15th Mar 2006 07:01
BRIT Insurance Holdings PLC15 March 2006 For immediate release15 March 20067.00 a.m. BRIT INSURANCE HOLDINGS PLC Preliminary Results for the 12 months ending 31 December 2005 Brit Insurance Holdings PLC, the UK-based international general insurer andreinsurer, today announces final results for the year ended 31 December 2005. Highlights • Gross written premium increased by 10.7% to £1,202.5m • Pre-tax profit of £62.4m (2004: £116.1m), achieved in a year of record catastrophe claims activity • Very strong investment performance of £121.8m (2004: £76.1m) • Combined ratio 105.2% (2004: 92.9%) • Recommended final dividend of 3p per share, bringing the total for year to 6p per share • Completion of strategic review of Group capital structure and gearing, culminating in successful £150m tier two subordinated bond issue bringing pro-forma gearing to 23% • Dividend policy revised - from 2006 for the foreseeable future (not less than three years), the Board will pay up to 50% of earnings over the period, subject to a minimum distribution of 5p per 25p ordinary share per annum, absent unforeseen circumstances • Appointment of Citigroup as joint brokers and advisers • Proposed share consolidation of 1 new ordinary share of 75p nominal value for every 3 existing ordinary shares of 25p nominal value Results Year ended Year ended 31 December 31 December 2005 2004 £m £mGross premiums written 1,202.5 1,086.7Net premiums written 970.9 910.4Gross premiums earned 1,173.4 1,030.3Net premiums earned 942.5 857.4Investment return 121.8 76.1 Pre-tax profit 62.4 116.1Profit after tax 47.6 84.5Basic earnings per share 4.93p 8.73p Net tangible assets 638.4 643.5Net tangible assets per share 65.1p 66.1p Combined ratio 105.2% 92.9% Dane Douetil, Chief Executive Officer, said: "2005 must be looked at in thecontext of three of the largest catastrophe events in history and with this inmind, I am very pleased that our talented underwriters, our diverse spread ofbusiness and a strong investment performance have contributed to anotherprofitable year. 2006 has started encouragingly with pricing across many areascontinuing to improve, giving us confidence for the remainder of the year. For further information, please contact Dane Douetil, Chief Executive Officer, Brit Insurance Holdings PLC 020 7984 8500David Haggie/Peter Rigby, Haggie Financial 020 7417 8989 CHAIRMAN'S STATEMENT Overview Two years ago I set two specific goals for the Company: • To return to the dividend list; • To grow the market capitalisation of the Company to £1bn without a new equity issue. I am delighted to reflect that these objectives have now been achieved, in May2004 and February 2006 respectively. I will be setting further demandingtargets for management. Market Conditions in 2005 2005 will go down in history as a year of natural catastrophes of unprecedentedfrequency and severity. Before making any comment on their effect on Brit'sfinancial statements, prospects and strategy, I consider it appropriate toreflect on the human costs of these events. I regard the Group'sTsunami-related charitable donations as an appropriate response. Only time will tell whether the current significant increase in world-widenatural catastrophes is seen to abate again towards historic normalised levelsor to escalate yet further, fuelled by global warming and increasing economicdevelopment in risk-exposed zones. Results We are delighted to have reported a pre-tax profit for the year of £62.4m and afull year dividend of six pence per share, in what was by a considerable marginthe worst ever year for global catastrophe claims. This level of profit showsthe strength, diversity, depth and quality of the Group's business. Wecontinued to grow top line premium significantly but selectively and profitably,despite an insurance cycle which was, for the greater part of the year beforethe US hurricanes, softening. Our broad spread of business and the quality ofour underwriting have served us very well. Non-catastrophe lines of businesshave performed extremely well, especially the liability classes which havebenefited from back year releases from reserves and increased investment incomefrom assets held to match longer tail business. Strategy and Risk Appetite We have built Brit significantly over recent years on a sound, prudentunderwriting, financial and operational model. We aim to deliver superiorshareholder value based on growing profits and reducing volatility. We have re-examined our risk models and reduced our risk appetites in peakzones, recognising that this will result in writing less premium in certainclasses of business and forgoing short-term pricing opportunities in highlycatastrophe-exposed areas. Capital Structure and Dividend Policy Review As indicated at the half year, we have conducted a thorough review of theGroup's capital structure and were delighted by the market's response to our£150m subordinated bond issue in December. The issue was more thantwo-and-a-half times subscribed and has provided the Group with new long-termcapital qualifying as lower tier two for regulatory purposes. This has opened anew source of quality long-term finance for the Group which is cheaper thanequity capital and has re-balanced our gearing ratio to a more appropriate levelof approximately 23% debt to net tangible assets on a proforma basis. We expectthe improved capital mix to deliver a higher return on equity over the long-termand therefore to be value-enhancing to shareholders. The new debt, beingsubordinated, also adds further security to our customer proposition and allowsus to continue our measured growth strategy without impairing our financialstrength ratings and without recourse to the equity markets. As previously indicated, Brit