Preliminary Results

14th Mar 2006 07:03

Beazley Group PLC14 March 2006 Press release Beazley Group plc, preliminary results for the year ended 31 December 2005 Beazley Group plc has achieved a profit of £16.1m London, UK, March 14 2006 • The group has achieved a profit of £16.1m;• Hurricanes Katrina, Rita and Wilma combined had a net impact on the group result of £60m;• Growth in written premiums of £155.7m (39%);• A.M. Best rating for syndicate 2623 reaffirmed as A (excellent);• Beazley US completes its first year of operations;• Total managed capacity for 2006 is £830m (2005: £742m); our group share of total capacity has increased to 78% (£647m); and• Syndicated loan facility increased to £150m (2004: £70m). 2005 2004 % change Gross premiums written (£m) 558.0 402.3 39Net premiums written (£m) 425.8 329.0 29Net earned premiums (£m) 372.3 302.7 23 Profit before tax (£m) 16.1 35.4 Claims ratio 73% 60%Expense ratio 32% 29%Combined ratio 105% 89% Earnings per share (p) 3.1 9.9 (69)Dividends per share (p) 4.0 1.0 300Net assets per share (p) 77.8 77.0 1.0 Cash and investments (£m) 884.5 551.4 60 Andrew Beazley says: "I am pleased to report a profit before tax of £16.1m, despite what has been themost costly year in history for the insurance industry. The scale of the losseshas tested both the market and the strength of our business. Following theimpact of the hurricane season, we have seen the rating environment improveacross the commercial property, offshore energy and reinsurance lines ofbusiness. Our US expansion plans have been vigorously pursued and theseoperations will continue to provide further growth opportunities. We are pleasedto announce a final dividend of 2.5p, making a total for the year of 4.0p, inline with our commitment at the time of the rights issue in November 2004." ENDS For further information, please contact: Beazley Group plc Andrew BeazleyT: +44 (0)20 7667 0623Andrew HortonT: +44 (0)20 7667 0623 Finsbury Simon MoyseAmanda LeeT: +44 (0)20 7251 3801 Notes to editors: Based in London, U.K. since 1986, Beazley (BEZ.L) is the parent company of aglobal specialist risk insurance and reinsurance business operating throughLloyd's syndicates 2623 and 623 in the UK and Beazley Insurance Company, Inc., aUS admitted carrier in all 50 states. Both syndicates are rated A by A.M. Bestwith an aggregate capacity for 2006 of £830m (over $1.4bn). Beazley InsuranceCompany, Inc. is rated A- by A.M. Best. Beazley is a market leader in many of its chosen lines of business, whichinclude professional indemnity, marine, reinsurance, commercial property andpersonal lines. Further information about us is available at www.beazley.com CHAIRMAN'S STATEMENT Beazley has achieved a profit before tax of £16.1m despite the extreme adverseconditions of the last year. Our unbroken record of profitable resultsthroughout uncertain and difficult times proves that our commitment to excellentunderwriting, a balanced and diversified portfolio, rigorous risk managementpractices and a strong reinsurance program are central to what we do. 2005 was a year dominated by the worst catastrophe season including somefourteen hurricanes near the US. The cost in human terms of these unpredictableevents has been devastating. The cost to the insurance industry, estimated to bebetween $60bn and $80bn, was the highest in recorded history, as is the total ofsome three million claims, and has had a profound effect on the fate ofindividual insurance businesses. The combined impact on group profit before taxof the three major hurricanes (Katrina, Rita, and Wilma) was £60m net ofreinsurance. Before the hurricane season we had experienced some deterioration in our ratingenvironment particularly in our commercial property and reinsurance lines ofbusiness. In the fourth quarter, however, we saw the rating environment improveacross the commercial property, offshore energy and reinsurance lines ofbusiness. Our US expansion plans have been pursued vigorously in 2005. We now operatethrough two entities - our managing general agent (MGA) which writes businessdirectly to syndicates 2623/623 and our own insurance company. We completed thepurchase of Omaha Property and Casualty Insurance Company during the year andchanged its name to Beazley Insurance Company, Inc. (BICI). It is licensed towrite insurance business in all 50 states. In 2005 the MGA wrote gross writtenpremiums of $13.8m and the insurance company wrote $1.6m. We have increased our syndicated loan facility to £150m. We used £70m to supportour underwriting at Lloyd's in 2006 and a further $50m to capitalise BICI. Ourcapital position gives us the financial strength to continue with our strategyof growing our business in a defined and disciplined way. For 2006, the group increased its underwriting capacity to £647m (2005: £522m)through further purchases of syndicate 623 capacity. We paid £1.6m for thiscapacity which we believe will increase our profitability in future years. The board has proposed a final dividend of 2.5p (2004: 0.7p), bringing the fullyear dividend to 4.0p (2004: 1.0p) in line with our commitment at the time ofthe rights issue in November 2004. The final dividend will be paid on 12 May2006 to shareholders registered on 18 April 2006. The uncertainty created by the 2005 hurricane season has opened up opportunitiesin 2006, particularly in our catastrophe-based lines, and for the remainder ofour account there is significant profit potential. 