Castelnau Group Regulatory News (CGL)

6 Mar 2008 07:01

Catlin Group Limited06 March 2008 PART 2 Catlin Group LimitedNotes to the Consolidated Financial StatementsFor the years ended 31 December 2007 and 2006(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 itssubsidiaries, which together with the Company are referred to as the 'Group',Catlin underwrites specialty classes of insurance and reinsurance on a globalbasis. The Group consists of four underwriting platforms: •The Catlin Syndicate (Syndicate 2003) which operates at Lloyd's of London;•Catlin Bermuda (Catlin Insurance Company Ltd.);•Catlin UK (Catlin Insurance Company (UK) Limited); and•Catlin US, which is the trading name for the Company's various subsidiaries in the United States. Catlin US includes Catlin Inc. as well as two insurance companies: Catlin Insurance Company Inc. and Catlin Specialty Insurance Company Inc. At 31 December 2007, the Company, through intermediate companies, also hadestablished operations in Canada, Australia, Singapore, Malaysia, China,Germany, Belgium, Guernsey, France, Spain, Austria, Switzerland, Italy andBrazil. On 18 December 2006, the Company 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 market.Wellington also owned a managing general agent in the United States and aUS-based specialist insurance company. This acquisition is described in Note 3. 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, renamed Catlin Insurance Company Inc., is now part of theCompany's US operations. 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. 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 and derivatives. The accountingestimates and actuarial determinations are sensitive to market conditions,investment yields, commissions and other policy acquisition costs. As additionalinformation becomes available, or actual amounts are determinable, the recordedestimates will be revised and reflected in operating results. Although somevariability is inherent in these estimates and actual results may differ fromthe estimates used in preparing the consolidated financial statements,management believes the amounts recorded are reasonable. Certain insignificant reclassifications have been made to prior years' amountsto conform to the 2007 presentation. 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 United States dollars ('US dollars' or'$'). Investments 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 net income 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 net income(through net realised losses on investments) in the proper period. The Group'sdecision to make an impairment provision is based on regular objective reviewsof the issuer's current financial position and future prospects, its financialstrength rating and an assessment of the probability that the current marketvalue will recover to former levels and requires the judgment of management. Inassessing the potential recovery of market value for debt securities, the Groupalso takes into account the timing of such recovery by considering whether ithas the ability and intent to hold the investment to the earlier of (a)settlement or (b) market price recovery. Any security whose price decrease isdeemed other-than-temporary is written down to its then current market level andthe cumulative net loss previously recognised in stockholders' equity is removedand charged to net income. Inherently, there are risks and uncertaintiesinvolved in making these judgments. Changes in circumstances and criticalassumptions such as a continued weak economy, financial markets disruption orunforeseen events which affect one or more companies, industry sectors orcountries could result in additional writedowns in future periods forimpairments that are deemed to be other-than-temporary. Additionally, unforeseencatastrophic events may require us to sell investments prior to the forecastmarket 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. Investments in funds The Group's investments in funds are considered to be trading and are carried atfair value. The fair value is based on either the quoted market price of thesefunds provided by independent pricing services or the net asset value of theindividual funds. The change in fair value of the individual funds is recordedin net income as net investment income. 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 Financial Accounting Standard No. 133, Accounting forDerivative Instruments and Hedging Activities ('FAS 133'), the Group recognisesderivative financial instruments as either assets or liabilities measured atfair value. Gains and losses resulting from changes in fair value are includedin net income. The fair values of the catastrophe swap agreements described in Note 9 aredetermined by management using internal models based on the valuation of theunderlying notes issued by the counterparty, which are publicly quoted. Thedetermination of fair value takes into account changes in the market forcatastrophe reinsurance contracts with similar economic characteristics and thepotential for recoveries from events preceding the valuation date. The fairvalue of options to purchase shares in Aspen Insurance Holdings Ltd ('Aspen')was estimated using the Black-Scholes valuation model. The fair values of allother derivative financial instruments are obtained from independent valuationsources. 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 inthe Consolidated Statements of Operations. 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, andwhere the insured or reinsured has the ability to commute or cancel coveragewithin the term of the policy, only the annual premium is included as writtenpremium at policy inception. Annual instalments are included as written premiumat each successive 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 net income 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 estimated future profits associated with unearned premiums wasrecorded. The value of in-force insurance contracts is amortised over the periodin which the related premiums are earned and was fully amortised as at 31December 2007. 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 inthe Consolidated Balance Sheets. Reinsurers' share of unearned premiums represent the portion of premiums cededto reinsurers applicable to the unexpired terms of the reinsurance contracts inforce. Reinsurance recoverables include 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 in the Consolidated Balance Sheets. 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 values of the reportingunits is determined based on an evaluation of a number of factors, includingranges of future discounted earnings. Certain key assumptions considered includeforecasted trends in revenues, operating expenses and effective tax rates. Intangible assets are valued at their fair value at the time of acquisition. TheGroup's intangible assets relate to the purchase of syndicate capacity, thedistribution network and admitted as well as surplus lines licenses. Purchased syndicate capacity and admitted licenses are considered to have anindefinite life and as such are subject to annual impairment testing. Surpluslines authorisations are considered to have a finite life and are amortised overtheir estimated useful lives of five years. Distribution channels are amortisedover their useful lives of five years. The Group evaluates the recoverability of its intangible assets whenever changesin circumstances indicate that an intangible asset may not be recoverable. If itis determined that an impairment exists, the excess of the unamortised balanceover the fair value of the intangible asset is recognised as a change in netincome. 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 presentation currency of the Group has been determined to be US dollars. Thefinancial statements of each of the Group's entities are initially measuredusing the entity's functional currency, which is determined based on itsoperating environment and underlying cash flows. For entities with a functionalcurrency other than US dollars, foreign currency assets and liabilities aretranslated into US dollars using period end rates of exchange, while statementsof operations are translated at average rates of exchange for the period. Theresulting translation differences are recorded as a separate component ofaccumulated other 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 recognition of untaxed profits, and intangible assetsarising from the acquisition of Wellington in December 2006. The effect ondeferred tax assets and liabilities of a change in tax rates is recognised inincome in the period that includes the enactment date. A valuation allowanceagainst deferred tax assets is recorded if it is more likely than not that allor some portion of the benefits related to deferred tax assets will not berealised. 