has also reviewed its dividend policy and ispleased to announce that for the foreseeable future (by which Brit means aminimum of the next three years) the intention of the Board is to pay up to 50%of earnings over the period subject to a minimum of 5p per 25p ordinary shareper annum. However, in the event that market conditions do not permit Brit toutilise fully its capital then it would be the Board's intention to seek toreturn such excess capital to shareholders in the most appropriate and efficientmanner. As set out in more detail in the Notice of Annual General Meeting, we are alsoproposing a share consolidation on a one new share for three existing sharesbasis, which we believe will make our shares more attractive to investors. Board, Advisers and Senior Management The year saw a number of significant changes. Ernst & Young succeeded Mazars asthe Group's auditor. Mazars' input over many years was invaluable and we haveretained them as tax advisers. We have appointed Citigroup as joint adviser andcorporate broker alongside Numis. Neil Eckert stepped down from the post of CEOand is now a Non-Executive Director. Glyn MacAulay, another of the foundingdirectors from 1995, retired from the Board. In last year's report I paidtribute to their enormous contributions over the years. Don McCrickard hasannounced his intention to stand down from the Board at the end of 2006. DaneDouetil was promoted to CEO; Cees Schrauwers and Joe MacHale joined asNon-Executive Directors, and Peter Hazell became Chairman of the AuditCommittee. Within the Group's senior executive management, Mike Sibthorpe waspromoted to the Executive Management Committee and Kathy Lisson joined fromBarclays as Group COO and member of the Executive Management Committee. Staff and Culture I am very proud of the strong culture of teamwork and excellence we have builtat Brit and of the quality and unstinting determination of staff at all levelsin the organisation, for which I thank all concerned. It also fills me withhuge confidence. Outlook Extraordinary events affect the ordinary cycle of supply, demand and pricing inthe insurance industry. The downward pressure on pricing in mid 2005 has beenreversed in some classes and arrested in others. We expect this pattern tocontinue in 2006 and Brit is well positioned to take full advantage of thisfavourable environment. Clive CoatesChairman14 March 2006 OPERATING AND FINANCIAL REVIEW KEY POINTS • Continued premium growth - gross written premium £1,202.5m, up 10.7%; • Despite an unprecedented level of catastrophe claims, profit before tax of £62.4m and earnings per share of 4.93p; • Excellent investment performance - £121.8m, up 60.2%; • Robust claims reserves - £110.8m prior year releases (2004 £47.7m); • Final dividend of 3p per share and full year dividend of 6p per share underpinned by strong fundamentals; • Net tangible assets £638.4m, or 65.1p per share, down 0.8%; • Combined ratio 105.2% (2004 92.9%), materially affected by catastrophe claims; • Completion of strategic review of Group capital structure and gearing, culminating in successful £150m lower tier two subordinated bond issue; • Dividend policy revised - from 2006 for the foreseeable future (not less than three years), the Board will distribute up to 50% of earnings over the period, subject to a minimum distribution of 5p per 25p ordinary share per year, absent unforeseen circumstances; • Proposed share consolidation on a one new share for three existing shares basis. FINANCIAL HIGHLIGHTS Gross Written Premium Year £'m 2002 662.7 2003 1015.7 2004 1086.7 2005 1202.5 Investment Return Year £'m 2002 7.6 2003 42.7 2004 76.1 2005 121.8 Pre-tax Profit Year £'m 2002 10.0 2003 77.6 2004 116.1 2005 62.4 Earnings Per Share Year Pence per share 2002 1.11 2003 6.58 2004 8.73 2005 4.93 Figures for 2002 and 2003 are stated in accordance with UK GAAP; figures for2004 and 2005 are stated in accordance with IFRS THE INSURANCE MARKET IN 2005 The first half of 2005 saw a relatively benign claims environment with a gentlysoftening insurance cycle. This situation changed fundamentally towards the endof the year and into 2006: Catastrophe Activity • The chart below shows that the level of natural catastrophe claims for 2005 was over twice that of 2004, which itself, was over 35% higher than any previous recorded year. Line Graph - Great Natural Disasters - Insured Losses Year Insured Year Insured Losses Losses US$'bn* US$'bn* 1970 1.0 1988 2.0 1971 0.0 1989 9.0 1972 0.0 1990 12.0 1973 0.0 1991 10.0 1974 2.0 1992 29.0 1975 0.0 1993 8.0 1976 2.0 1994 22.0 1977 0.0 1995 11.0 1978 0.0 1996 5.0 1979 5.0 1997 1.0 1980 0.5 1998 9.0 1981 0.0 1999 22.0 1982 0.5 2000 0.5 1983 6.0 2001 4.0 1984 0.7 2002 3.0 1985 1.0 2003 7.0 1986 0.5 2004 40.0 1987 6.0 2005 81.0 Source: Munich Re * Costs rebased to 2005 US dollars. • The following table shows that nine of the 20 largest insured events in history have occurred in the last two years, causing insurers and reinsurers to review not only 2005 experience but also to consider whether the combination of frequency and severity in both 2004 and 2005 signals some kind of change in the long-term trend of natural catastrophes, or just a short term fluctuation. Most Expensive Insured Losses (2004, 2005 in bold) Rank Year Event Region Insured Cost (US$'bn) * 1 2005 Hurricane Katrina US 50.02 1992 Hurricane Andrew US 21.53 2001 WTC US 20.04 1994 Northridge Earthquake US 17.85 2004 Hurricane Ivan US, Caribbean 11.06 2005 Hurricane Wilma US, Mexico 10.07 2005 Hurricane Rita US 8.08 2004 Hurricane Charley US 8.09 1991 Typhoon Mireille Japan 7.810 1990 Winterstorm Daria France, UK et al 6.611 1999 Winterstorm Lothar Western Europe 6.612 1989 Hurricane Hugo US, Puerto Rico 6.413 2004 Hurricane