2005 was a difficult year which tested both the market and the strength of ourbusiness. We intend to grow in 2006 whilst remaining steadfast to our corecompetencies of quality underwriting and a diversified portfolio. MARKET AND BUSINESS OVERVIEW Renewal rate movement based on 2001 prevailing rates. 2001 2002 2003 2004 2005 % % % % % Marine 100 118 129 128 131Property 100 126 132 125 123Specialty 100 134 160 166 164linesReinsurance 100 142 149 148 149 Total 100 131 145 146 145 Year on year rate increases 2004 2005 Jan/Feb 2006 % % %Marine - 2 8Property (5) (1) 5Specialty 4 (1) 3linesReinsurance - - 19 Total 1 - 5 Overview Inflating values and an unprecedented increase in demand for insurance productsworldwide are some of the factors that clearly indicate that insurance is agrowth industry. As we progress year to year and better understand the meaning of risk in aturbulent and constantly changing world, we are better equipped to manage ourexposures, including those to the most severe natural and man-made catastrophes.It is through this experience and with effective risk management that we areable to change and respond to the unpredictable and consistently produceprofits. Rating Environment Despite rates deteriorating in some of our business lines in 2005, we aretrading in a good rating environment, which is substantially better than in2001. In the fourth quarter, after the hurricane season, rates increased incatastrophe-prone areas, particularly on our offshore energy, US commercialproperty and reinsurance accounts. We believe that business most impacted by thehurricane season of 2005 will see major changes in the way it will beunderwritten in terms of cover and pricing in 2006. Our group business plan for2006 has been adjusted accordingly, with the impact of these changes leading toa 12% increase in total managed premium capacity. In our largest division, specialty lines, we had seen rates increasedramatically by 66% from 2001 until year-end 2004. While tougher marketconditions forced them to fall back marginally during 2005, we continue toexercise tight controls to ensure only good quality risks are selected by ourunderwriters. While rates are moving radically in areas of the business that arecatastrophe-prone, we are not expecting rates in other areas to increasesubstantially. Ratings agencies are demanding an increase in capital for insuring business moresusceptible to catastrophe, which is helping to drive rates up. We are delightedthat A.M. Best recently reaffirmed our syndicates A (excellent) ratings, whichin the difficult market of 2005, is an indication of our strength and trackrecord. Hurricanes In the third quarter of 2005 the insurance industry incurred a number of marketchanging events. Hurricane Katrina caused human tragedy and massive propertylosses in the southern United States making it the largest insured loss inhistory. The global insurance market incurred losses on Katrina alone ofapproximately $60bn, to be closely followed by Hurricane Rita and HurricaneWilma with losses of approximately $10bn each. Lloyd's share of this loss hasbeen estimated at £1.9bn for Katrina with an estimate of £1bn for Rita and Wilmacombined. This combined represents 21% of Lloyd's 2005 capacity (£13.7bn). The insurance losses incurred from the 2005 hurricane season are extremelydifficult to estimate and have highlighted a number of issues with currentindustry wide modelling software. Initial estimates from the modelling agencieswere for an insured loss of no more than $25bn. These estimates were laterincreased and stand at between $60bn and $80bn. The group's share of theselosses amounted to $130m, having a £60m net impact on the group's 2005 profit,equivalent to 21% of shareholders' funds. The proof of our disciplined approachto underwriting is the fact that we were still able to produce a profit. Following the human tragedy of the hurricane season in 2005, people's homes andbusinesses in and around New Orleans are being rebuilt, which yet againdemonstrates the important role the insurance industry plays in day-to-day life. Growth Our managed capacity for 2005 was £742m (2004: £741m) which has been increasedto £830m for 2006. The increase was driven by a rise in insurance ratesfollowing the 2005 hurricane season and also influenced by our decision to takea greater share in the risks we lead and know well. Our view in 2005 was that the market was declining, therefore our original planfor 2006 was to pull back group underwriting. However, following the hurricaneseason, we reassessed our plans and now look to increase our managed syndicatewritings by 12%. At the same time we increased our group share of the managedsyndicates' portfolio, delivering an increase of 24% premium capacity to thegroup. Our managed syndicates (both 2623/623) have more than doubled their capacity in2006 since 2002. Most of this increase was generated at the