasury shares acquired 7,490 --------------Goodwill $68,970 -------------- Of the $472,556 of acquired intangible assets, $461,580 was assigned topurchased syndicate capacity, which is not subject to amortisation as it isdeemed to have an indefinite life. The remaining acquired intangible assetsconsist of $4,900 of distribution network with an average life of five years and$6,076 of licenses with an average life of five years. The values assigned togoodwill and intangible assets with finite and indefinite lives were determinedbased on independent third-party valuations. The value of in-force business acquired of $118,384 represents the estimatedpresent value of future profits associated with the unearned premium acquired,and replaces the deferred policy acquisition costs that were carried onWellington's historical balance sheet. Its value was determined based on anindependent third-party valuation. Given the timing of the acquisition of Wellington, the goodwill arising has notyet been allocated to a segment. This allocation will take place in early 2007.The goodwill is not expected to be deductible for income tax purposes. The unaudited pro forma financial information presented below assumes theacquisition occurred as at 1 January 2005. The following unaudited pro formaresults have been prepared for comparative purposes only and do not purport tobe indicative of the actual results of operations that would have occurred hadthe acquisition been consummated at the beginning of the periods presented. 2006 2005 --------- ---------Gross premiums written $2,721,800 $2,360,770Total revenues 2,488,451 2,152,266Net income 408,635 (53,813) Earnings per share:Basic $1.73 $(0.23)Diluted $1.63 $(0.23) Shares outstanding: Basic 236,601,569 229,398,754Diluted 250,078,528 237,443,942 Restructuring costs In December 2006, the Group's management approved and committed to plans toterminate the employment of certain employees of Wellington. A liability of$5,565 representing the cost of these actions has been included in theallocation of the purchase price of the Wellington acquisition. No payments weremade against these liabilities during 2006. Termination costs with respect toidentified employees employed by the Group prior to the acquisition wererecorded as part of other expenses. 4 Segmental information At 31 December 2006, there were four intra-Group reinsurance contracts in place:a 10 per cent Qualifying Quota Share ('QQS') contract on the 2004 Year ofAccount; a Long Tail Stop Loss ('LTSL'); and a 50 per cent Corporate Quota Share('CQS'), all of which cede Catlin Syndicate risk to Catlin Bermuda, as well asthe 60 per cent Quota Share contract that cedes Catlin UK risk to Catlin Bermuda('CUK QS'). The effects of each of these reinsurance contracts are includedwithin each of the operating segments, as this is the basis upon which theperformance of each segment is assessed, and are then eliminated to reconcile tothe Group position. For the years ended 31 December 2006 and 2005, 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 for the year ended 31 December 2006 is as follows: Catlin Catlin Syndicate Syndicate Catlin Catlin Intra- Direct Reinsurance Bermuda UK Group Total Gross premiums written $836,312 $270,308 $728,755 $299,255 $(529,611) $1,605,019Reinsurance premiumsceded (420,875) (138,084) (6,235) (159,313) 529,611 (194,896) -------- -------- -------- -------- -------- --------Net premiums written 415,437 132,224 722,520 139,942 - 1,410,123 -------- -------- -------- -------- -------- --------Net premiums earned 402,701 138,616 652,025 132,519 - 1,325,861Losses and loss expenses (156,777) (89,038) (368,368) (67,366) - (681,549)Policy acquisitioncosts (191,587) (51,777) (97,641) (58,307) 57,781 (341,531)Administrative and otherexpenses (23,914) (5,852) (64,654) (5,064) (57,781) (157,265) -------- -------- -------- -------- -------- --------Net underwriting result 30,423 (8,051) 121,362 1,782 - 145,516 -------- -------- -------- -------- -------- --------Net investment income, net realised losses on investments and change in fair value ofderivatives 26,615 9,161 43,093 8,758 - 87,627 Net realised gains onforeign currencyexchange 11,768 4,051 19,054 3,873 - 38,746Other income 1,071 369 1,735 353 - 3,528 -------- -------- -------- -------- -------- --------Income before income taxexpense $69,877 $5,530 $185,244 $14,766 - $275,417 -------- -------- -------- -------- -------- --------Total revenue $442,155 $152,197 $715,907 $145,503 - $1,455,762 -------- -------- -------- -------- -------- -------- Net income before tax by operating segment for the year ended 31 December 2005 is as follows: Catlin Catlin Syndicate Syndicate Catlin Catlin Intra- Direct Reinsurance Bermuda UK Group Total -------- -------- -------- -------- -------- --------Gross premiums written $698,841 $278,450 $566,805 $232,129 $(389,625) $1,386,600Reinsurance premiumsceded (360,037) (122,814) (8,341) (95,934) 389,625 (197,501) -------- -------- -------- -------- -------- --------Net premiums written 338,804 155,636 558,464 136,195 - 1,189,099 -------- -------- -------- -------- -------- --------Net premiums earned 478,670 186,191 395,727 155,854 - 1,216,442Losses and loss expenses (205,042) (184,556) (382,577) (93,110) - (865,285)Policy acquisition costs (176,886) (58,495) (45,513) (36,203) 11,558 (305,539)Administrative and otherexpenses (29,109) (11,322) (24,064) (9,477) (11,558) (85,530) -------- -------- -------- -------- -------- --------Net underwritingresult 67,633 (68,182) (56,427) 17,064 - (39,912) -------- -------- -------- -------- -------- --------Net investment income andnet realised losses oninvestments 31,727 12,341 26,229 10,330 - 80,627Net realised losses onforeign currencyexchange (5,426) (2,111) (4,487) (1,767) - (13,791)Other income 291 113 242 95 - 741 -------- -------- -------- -------- -------- --------Income/(loss) beforeincome tax expense $94,225 $(57,839) $(34,443) $25,722 $27,665 -------- -------- -------- -------- -------- --------Total revenue $505,262 $196,534 $417,711 $164,512 - $1,284,019 -------- -------- -------- -------- -------- -------- Total revenue is the total of net premiums earned, net investment income and net realised gain/(loss) on investments, net realised gain/(loss) on foreign currency exchange, and other income. Total assets by segment at 31 December 2006 and 2005 are as follows: 2006 2005 --------- ---------Catlin Syndicate Direct $1,953,095 $2,190,303Catlin Syndicate Reinsurance 835,510 749,162Catlin Bermuda 2,932,168 1,913,467Catlin UK 708,546 509,869Other 2,438,957 860,990Assets acquired from Wellington 4,214,867 -Consolidation adjustments (4,276,825) (2,363,808) --------- ---------Total assets $8,806,318 $3,859,983 --------- --------- 'Other' in the table above includes assets such as investments in Groupcompanies which are not allocated to individual segments. Net assets acquiredfrom Wellington have not as yet been allocated to segments. As noted above, goodwill associated with the acquisition of Wellington has notyet been allocated to segments. Previously recognised goodwill has beenallocated to the relevant segments, being Catlin Syndicate Direct and CatlinSyndicate Reinsurance. The amount of goodwill allocated as at 31 December 2006was $10,179 (2005: $11,740) for Catlin Syndicate Direct and $3,504 (2005: $3,173) for Catlin Syndicate Reinsurance. 