Frances US 5.014 2004 Tsunami Indian Ocean 5.015 1987 European Storms Europe 5.016 1990 Winterstorm Vivian Europe 4.617 1999 Typhoon Bart Japan 4.618 1998 Hurricane Georges US, Caribbean 4.119 2004 Hurricane Jeanne US, Dom Rep 4.020 2004 Typhoon Songda Japan 3.621 2001 Tropical Storm Allison US 3.422 2003 Thunderstorms, Tornadoes US 3.323 1988 Piper Alpha Explosion UK 3.224 1995 Kobe Earthquake Japan 3.125 1999 Winterstorm Martin Spain, France, CH 2.7 Source: Swiss Re, RMS * Costs rebased to 2004 US dollars. Non-Catastrophe Classes The performance of these classes in 2005 was in marked contrast to thecatastrophe classes. There was a notable absence of major new claims in thebig-ticket liability classes (such as US professional indemnity) and a number ofoutstanding prior year cases were wholly or partially resolved at a discount tothe reserves which we had already established. UK division claims experience inall key areas (motor, liability and property) was also benign for both currentand prior years. Industry Pricing for 2005 and Outlook • The premium rating index charts for our three underwriting centres later in this review show the effect on pricing of last year's catastrophes. As yet, and as we would expect, this effect is largely limited to the higher-risk, higher-reward classes of business, particularly catastrophe retrocessional, US property reinsurance and primary business including energy and property in directly wind-exposed areas of the USA. Based on both economic fundamentals and experience, we expect the firming of rates, albeit less marked, to ripple into other reinsurance classes and then into primary business classes as the price-rises and annual renewals cycle work their way through the system; • In our least catastrophe-exposed underwriting centre, the UK division, rates continued to fall throughout 2005. This is likely to be the last of our underwriting centres to be affected by any general improvement in market pricing, and the effects are unlikely to have worked through before late 2006. Brit's Competitive Position and Peer Group While there are a number of examples in the insurance industry of growth orprofitability, a continued combination of both is much rarer and is a measure ofthe high quality of our entire underwriting team and approach. Our overall result for the year shows the strength of our diversified businessmodel, such that favourable experience in one area was able to counterbalanceadverse volatility in another. Brit operates through its three distinct customer-facing underwriting centres,as follows: London Market - Brit competes with the major Lloyd's syndicates and LondonMarket insurers for global business distributed into London by broking firms.Lloyd's has 62 syndicates of which Brit owns and manages the ninth largestLloyd's syndicate, with a Lloyd's market share of approximately 3.4%. Brit istargeting growth in the non-aggregating areas within its London Market business. UK - Brit estimates the UK commercial lines market to be approximately £20bn.It is a concentrated market with the top seven groups having an estimated shareof in excess of 50%. Brit's share of this market is approximately 2%, already atop ten market participant, and is targeting growth in this area over the mediumterm. Growth has not been pursued during the soft market conditions of 2005 andearly 2006 because it would have meant reducing pricing excessively. It is afeature of UK commercial insurance that during softer points in the pricingcycle, more business is done in the regions and less in London. We anticipatedthis and established our network of regional offices in time to take a share ofthis business as it migrated away from London. Reinsurance - Brit competes globally with other major reinsurers, especiallythose based in Continental Europe, Bermuda and at Lloyd's. Brit's global marketshare is less than 1%. Global reinsurance market conditions are currentlyundergoing significant change in the light of the 2004 and 2005 catastrophes,new capital and revisions to risk estimates of buyers and catastrophe modellingagencies. This represents significant challenge and opportunity. Key Business Relationships Brit actively monitors its financial and operational exposures tocounterparties. All of Brit's business comes via intermediaries. As such, Brit is exposed tothe insurance broking industry. This is a highly concentrated industry,especially among the "Big Three" - Marsh, Aon and Willis. Brit believes it isless reliant on these three counterparties than most insurers. Brit's reinsurance purchasing exposes it to the global reinsurance industry.This industry is experiencing both increasing consolidation and credit ratingdowngrades for many participants. Such trends serve to reduce the number ofpotential providers of acceptable security for Brit. However, as the Groupgrows and further diversifies, Brit's need to purchase reinsurance is reducing. New Regulations and Other Key Process Changes 2005 also saw progress on a series of regulatory initiatives which we believewill have a profound effect on the insurance marketplace and potential benefitto the Group in terms of its competitive market position: • The likely shift in a number of administrative functions from brokers to insurers; • FSA contract certainty requirements, which are being enforced incrementally through 2006; • Increased capital requirements driven by the FSA, Lloyd's, EU regulation and global rating agency criteria Brit has been at the forefront of each of these areas and is confident ofrealising benefit from its proactivity. For example: • Having previously held a number of significant industry positions, Dane Douetil has been elected by his peers in 2006 to the leading post as Chair of the