time of flotation onthe London Stock Exchange (November 2002), when we created the parallel 2623syndicate. The group's share of the premiums we manage has also increaseddramatically from £330m in 2003 to £647m in 2006 (2005: £522m). In addition to developing the portfolio of Lloyd's business in London, one ofour key initiatives is to expand our access to business worldwide. To help us dothis, we have established two entities in the US. During 2005 we finalised the acquisition of Omaha Property and CasualtyInsurance Company (OPAC) for $20.5m and subsequently renamed it BeazleyInsurance Company, Inc. (BICI). We capitalised it up to $50m and succeeded inachieving an A.M. Best rating of A-. BICI enables us to underwrite business forthose clients who have not traditionally come to Lloyd's for a couple ofreasons. Firstly, because they want to buy from the US admitted market acrossall 50 states and Lloyd's is only admitted in Illinois and Kentucky. Secondlybecause they are small to mid-sized customers whose business may not typicallyflow through London. Our managing general agent (MGA) also established its operation in 2005 and isnow writing both property and specialty lines business on behalf of our managedsyndicates. The property division in the US, which focuses on high-valuehomeowners' property risk in the Carolinas, Florida and Georgia, wrote $6.2m bythe end of 2005. The specialty lines business, with a variety of professionalindemnity and directors and officers liability insurance cover, has written$7.6m. By the end of 2005 we had recruited a number of high calibre individuals to bothwrite and manage the business conducted by the MGA and insurance company,growing the team in the US to 44 employees. Outlook 2006 is the year that Beazley's underlying business will celebrate its 20thanniversary since the formation of Beazley Furlonge Limited in 1986. We havebeen through both rewarding and challenging times and are very proud of ourlong-standing reputation for excellent underwriting and producing a profit yearafter year. GROUP PERFORMANCE 2005 2004 £m £mBeazley Group plc Gross premiums written 558.0 402.3Net premiums written 425.8 329.0 Net earned premiums 372.3 302.7 Net investment income 31.6 11.3Other income 6.9 11.2 Revenue 410.8 325.2 Net insurance claims 273.0 182.0Acquisition and administrative expenses 118.5 89.0Other expenses 1.4 17.8Finance costs 1.8 1.1 Expenses 394.7 289.9Share of profit of associates - 0.1 Profit before tax 16.1 35.4 Claims ratio 73% 60%Expense ratio 32% 29%Combined ratio 105% 89% Rate increase/(decrease) - 1% Earnings per share 3.1p 9.9p Dividends per share - interim and final 4.0p 1.0p Net assets per share 77.8p 77.0p Return on equity 4.0% 8.9% PERFORMANCE The group has achieved a profit before tax of £16.1m (2004: £35.4m). This gaverise to earnings per share of 3.1p (2004: 9.9p) and net assets per share of77.8p (2004: 77.0p). Underwriting performance Gross premiums written in 2005 increased by 39% to £558m. The group share of thecombined syndicate underwriting capacity increased to 70% in 2005 (2004: 54%).The group initially suffered rate reductions in a number of lines of business,in particular in the commercial property. Overall we saw rates unchanged in 2005(in 2004 rates increased by 1.0%). The claims environment throughout the year, excluding the impact of thehurricane season, was fairly benign. During the year we experienced lower thanexpected claims costs in several of our lines of business, which enabled us tomake releases against a number of reserves totalling £12.2m. We have estimatedthat if we exclude the impact of the hurricanes, our claims ratio for the yearwould have been 55% (2004: 52%). However, when the impact of the hurricaneseason is taken into account this ratio increases to 73% (2004: 60%). Our expense ratio has increased during the year to 32% (2004: 29%). This ratioincludes both acquisition costs and our internal administration expenses. Theratio has been impacted by the reinsurance reinstatement costs paid. These costsreduced the net earned premiums by £13m thereby increasing the expense ratio by1%. As a consequence of the above factors the group's combined ratio has increasedto 105% (2004: 89%). Our return on capacity for the 2003 year of account has increased to 16.5% (asat 31 December 2004: 12.9%) as a result of a better than expected claimsenvironment in our marine and property accounts. Despite the impact of thehurricanes the 2004 expected return on capacity remains at 6.5%; at this earlystage our expectation is that the 2005 year of account will breakeven. Beazley in the US Beazley in the US, which incorporates both an insurance company and a managinggeneral agent (MGA), was successfully established in 2005. The MGA wrote grosspremiums of $13.8m and the insurance company wrote $1.6m. The focus in our firstyear was to recruit the highest calibre underwriters to ensure our risks aremanaged effectively and the right quality of business is generated from theearliest stages. Our search for these individuals took us longer than expected,but by year-end infrastructure was in place, and we anticipate increasedpremiums in 2006. The MGA generates