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 In 2002, the Group issued convertible preference shares with detachable stockpurchase warrants. The preference shares were converted into common shares in2004. The portion of the proceeds allocable to the warrants has been accountedfor as additional paid-in capital. This allocation was based on the relativefair values of the two securities at the time of issuance. Warrant contracts areclassified as equity so long as they meet all the conditions of equity outlinedin EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, andPotentially Settled in, a Company's Own Stock. Subsequent changes in fair valueare not recognised in the Statement of Operations as long as the warrantcontracts 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. As a result of the acquisition of Wellington in December 2006, the Group alsosponsors a defined benefit pension scheme which was closed to new members in1993. The recorded asset related to the plan was set equal to the value of planassets in excess of the defined benefit obligation at the date of the businesscombination. 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 February 2006, the Financial Accounting Standards Board ('FASB') issuedFinancial Accounting Standard 155, ('FAS 155'), Accounting for Certain FinancialInstruments: an amendment of FASB Statements No. 133 and 140. This Statementresolves issues addressed in FAS 133 Implementation Issue No. D1, 'Applicationof Statement 133 to Beneficial Interests in Securitized Financial Assets'. FAS155 is effective for reporting periods beginning after 15 September 2006,although early adoption is permitted. The adoption of FAS 155 has not had amaterial effect on the Group's financial position or results of operations In June 2006, the FASB issued FASB Interpretation No. 48, Accounting forUncertainty in Income Taxes - an interpretation of FASB Statement No. 109, ('FIN48'). FIN 48 provides guidance on financial statement recognition, measurementand disclosure of uncertain tax positions. FIN 48 is effective for fiscal yearsbeginning after 15 December 2006. The Group adopted the provisions of FIN 48effective 1 January 2007. There were no changes to the Group's financialposition as a result of adopting FIN 48. The Group's tax uncertainties aredescribed in Note 12. In September 2006, the FASB issued Financial Accounting Standard 157, Fair ValueMeasurements ('FAS 157'). FAS 157 provides a common definition of fair value andestablishes a framework to make the measurement of fair value in generallyaccepted accounting principles more consistent and comparable. FAS 157 alsorequires expanded disclosures to provide information about the extent to whichfair 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 in 2008 isnot expected to have a material effect on the Group'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 ofthe measurement date provisions of FAS 158 in 2009 will not have a materialeffect on the Group's financial position or results of operations. In February 2007, the FASB issued Financial Accounting Standard No. 159, TheFair Value Option for Financial Assets and Financial Liabilities ('FAS 159').FAS 159 permits companies to choose to measure many financial instruments andcertain other items at fair value. The objective is to improve financialreporting by providing companies with the opportunity to mitigate volatility inreported earnings caused by measuring related assets and liabilities differentlywithout having to apply complex hedge accounting provisions. FAS 159 iseffective for fiscal years beginning after 15 November 2007. Companies are notallowed to adopt FAS 159 on a retrospective basis unless they chose earlyadoption. The Group will adopt FAS 159 effective 1 January 2008 and has electedto apply the fair value option to its available-for-sale investment portfolio.On adoption of FAS 159, net unrealised gains of $14,424, after allowing for taxeffects, will be reclassified from accumulated other comprehensive income toretained earnings as at 1 January 2008. In December 2007, the FASB issued Financial Accounting Standard 141(R), BusinessCombinations - a replacement of FASB Statement No.141 ('FAS 141(R)'), whichchanges the principles and requirements for how the acquirer of a businessrecognises and measures in its financial statements the identifiable assetsacquired, the liabilities assumed, and any non-controlling interest in theacquiree. The statement also provides guidance for recognising and measuring thegoodwill acquired in the business combination and determines what information todisclose to enable users of the financial statements to evaluate the nature andfinancial effects of the business combination. This statement is effectiveprospectively for fiscal years beginning after 15 December 2008. The Group willadopt FAS 141(R) in 2009. The adoption of FAS 141(R) is not expected to have amaterial effect on the Group's financial position or results of operations. In December 2007, the FASB issued FAS 160, Non-Controlling Interests inConsolidated Financial Statements - an amendment of ARB No. 51 ('FAS 160'). Thisstatement establishes accounting and reporting standards for the non-controllinginterest in a subsidiary and for the deconsolidation of a subsidiary. Thestatement requires consolidated net income to be reported at amounts thatinclude the amounts attributable to both the parent and the non-controllinginterest. It also requires disclosures to be on the face of the consolidatedstatement of operations, of the amounts of consolidated net income attributableto the parent and to the non-controlling interest. This statement is effectiveprospectively, except for certain retrospective disclosure requirements, forreporting periods beginning after 15 December 2008. The Group will adopt FAS 160in 2009 and is currently evaluating the impact of adoption. The adoption of FAS160 is not expected to have a material effect on the Group's financial positionor results 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 are 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 is a major international specialty insuranceand reinsurance business with well established underwriting platforms in theUnited 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 $1,186,300, 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 was accrued in the 31December 2006 balance sheet as a liability for the cash consideration and withinadditional paid-in capital for the equity consideration, and was acquired inearly 2007. Changes to the purchase price allocation in 2007 have resulted in an increase ingoodwill from $68,970 to $74,512. This increase is primarily due to additionalacquisition expenses of $1,366 and an increase of $2,664 in the liability forrestructuring costs as described below. The following table summarises the estimated fair values of the assets acquiredand liabilities assumed at the date of acquisition.------------------------------------ --------------Investments and cash $2,288,886Premiums and other receivables 339,366Reinsurance recoverable 804,787Value of in-force business acquired 118,384Intangible assets 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 133,539Other liabilities 222,552------------------------------------ --------------Total liabilities assumed 3,039,357------------------------------------ --------------Net assets acquired $1,104,298------------------------------------ -------------- The table below summarises the calculation of goodwill arising on theacquisition.------------------------------------ --------------Cash consideration $347,431Catlin share consideration 812,427Acquisition expenses 26,442------------------------------------ --------------Total consideration $1,186,300------------------------------------ --------------Net assets acquired 1,104,298Treasury shares acquired 7,490------------------------------------ --------------Goodwill $74,512------------------------------------ -------------- 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 acquiredand replaces the deferred policy acquisition costs that were carried onWellington's historical balance sheet. Its value was determined based on anindependent third-party valuation. Of the goodwill arising on the acquisition of Wellington, $64,289 was allocatedto Catlin Syndicate, and the remaining $10,223 was allocated to Catlin US. The unaudited pro forma financial information presented below assumes theacquisition occurred as at 1 January 2006. 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 period presented. 2006-------------------------------- ----------Gross premiums written $2,721,800Total revenues 2,488,451Net income 395,327 Earnings per share: Basic $1.67 Diluted $1.58 Shares outstanding: Basic 236,601,569 Diluted 250,078,528-------------------------------- ---------- Restructuring costs In December 2006, the Group's management approved and committed to plans toreduce staff headcount as part of the integration of the two businesses. Aliability of $5,565 representing the cost associated with terminating theemployment of certain former Wellington employees was included in the initialallocation of the purchase price of the Wellington acquisition as at 31 December2006. During 2007, the actual amount of this liability was determined to be$9,429. The increase of $3,864 has been treated as an adjustment to the purchaseprice allocation and has resulted in an increase in goodwill of $2,664 afterallowing for deferred tax effects. All termination costs were paid in 2007 andcharged against this liability. Costs associated with terminating the employmentof certain legacy Catlin employees as part of the integration process wererecorded as part of administrative expenses. 