Market Reform Group, a reflection of Brit's commitment to leading the modernisation of the industry; • Brit's contract certainty platform, RI3K, enabled the achievement for its own 1 January 2006 reinsurance purchases of full contract certainty at inception of 75% of its program and 100% certainty by 12 January 2006. This was a significant achievement as it involved more than 15 brokers and 50 carriers globally, and would have been impossible without the technology. UNDERWRITING STRATEGY The Group's underwriting core policies and values are as follows: • Quality of underwriting is the number one criterion at all times; • Broadly spread underwriting portfolio encompassing more than 80 sub-classes of business to maximise opportunity and reduce concentration on any single risk, class or individual; • Constant monitoring of exposure limits; • Strong collegiate team ethic and culture, including collective incentivisation of underwriting and other staff within a single Group bonus pool based on Group profitability. This bonus structure helps maximise alignment of interests of staff with each other and with shareholders; strong peer review process among underwriters; internal capital market for continual capital re-assignment, which resulted in 94 internal trades in respect of £144.1m of underwriting capital in 2005; • Maintenance of high A insurer financial strength rating from our chosen ratings agency partners so as to attract and retain the right quality of new business from brokers and clients; • Commitment to empowerment of underwriters within the control framework to allow prompt decisive customer-facing decisions to be made; we employ 128 lead underwriters and 254 underwriting staff; • Strong reserving process and track record; • Commitment to highest standards of customer security and service, including integrity of process and technology. We continue to deliver on this strategy on all fronts. For any insurance group,however, the quality of the underwriting is absolutely paramount. In thiscontext, it is particularly pleasing to note, for example, that our activeLloyd's Syndicate 2987 has closed its 2003 year of account with a return oncapacity of 25.6%, which we believe will be in the upper quartile of marketresults; and our UK Underwriting Centre has produced a record of growth andcombined ratio that compares favourably with its peers in that market. UNDERWRITING RESULTS Overview London Market Reinsurance UK 31.12.05 31.12.04 31.12.05 31.12.04 31.12.05 31.12.04 £'000 £'000 £'000 £'000 £'000 £'000 Gross premiums written 558,568 431,613 328,807 279,994 317,862 345,401Earned premiums, net of 412,136 367,410 224,199 179,878 302,595 300,948reinsuranceUnderwriting result before (768) 28,151 (103,494) 8,967 65,653 24,484investment returnTotal result 44,181 57,386 (81,120) 23,204 112,304 54,333 Claims ratio 63.8% 58.0% 119.8% 68.5% 55.8% 68.1%Expense ratio 38.2% 34.5% 28.5% 26.6% 22.6% 23.9%Combined ratio 102.0% 92.5% 148.3% 95.1% 78.4% 92.0% If 2005 had been a "normal" catastrophe year, we would have expected a Groupclaims ratio not greater than 60.9%, which would have represented netcatastrophe claims of £117.3m. In fact it totalled 74.4%, giving a differencefrom our assumed long-term result of £127.0m. This has materially affected theresults for 2005. Premium Index Brit's Premium Index uses 2000 as its base year and reflects the broad trend foreach underwriting centre in respect of rates, terms and conditions. Theanalysis is based on a set coding structure with the data being input by Brit'sunderwriters. It is compulsory for all open market business to be included andthe data is independently audited by the compliance team on a regular basis.The index mainly tracks renewal business as it is often hard to judgedifferences in rates for new business. Some caution needs to be exercised whenusing this table as the varying levels of claims inflation in different classesrequire different rating increases simply to retain the status quo. Inevitablythere is also an element of subjectivity in respect of any assessment of theimpact of changes in terms and conditions. Premium Index (Year 2000 as base year) 2000 2001 2002 2003 2004 2005 28.02.06 London Market Underwriting CentreAccident & Financial Division N/A 100 131 142 147 150 156Aerospace Division 100 158 202 237 260 268 268Casualty Division 100 122 207 288 303 301 301Marine Division 100 112 144 156 159 171 186Property Division 100 112 150 155 152 151 174 Reinsurance Underwriting CentreProperty - USA and Canada Division 100 110 149 154 155 159 201Property - International Division 151 151 161Property - Retrocessional Division 100 110 132 120 117 126 N/AMarine Division 100 115 171 179 183 193 217Casualty Division 100 115 182 215 230 228 231Aviation Division 100 100 167 159 139 128 128 UK Underwriting CentreProperty Division 100 104 123 132 131 130 129Casualty Division N/A N/A 100 130 130 120 119Motor Division 100 108 115 120 122 111 110Liability Division N/A 100 200 286 284 257 258 The indices are based on the underwriters' estimates of the rate movementsexperienced by their business. They are subjective as they are calculated usingjudgement to estimate the effect of changes in terms and conditions as well aschanges in premium. London Market Underwriting Centre The impressive growth of our London Market Underwriting Centre continued in 2005and gross written premium income grew ahead of expectations from £431.6m to£558.6m. Much of this growth was achieved by building on the new classes ofunderwriting introduced over the past few years. Brit has been successful inattracting quality underwriting teams bringing potential new business with them.With pro-active management and first class infrastructure support we have beenable