5 Investments Fixed maturitiesThe fair values and amortised costs of fixed maturities at 31 December 2006 and2005 are as follows: 2006 2005 Fair Amortised Fair Amortised Value Cost Value Cost ---------- ---------- ---------- ----------US government and agencies $733,861 $744,753 $860,839 $869,655Non-US governments 338,525 342,150 378,339 381,449Corporate securities 424,901 426,167 277,575 281,500Asset-backed securities 535,718 535,974 208,141 209,949Mortgage-backed securities 636,432 636,916 19,149 19,415 ---------- ---------- ---------- ----------Total fixed maturities $2,669,437 $2,685,960 $1,744,043 $1,761,968 ---------- ---------- ---------- ---------- The composition of the amortised cost of fixed maturities by ratings assigned byratings agencies is as follows: 2006 2005 ----------------- ---------------- Amortised Amortised Cost % Cost % --------- ---------- --------- ---------US government and agencies $744,753 28% $869,655 49%Non-US governments 342,150 13% 381,449 22%AAA 1,156,200 43% 337,923 19%AA 165,875 6% 74,210 4%A 263,875 10% 98,731 6%BBB 12,513 -% - -%Other 594 -% - -% --------- ---------- --------- ---------Total fixed maturities $2,685,960 100% $1,761,968 100% --------- ---------- --------- --------- The gross unrealised gains and losses related to fixed maturities at 31 December2006 and 2005 are as follows: 2006 2005 ----------------- ----------------- Gross Gross Gross Gross unrealised unrealised unrealised unrealised gains losses gains losses ---------- ---------- ---------- ----------US government and agencies $540 $11,432 $925 $9,742Non-US governments 261 3,886 315 3,425Corporate securities 486 1,752 33 3,958Asset-backed securities 240 495 101 1,908Mortgage-backed securities 756 1,241 - 266 ---------- ---------- ---------- ----------Total fixed maturities $2,283 $18,806 $1,374 $19,299 ---------- ---------- ---------- ---------- There were no other than temporary declines in the value of investments in theyear to 31 December 2006 or 2005. The net realised losses on fixed maturitiesfor the year ended 31 December 2006 were $17,236 (2005: $1,314). The following is an analysis of how long each of the fixed maturities that werein an unrealised loss position as at 31 December 2006 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. Equal to or Less than 12 greater than 12 months months ----------------- ----------------- Gross Gross Fair unrealised Fair unrealised value losses value losses ---------- ---------- ---------- ----------US government andagencies $323,295 $6,104 $176,196 $5,328Non-US governments 227,473 2,231 65,251 1,655Corporate securities 186,233 1,106 33,676 646Asset-backed securities 121,402 428 5,375 67Mortgage-backed securities 188,623 961 18,932 280 ---------- ---------- ---------- ----------Total fixed maturities $1,047,026 $10,830 $299,430 $7,976 ---------- ---------- ---------- ---------- Over 80 per cent of the unrealised losses at 31 December 2006 related to 40securities. The securities in an unrealised loss position as at 31 December 2006have been reviewed by the Group with regard to the severity and duration of thelosses, and to the nature of the investments and of the issuers. On this basis,the Group has determined that the unrealised losses are temporary. Proceeds from the sales and maturities of fixed maturities during 2006 were$2,122,297 (2005: $1,523,854). Proceeds from the sales and maturities ofshort-term investments during 2006 were $102,219 (2005: $429,616). Gross gainsof $1,705 (2005: $5,962) and gross losses of $18,896 (2005: $7,469) wererealised on sales of fixed maturities and short-term investments in 2006. Mortgage-backed securities issued by US government agencies are combined withall other asset-backed securities and are included in the category 'asset-backedsecurities'. Approximately 15 per cent (2005: 8 per cent) of the totalasset-backed holdings at 31 December 2006 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 2006 and 2005. Fixed maturities at 31 December 2006, 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 $153,195 $153,814Due after one through five years 878,786 884,981Due after five years through ten years 451,594 460,352Due after ten years 13,712 13,923 --------- --------- 1,497,287 1,513,070Asset-backed securities 535,718 535,974Mortgage-backed securities 636,432 636,916 --------- --------- Total $2,669,437 $2,685,960 --------- --------- Investment in funds The Group has classified its investment in funds as a trading security andaccordingly, all realised and unrealised gains and losses on this investment arerecorded in net income. This investment comprises investments in a fixedmaturities fund, an equity fund and a fund of hedge funds. The change in fairvalue of the investment in funds is recorded in as net investment income. Theamount of net investment income for the year to 31 December 2006 that relates toinvestment in funds still held at the year end was $2,960 (2005: $nil). Net investment income The components of net investment income for the years ended 31 December 2006 and2005 are as follows: 2006 2005 --------- ---------Interest income $102,438 $71,153Amortisation of premium/discount 6,185 12,371Equity in income of associate 1,275 1,343Change in fair value of investment in funds 2,960 - --------- ---------Gross investment income 112,858 84,867Investment expenses (7,571) (2,720) --------- ---------Net investment income $105,287 $82,147 --------- --------- 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 10. 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 2006 and2005 are as follows: 2006 2005 --------- ---------Fixed maturities, available for sale $1,666,967 $741,281Short term investments 10,951 6,957Cash and cash equivalents 751,908 98,873 --------- ---------Total restricted assets $2,429,826 $847,111 --------- --------- Securities lending The Group participates in a securities lending program under which certain ofits fixed maturity investments are loaned to third parties through a lendingagent. Collateral in the form of cash, government securities and letters ofcredit is required at a minimum rate of 102 per cent of the market value of theloaned securities and is monitored and maintained by the lending agent. TheGroup had $124,486 (2005: $nil) of securities on loan at 31 December 2006. 