4. Segmental information Following the acquisition of Wellington in December 2006, Catlin has madecertain changes to its segmental reporting to reflect the manner in whichresults are now reviewed by management. Comparative segmental disclosures havebeen restated accordingly. In 2006, Catlin had four reportable segments: Catlin Syndicate Direct, CatlinSyndicate Reinsurance, Catlin Bermuda and Catlin UK. From 2007, Catlin SyndicateDirect and Catlin Syndicate Reinsurance have been combined into a singlesegment, and Catlin US has been added as an additional reportable segment.Catlin US did not generate business in its own right in 2006, and isconsequently not shown separately in the comparative disclosures. In 2006, the segment result was based on income or loss before income taxexpense. From 2007, the segment result is based on net premiums earned lesslosses, loss expenses and brokerage costs. In 2006, segment revenue and results included the effects of intra-Groupreinsurance. From 2007, segment revenue and results are stated prior to theeffects of intra-Group reinsurance and therefore reflect reinsurance withexternal parties only. Catlin determines its reportable segments by platform, consistent with themanner in which results are reviewed by management. The four reportable segmentsare: •Catlin Syndicate, which comprises direct insurance and reinsurance business underwritten by the Catlin Syndicate at Lloyd's;•Catlin Bermuda, which primarily underwrites reinsurance business, excluding intra-Group reinsurance;•Catlin UK, which primarily underwrites direct insurance; and•Catlin US, which primarily underwrites speciality business in the United States. At 31 December 2007, there were four intra-Group reinsurance contracts in place:the 50% Corporate Quota Share ('CQS'), which cedes Catlin Syndicate risk toCatlin Bermuda, the 60% Quota Share contract ('CUK QS') which cedes Catlin UKrisk to Catlin Bermuda and also two 75% Quota Share contracts ('CUS QS') whichcede Catlin US risk to Catlin Bermuda. The Long Tail Stop Loss ('LTSL') betweenthe Catlin Syndicate and Catlin Bermuda has not been renewed and the CQScovering the 2004 underwriting year of account has been commuted; however thereis still some movement in 2007 on these contracts as the covered years continuedto develop. The effects of each of these reinsurance contracts are excluded fromsegmental revenue and results, as this is the basis upon which the performanceof each segment is assessed. Net underwriting contribution by operating segment for the year ended 31December 2007 is as follows: -------------- -------- -------- -------- -------- --------- Catlin Catlin Catlin Catlin Syndicate Bermuda UK US Total-------------- -------- -------- -------- -------- ---------Gross premiums written $2,537,904 $311,976 $439,440 $71,306 $3,360,626Reinsurance premiums ceded (665,581) (48,151) (69,427) (3,949) (787,108)-------------- -------- -------- -------- -------- ---------Net premiums written 1,872,323 263,825 370,013 67,357 2,573,518-------------- -------- -------- -------- -------- ---------Net premiums earned 1,903,044 228,647 305,198 52,645 2,489,534Losses and loss expenses and profit commission (835,089) (88,925) (200,010) (30,646) (1,154,670)Brokerage (399,137) (43,427) (72,649) (15,759) (530,972)-------------- -------- -------- -------- -------- ---------Net underwriting contribution $668,818 $96,295 $32,539 $6,240 $803,892-------------- -------- -------- -------- -------- --------- Net underwriting contribution by operating segment for the year ended 31December 2006 is as follows:--------------------- -------- -------- -------- --------- Catlin Catlin Catlin Syndicate Bermuda UK Total--------------------- -------- -------- -------- ---------Gross premiums written $1,106,620 $199,144 $299,255 $1,605,019Reinsurance premiums ceded (144,479) (6,235) (44,182) (194,896)--------------------- -------- -------- -------- ---------Net premiums written 962,141 192,909 255,073 1,410,123--------------------- -------- -------- -------- ---------Net premiums earned 917,530 180,320 228,011 1,325,861Losses and loss expenses andprofit commission (462,503) (59,852) (159,194) (681,549)Brokerage (194,196) (31,617) (57,323) (283,136)--------------------- -------- -------- -------- ---------Net underwriting contribution $260,831 $88,851 $11,494 $361,176--------------------- -------- -------- -------- --------- Total revenue is the total of net premiums earned as disclosed above, plus netinvestment income and net realised losses on investments, net realised (losses)/gains on foreign currency exchange, and other income. Of these items, only netpremiums earned are measured and managed on a segmental basis. Total assets by segment at 31 December 2007 and 2006 are as follows: 2007 2006-------------------------------- ---------- ----------Catlin Syndicate $7,366,964 $2,788,605Catlin Bermuda 5,355,747 2,932,168Catlin UK 1,117,368 708,546Catlin US 363,740 -Other 4,320,178 2,438,957Assets acquired from Wellington - 4,214,867Consolidation adjustments (8,710,862) (4,276,825)-------------------------------- ---------- ----------Total assets $9,813,135 $8,806,318-------------------------------- ---------- ---------- 'Other' in the table above includes assets such as investments in Groupcompanies which are not allocated to individual segments. In 2007 the assetsacquired from Wellington have been allocated to the appropriate segment. At 31December 2006 net assets acquired from Wellington had not yet been allocated tosegments and therefore were included in one line above. The amount of goodwill allocated as at 31 December 2007 was $79,245 (2006:$18,363) for Catlin Syndicate and $13,806 (2006: $nil) for Catlin US. At 31December 2006 goodwill of $68,970 associated with the acquisition of Wellingtonhad not yet been allocated to segments. 5. Investments Fixed maturities The fair values and amortised costs of fixed maturities at 31 December 2007 and2006 are as follows: ----------------- ----------------- 2007 2006 ----------------- ----------------- Fair Amortised Fair Amortised value cost value cost---------------- ---------- ---------- ---------- ----------US government andagencies $721,952 $704,623 $733,861 $744,753Non-US governments 424,098 426,520 338,525 342,150Corporate securities 529,906 527,476 424,901 426,167Asset-backed securities 428,508 429,438 535,718 535,974Mortgage-backedsecurities 844,486 840,660 636,432 636,916---------------- ---------- ---------- ---------- ----------Total fixed maturities $2,948,950 $2,928,717 $2,669,437 $2,685,960---------------- ---------- ---------- ---------- ---------- $289,091 (2006: $177,943) of the total mortgage-backed securities at 31 December2007 are represented by investments in Government National Mortgage Association,Federal National Mortgage Association, Federal Home Loan Bank and Federal HomeLoan Mortgage Corporation bonds. The composition of the amortised cost of fixed maturities by ratings assigned byratings agencies is as follows: ----------------- ----------------- 2007 2006 ----------------- ----------------- Amortised Amortised cost % cost %---------------- ---------- ---------- ---------- ----------US government and agencies $704,623 24% $744,753 28%Non-US governments 426,520 14% 342,150 13%AAA 1,302,147 45% 1,156,200 43%AA 182,793 6% 165,875 6%A 282,386 10% 263,875 10%BBB 27,438 1% 12,513 -%Other 2,810 -% 594 -%---------------- ---------- ---------- ---------- ----------Total fixed maturities $2,928,717 100% $2,685,960 100%---------------- ---------- ---------- ---------- ---------- The gross unrealised gains and losses related to fixed maturities at 31 December2007 and 2006 are as follows: ----------------- ----------------- 2007 2006 ----------------- ----------------- Gross Gross Gross Gross unrealised unrealised unrealised unrealised gains losses gains losses---------------- ---------- ---------- ---------- ----------US government andagencies $17,409 $80 $540 $11,432Non-US governments 3,243 5,665 261 3,886Corporate securities 5,226 2,796 486 1,752Asset-backed securities 1,381 2,311 240 495Mortgage-backedsecurities 5,754 1,928 756 1,241---------------- ---------- ---------- ---------- ----------Total fixed maturities $33,013 $12,780 $2,283 $18,806---------------- ---------- ---------- ---------- ---------- In 2007, net realised losses in investments included a loss of $76,787 relatingto certain fixed maturities where the Group determined that there was an otherthan temporary decline in the value of those investments. There were no otherthan temporary declines in the value of investments in the year to 31 December2006. The net realised losses on fixed maturities for the year ended 31 December2007 were $78,604 (2006: $17,236). The following is an analysis of how long each of the fixed maturities that werein an unrealised loss position as at 31 December 2007 had been in a continualloss position. ----------------- ---------------------------------- Less than 12 months Equal to or greater than 12 months ----------------- ---------------------------------- Gross Gross Fair unrealised Fair unrealised value losses value losses------------- ---------- ---------- ---------- ----------US governmentand agencies $39,426 $80 $- $-Non-USgovernments 42,075 4,809 82,200 856Corporatesecurities 140,021 2,316 29,387 480Asset-backedsecurities 