significantly to advance our business proposition. In addition to new classes of business, disciplined underwriting throughout theLondon Market team has been instrumental in developing a diversified riskportfolio. This diversification has been critical in 2005 - catastrophe lossesincurred on the North American Property book and the Marine (Off-Shore Energy)account have been more than offset by excellent results from the Casualty,Accident & Financial and Aerospace classes. These are long-term, sustainablebusiness sectors where Brit has an excellent market position. Market conditions in the loss affected classes are very much improved but we arelooking at aggregated exposures on a group basis. Elsewhere in the LondonMarket environment, terms and conditions remain broadly favourable. Thedivision is well placed to take advantage of these market conditions and to makea good contribution to the Group's results in 2006. Reinsurance Underwriting Centre The Reinsurance Underwriting Centre enjoyed strong premium growth during 2005writing £328.8m of premiums (2004: £280.0m). While an element of the reportedpremium increases represented reinstatement premiums arising from the year'smajor catastrophes, the underlying growth in premiums was also ahead ofexpectations. The division posted a loss after allocated investment return for the year of£81.1m compared with a profit of £23.2m in 2004. This deterioration is morethan fully accounted for by an increase in catastrophe claims, and the trends ofboth premium income and underlying profitability are both encouraging. The impact of the catastrophes in 2005 has generated a positive pricingenvironment for the loss impacted classes and at the same time has helped tostabilise the pricing environment in other non-affected lines of business. Thisbodes well for the performance of the account in 2006. We have adopted a more conservative aggregate management policy using newindustry models and risk accumulation tools so as to help the Group reduce theaccount's overall volatility. This will result in a notable reduction of ourpeak zone catastrophe aggregates. This has meant, for example, that we have not participated in the 1 January 2006renewals round for "catastrophe retrocessional" business, even though it ispriced more attractively than it was in 2005 and prior. We have notpermanently withdrawn from this line of business, but we are allowing time tomanage down existing exposures, review the market and consider our strategy forthis kind of potentially very profitable but high volatility business. Futurestrategy in this area may include the possible use of a so-called "side-car"structure utilising third party underwriting capital. UK Underwriting Centre Given its position at a relatively soft point in its separate underwritingcycle, 2005 was a year of protecting the bottom line even if that meant modesttop-line reduction. Gross premiums written were down 8.0%. We successfullyrenewed 55.9% of our existing book of business without aggressively chasing newbusiness market share at the expense of underwriting discipline orprofitability. We continued to establish our regional presence during the year, replacingtemporary accommodation with permanent offices in Leeds and Manchester. Ourfinal regional office (Reading) has been opened in 2006. Non-London premiumsincreased by 7.3% in the year. It is the normal pattern in a softening marketfor certain premiums to migrate from London to regional markets and wepositioned ourselves well for this development. The combined ratio for this division was an excellent 78.4% (2004: 92.0%). Inaddition to quality underwriting in a competitive market, the division benefitedfrom favourable reserve development for prior years. It is the Group's overallpolicy to take a cautious stance on projected ultimate claims ratios for newclasses of business until a proven track record and development pattern isestablished. A favourable pattern of claims experience is now beginning toemerge as prior years mature, following the formation of this division in 2002.Any combined ratio below 95% is an excellent achievement in terms of competitiveposition and return on capital, given the lower risk nature of this business. FINANCIAL MANAGEMENT Balance Sheet The balance sheet remains strong despite the most challenging catastropheenvironment in history. BIL's credit ratings were unchanged throughout the yearwith both the relevant ratings agencies. Significantly at no stage was eitherrating placed on creditwatch. Following a strategic review of the Group's capital structure, the Group balancesheet was further strengthened by the successful lower tier two subordinatedbond issue in December 2005 so that we finished the year both with increasedcapital resources compared with 2004 and with a more efficient mix of equity anddebt, which has lowered our overall weighted average cost of capital goingforward. Capital Resources We set out below a summary of our capital resources, which we define as nettangible assets plus subordinated borrowings which have at least five yearsremaining to maturity or call and are of the types which qualify as regulatorycapital. 