6 Investment in associate The Group, through Catlin Inc., one of its US subsidiaries, has a 25 per centmembership interest in Southern Risk Operations, L.L.C. ('SRO') which isaccounted for using the equity method. The Group received cash distributionsfrom SRO during the year ended 31 December 2006 of $1,452 (2005: $1,418). Theshare of SRO's profit included within the Consolidated Statement of Operationsduring 2006 was $1,275 (2005: $1,343). In management's opinion, the fair valueof SRO is not less than its carrying value. 7 Reserves for losses and loss expenses The Group establishes reserves for losses and loss expenses, which are estimatesof future payments of reported and unreported claims for losses and relatedexpenses, with respect to insured events that have occurred. The process ofestablishing reserves is complex and imprecise, requiring the use of informedestimates and judgments. The Group's estimates and judgments may be revised asadditional experience and other data become available and are reviewed, as newor improved methodologies are developed or as current laws change. Any suchrevisions could result in future changes in estimates of losses or reinsurancerecoverable, and would be reflected in earnings in the period in which theestimates are changed. Management believes they have made a reasonable estimateof the level of reserves at 31 December 2006 and 2005. The reconciliation of unpaid losses and loss expenses for the years ended 31December 2006 and 2005 is as follows: 2006 2005 --------- ---------Gross unpaid losses and loss expenses, beginning ofyear $1,995,485 $1,472,819Reinsurance recoverable on unpaid loss and lossexpenses (575,522) (359,154) --------- ---------Net unpaid losses and loss expenses, beginning ofyear 1,419,963 1,113,665 --------- ---------Net incurred losses and loss expenses for claimsrelated to:Current year 679,115 959,492Prior years 2,434 (94,207) --------- ---------Total net incurred losses and loss expenses 681,549 865,285 --------- ---------Net paid losses and loss expenses for claims relatedto:Current year (64,247) (115,128)Prior year (528,661) (363,449) --------- ---------Total net paid losses and loss expenses (592,908) (478,577) --------- ---------Foreign exchange and other 86,607 (80,410)Business combinations (1) 1,413,026 - --------- ---------Net unpaid losses and loss expenses, end of year 3,008,237 1,419,963Reinsurance recoverable on unpaid loss and lossexpenses 996,896 575,522 --------- ---------Gross unpaid losses and loss expenses, end of year $4,005,133 $1,995,485 --------- --------- (1) Wellington net unpaid losses and loss expenses at 31 December 2006.Wellington gross unpaid losses and loss expenses at 31 December 2006 were$2,026,268. As a result of the changes in estimates of insured events in prior years, the2006 reserve for losses and loss expenses net of reinsurance recoveriesincreased by $2,434 (2005: decrease of $94,207). In 2006 the increase was due toa deterioration of $52,454 in respect of the 2005 hurricanes and $29,400 inrespect of a South African motor loss, offset by positive development in respectof recent underwriting years over a number of business classes. In 2005, thedecrease was due to changes in estimates of insured events in previous yearsresulting from reductions of expected ultimate loss costs, settlement of lossesat amounts below previously estimated loss costs and reduction in uncertaintysurrounding the quantification of the net cost of claim events. 2005 hurricanes The table below shows the Group's estimated ultimate loss as at 31 December2006, showing separately the amounts assumed in 2006 as part of the acquisitionof Wellington described in Note 3. Legacy Legacy 2006 2005 Wellington Catlin Total --------- --------- --------- --------Gross losses $987,017 $674,881 $1,661,898 $615,097Reinsurance recoveries (654,076) (288,921) (942,997) (281,591) --------- --------- --------- --------Net loss prior to reinsurancecosts 332,941 385,960 718,901 333,506Net reinstatements due onceded business 69,674 51,040 120,714 48,258Reinsurance restatements onassumed business (24,087) (38,087) (62,174) (31,540) --------- --------- --------- --------Net loss $378,528 $398,913 $777,441 $350,224 --------- --------- --------- -------- The figures above represent management's best estimate of the likely finallosses to the Group from the three hurricanes: Katrina, Rita and Wilma. Inmaking this estimate, management has used the best information available,including estimates performed by the Group's underwriters, actuarial and claimsstaff, retained external actuaries, outside agencies and market studies.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. 8 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: 2006 2005 Premiums Premiums Premiums Premiums written earned written earned ---------- ---------- ---------- ----------Direct $1,154,851 $1,070,621 $953,172 $992,181Assumed 450,168 434,417 433,428 427,515Ceded (194,896) (179,177) (197,501) (203,254) ---------- ---------- ---------- ----------Net premiums $ 1,410,123 $1,325,861 $1,189,099 $1,216,442 ---------- ---------- ---------- ---------- The Group's provision for reinsurance recoverable as at 31 December 2006 and2005 is as follows: 2006 2005 --------- ---------Gross reinsurance recoverable $1,284,322 $631,957Provision for uncollectible balances (46,791) (24,511) --------- ---------Net reinsurance recoverable $1,237,531 $607,446 --------- --------- The Group evaluates the financial condition of its reinsurers and potentialreinsurers on a regular basis and also monitors concentrations of credit riskwith reinsurers. All current reinsurers have a financial strength rating of atleast 'A' from Standard & Poor's or 'A-' from A M Best, or provide appropriatecollateral. However, certain reinsurers from prior years have experiencedreduced ratings which has led to the need for the provision. At 31 December2006, there were five reinsurers which accounted for 5 per cent or more of thetotal reinsurance recoverable. % of AM Best reinsurance recoverable Rating ---------- ---------Hannover Ruck AG 11% AMunich Re 11% A+National Indemnity Company 7% A++GE Frankona Ruck AG 7% AAllianz Global Corporate & Specialty AG 5% A ---------- --------- At 31 December 2006, the Group had a deposit with reinsurer of $nil (2005: $21,823) 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. Thedeferred gain under the contract of $nil (2005: $6,898) is recognised in incomeas recoveries are made. During 2006, $6,898 of the deferred gain was recognisedin income (2005: $11,380). Assets equivalent in value to the amount accounted asa deposit were held by an independent trustee for the benefit of the reinsuredsyndicates. 