171,210 2,233 2,724 78Mortgage-backedsecurities 206,134 1,421 35,069 507-------------- ---------- ---------- ---------- ----------Total fixedmaturities $598,866 $10,859 $149,380 $1,921-------------- ---------- ---------- ---------- ---------- Over 80 per cent of the unrealised losses at 31 December 2007 is related to 40securities. The securities in an unrealised loss position as at 31 December 2007have 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 2007 were$2,733,266 (2006: $2,122,297). Proceeds from the sales and maturities ofshort-term investments during 2007 were $191,106 (2006: $102,219). Gross gainsof $13,558 (2006: $1,705) and gross losses of $92,528 (2006: $18,896) wererealised on fixed maturities and short-term investments in 2007. Fixed maturities at 31 December 2007, 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 $51,344 $51,265Due after one through five years 1,350,723 1,340,211Due after five years through ten years 262,969 256,522Due after ten years 10,920 10,621-------------------------------- ---------- ---------- 1,675,956 1,658,619Asset-backed securities 428,508 429,438Mortgage-backed securities 844,486 840,660-------------------------------- ---------- ----------Total $2,948,950 $2,928,717-------------------------------- ---------- ---------- The Group did not have an aggregate investment with a single counterparty, otherthan the US government, in excess of 10 per cent of total investments at 31December 2007 and 2006. Investments in funds Investment in funds comprises investments in a fixed maturities fund, an equityfund, direct hedge funds, funds of hedge funds and cash on deposit with fundmanagers. As at 31 December 2007 investment in funds included cash on depositwith 13 direct hedge fund managers of $275 million which were made to allowunits in the funds to be issued to the Group in January 2008. The Group hasclassified its investment in funds as trading securities and, accordingly thechange in fair value of the individual funds will be recorded in net income asnet investment income. The amount of net investment income for the year ended 31December 2007 that relates to investment in funds still held at year end was$29,824 (2006: $2,960). Net investment income The components of net investment income for the years ended 31 December 2007 and2006 are as follows: 2007 2006-------------------------------- ---------- ----------Interest income $259,164 $102,438Amortisation of premium/(discount) 3,450 6,185Equity in income of associate 983 1,275Change in fair value of investment in funds 29,824 2,960-------------------------------- ---------- ----------Gross investment income 293,421 112,858Investment expenses (3,308) (6,869)-------------------------------- ---------- ----------Net investment income $290,113 $105,989-------------------------------- ---------- ---------- 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 set up for the benefit of the ceding companies, generally in placeof LOC requirements. The total value of these restricted assets by category at 31 December 2007 and2006 are as follows: 2007 2006-------------------------------- ---------- ----------Fixed maturities $1,422,521 $1,666,967Short term investments 22,881 10,951Cash and cash equivalents 558,868 751,908-------------------------------- ---------- ----------Total restricted assets $2,004,270 $2,429,826-------------------------------- ---------- ---------- Securities lending The Group participates in securities lending programmes 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 $43,917 (2006: $124,486) of securities on loan at 31 December 2007. 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 2007 of $1,064 (2006: $1,452). Theshare of SRO's profit included within the Consolidated Statement of Operationsduring 2007 was $983 (2006: $1,275). In management's opinion, the fair value ofSRO 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 2007 and 2006. The reconciliation of unpaid losses and loss expenses for the years ended 31December 2007 and 2006 is as follows: 2007 2006-------------------------------- ---------- ----------Gross unpaid losses and loss expenses, beginning ofyear $4,005,133 $1,995,485Reinsurance recoverable on unpaid loss and lossexpenses (996,896) (575,522)-------------------------------- ---------- ----------Net unpaid losses and loss expenses, beginning ofyear 3,008,237 1,419,963-------------------------------- ---------- ----------Net incurred losses and loss expenses for claimsrelated to:Current year 1,293,914 679,115Prior years (139,244) 2,434-------------------------------- ---------- ----------Total net incurred losses and loss expenses 1,154,670 681,549-------------------------------- ---------- ----------Net paid losses and loss expenses for claims relatedto:Current year (105,218) (64,247)Prior year (832,278) (528,661)-------------------------------- ---------- ----------Total net paid losses and loss expenses (937,496) (592,908)-------------------------------- ---------- ----------Foreign exchange and other 50,930 86,607Loss portfolio transfer 101,003 -Business combinations (1) - 1,413,026-------------------------------- ---------- ----------Net unpaid losses and loss expenses, end of year 3,377,344 3,008,237Reinsurance recoverable on unpaid loss and lossexpenses 860,181 996,896-------------------------------- ---------- ----------Gross unpaid losses and loss expenses, end of year $4,237,525 $4,005,133-------------------------------- ---------- ---------- (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, the2007 reserves for losses and loss expenses net of reinsurance recoveriesdecreased by $139,244 (2006: increase of $2,434). In 2007 the decrease inreserves relating to prior years is due to reductions in expected ultimate losscosts and reductions in uncertainty surrounding the quantification of the netcost of claim events. In 2006 the increase was due to a deterioration of $52,454in respect of the 2005 hurricanes and $29,400 in respect of a South Africanmotor loss, offset by positive development in respect of recent underwritingyears over a number of business classes. The Group's ultimate gross loss arising from Hurricanes Katrina, Rita and Wilmain 2005 is estimated to be $1,734,281 (2006: $1,661,898) and its ultimate netloss after reinsurance recoveries of $975,190 (2006: $942,997) and netreinstatement premiums of $61,514 (2006: $58,540) is estimated to be $820,605(2006: $777,441). These amounts represent management's best estimate of thelikely final losses to the Group from the three hurricanes. In making thisestimate, management has used the best information available, includingestimates performed by the Group's underwriters, actuarial and claims staff,retained external actuaries, outside agencies and market studies. Allowance ismade in the overall management best estimate of net unpaid losses for anappropriate level of sensitivity, for both individual large losses and theoverall 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. Loss portfolio transfer In 2007 Syndicate 2020 closed the 2004 Lloyd's underwriting year of account byway of a Lloyd's reinsurance to close. In closing the 2004 year of account, alloutstanding losses were transferred into the 2005 year of account. The Group hadan additional ownership of approximately 10 per cent acquired from the externalNames in respect of the 2005 year of account, which resulted in an increase inloss reserves of $101,003; this has been treated as a loss portfolio transfer.To the extent that the future run-off of the 2004 year of account differs fromwhat has been recorded, that development will be recorded in the ConsolidatedStatement of Operations in the period that it is incurred. 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: ----------------- ----------------- 2007 2006 ----------------- ----------------- Premiums Premiums Premiums Premiums written earned written earned-------------- ---------- ---------- ---------- ----------Direct $2,505,216 $2,355,056 $1,154,851 $1,070,621Assumed 855,410 804,110 450,168 434,417Ceded (787,108) (669,632) (194,896) (179,177)---------------- ---------- ---------- ---------- ----------Net premiums $2,573,518 $2,489,534 $1,410,123 $1,325,861---------------- ---------- ---------- ---------- ---------- The Group's provision for reinsurance recoverable as at 31 December 2007 and2006 is as follows: 2007 2006-------------------------------- ---------- ----------Gross reinsurance recoverable $1,153,307 $1,284,322Provision for uncollectible balances (33,460) (46,791)-------------------------------- ---------- ----------Net reinsurance recoverable $1,119,847 $1,237,531-------------------------------- ---------- ---------- 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 December2007, there were four reinsurers which accounted for 5 per cent or more of thetotal reinsurance recoverable. % of reinsurance A.M. Best recoverable rating------------------------------- ----------- ---------Hannover Ruck AG 11% AMunich Re 11% A+GE Frankona ReinsuranceLimited 7% ANational Indemnity Company 6% A++-------------------------------- ----------- --------- 9. Derivative financial instruments Catastrophe swap agreements Newton Re On 17 December 2007, Catlin Bermuda entered into a catastrophe swap agreement('cat swap') that provides