31 December 2005 31 December 2004 £'m £'m Net tangible assets 638.4 643.5Long-term subordinated debt 147.1 -Total capital resources 785.5 643.5 As described more fully in Note 26 to the financial statements, the new bondissue represents unsecured subordinated debt with 25-year maturity and a 15-yearcall option exercisable by Brit. The interest rate is fixed at 6.71% for thefirst 15 years, after which (if not called) it is re-set to a level equal to 3.4percentage points above the relevant gilt for the remaining ten years of itslife. The loan instrument contains no financial covenants. There areprovisions which would permit Brit to defer interest payments in certain definedcircumstances, for instance in the event that such payment would cause, orincrease, a shortfall in regulatory capital in the Company or in BIL. This represents high quality subordinated debt capital, given the long maturity,the wide-ranging interest deferral features and the absence of materialfinancial covenants. Brit was the first UK insurer (life or non-life) to accessthe public debt markets following Hurricane Katrina; the issue was also thefirst public insurance-related subordinated Eurobond to be successfully issuedwith an indicative rating from Fitch Ratings only and the first public bondissue by an insurance group with a material proportion of its business atLloyd's. The issue was priced at the bottom of its indicative pricing spread above gilts(i.e. favourable to Brit), and generated total demand of £390m for a £150m issuefrom 35 institutional investors, many of whom were not existing holders of Britsecurities and thus represented a new source of capital to the Group. Weestimate that this new source of approximately 20% of our overall enlargedcapital base has lowered our overall weighted average cost of capital byapproximately one percentage point. Our intended uses of the funds are as follows: Use £'m Business growth 80+Refinancing of short term loan stock, early or on maturity 44Elimination of pension fund deficit, in part or whole Up to 23Total net proceeds 147 We have continued to be proactive in our balance sheet management into 2006. Weissued a tender offer for our £40m nominal of loan stock due 2008 (whichapproximately 49% by value accepted and we have subsequently purchased a further3%). With only three years to maturity, the 2008 loan stock was not providingus with suitable long-term capital. We also held an Extraordinary General Meeting on 3 March 2006 at whichshareholders approved a further share premium reduction to create moredistributable reserves subject to High Court approval later this month. Thecreation of more distributable reserves provides maximum flexibility for capitalmanagement for the Group in a number of ways: • Bridging the three year gap which can otherwise exist between Lloyd's reported profits and cash distribution; • Facilitating regular dividends at parent company level without reducing capital strength in key operating subsidiaries; • Allowing a full and prompt return of cash to shareholders by way of share buy-back or special dividend should excess capital build up at any time in the light of prevailing market conditions. Our gearing ratio at 31 December 2005 was approximately 30.4%. Following postyear end activity, the tender offer for our 2008 loan stock and the settingaside of funds in connection with the share premium account reduction, thepro-forma gearing ratio has reduced to around 23%. High A Rating Maintained The Group is pleased that BIL maintained its ratings of A+ (Strong) with FitchRatings and A (Excellent) with AM Best throughout the year, especially given: • An industry-wide trend of downgrades for insurance groups as a wholesince 2001; • Widespread downgrades and/or announcements of credit-watch withnegative outlook throughout the industry when the large claims estimates andsubsequent revisions were announced in September to December 2005. As part ofour own processes, we monitor rating agency actions not only for Brit but for apeer-group of 31 other major international reinsurers as rated by one or more ofStandard & Poor's, AM Best and Fitch. Apart from BIL, only five of thispeer-group were neither downgraded nor placed on negative outlook between 1September and 31 December 2005. We regard BIL's financial strength rating and its stability as important inbuilding the Group's non-Lloyd's business with appropriate quality brokers andclients. The £150m new bond issue was assigned debt ratings of BBB by Fitch Ratings andBBB- by AM Best, in each case representing four notches below the financialstrength rating of BIL, taking into account the subordination features and thefact that the bonds were issued by the holding Company rather than the ratedoperating subsidiary and without an upstream guarantee. Such a four-notchdifferential is common in such structures. Regulatory Capital The FSA is introducing new capital regulations for Lloyd's business on a similarbasis to company regulation. In June 2005 the Group submitted calculations forits Individual Capital Assessment ("ICA") for its Lloyd's Syndicate 2987 andprovided updated calculations in December 2005. In December 2005 the Groupreceived a routine "ARROW" visit from its monitoring team at the FSA. InJanuary 2006 the Group submitted updated calculations for its Enhanced CapitalRequirements ("ECR") and ICA for BIL, this following initial agreement in 2004. Reinsurance Security The table below sets out the ratings of our reinsurance recoverables on paid,outstanding and IBNR claims at 31 December 2005. Reinsurance recoverables haverisen during the year because of the high incidence of catastrophe events, bothin terms of frequency and severity, which the reinsurance outwards program isprincipally designed to cover. We have kept the level of security high albeitthat the number of highly rated reinsurers continues to reduce by virtue ofindustry consolidation and more demanding scrutiny by ratings agencies. Rating of Reinsurance Recoverables 31 December 2005 31 December 2004 % % AAA 0.4 1.2AA 29.7 21.3A 62.6 69.1BBB and below 2.1 0.4Not rated 5.2 8.0 100.0 100.0 Expense Management Overheads grew by 7.2% compared with 2004 in line with business growth. Thepure expense ratio (excluding commission costs) was 8.8% of net earned premium(2004:8.6%). Total headcount rose from 530 to 