9 Derivative financial instruments Catastrophe swap agreement On 17 November 2006, Catlin Bermuda entered into a catastrophe swap agreement('Cat Swap') that provides up to $200.25 million in coverage in the event of aseries of natural catastrophes. Catlin Bermuda's counterparty in the Cat Swap isa special purpose vehicle, Bay Haven Limited ('Bay Haven'). Bay Haven has issuedto investors $200.25 million in three-year floating rate notes, divided intoClass A and Class B notes. The proceeds of those notes provide the collateralfor Bay Haven's potential obligations to Catlin Bermuda under the Cat Swap. The Cat Swap responds to certain covered risk events occurring during a threeyear period. No payment will be made for the first three such risk events. BayHaven will pay Catlin Bermuda $33.375 million per covered risk event thereafter,up to a maximum of six events. The aggregate limit potentially payable to CatlinBermuda is $200.25 million. The categories of risk events covered by the transaction are: US hurricanes (Florida, Gulf States and East Coast), California earthquakes, US Midwestearthquakes, UK windstorms, European (excluding UK) windstorms, Japanesetyphoons and Japanese earthquakes. Only one payment will be made for eachcovered risk event, but the Cat Swap will respond to multiple occurrences of agiven category of risk event, such as if more than one qualifying US hurricaneoccurs during the period. The catastrophe swap will be triggered for US risk events if aggregate insuranceindustry losses, as estimated by Property Claims Services, meet or exceeddefined threshold amounts. Coverage for non-US risk events will be triggered ifspecific parametric criteria, such as wind speeds or ground motions, are met orexceeded. The first two events paid under the catastrophe swap would impact theClass B notes; subsequent events, up to the limit of six events over the threeyear period, would impact the Class A notes. In addition, on 17 November 2006 Catlin Bermuda entered into a furthercatastrophe swap agreement with ABN AMRO Bank N.V. London Branch which will respond to the third covered risk event (that is, the covered risk event before the Class B notes are triggered). The terms are otherwise as described for the Class A and Class B notes, except that the limit payable is $46,500. The Cat Swap falls within the scope of SFAS 133 ("Accounting for DerivativeInstruments and Hedging Activities" as amended ("SFAS 133") and is thereforemeasured in the balance sheet at fair value with any changes in the fair valueincluded in earnings. As at 31 December 2006, the fair value of the Cat Swap isa liability of $619. As there is no quoted market value available for thisderivative, the fair value is determined by management using internal modelsbased on the valuation of the Class A and Class B notes issued by Bay Haven,which are publicly quoted. The fair value model takes into account changes inthe market for catastrophe reinsurance contracts with similar economiccharacteristics and the potential for recoveries from events preceding thevaluation date. Other derivative instruments On acquisition of Wellington, the Group acquired various foreign currencyderivatives (forward contracts, caps and collars) and options to purchase sharesin Aspen Insurance Holdings Ltd. As at 31 December 2006, the fair value of theforeign currency derivatives was $24,847, of which $18,324 had a remaining termof less than 12 months, and the fair value of the Aspen options was $21,190. 10 Notes payable, debt and financing arrangements The Group's outstanding debt as at 31 December 2006 and 2005 consisted of thefollowing: 2006 2005 -------- -------Notes payableRevolving bank facility, due 22 January 2007 $50,000 $50,000 -------- -------Total notes payable 50,000 50,000 -------- -------Subordinated debt (1) Variable rate, face amount €7,000, due 15 March 2035 10,032 -Variable rate, face amount $27,000, due 15 March 2036 29,274 -Variable rate, face amount $31,300, due 15 September 2036 34,103 -Variable rate, face amount $9,800, due 15 September 2036 10,677 -Variable rate, face amount €11,000, due 15 September 2036 15,850 - -------- -------Total subordinated debt 99,936 - -------- -------Bridge financing 500,290 - -------- -------Total debt $650,226 $50,000 -------- ------- (1) Debt instruments acquired in business combination Future interest payments on notes payable and bridge financing as at 31 December2006 are $3,185, due in 2007. Future annual interest payments on subordinateddebt, estimated at interest rates in effect at 31 December 2006, are $7,345. The Group paid $2,655 in interest during the year ended 31 December 2006 (2005:$2,113). Subordinated debt On 12 May 2006 Wellington issued $27,000 and €7,000 of variable rate unsecuredsubordinated notes. The notes are subordinated to the claims of all SeniorCreditors, as defined in the agreement. The notes pay interest based on the rateon three-month deposits in US Dollars plus a margin of 317 basis points for theDollar note and 295 basis points for the Euro note. Interest is payablequarterly in arrears. The notes are redeemable at the discretion of the issuerbeginning on 15 March 2011 with respect to the Dollar notes and 22 May 2011 withrespect to the Euro notes. On 20 July 2006 Wellington issued $31,300, $9,800 and €11,000 of variable rateunsecured subordinated notes. The notes are subordinated to the claims of allSenior Creditors, as defined in the agreement. The notes pay interest based onthe rate on three-month deposits in US Dollars plus a margin of 310 basis pointsfor the $31,300 notes and 300 basis points for the other two notes. Interest ispayable quarterly in arrears. The notes are each redeemable at the discretion ofthe issuer on 15 September 2011. Bridge financing On 30 October 2006 Catlin entered into a bridge financing arrangement with JPMorgan Cazenove under which it could borrow up to $500 million. On 27 and 28December 2006 Catlin borrowed $325 and $175 million, respectively, under thisbridge facility to partially finance the Wellington acquisition. The interestrate on this bridge loan is based on three-month Libor plus 45 basis points. Theweighted average interest rate on the bridge loan at 31 December 2006 is 5.8 percent. As at 31 December 2006 the Group had a balance of $500.3 millionoutstanding on this facility. The bridge financing was repaid with the proceeds of the non-cumulativeperpetual preferred shares in January 2007, described in Note 21. Bank facilities Since November 2003, the Group has participated in a Letter of Credit/ RevolvingLoan Facility (the 'Club Facility') with three, and since 15 December 2006, fourbanks. Each bank participates equally in the Club Facility. The Club Facility iscomprised of three tranches as detailed below. The Club Facility has beenvaried, amended and restated since it was originally entered into, most recentlyon 15 December 2006 when the credit available under the Club Facility increasedfrom $250,000 and £150,000 to $400,000 and £275,000 respectively. The followingamounts were outstanding under the Club Facility as at 31 December 2006: • 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 per cent, 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. This loan was repaid including interest on 22 January 2007. • A clean, irrevocable standby LOC of $294,000 (£150,000) is provided to support CSL's underwriting at Lloyd's ('Facility B'). As at 31 December 2006, CSL has utilised Facility B and deposited with Lloyd's an LOC in the amount of $294,000 (£150,000). 