up to $225,000 in coverage in the event of one ormore natural catastrophes. Catlin Bermuda's counterparty in the cat swap is aspecial purpose vehicle, Newton Re Limited ('Newton Re'). Newton Re has issuedto investors $225,000 in three-year floating rate notes, divided into Class Aand Class B notes. The proceeds of those notes provide the collateral for NewtonRe's potential obligations to Catlin Bermuda under the cat swap. The Newton Re cat swap responds to certain covered risk events occurring duringa three year period. The categories of risk events covered by the transactionare US hurricanes (Florida, Gulf States, East Coast and Hawaii) and USearthquakes. Newton Re will pay a maximum of $137,500 for US hurricane eventsand $87,500 for US earthquake events. The Newton Re cat swap will be triggered for risk events if aggregate insuranceindustry losses, as estimated by Property Claims Services, meet or exceeddefined threshold amounts. Bay Haven On 17 November 2006, Catlin Bermuda entered into a cat swap that provides up to$200,250 in coverage in the event of a series of natural catastrophes. CatlinBermuda's counterparty in the cat swap is a special purpose vehicle, Bay HavenLimited ('Bay Haven'). Bay Haven has issued to investors $200,250 in three-yearfloating rate notes, divided into Class A and Class B notes. The proceeds ofthose notes provide the collateral for Bay Haven's potential obligations toCatlin Bermuda under the cat swap. The Bay Haven cat swap responds to certain covered risk events occurring duringa three-year period. No payment will be made for the first three such riskevents. Bay Haven will pay Catlin Bermuda $33,375 per covered risk eventthereafter, up to a maximum of six events. The aggregate limit potentiallypayable to Catlin Bermuda is $200,250. The categories of risk events covered by the Bay Haven transaction are: UShurricanes (Florida, Gulf States and East Coast), California earthquakes, USMidwest earthquakes, 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 Bay Haven cat swap will be triggered for US risk events if aggregateinsurance industry losses, as estimated by Property Claims Services, meet orexceed defined threshold amounts. Coverage for non-US risk events will betriggered if specific parametric criteria, such as wind speeds or groundmotions, are met or exceeded. The first two events paid under the catastropheswap would impact the Class B notes; subsequent events, up to the limit of sixevents over the three year period, would impact the Class A notes. In addition, on 17 November 2006 Catlin Bermuda entered into a further cat swapagreement with ABN AMRO Bank N.V. London Branch which will respond to the thirdcovered risk event (that is, the covered risk event before the Class B notes aretriggered). The terms are otherwise as described for the Class A and Class Bnotes, except that the limit payable is $56,500 (2006: $46,500). Accounting treatment The Newton Re and Bay Haven cat swaps fall within the scope of FAS 133 and aretherefore measured in the balance sheet at fair value with any changes in thefair value included in earnings. As at 31 December 2007, the fair value of thecat swaps is a liability of $9,099 (2006: $619). As there is no quoted marketvalue available for these derivatives, the fair values are determined bymanagement based on the valuation of the notes issued by Newton Re and BayHaven, which are publicly quoted. The fair value of the Newton Re cat swap isderived from indicative prices for the Class A and Class B notes issued byNewton Re. The fair value of the Bay Haven cat swap is determined using aninternal model that takes into account changes in the market for catastrophereinsurance contracts with similar economic characteristics and the potentialfor recoveries from events preceding the valuation 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. As at 31 December 2007, the fair value of the foreign currencyderivatives was an asset of $9,035 (2006:$24,847), of which $6,139 (2006:$18,324) had a remaining term of less than 12 months. All of the options topurchase shares in Aspen were exercised during 2007. The exercise of the Aspenoptions resulted in a loss of $6,354, recorded in net realised losses onderivatives. The fair value of the Aspen options at 31 December 2006 was$21,190. 10. Notes payable, debt and financing arrangements The Group's outstanding debt as at 31 December 2007 and 2006 consisted of thefollowing: 2007 2006--------------------------------- --------- ---------Notes payableRevolving bank facility $- $50,000--------------------------------- --------- ---------Total notes payable - 50,000--------------------------------- --------- ---------Subordinated debtVariable rate, face amount €7,000, due 15 March 2035 10,873 10,032Variable rate, face amount $27,000, due 15 March 2036 28,831 29,274Variable rate, face amount $31,300, due 15 September2036 33,480 34,103Variable rate, face amount $9,800, due 15 September 2036 10,482 10,677Variable rate, face amount €11,000, due 15 September2036 17,159 15,850--------------------------------- --------- ---------Total subordinated debt 100,825 99,936--------------------------------- --------- ---------Bridge financing - 500,290--------------------------------- --------- ---------Total debt $100,825 $650,226--------------------------------- --------- --------- Subordinated debt On 12 May 2006 Wellington Underwriting plc (which has been subsequently renamed'Catlin Underwriting') 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 Underwriting plc issued $31,300, $9,800 and €11,000of variable rate unsecured subordinated notes. The notes are subordinated to theclaims of all Senior Creditors, as defined in the agreement. The notes payinterest based on the rate on three-month deposits in US dollars plus a marginof 310 basis points for the $31,300 notes and 300 basis points for the other twonotes. Interest is payable quarterly in arrears. The notes are each redeemableat the discretion of the issuer on 15 September 2011. Bridge financing On 30 October 2006 Catlin entered into a bridge financing arrangement underwhich it could borrow up to $500,000. On 27 and 28 December 2006 Catlin borrowed$325,000 and $175,000, respectively, under this bridge facility to partiallyfinance the Wellington acquisition. The interest rate on this bridge loan wasbased on three-month Libor plus 45 basis points. The weighted average interestrate on the bridge loan at 31 December 2006 was 5.8 per cent. As at 31 December2006 the Group had a balance of $500,290 outstanding on this facility. Thebridge financing was repaid in full with the proceeds of the non-cumulativeperpetual preferred shares in January 2007. Bank facilities Since November 2003, the Group has participated in a Letter of Credit/RevolvingLoan Facility (the 'Club Facility'). The Club Facility has been varied, amendedand restated since it was originally entered into, most recently on 15 December2006 when the credit available under the Club Facility increased from $250,000and £150,000 to $400,000 and £275,000, respectively. The facility initiallyincluded three banks, on 15 December 2006 it increased to four banks and on 25January 2007 it expanded to seven banks. Each bank participates equally in theClub Facility. The Club Facility is composed of three tranches as detailedbelow. The following amounts were outstanding under the Club Facility as at 31December 2007: • A 364-day $50,000 revolving facility with a one-year term-out option ('Facility A') is available for utilisation by the Group. Facility A, while not directly collateralised, is secured by floating charges on Group assets and cross-guarantees from material subsidiaries (together with Facilities B and C). Facility A was fully drawn at 31 December 2006 and was repaid including interest on 22 January 2007. • Clean, irrevocable standby LOCs of $497,500 (£250,000) are provided to support the Catlin Syndicate's underwriting at Lloyd's ('Facility B'). As at 31 December 2007, the Catlin Corporate names and Syndicate have utilised Facility B and deposited with Lloyd's 13 LOCs which total the amount of $497,500 (£250,000). In the event that the Catlin Syndicate fails to meet its obligations under policies of insurance written on its behalf, Lloyd's could draw down this letter of credit. These LOCs have an initial expiry date of 20 November 2011. Collateral of $79,600 (£40,000) was provided in 2007. • A two-year $350,000 standby LOC facility is available for utilisation by Catlin Bermuda and Catlin UK ('Facility C'). It is split into two equal tranches of $175,000 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 2007, $163,376 in LOCs were outstanding, of which $160,043 were issued for the benefit of insureds and reinsureds of Catlin Bermuda, and $3,333 (£1,675) issued for the benefit of an insured of Catlin UK. $80,132 of the LOCs were issued on an unsecured basis. 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 Group was in compliance with allcovenants during 2007. A second Letter of Credit Facility administered by Citibank on behalf of Lloyd'sacting for the Lloyd's Syndicates had letters of credit totalling $9,848outstanding at December 31, 2007. These letters of credit are fully secured. 