premium income on behalf of the two syndicates, for which itcharges an arms-length commission rate of up to 10% per risk. Based on thepremiums written in 2005, this generated a commission for the group of $1.1m. Costs in year one of $10.9m, include one-off set up costs such as recruitment,IT development and legal costs. The venture makes extensive use of ourBeazleyTrade online broker platform, and a number of products have been designedspecifically for clients in this market. BeazleyTrade gives us the advantage oflowering costs in the future, as well as giving us a competitive advantage ofsuperior service delivery over other insurance providers. Investment performance Average Return Return Balance (%) (£m) (£m)Group Funds inc Funds at LloydsGBP 288 4.9% 14.1 Syndicate Funds (Investment Grade Bonds & Cash)GBP 107 4.9% 5.2USD 236 2.9% 6.9Other 48 2.1% 1.0 Syndicate Funds (Alternative Assets)USD 81 6.5% 5.3Investment expenses - - (0.9) Net investment return 760 4.2% 31.6 The group achieved investment return of £31.6m (2004: £11.3m) in 2005, giving usan investment return of 4.2% (2004: 3.3%). Investment income in 2005 isconsiderably more than in 2004 due to additional cash and investment balances inthe syndicate, larger funds managed by the group, and increased yields as USdollar interest rates increased throughout the year. The syndicate balanceincreased due to the additional underwriting capacity of syndicate 2623 in 2005and the inclusion of the reinsurance to close from 2002, which at the start of2005 was valued at £97m. It is expected that the syndicate funds will continueto grow at around 50% of our total business each year is medium tail where theclaims are paid out on average 5 years after writing the business. Our specialtylines business which is predominantly medium tail grew significantly from 2003which should fuel growth in our syndicate cash balance. The group increase ininvestment income was a result of the additional funds of £105m raised duringthe rights issue in November 2004. The majority of the group's managed funds are held in high grade fixed incomebonds, which are of a short duration. In 2005, the group had not changed itsinvestment risk appetite and continued to allocate up to 12% of the syndicates'managed funds to be invested in alternative assets, including equities, hedgefunds and high yield bonds. Impact of GBP/US exchange rate on net assets IFRS - non-monetary items In 2005, the adjustment in respect of foreign exchange on non-monetary items hasadded an £8.2m profit (2004: £2.3m) to our profit before tax. Non-monetary itemsinclude unearned premium reserve, reinsurers' share of unearned premium reserveand deferred acquisition costs. Under International Financial ReportingStandards (IFRS) these balances are carried at historic exchange rates, whilstmonetary items are translated at closing rates. This mismatch under IFRS willlead to more volatility in reported profits than has historically occurred underUK GAAP. As a large proportion of our business is US dollar-based, the movements in theUS dollar are important in understanding the impact of this adjustment on thegroup. We have historically seen that the adjustment relating to foreign exchange onnon-monetary items has a positive impact on net assets in periods where sterlingis weakening against the US dollar. This is because the total non-monetary itemsare valued lower under IFRS than under UK GAAP. Employee numbers 2005 2004 Reinsurance 7 8Specialty lines 101 67Property 41 33Marine 20 11Support 113 67 Total 282 186 UK 238 179US 44 7 During 2005, our employee numbers grew significantly and we continue to recruithigh calibre staff in both the UK and in the US. In the UK, we strengthened anumber of areas including our specialty lines team in both underwriting andclaims management. In the US, we recruited experienced personnel in all areas ofthe business as we established operations in our Florida and Connecticut officesand set up small regional offices. CAPITAL POSITION 2005 2004 £m £m Uses of fundsLloyds underwriting 301.7 244.1Capital for US Insurance company 32.6 - Sources of fundsShareholders funds 280.4 277.6Subordinated debt 10.5 9.4Bank facility 150.0 70.0 Surplus 106.6 112.9 Sources and uses of fundsThe group has two requirements for capital: 1. To support underwriting at Lloyd's through syndicate 2623, which is based on the group's own individual capital adequacy. This may be provided in the form of either the group's own cash and investments or bank facilities; and2. To support its underwriting in BICI in the US. Our funding comes from a variety of sources: 1. £280.4m comes from our shareholders own funds (i.e. net assets);2. In 2005 we increased our banking facility from £70m to £150m through a syndicated facility involving five banks, led by Lloyds TSB;3. The final source of funds comes from our $18m subordinated long term debt with a maturity in 2034. Individual Capital Adequacy We use stochastic modelling techniques to regularly assess our IndividualCapital Adequacy (ICA) for our Lloyd's underwriting operations. Through detailedmeasurement of risk exposures, we allocate capital to support businessactivities