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 has an initial expiry date of 27 November 2010. Collateral of $78,400 (£40,000) was provided in 2006. • A two-year $350 million standby LOC facility is available for utilisation by Catlin Bermuda and Catlin UK ('Facility C'). It is split into two equal tranches of $175 million with the first being fully secured by OECD Government Bonds, US Agencies and or cash discounted at varying rates. The second tranche is unsecured. At 31 December 2006, $106,922 in LOC's were outstanding, of which $103,639 are issued for the benefit of Catlin Bermuda, with a single LOC of $3,283 (£1,675) being for the benefit of Catlin UK. 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 2006 and increase over time, for items such as consolidated netincome in future accounting periods. The Group was in compliance with allcovenants during 2006. At 31 December 2006 a Wellington bank facility was still in existence.Wellington had deposited with Lloyd's unsecured LOCs totalling $147,000(£75,000). In February 2007, these unsecured letters of credit were cancelledand replaced with letters of credit issued under the Group's Facility Bdescribed above. 11 Intangible assets and goodwill Net intangible assets and goodwill as at 31 December 2006 and 2005 consist ofthe following: Indefinite Finite life life Goodwill intangibles intangibles Total --------- --------- --------- ---------Gross value at 1 January 2005 $36,099 - $64,302 $100,401Accumulated amortisation (19,869) - (9,294) (29,163) --------- --------- --------- ---------Net value at 1 January 2005 16,230 - 55,008 71,238 --------- --------- --------- ---------Movements during 2005:Reclassification of intangible asset - 54,337 (54,337) - Additions - - 51 51Foreign exchange adjustment (1,317) (5,660) (2) (6,979)Write off - - (671) (671) --------- --------- --------- ---------Total movements during 2005 (1,317) 48,677 (54,959) (7,599) --------- --------- --------- ---------Gross value at 31 December 2005 32,805 56,966 49 89,820 Accumulated amortisation (17,892) (8,289) - (26,181) --------- --------- --------- ---------Net value at 31 December 2005 $14,913 $48,677 $49 $63,639 --------- --------- --------- ---------Movements during 2006:Business combination 68,970 461,580 10,976 541,526Additions 704 253,446 325 254,475Foreign exchange revaluation 1,648 6,792 21 8,461Amortisation charge - - (75) (75) --------- --------- --------- ---------Total movements during 2006 71,322 721,818 11,247 804,387 --------- --------- --------- ---------Gross value at 31 December 2006 106,498 779,941 11,376 897,815Accumulated amortisation (20,263) (9,446) (80) (29,789) --------- --------- --------- ---------Net value at 31 December 2006 $86,235 $770,495 $11,296 $868,026 --------- --------- --------- --------- Neither goodwill nor intangibles were impaired in 2006 or 2005. Goodwill, purchased syndicate capacity and admitted licenses are considered tohave an indefinite life and as such are subject to annual impairment testing. The Group's intangibles relate to the purchase of syndicate capacity, customerrelationships, distribution channels and admitted as well as surplus lineslicenses. Distribution channels and surplus lines licenses are considered to have a finitelife and are amortised over their estimated useful lives of five years.Amortisation of intangible assets for the next five years at current exchangerates will amount to approximately $2,275 per annum. Purchased syndicate capacity 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. In connection with the Wellington acquisition, the Group purchased Wellington's67 per cent share of the underwriting capacity of Syndicate 2020. A portion ofthe purchase price of Wellington has been allocated to this capacity (see Note 3for further details). In a separate transaction executed simultaneously with the Wellingtonacquisition, the Group, by way of cessation of Syndicate 2020, in effectacquired the remaining 33 per cent of Syndicate 2020's capacity from theunaligned members. As compensation for the cessation (and, in effect, forsurrendering the capacity), unaligned members were given the option of i) 50pence per £1.00 of capacity; or ii) 40 pence per £1.00 of capacity and theability to participate in a new reinsurance syndicate that will write a wholeaccount quota share reinsurance of Syndicate 2003 for the 2007 and 2008 years ofaccount. Approximately one-third of unaligned members elected to take option i),with the balance taking option ii). This asset has been valued at $250,071, or 50 pence per £1.00 of capacityacquired. This represents the cash paid plus an amount representing theparticipation in a new reinsurance syndicate, a non-monetary asset, which hasbeen valued at 10 pence per £1.00 of capacity acquired. This non-monetaryamount, $30,514, has been accounted for as a reinsurance creditor and will beamortised over the two years of participation in the new reinsurance syndicate. Effective 1 January 2007, Syndicate 2020 ceased underwriting and the purchasedcapacity (and that falling to the Group by way of cessation of Syndicate 2020)has been re-deployed to increase the capacity of Syndicate 2003. 12 Taxation Bermuda Under current Bermuda law neither the Company nor its Bermuda subsidiary, CatlinBermuda, are required to pay any taxes in Bermuda on their income or capitalgains. Both the Company and Catlin Bermuda have received undertakings from theMinister of Finance in Bermuda that, in the event of any taxes being imposed,they will be exempt from taxation in Bermuda until March 2016. United Kingdom The Group also operates in the UK through its UK subsidiaries and the income ofthe UK companies is subject to UK corporation taxes. Income from the Group's operations at Lloyd's is also subject to US incometaxes. Under a Closing Agreement between Lloyd's and the Internal RevenueService (IRS), Lloyd's Members pay US income tax on US connected income writtenby Lloyd's Syndicates. US income tax due on this US connected income iscalculated by Lloyd's and remitted directly to the Internal Revenue Service andis charged by Lloyd's to Members in proportion to their participation on therelevant Syndicates. The Group's Corporate Members are all subject to thisarrangement but, as UK tax residents, will receive UK corporation tax creditsfor any US income tax incurred up to the value of the equivalent UK corporationincome tax charge on the US income. United States The Group also operates in the US through its US subsidiaries and their incomeis subject to both US State and US Federal income taxes. Other international income taxes The Group has a network of international operations and they also are subject toincome taxes imposed by the jurisdictions in which they operate but they do notconstitute a material component element of the Group's tax charge. 