11. Intangible assets and goodwill The Group's intangibles relate to the purchase of syndicate capacity, customerrelationships, distribution channels and US insurance licenses (as admitted andeligible surplus lines insurers). Net intangible assets and goodwill as at 31 December 2007 and 2006 consist ofthe following: Indefinite Finite life life Goodwill intangibles intangibles Total-------------------- --------- --------- --------- ---------Net value at 1January 2006 $14,913 $48,677 $49 $63,639-------------------- --------- --------- --------- ---------Movements during 2006:Businesscombination 68,970 461,580 10,976 541,526Additions 704 253,446 325 254,475Foreignexchangerevaluation 1,648 6,792 21 8,461Amortisationcharge - - (75) (75)-------------------- --------- --------- --------- ---------Totalmovementsduring 2006 71,322 721,818 11,247 804,387-------------------- --------- --------- --------- ---------Net value at31 December2006 86,235 770,495 11,296 868,026-------------------- --------- --------- --------- ---------Movements during 2007:Amendments topurchase priceallocation 5,542 - - 5,542Foreignexchangerevaluation 1,274 11,721 80 13,075Amortisationcharge - - (2,215) (2,215)-------------------- --------- --------- --------- ---------Totalmovementsduring 2007 6,816 11,721 (2,135) 16,402-------------------- --------- --------- --------- ---------Net value at31 December2007 $93,051 $782,216 $9,161 $884,428-------------------- --------- --------- --------- --------- Goodwill, purchased syndicate capacity and admitted licenses are considered tohave an indefinite life and as such are subject to annual impairment testing.Neither goodwill nor intangibles were impaired in 2007 or 2006. Distribution channels and surplus lines authorisations are considered to have afinite life and are amortised over their estimated useful lives of five years.As at 31 December 2007, the gross carrying amount of finite life intangibles was$11,456 (2006: $11,376) and accumulated amortisation was $2,295 (2006: $80).Amortisation of intangible assets at current exchange rates will amount toapproximately $2,290 per annum for the next four years and nil thereafter. Purchased syndicate capacity In connection with the Wellington acquisition in December 2006, the Grouppurchased Wellington's 67 per cent share of the underwriting capacity ofSyndicate 2020. Of the purchase price of Wellington, $461,580 was allocated tothis capacity (see Note 3 for 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 writes 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 was valued at $250,071, or 50 pence per £1.00 of capacity acquired.This represents the cash paid plus an amount representing the participation in anew reinsurance syndicate, a non-monetary asset, which has been valued at 10pence per £1.00 of capacity acquired. This non-monetary amount, $30,514, hasbeen accounted for as a reinsurance creditor and is amortised over the two yearsof 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. The syndicate capacity intangible asset also includes amounts purchased byCatlin in 2002. 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 incomewritten by 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 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 2007 and 2006 is asfollows: 2007 2006--------------------------------- --------- ---------Current tax benefits - $(5,438)Deferred tax expense $59,790 22,044--------------------------------- --------- ---------Expense for income taxes $59,790 $16,606--------------------------------- --------- --------- 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 is11.0 per cent (2006: 6.0 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 2007 and 2006 is providedbelow. 2007 2006--------------------------------- ---------- ----------Expected tax expense at weighted average rate $98,206 $1,889Permanent differences:Disallowed expenses 1,938 474Prior year adjustments including changes in uncertain taxpositions (23,385) (1,297)Impact of tax rate changes in the UK (16,969) -Specific contingency provision - 15,540--------------------------------- ---------- ----------Expense for income taxes $59,790 $16,606--------------------------------- ---------- ---------- The components of the Group's net deferred tax liability as at 31 December 2007and 2006 are as follows: 2007 2006--------------------------------- ---------- ----------Deferred tax assets:Net operating loss carryforwards $47,694 $73,346Future UK double tax relief - 7,953Stock options 7,839 -Deep discount security unwind 1,146 770Accelerated capital allowances 1,989 1,137Compensation accruals 12,329 5,080Syndicate capacity amortisation and other 3,093 156--------------------------------- ---------- ----------Total deferred tax assets $74,090 $88,442--------------------------------- ---------- ----------Deferred tax liabilities:Intra-Group financing charges - (8,932)Untaxed profits (179,784) (104,030)Intangible assets arising on business combination (119,148) (127,017)--------------------------------- ---------- ----------Total deferred tax liabilities (298,932) (239,979)--------------------------------- ---------- ----------Net deferred tax liability $(224,842) $(151,537)--------------------------------- ---------- ---------- As at 31 December 2007, there are potential deferred tax assets of $9,217 in theUS companies relating to 2007 calendar year losses but a 100 per cent valuationallowance has been recognised in respect of the losses. A deferred tax asset of$2,184 relating to US losses was recognised as at 31 December 2006. As at 31 December 2007, a net deferred tax liability of $224,842 is recognisedin the balance sheet. As at 31 December 2006, a deferred tax asset of $2,184relating to US losses was included in other assets in the balance sheet and$153,721 relating to non-US jurisdictions was reported as a deferred taxliability. As at 31 December 2007, the Group has net operating loss carry forwards ofapproximately $170,336 (2006: $243,401) which are available to offset futuretaxable income. The net operating loss carry forwards primarily arise in the UKsubsidiaries where they are expected to be fully used. There are no timerestrictions on the use of these losses. Uncertain tax positions With effect from 1 January 2007, the Group adopted FASB Interpretation No. 48,'Accounting for Uncertainty in Income Taxes - an Interpretation of FASBStatement No. 109'. On adoption of FIN 48, the total amount of the Group'sunrecognised tax benefits arising from uncertain tax positions was $11,201. Asat 31 December 2007, this amount was $9,300. All unrecognised tax benefits wouldaffect the effective tax rate if recognised. A reconciliation of the beginning and ending amount of unrecognised tax benefitsarising from uncertain tax positions is as follows: 2007-------------------------------- ----------Unrecognised tax benefits balance at 1 January 2007:Gross increases for tax positions in current year $11,201Gross increases for tax positions of prior years 7,031Gross decreases for tax positions of prior years (8,932)-------------------------------- ----------Unrecognised tax benefits balance at 31 December 2007 $9,300-------------------------------- ---------- The Group does not believe it would be subject to any penalties in any open taxyears and has not accrued any such amounts. The Group accrues interest andpenalties (if applicable) as income tax expenses in the consolidated financialstatements. The Group did not pay or accrue any interest and penalties in 2007relating to uncertain tax positions. The following table lists the open tax years that are still subject toexamination by local tax authorities in major tax jurisdictions: Major tax jurisdiction Years-------------------------------- -----------------United Kingdom 2006-2007United States 2004-2007-------------------------------- ----------------- 13. Stockholders' equity The following is a detail of the number and par value of common sharesauthorised, issued and outstanding as at 31 December 2007 and 2006: ----------------- ----------------- Issued and Authorised outstanding ----------------- ----------------- Number Number of Par value of Par value shares $000 shares $000---------------- ---------- ---------- ---------- ---------- Ordinary common shares,par value $0.01 per share---------------- ---------- ---------- ---------- ----------As at 31December 2007 400,000,000 $4,000 253,122,072 $2,531---------------- ---------- ---------- ---------- ----------As at 31December 2006 400,000,000 $4,000 238,283,281 $2,383---------------- ---------- ---------- ---------- ----------Preferred shares, parvalue $0.01 per share ---------------- ---------- ---------- ---------- ----------As at 31December 2007 600,000 $6 600,000 $6---------------- ---------- ---------- ---------- ---------- The following table outlines the changes in common shares issued and outstandingduring 2007 and 2006: 2007 2006--------------------------------- --------- ---------Balance, 1 January 238,283,281 155,914,616Exercise of stock options and warrants 3,159,154 249,108Equity raise - 7,704,900Business combination 11,679,637 74,414,657--------------------------------- --------- ---------Balance, 31 December 253,122,072 238,283,281--------------------------------- --------- --------- 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 at 31 December 2006 acceptances totalling 88 per cent of Wellington's sharecapital subject to the Group's offer to acquire Wellington ('the Offer') hadbeen settled, resulting in an issuance of 74,414,657 common shares. Theremaining Wellington shares subject to the Offer were settled in 2007, resultingin a further issuance of 11,679,637 shares. Preferred shares On 18 January 2007, Catlin Bermuda issued 600,000 of non-cumulative perpetualpreferred shares, par value of $0.01 per share, with liquidation preference of$1,000 per share, plus declared and unpaid dividends. Dividends are payablesemi-annually in arrears only if, as and when declared by the Board ofDirectors, on 19 January and 19 July, commencing on 19 July 2007, at a rate of7.249 per cent on the liquidation preference, up to but not including 19 January2017. Thereafter, if the shares have not yet been redeemed, dividends will bepayable quarterly at a rate equal to 2.975 per cent plus the 3-month LIBOR Rateof the liquidation preference. Catlin Bermuda received proceeds of approximately$589,785, net of issuance costs, which were used to repay the $500,000 bridgefacility as well as Facility A described in Note 10, and for general corporatepurposes. The preference shares do not have a maturity date and are notconvertible into or exchangeable into any of Catlin Bermuda's or the Group'sother securities. 