according to risk profile. Stress and scenario analysis is performedand the results are documented and reconciled to the board's risk appetite. +-----------+----------+---------------------------------------------+|Prudential |Importance| Comment || risk type | to group | |+-----------+----------+---------------------------------------------+|Insurance |Dominant |This is the largest risk we face as our || | |primary business is to accept insurance and || | |reinsurance risk by means of appropriate || | |premiums to cover claims and operational || | |costs, and to maximise the expected return on|| | |regulatory capital. |+-----------+----------+---------------------------------------------+|Credit |Material |Both brokers and reinsurers are of good || | |quality. |+-----------+----------+---------------------------------------------+|Liquidity |Low |This risk is low because the group's assets || | |are liquid and short term. |+-----------+----------+---------------------------------------------+|Market |Material |Group assets are high quality, well || | |diversified and short term. |+-----------+----------+---------------------------------------------+|Operational|Low |Our allocation of capital to these risks is || | |cautious and is based upon a set of worst || | |case defined scenarios. |+-----------+----------+---------------------------------------------+|Group |Low |This risk is low, but may increase with || | |growth of the US operation. |+-----------+----------+---------------------------------------------+ Insurance risk is our biggest risk, and includes both catastrophe andnon-catastrophe exposures. To manage these exposures we model aggregate risksand the likely financial impact to the group for defined events. To manage our underwriting, we assign maximum gross and net line sizes for allunderwriters. This limit is adjusted according to the nature of the businessbeing underwritten and the experience of the underwriter and cannot be exceededunless appropriately authorised. To ensure that our decisions are robust, thereis a comprehensive sign-off process for underwriting transactions including dualsign-off for all line underwriters. Reserving activities are rigorously controlled to ensure adequate reserves areset. A quarterly peer review process exists for the underwriting teams andsyndicate actuary to independently determine required movements. Hedging Our policy is to minimise our largest foreign exchange currency risk-exposurewhich is to the US dollar. This is managed by estimating our US dollar profitseach year, and selling a proportion each month. This reflects the fact that USdollar denominated profits are earned throughout the year. In 2005, the groupsold US dollars at an average exchange rate of 1.87. Reinsurance We invest considerable time and resources in developing and implementing ourreinsurance strategy, which includes capital management, group risk appetite,relationship management (especially with key reinsurers) and cycle management. Significant amounts of reinsurance are purchased to mitigate the impact ofcatastrophes such as the recent hurricanes in the US, provide lead linecapabilities to our underwriters and manage the group's capital position. The long term financial security of our reinsurance is key and our reinsurancecommittee meets monthly to assess and review our reinsurance counterparties. We have strict processes in place to manage reinsurance debt and ensurecollection occurs as quickly as possible. The combination of security vetting,strict policy wordings and reinsurance collection processes has helped manageour aged debt. We are confident that these processes will respond well followingthe recent hurricanes. Whilst prices remained high in 2005 we were able to place all the reinsurancesat satisfactory terms and conditions. As the business has grown, we haveincreased our retentions, and moved away from purchasing as much riskreinsurance, concentrating more on our catastrophe covers. This strategy workedwell as the reinsurances reacted as expected following the 2005 hurricanes. Reinsurance market conditions are likely to be difficult in 2006, especially inthose lines of business most impacted by 2005 hurricanes, namely energy,property and property catastrophe. MARINE Profile The marine team accounted for 17% of the group's gross premiums written. Since1998 our lead capability, based on our experience and expertise has enabled usto provide clients with comprehensive and competitive risk solutions. We seek to utilise our market leading position and our in-depth knowledge of thesegment to access the highest quality business. This capability combined withselective underwriting allows us to write a profitable account of business atthe same time as limiting potential downside in the event of catastrophiclosses. Market overview The year began with softening market conditions resulting in increased pricingpressure across the marine insurance industry. This pressure was abated in thesecond half of the year due to the impact of the hurricane season. Outside theenergy account, capacity in world markets is such that rating remainscompetitive. Current Performance During the past