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 2006 and 2005 is asfollows: 2006 2005 --------- ---------Current tax (benefit)/expense $(5,438) $6,477Deferred tax expense 22,044 1,526 --------- ---------Expense for income taxes $16,606 $8,003 --------- --------- 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 is6.0 per cent (2005: 29.9 per cent). A reconciliation of the difference betweenthe expense for income taxes and the expected tax expense at the weightedaverage tax rate for the years ended 31 December 2006 and 2005 is providedbelow. 2006 2005 --------- ---------Expected tax expense at weighted average rate $1,889 $8,307Permanent differences:Disallowed expenses 474 1,149(Over)/under accrual of tax in prior periods (1,297) 262Items taxed in previous years - (1,212)Specific contingency provision 15,540 -Other - (503) --------- ---------Expense for income taxes $16,606 $8,003 --------- --------- The components of the Group's net deferred tax liability as at 31 December 2006and 2005 are as follows: 2006 2005 --------- ---------Deferred tax assets:Net operating loss carryforwards $73,346 $7,462Future UK double tax relief 7,953 7,507Whole account stop loss - 2,069Deep discount security unwind 770 1,201Accelerated capital allowances 1,137 488Compensation accruals 5,080Cumulative translation adjustment - 4,447Syndicate capacity amortisation and other 156 2,022 --------- ---------Total deferred tax assets $88,442 $25,196 --------- ---------Deferred tax liabilities:Intragroup financing charges (8,932) -Untaxed profits (104,030) (29,377)Intangible assets arising on business combination (127,017) - --------- ---------Net deferred tax liability $(151,537) $(4,181) --------- --------- As at 31 December 2006, a deferred tax asset of $2,184 (2005: $nil) and adeferred tax liability of $153,721 (2005: $4,181) are recognised in the balancesheet. No valuation allowance was necessary as at 31 December 2006 and 2005. As at 31 December 2006, the Group has net operating loss carryforwards ofapproximately $243,401, which are available to offset future taxable income(2005: $24,873). The net operating loss carry forwards primarily arise in the UKsubsidiaries where they are expected to be fully utilised. There are no timerestrictions on the utilisation of these losses. 13 Stockholders' equity The following is a detail of the number and par value of common sharesauthorised, issued and outstanding as at 31 December 2006 and 2005: Issued and Authorised outstanding ----------------- ----------------- Par Par Number value Number value of shares $000 of shares $000 ---------- ---------- ---------- ----------Ordinary common shares,par value $0.01 per shareAs at 31 December 2006 400,000,000 $4,000 238,283,281 $2,383 ---------- ---------- ---------- ----------As at 31 December 2005 250,000,000 $2,500 155,914,616 $1,559 ---------- ---------- ---------- ---------- The following table outlines the changes in common shares issued and outstandingduring 2006 and 2005: 2006 2005 ---------- ----------Balance, 1 January 155,914,616 154,097,989Exercise of stock options and warrants 249,108 1,816,627Equity raise 7,704,900 -Business combination 74,414,657 - ---------- ----------Balance, 31 December 238,283,281 155,914,616 ---------- ---------- Equity raise On 14 March 2006, the Group placed 7,704,900 new common shares with par value of$0.01 each at $8.68 (£5.00) per share, raising $65,231 net of expenses. Business Combination As described more fully in Note 3, the Group has issued 74,414,657 common sharesas at 31 December 2006 to former holders of Wellington shares in connection withthe acquisition of Wellington. Treasury stock In connection with the Performance Share Plan ('PSP'), at each dividend date, anamount equal to the dividend that would be payable in respect of the shares tobe issued under the PSP (assuming full vesting), is paid into an EmployeeBenefit Trust ('EBT'). The EBT uses these funds to purchase Group shares on theopen market. These shares will ultimately be distributed to PSP holders to theextent that the PSP awards vest. During 2006, the Group, through the EBT,purchased 155,155 of the Group's shares, at an average price of $8.72 (£4.65)per share. The total amount paid of $1,352 is shown as a deduction tostockholders' equity. Wellington also had an EBT which held shares in Wellington. The EBT accepted theOffer and therefore at year end, it held 555,768 of the Group's shares at aprice of $9.44 (£4.99) per share. Dividends On 12 June 2006, the Group paid a final dividend relating to the 2005 financialyear of $0.176 (£0.101) per share to shareholders of record at the close ofbusiness on 12 May 2006. The total dividend paid for the 2005 financial year was$0.275 (£0.155) per share. On 10 November 2006, the Group paid an interim dividend relating to the 2006financial year of $0.113 per share (£0.060 per share) to shareholders of recordas at 13 October 2006. 14 Employee stock compensation schemes The Group has two stock compensation schemes in place under which awards areoutstanding: a Performance Share Plan, which was adopted in 2004, and a LongTerm Incentive Plan, adopted in 2002. These financial statements include thetotal cost of stock compensation for both plans, calculated using the fair valuemethod of accounting for stock-based employee compensation. The total cost ofthe plans expensed in the year ended 31 December 2006 was $11,000 (2005: $4,246). Remaining stock compensation to be expensed in future periods relating tothese plans is $20,913. Performance Share Plan ('PSP') On 9 March 2006, a total of 2,020,301 options with $nil exercise price and275,296 non-vested shares (total of 2,295,597 securities) were granted to Groupemployees under the PSP. Up to half of the securities will vest on 9 March 2009and up to half will vest on 9 March 2010, subject to certain performanceconditions. These securities have been treated as non-vested shares and as such have beenmeasured at their fair value as if they were vested and issued on the grantdate, 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 current vestingconditions assume that employees will ultimately receive 100% of grantedsecurities and that the annual attrition rate is 3%. The total number of PSPsecurities outstanding at 31 December 2006 