601. Year ended Year ended 31 December 2005 31 December 2004 £'000 £'000 Staff costs 45,110 41,672Other staff related costs 4,423 3,775Accommodation costs 5,741 4,073Legal and professional charges 6,218 3,050IT costs 4,727 4,084Marketing and communications 3,261 2,613Irrecoverable VAT 1,691 2,299Depreciation of property, plant and equipment 1,648 1,757Amortisation of intangible assets 3,202 3,087Printing, stationery, postage and telephone 1,056 1,148Travel and entertaining 2,557 2,174Insurance 1,419 1,413Regulatory levies and charges 14,777 14,096Other 2,907 1,679Movement on related non-commission acquisition cost deferral (1,031) 4,223Total overheads 97,706 91,143Investment management expenses 3,066 2,744Total expenses 100,772 93,887Commission acquisition costs 219,570 188,889Movement on related commission acquisition cost deferral (12,133) (12,347)Total Commission costs 207,437 176,542Acquisition costs and other operating expenses 308,209 270,429 Taxation During the year we became a net payer of UK corporation tax for the first timesince 2000. Lloyd's profits are historically taxed only on a distributionbasis, three years after the accounting profit is reported. We are thereforebeginning to pay tax on the strong Lloyd's profits of the 2002-4 underwritingyears, which had previously been recognised in our deferred tax calculations.Our overall current and deferred tax rate for the year was 23.7%, reflecting anumber of "once only" reliefs, principally the utilisation of capital allowancesand capital losses not previously recognised. Our effective rate is expected totrack the UK rate of 30% fairly closely in the medium term. Overseas taxationis expected to be lower for the Group in future years than in past years due toa lower basis of US taxation of Lloyd's syndicate profits from 2005. Pension Fund Liability With the adoption of International Financial Reporting Standards ("IFRS"), ourpension fund deficit is now included as a net liability on the Group balancesheet. During the year it grew from £18.5m to £22.8m (before deferred tax) onthe basis of IAS 19, despite a strong investment performance, principallybecause the relevant calculation is more sensitive to changes in liability-basedassumptions concerning long-term interest rates, salary inflation and mortalitythan to asset growth in a single period. As a percentage of the Group's marketcapitalisation and liquid resources, the deficit is small compared with many inthe FTSE 350. Nevertheless, the Group will make extra contributions of £2m in2006 and £5m per annum from 2007 to reduce the current stated deficit. Thescheme has been closed to new members since October 2001. INVESTMENTS The Group's investment return was ahead of expectations for 2005. Totalinvested assets grew from £1.9bn to £2.4bn, principally based on strong cashflows from continued growth of premium income and the planned increase in assetsheld to match claims reserves, especially on the medium and longer tail classesof business. Funds were also increased by the new bond issue. The average return on invested assets was 5.4% (2004 4.6%) based on a consistentapproach to asset allocation (over 90% cash and fixed income, very high creditquality, short bond duration) and a strong relationship with our investmentmanagers, especially our affiliate, Equity Investment Partners Limited ("EIP")and its subsidiaries, which manage 84.6% of our total invested assets. Ourpolicy of setting total return mandates for our investment managers has beensuccessful. The sterling bond portfolio has performed particularly well, as themanagers have judged market movements well and have been successful in switchingduration within the guidelines of 0-3 years to maximise value from interest ratefluctuations. The Group's equity investments have again outperformed therelevant indices. We have this year continued our trend of realising assets which are unlisted orrelatively illiquid given the size of our holding compared with market volumesregularly traded. A number of these assets represented residual holdings from1999 and before, when Brit was an investment trust taking material stakes ininsurers and insurance-related businesses, compared with our current corestrategy of underwriting for our own account. In 2005 we disposal of ourremaining shares in Chaucer Holdings PLC. We also decided during 2005 that it is not in shareholders' interests that theGroup remains a long-term shareholder of EIP, despite its very good investmentperformance track record. Accepted best practice has become for insurers,especially non-life, to dispose of their in-house asset managers and to contractfor these services from third parties, while retaining in-house capability inasset allocation and supervision of outsourcing. The Board believes Brit islikely to receive more value from a sale of our stake in EIP than either itsbook value or the implicit value which is currently ascribed to the stake in theGroup's share price and accordingly has appointed financial advisers with a viewto seeking a buyer at a suitable price. Under the new IFRS rules and in thelight of the process which is now underway, EIP is now held in the balance sheetat its book value of £1.1m as an asset held for sale rather than as anassociate. EIP's results have ceased to be equity-accounted from 15 November2005. The process is currently at an early stage; a number of parties haveexpressed interest. Asset Allocation 31 December 2005 31 December 2004 £'m £'m Equities 219.0 173.3Bonds 1,626.6 1,141.0Cash and deposits 528.1 544.2Total 2,373.7 1,858.5 Bonds, Cash and Deposits Currency Mix 31 December 2005 31 December 2004 % % Sterling 62.9 64.6US Dollar 28.2 26.4Euro 6.1 7.1Other 2.8 1.9 100.0 100.0 Sterling Fixed Income Performance 31 