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 Employee BenefitTrust ('EBT'). The EBT uses these funds to purchase Group shares on the openmarket. These shares will ultimately be distributed to PSP holders to the extentthat the PSP awards vest. During 2007, the Group, through the EBT, purchased484,331 of the Group's shares, at an average price of $9.28 (£4.64) per share.The total amount paid of $4,497 is shown as a deduction to stockholders' equity. In conjunction with the Wellington acquisition, the Group agreed to compensatelegacy Wellington employees that held units in the Wellington EBT. There were nocosts associated with the distribution of the Group shares. 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. During 2007,warrants to purchase 5,963,369 common shares were exercised and settled net for2,988,758 common shares, leaving warrants entitling the purchase of 8,980,682common shares outstanding. No warrants were exercised during 2006. Dividends Dividends on common shares On 8 June 2007, the Group paid a final dividend on the common shares relating tothe 2006 financial year of $0.328 (£0.170) per share to stockholders of recordat the close of business on 11 May 2007. The total dividend paid for the 2006financial year was $0.441 (£0.230) per share. On 9 November 2007, the Group paid an interim dividend relating to the 2007financial year of $0.164 per share (£0.081 per share) to stockholders of recordas at 12 October 2007. Dividends on preferred shares On 17 July 2007, the Board of Catlin Bermuda approved a dividend of $21,868 tothe holders of the non-cumulative perpetual preference shares. This dividend waspaid on 19 July 2007. 14. Employee stock compensation schemes The Group has two stock compensation schemes in place under which awards areoutstanding: a Performance Share Plan, adopted in 2004, and a Long TermIncentive Plan, adopted in 2002. These financial statements include the totalcost 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 2007 was $13,668 (2006:$11,000). Remaining stock compensation to be expensed in future periods relatingto these plans is $27,510. Performance Share Plan ('PSP') On 9 March 2007, a total of 2,721,517 options with $nil exercise price and518,999 non-vested shares (total of 3,240,516 securities) were granted to Groupemployees under the PSP. On 10 October 2007, a further 252,737 options with $nilexercise price and 120,852 non-vested shares (total of 373,589 securities) weregranted, resulting in a total of 3,614,105 securities granted to Group employeesunder the PSP in 2007. Up to half of the securities will vest on 9 March 2010and up to half will vest on 9 March 2011, subject to certain performanceconditions. These securities have been treated as non-vested shares and as such have beenmeasured at their fair value on the grant date as if they were fully vested andissued and assuming an annual attrition rate amongst participating employees of12 per cent for grants made in 2007, 6 per cent for grants made in 2006 and 3per cent for grants made in 2005. This initial valuation is revised at eachbalance sheet date to take account of actual achievement of the performancecondition that governs the level of vesting and any changes that may be requiredon the attrition assumption. The difference is charged or credited to the incomestatement, with a corresponding adjustment to equity. The total number of PSPsecurities outstanding at 31 December 2007 was 7,732,772 (2006: 4,426,886) andthe total compensation expense relating to the PSP for the year ended 31December 2007 was $13,313 (2006: $9,669). None of the PSP securities have vested. The table below shows the unvested PSPsecurities as at 31 December: 2007 2006--------------------------------- --------- ---------Outstanding, beginning of year 4,426,886 2,203,786Granted during year 3,614,105 2,295,597Forfeited during year (308,219) (72,497)--------------------------------- --------- ---------Outstanding, end of year 7,732,772 4,426,886--------------------------------- --------- ---------Fair value per PSP security as at date of grant -March $9.70 $8.71--------------------------------- --------- ---------Fair value per PSP security as at date of grant -October $9.46 N/A--------------------------------- --------- --------- 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$3,879 in 2007, 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 16,791,592 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 2007 was $359 (2006: $1,331). The options are fully vested as at 31 December 2007 and all options will expireby 4 July 2012. Options with exercise prices of $10.00, $12.50 and $15.00expired on 31 December 2007. The table below shows the vesting dates and thenumber of options that have vested on those dates: Date --------------------------------------- Number of options vesting -----------4 July 2003 1,576,1106 April 2004 (IPO date) 4,815,4844 July 2004 1,668,2614 July 2005 1,655,1584 July 2006 1,647,5644 July 2007 5,429,015--------------------------------------- -----------Total 16,791,592--------------------------------------- ----------- The table below shows the status of the interests in shares as at 31 December:---------------- --------- ---------- --------- ---------- 2007 2006---------------- --------- ---------- --------- ---------- Weighted average Weighted average Number exercise price($) Number exercise price($)---------------- --------- ---------- --------- ---------- Outstanding, beginning of period 15,270,679 9.76 15,979,915 9.68Exercised during year (501,044) 5.92 (544,500) 4.97Forfeited during year (130,168) 12.32 (164,736) 11.94Expired during year (9,495,358) 12.53 - ----------------- --------- ---------- --------- ----------Outstanding, end of period 5,144,109 4.94 15,270,679 9.76---------------- --------- ---------- --------- ----------Exercisable, end of period 5,144,109 4.94 10,084,791 8.45---------------- --------- ---------- --------- ---------- Exercise price Average--------------------------------- Number of remaining options contractual outstanding life (years) --------- ---------$5.00 4,945,552 4.5£3.50 198,557 4.5--------------------------------- --------- ---------Total 5,144,109 4.5--------------------------------- --------- --------- As at year end, there was no amount receivable from stockholders on the exerciseof interests in shares. The fair value of the options granted during 2004 was calculated using theBlack-Scholes valuation model and is amortised over the expected vesting periodof the options, being four years for the £3.50 tranche, 1.875 years for theperformance based tranche that vested on admission and 3.625 for the performancebased tranche that vested on 4 July 2007. The valuation has assumed an averagevolatility of 40 per cent, no expected dividends and a risk free rate using USdollar swap rates appropriate for the expected life assumptions: 2.8 per centfor four years; 1.79 per cent for 1.875 years; and 2.64 per cent for 3.625years. The fair value of the options granted prior to 2004 was calculated using theBlack-Scholes valuation model and is being amortised over the expected vestingperiod of the options, being 4.5 years from the date of the subscriptionagreement. The valuation has assumed a risk free rate of return at the averageof the four- and five-year US dollar swap rates of 3.39 per cent and no expectedvolatility (as the minimum value method was utilised because the Company was notlisted on the date the options were issued). 15. Earnings per share Basic earnings per share is calculated by dividing the earnings attributable tocommon stockholders by the weighted average number of common shares in issueduring the year. Diluted earnings per share is calculated by dividing the earnings attributableto all stockholders 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 Income available to common stockholders is arrived after deducting preferredshare dividends of $21,868 (2006: $nil). Reconciliations of the number of shares used in the calculations are set outbelow. 