was 4,429,075 and the totalcompensation expense relating to the PSP for the year ended 31 December 2006 was$9,669. None of the PSP securities have vested. The table below shows the unvested PSPsecurities as at 31 December: 2006 2005 ------------ ------------Outstanding, beginning of period 2,203,786 -Granted during year 2,295,597 2,223,959Forfeited during year (72,497) (20,173) ------------ ------------Outstanding, end of period 4,426,886 2,203,786 ------------ ------------Fair value per PSP security as at date of grant $8.71 $7.13 ------------ ------------ 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 (assumingfull vesting), is paid into an Employee Benefit Trust. This amount, totalling$1,306 in 2006, is treated as a deferred compensation obligation and as such istaken directly to retained earnings and capitalised in stockholders' equitywithin additional paid-in capital. Long Term Incentive Plan ('LTIP') Interests in a total of 16,051,613 ordinary common shares were granted toeligible employees. The individual awards were divided into options with anexercise price of $5.00 and exercisable in four equal annual tranches, andoptions with exercise prices of $10.00, $12.50 and $15.00, exercisable on 1 July2007. The total compensation expense relating to the LTIP for the year ended 31December 2006 was $1,331. The options vest on various dates as prescribed under LTIP plan documentation,but in any event all will have vested and will expire by 4 July 2012. The tablebelow shows the vesting dates and the number of options that have vested onthose dates: Number of optionsDate vesting -----------4 July 2003 1,576,1106 April 2004 (IPO date) 4,815,4844 July 2004 1,668,2614 July 2005 1,655,1584 July 2006 1,647,564 ----------- Total 11,362,577 ----------- The table below shows the status of the interests in shares as at 31 December: 2006 2005 ---------- ---------- Weighted Weighted average average exercise exercise Number price ($) Number price ($) ---------- --------- ---------- ---------Outstanding, beginning of period 15,979,915 9.68 16,440,660 9.60Exercised during year (544,500) 4.97 (322,877) 5.05Forfeited during year (164,736) 11.94 (137,868) 11.27 --------- ---------- --------- ----------Outstanding, end of period 15,270,679 9.76 15,979,915 9.68 --------- ---------- --------- ----------Exercisable, end of period 10,084,791 8.45 9,005,511 8.94 --------- ---------- --------- ---------- Average Number of remainingExercise price options contractual outstanding life (years) ------------ -------------$5.00 5,197,217 5.5£3.50 322,155 5.5$10.00 3,250,427 1.0$12.50 3,250,427 1.0$15.00 3,250,453 1.0 ------------ -------------Total 15,270,679 2.5 ------------ ------------- 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 four years for the £3.50 tranche, 1.875 years forthe performance based tranche that vested on admission and 3.625 for theperformance based tranche that vests on 4 July 2007. The valuation has assumedan average volatility of 40 per cent, no expected dividends and a risk free rateusing US dollar swap rates appropriate for the expected life assumptions: 2.8per cent for four years; 1.79 per cent for 1.875 years; and 2.64 per cent for3.625 years. 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. Warrants may be exercised in whole or in part, at any time, until4 July 2012 and are exercisable at a price per share of $5.00. No warrants wereexercised during 2006. During 2005, warrants to purchase 5,120,465 common shareswere exercised and settled net for 1,703,386 common shares, leaving warrantsentitling the purchase of 14,944,051 common shares outstanding. 15 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) PSP;(ii) LTIP; and(iii) Warrants There is no difference between net income attributable to ordinary stockholdersand net income attributable to all stockholders for the years ended 31 December2006 and 2005. Reconciliations of the number of shares used in the calculations are set outbelow. 31 December 31 December 2006 2005 ---------- ----------Weighted average number of shares 162,598,043 154,984,097Dilution effect of warrants 6,492,633 5,101,067Dilution effect of stock options andnon-vested shares 6,771,102 2,013,603Dilution effect of stock options and warrantsexercised in theperiod 213,223 930,519 ---------- ----------Weighted average number of shares on adiluted basis 176,075,001 163,029,285 ---------- ---------- Earnings per common shareBasic $1.59 $0.13Diluted $1.47 $0.12 Options to purchase 9,751,307 shares (2005: 9,903,849) under the LTIP wereoutstanding during the year but were not included in the computation of dilutedearnings per share because the options' exercise price was greater than theaverage market price of the common shares. All securities awarded under the PSPwere included in the computation of diluted earnings per share because theperformance conditions necessary for these securities to vest were met as at 31December 2006 (2005: 2,203,786 securities were excluded). Finally, the issuanceof new shares in connection with the acquisition of Wellington had a minimaldilutive effect on earnings per common share because it happened very late inthe year. 16 Other comprehensive loss The following table details the tax effect of the individual components of othercomprehensive loss for 2006 and 2005: Amount before Tax benefit Amount2006 tax /(expense) after tax --------- --------- ---------Unrealised gains arising during year $18,684 $(5,750) $12,934Less reclassification for lossesrealised in income (17,041) 3,564 (13,476) --------- --------- ---------Net unrealised gains on investments 1,643 (2,186) (542)Cumulative translation adjustments (9,055) 4,907 (4,149) --------- --------- ---------Change in accumulated othercomprehensive loss $(7,412) $2,721 $(4,691) --------- --------- --------- Amount before Tax benefit/ Amount2005 tax (expense) after tax --------- --------- ---------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 loss $(27,654) $2,099 $(25,555) --------- --------- --------- 17 Pension commitments The Group operates various pension schemes for the different countries ofoperation. In addition, the Group acquired a defined benefit pension plan anddefined contribution plans as part of the Wellington acquisition. 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 $4,184 for the year ended 31 December 2006(2005: $3,265). 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 $683 for the year ended 31 December 2006(2005: $470). 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 $567 for the year ended31 December 2006 (2005: $303). In connection with the acquisition of Wellington, the Group assumed liabilitiesassociated with a defined benefit pension scheme which Wellington sponsored. Thescheme has been closed to new members since 1993. The current membershipconsists only of pensioners and deferred members. The movements in the periodare shown in the table below. 