December 2005 31 December 2004 % % The Group's sterling investments 5.36 4.561 month sterling LIBID 4.72 4.400-1 year Gilt Index 4.57 4.231-3 year Gilt Index 4.98 4.64 US Dollar Fixed Income Performance 31 December 2005 31 December 2004 % % The Group's dollar investments 1.87 1.191 month dollar LIBID 3.18 1.301 year US Treasury Note Index 2.84 0.821-3 year US Treasury Bond Index 1.67 0.91 Equity Returns 31 December 2005 31 December 2004 % % The Group's equities 27.10 18.99FT All Share Index 20.91 9.21FTSE 100 19.63 7.54 Bond Portfolio Duration 31 December 2005 31 December 2004 Yrs Yrs Sterling 1.57 0.94US Dollar 1.40 1.51Euro 1.40 0.20Can dollar 1.48 1.47 Bond Portfolio Credit Ratings 31 December 2005 31 December 2004 % % Government 49 50AAA 14 22AA 26 20A 11 8Total 100 100 RISK MANAGEMENT The Group proactively manages risk under five main headings consistent with theFSA's categorisation; at its most recent FSA "ARROW" visit in December 2005, allmain areas of risk were discussed with the FSA, including areas which the Grouptargets for further improvement in 2006. Insurance Risk The Group's underwriting philosophy is set out earlier in this review. TheGroup aspires to the highest standards in both underwriting and reserving. By its nature insurance business always requires a level of estimation of futureclaims payments, and the reported result for any single accounting period issensitive to the accuracy of these estimates. This year, for the first time, weare pleased to disclose further details of claims development by accident yearto show how our ultimate claim estimates have stood the test of time: Ultimate Gross Claims Accident year 2001 & all 2002 2003 2004 2005 Total prior years £'000 £'000 £'000 £'000 £'000 £'000 At end of accident year 1,961,803 262,425 452,550 730,336 1,220,765One year later 2,001,444 263,352 424,164 678,241 -Two years later 2,022,510 258,963 392,229 - -Three years later 2,024,380 261,961 - - -Four years later 2,023,016 - - - -Estimate of cumulative claims 2,023,016 261,961 392,229 678,241 1,220,765 4,576,212Cumulative paid claims (2,583,014)Less third party participations (533)on syndicatesGross liability as per the 1,992,665balance sheet (Note 21(i)) Ultimate Net Claims Accident year 2001 & all 2002 2003 2004 2005 Total prior years £'000 £'000 £'000 £'000 £'000 £'000 At end of accident year 1,339,601 200,724 399,121 599,486 839,212One year later 1,383,494 200,991 373,484 527,553 -Two years later 1,394,342 197,452 336,905 - -Three years later 1,384,918 193,404 - - -Four years later 1,386,664 - - - -Estimate of cumulative claims 1,386,664 193,404 336,905 527,553 839,212 3,283,738Cumulative paid claims (1,882,521)Less third party participations (533)on syndicatesNet liability as per the balance 1,400,684sheet (Note 21(i)) The tables above show the development of claims over a period of time on a grossand net of reinsurance basis. The tables show the cumulative incurred claims,including both notified and IBNR claims, for each successive accident year ateach balance sheet date since 2001. The claims have been adjusted to make themcomparable on a year by year basis. They have been grossed up to include 100%of the managed syndicate claims rather than the claims that reflects the Britpercentage ownership of each syndicates capacity during the respective accidentyears. In addition, claims in currencies other than sterling have beenretranslated at 31 December 2005 exchange rates. In 2005, the total claims estimates from prior years were reduced by £110.8m(2004: £47.7m). It is part of the Group's reserving philosophy that the mostrecent years, with the greatest uncertainty of result, be prudently reservedleaving a potential for subsequent release. Many different classes of business experienced releases in 2005. In global longtail classes, claims experience was benign for recent years and a number oflong-standing issues were settled or progressed favourably. In the UK division,reserve development also reflects the release of conservative actuarial reservespertaining to early years of new classes of business which were set up before aproven underwriting track record had been established. Catastrophe Claims The table below shows the financial effect on the Group of large and smallcatastrophes, net of reinsurance recoveries and inwards and outwardsreinstatements, in 2005 and 2004. The large catastrophes are HurricanesKatrina, Rita and Wilma (2005) and Charley, Frances, Ivan and the South EastAsia Tsunami (2004). Other catastrophes include Hurricanes Jeanne and Dennis,Typhoon Songda, Windstorm Erwin and the Mumbai Floods. Year ended 31 December 2005 London Market Reinsurance Total US$'000 US$'000 US$'000 Large catastrophes 175,690 212,282 387,972Other catastrophes (12,459) 44,745 32,286Total 163,231 257,027 420,258 £'000 £'000 £'000 GBP equivalent* 94,902 149,434 244,336 * Converted at year end rates Year ended 31 December 2004 London Market Reinsurance Total US$'000 US$'000 US$'000 Large catastrophes 57,844 89,568 147,413Other catastrophes 6,372 17,962 24,333Total 64,216 107,530 171,746 £'000 £'000 £'000 GBP equivalent* 33,446 56,005 89,451 * Converted at year end rates When major events occur, Brit's response is to assemble a team from all keyareas of the business to conduct a complete contract review, in addition toimmediate site visits where practicable and reviewing any industry estimates forthe total insured exposure. Paste the following link into your web browser to download the PDF document related to this announcement: http://www.rns-pdf.londonstockexchange.com/rns/8115z_-2006-3-14.pdf This information is provided by RNS The company news service from the London Stock ExchangeRelated Shares:
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