2007 2006--------------------------------- --------- ---------Weighted average number of shares 250,311,588 162,598,043Dilution effect of warrants 4,258,094 6,492,633Dilution effect of stock options and non-vestedshares 10,130,761 6,771,102Dilution effect of stock options and warrantsexercised in the year 927,684 213,223--------------------------------- --------- ---------Weighted average number of shares on a dilutedbasis 265,628,127 176,075,001--------------------------------- --------- --------- Earnings per common shareBasic $1.84 $1.59Diluted $1.74 $1.47--------------------------------- --------- --------- All options to purchase shares under the LTIP were included in the computationof diluted earnings per share. In 2006, 9,751,307 options to purchase shareswere outstanding during the year but were not included in the computation ofdiluted earnings per share because the options' exercise price was greater thanthe average market price of the common shares. All securities awarded under thePSP were included in the computation of diluted earnings per share because theperformance conditions necessary for these securities to vest were met as at 31December 2007 and 2006. 16. Other comprehensive income/(loss) The following table details the tax effect of the individual components of othercomprehensive income/(loss) for 2007 and 2006: Amount before Tax benefit Amount 2007 tax (expense) after tax-------------------------- --------- --------- ---------Unrealised losses arising during the year $(42,547) $6,450 $(36,097)Reclassification for losses realised in income 78,970 (13,259) 65,711-------------------------- --------- --------- ---------Net unrealised losses on investments 36,423 (6,809) 29,614Defined benefit pension plan (818) 264 (554)Cumulative translation adjustments 42,097 (6,247) 35,850-------------------------- --------- --------- ---------Change in accumulated other comprehensive income $77,702 $(12,792) $64,910-------------------------- --------- --------- --------- Amount before Tax benefit Amount 2006 tax (expense) after tax-------------------------- --------- --------- ---------Unrealised losses arising during the year $18,684 $(5,750) $12,934Less reclassification for losses realised in income (17,041) 3,564 (13,477)-------------------------- --------- --------- ---------Net unrealised losses on investments 1,643 (2,186) (543)Cumulative translation adjustments (9,055) 4,907 (4,148)-------------------------- --------- --------- ---------Change in accumulated other comprehensive loss $(7,412) $2,721 $(4,691)-------------------------- --------- --------- --------- The following table details the components of accumulated other comprehensiveincome/(loss) as at 31 December: 2007 2006--------------------------------- --------- ---------Net unrealised gains/(losses) on investments $14,424 $(15,190)Cumulative translation adjustments 24,950 (10,900)Funded status of defined benefit pension plan adjustment (554) ---------------------------------- --------- ---------Accumulated other comprehensive income/(loss) $38,820 $(26,090)--------------------------------- --------- --------- 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 $8,035 for the year ended 31 December 2007(2006: $4,184). 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 $733 for the year ended 31 December 2007(2006: $683). In the US Catlin Inc. has adopted a 401(k).Profit Sharing Plan ('the Plan')qualified under the Internal Revenue Code in which all employees meetingspecified minimum age and service requirements are eligible to participate. ThePlan allows eligible participants to contribute a portion of their salary to thePlan on a tax-deferred basis. Catlin Inc. will match the employee contributionsup to 100 per cent of the first 6 per cent of salary contributed. An additionaldiscretionary contribution may be made to the plan as determined by the Board ofDirectors of Catlin Inc. on an annual basis and is allocated on a pro rate basisto individual employees based on eligible compensation. In 2005 Catlin Inc.established a Non-Qualified Deferred Compensation Plan ('Non-Qualified Plan')under which higher-paid employees are eligible for supplemental retirementbenefits in excess of statutory limitations on Plan contributions and benefits.The expense related to the Non-Qualified Plan in for the year ended 31 December2007 was $575 (2006: $183). The pension cost for the Plan for the year ended 31December 2007 was $2,875 (2006: $384). In connection with the acquisition of Wellington in December 2006, the Groupassumed liabilities associated with a defined benefit pension scheme whichWellington sponsored. The scheme has been closed to new members since 1993. Thecurrent membership consists only of pensioners and deferred members. Themovements in the period are shown in the table below. 2007 2006--------------------------------- --------- ---------Change in projected benefit obligation:Projected benefit obligation, beginning of year $32,720 -Interest cost 1,654 -Actuarial gain (1,074) -Benefits paid (1,948) -Foreign exchange 508 -Business combination - 32,720--------------------------------- --------- ---------Projected benefit obligation, end of year 31,860 $32,720--------------------------------- --------- ---------Change in plan assets:Fair value of plan assets, beginning of year 34,429 -Expected return on plan assets 1,742 -Actuarial loss (1,970) -Benefits paid (1,938) -Foreign exchange 518 -Business combination - 34,429--------------------------------- --------- ---------Fair value of plan assets, end of year 32,781 $34,429--------------------------------- --------- ---------Reconciliation of funded status:Funded status 921 $1,709--------------------------------- --------- ---------Net pension asset recognised at year end 921 $1,709--------------------------------- --------- --------- The amounts recognised in net income were as follows: 2007 2006--------------------------------- --------- ---------Interest cost 1,654 -Expected return on plan assets (1,742) ---------------------------------- --------- ---------Net credit recognised in net income (88) ---------------------------------- --------- --------- The actuarial assumptions used to value the benefit obligation at 31 Decemberwere as follows: 2007 2006--------------------------------- --------- ---------Discount rate 5.8% 5.1%Price inflation 5.8% 5.1%Pension increases to pensions in payment 3.0% 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 2007, approximately 100 per cent of plan assets were held indebt securities, with the remaining insignificant amount held as cash. No planassets are expected to be returned to the Group during 2008. 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:----------------------------------------- ---------2008 $2,0402009 $2,4882010 $2,2892011 $2,6372012 $2,5872013 to 2017 inclusive $14,975----------------------------------------- --------- No contributions are expected to be paid to the defined benefit plan in 2008. 18. Statutory financial data The Group's subsidiaries' statutory capital and surplus was $3,283,887 at 31December 2007 (2006: $1,459,950). The unaudited statutory surplus of each of itsprincipal operating subsidiaries is 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. 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 2007 are asfollows:----------------------------------------- ---------2008 $14,3682009 12,2282010 11,6482011 9,0612012 and thereafter 40,443----------------------------------------- ---------Total $87,748----------------------------------------- --------- Under non-cancellable sub-lease agreements, the Group is entitled to receivefuture minimum sub-lease payments of $1,298 (2006: $869). 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. The cost of servicespurchased from Catlin Estates Limited and Burnhope Lodge during 2007 was $242(2006: $58). During 2007, the Group entered into a lease agreement with The Whitfield GroupLtd., the president of which is related to a Director of Catlin Bermuda. Totalrent incurred during 2007 amounted to $141 (2006: $nil). All transactions with related parties were entered into on normal commercialterms. 21. Subsequent events Proposed dividend On 5 March 2008, the Board approved a proposed final dividend of $0.338 per share (£0.17 per share), payable on 23 May 2008 to stockholders of record at the close of business on 25 April 2008. The final dividend is determined in US dollars but partially payable in sterling based on the exchange rate of £1=$1.99 on 4 March 2008. Catastrophe bond On 21 February 2008 the Group entered into a further contract with Newton ReLimited for US$150,000 of annual aggregate protection against accumulated lossesfrom US windstorm, US earthquake, European windstorm, Japanese typhoon andJapanese earthquake events in the Group's property treaty book. The transactionprovides coverage on a first-event and accumulated aggregate retrocessionprotection on a fully collateralised basis. Preferred share dividend The Board of Catlin Bermuda approved a dividend of $21,750 to the holders of thenon-cumulative perpetual preference shares. This dividend was paid on 19 January2008. This information is provided by RNS The company news service from the London Stock Exchange