2006 ------------Change in projected benefit obligation: -Projected Benefit obligation, beginning of year -Business combination 32,720 ------------Projected benefit obligation, end of year $32,720 ------------Change in plan assets: -Fair value of plan assets, beginning of year -Business combination 34,429 ------------Fair value of plan assets, end of year $34,429 ------------Reconciliation of funded status:Funded status $1,709 ------------Net pension asset recognised at year end $1,709 ------------The actuarial assumptions used to value the benefit obligation at 31 December2006 were as follows: Discount rate 5.1%Price inflation 5.1%Pension increases to pensions in payment 3.2% ------------ As the plan was assumed from Wellington at 31 December 2006, there are no incomestatement effects in 2006. The objectives in managing the scheme's investments are to ensure thatsufficient assets are available to pay members' benefits as they arise, with dueregard to minimum regulatory requirements and the employer's ability to meetcontribution payments. It is believed that, in relation to membership consistingonly of pensioners and deferred members, these objectives are best met byinvestment in fixed income securities. The investments are in a pooled,non-government bond fund which is diversified across a large number ofsecurities in order to reduce specific risk. As at 31 December 2006, 97 per cent of plan assets were held in debt securities,with the remaining 3 per cent held as cash. No plan assets are expected to bereturned to the Group in the year ending 31 December 2007. The overall expected return on assets is calculated as the weighted average ofthe expected returns on each individual asset class. The return on debtsecurities is the current market yield on debt securities. The expected returnon other assets is derived from the prevailing interest rate set by the Bank ofEngland as at the measurement date. Estimated future benefit payments for the defined benefit pension plan, are asfollows: 2007 $1,8622008 $1,9602009 $2,0582010 $2,1562011 $2,2542012 to 2016 inclusive $12,740 -------- No contributions are expected to be paid to the defined benefit plan during2007. 18 Statutory financial data The Group's statutory capital and surplus was $1,459,950 at 31 December 2006(2005: $909,134). The statutory surplus of each of its principal operatingsubsidiaries is far in excess of regulatory requirements. 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. The Group is also subject to restrictions on some of its assets to support itsinsurance and reinsurance operations, as described in Note 5. 19 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 8 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 10. The Group has given guarantees to the providers under the previousWellington credit facility described in Note 10. Future lease commitments 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 2006 are asfollows: 2007 $9,7842008 8,4452009 5,6932010 5,6142011 and thereafter 33,978 -------- Total $63,514 -------- Under non-cancellable sub-lease agreements, the Group is entitled to receivefuture minimum sub-lease payments of $869 (2005: $nil). 20 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 2006 was $nil (2005: $201) and from Burnhope Lodgewas $nil (2005: $23). There were no material transactions between Catlin and Wellington prior to thebusiness combination in December 2006. Club Facility During 2005 and until 4 October 2006, Barclays plc held interests in more than10per cent of the issued share capital of the Company. An affiliate of Barclaysplc, Barclays Bank plc ('Barclays'), is one of the banks participating in theClub Facility, described in Note 10. Barclays participates equally with theother two banks in the Club Facility and, while Barclays plc held interests inmore than 10 per cent of the issued share capital, Barclays received fees asfollows: • A participation fee of one third of 0.085per cent on the total amount of the Club Facility; • A fronting fee of 0.125per cent 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 cent per annum on Facility A, one third of 0.25 per cent per annum on Facility B and one third of 0.135 per cent 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 cent per annum plus mandatory costs on Facility A; • Commission of one third of 1.2 per cent per annum, reducing to 0.3 per cent per annum in respect of securitised outstandings, on Facility B; and • Commission of one third of 0.6 per cent per annum, reducing to 0.3 per cent 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. 21 Subsequent events Proposed dividend On 8 March 2007, the Board approved a proposed final dividend of $0.328 pershare (£0.17 per share), payable on 8 June 2007 to shareholders of record at theclose of business on 11 May 2007. The final dividend is determined in US dollarsbut partially payable in sterling based on the exchange rate of £1=$1.93 on 7March 2007. Issuance of preferred shares On 18 January 2007, the Group, through Catlin Bermuda, issued $600,000 ofnon-cumulative perpetual preferred shares at a dividend rate of 7.249 per cent.The proceeds were used to repay the $500,000 bridge facility as well as FacilityA described in Note 10, and for general corporate purposes. Issuance of common shares As described in Note 3, at 31 December 2006, acceptances representing 88 percent of Wellington's share capital subject to the Offer had been settled. Theremaining Wellington shares subject to the Offer were settled in 2007, resultingin a further issuance of 11,679,637 shares. Payment to Lloyd's Wellington has agreed, without admission of wrongdoing or liability, to payLloyd's £16,071 to resolve an inquiry commenced by Lloyd's into the conduct ofWellington Underwriting Agencies Limited and Wellington (Five) Limited in theLloyd's capacity auctions held during September 2006. The amount equatesapproximately to the difference, in aggregate, between the price received bysellers of Syndicate 2020 capacity in the auctions and the amount they wouldhave received if they had not sold in the auction but had accepted the Syndicatecessation compensation offer of 50 pence per £1.00 of capacity. It isanticipated that the payment will be made before the end of the first quarter2007. Cat Swap On 13 February 2007, Catlin Bermuda entered into a further $10,000 Cat Swap withABN AMRO Bank N.V. London Branch which will respond to the third covered riskevent (that is, the covered risk event before the Class B notes are triggered).The terms are otherwise as described for the third covered event entered intoduring 2006 as described in Note 9, except that the limit payable is $10,000. This information is provided by RNS The company news service from the London Stock Exchange