year we employed a regional cargo team operating out ofBirmingham to write UK cargo business. This has increased our full time employeenumbers to 20, allowing us to broaden the number of marine product lines forsyndicate 2623. In the early part of 2005 we started to see some pressure on ratings across thebook. Due to the impact of the major US hurricanes this pressure has reducedsomewhat, although the hull and cargo markets still remain competitive. Inparticular, our energy book has seen rate increases with the most dramatic risesbeing reserved for business exposed to the Gulf of Mexico. The past year saw some notable claims activity. Hurricane Katrina closelyfollowed by Rita and Wilma has been an unprecedented succession of losses. Ourgross estimated loss from Hurricane Katrina currently stands in the region of$50m, with the net loss after reinsurance recoveries at less than $2m. Our grossloss from Hurricane Rita should not exceed $20m, and we have negligible notifiedlosses for Wilma. Relative to market share we believe these figures to be low,ostensibly due to selective underwriting particularly in the energy account,where several of the largest loss-making accounts were declined. We recently employed a marine surveyor on the hull and machinery account tomanage some of our claims. Swift attendance at marine casualties and efficientlydealing with claims proves an invaluable tool for our market reputation, lossmitigation and claims handling. The mix of business is broadly similar to last year. During 2005 the UK cargoteam launched five products on BeazleyTrade, our online brokerage platform,which makes it easier for our brokers to do business with us. Claims activity has been normal apart from the cargo account which had aslightly greater than average frequency. At the end of October the net incurredloss ratio for 2005 year of account stood at 24.4%, which compares favourablywith prior years. Our expertise in ocean marine cargo insurance has been honed in the Lloyd'smarket, traditionally the global centre for marine insurance. Last year weestablished a team in the US to bring the same level of expertise and responsiveservice to the local market. Outlook We believe that although some areas of the marine market are going to becompetitive, there are great opportunities for potential growth in revenue,especially within the offshore energy segment. The marine cargo account is now well established and we are focusing ourresources on the core accounts, which have been historically profitable with lowclaims volatility. We anticipate some modest growth in the hull accountspecifically in areas such as building risks. As proven this year, predicting future claims activity is difficult. Excludingmajor catastrophes, we believe that our claims pattern over the next year shouldbe consistent with 2005. We aim to increase our distribution channels by introducing products throughBeazleyTrade, which is in addition to our existing strategy of underwritingindividual risks through Lloyd's. PROPERTY Profile Property Group generated 23% of the group's gross premiums written. The team'sunderwriters are acknowledged market leaders in all chosen classes of propertyinsurance ranging from high-value homeowners' and covers to large corporateclients. Our geographic reach encompasses business from all parts of the globe.This diversity allied to our strong underwriting experience enables us toprovide our investors with a well balanced portfolio. Market Overview Rates continued to be under pressure during the first half of 2005, especiallyon the large risk managed accounts where we had to let go of business that wasinadequately rated. ISO's Property Claims Services (PCS) unit expects USproperty/casualty insurers to pay a record $50.3bn in catastrophe losses for2005 year. Performance The engineering team, who joined in September 2004, were well supported by ourbrokers during 2005 with some good opportunities to grow the business. They haveenjoyed an excellent showing of business by the brokers, who are able to accessa highly experienced and well respected team of specialist underwriters withmarket-leading capabilities. The market environment for construction anderection business, both annually renewable and for specific projects remainsstrong. The homeowners' and jewellers block account has continued to grow in 2005, withmost of the expansion coming from established books of business. We areprogressing plans to provide access to our jewellers block business in newmarkets such as the Middle East and China. The market environment remains stablewith rates holding firm in most areas. We had a successful first year in our Florida office, which has been establishedto write high value homeowners' property risks. We expect the loss we incurred from Hurricane Katrina to be contained wellwithin our reinsurance programme, a key achievement that differentiates us fromsome of our competitors. Selective and controlled underwriting has ensured thatour large commercial account has avoided many of the large individual risklosses in the market. Substantial reinsurance protection remains in place as at31 December 2005. Non hurricane loss activity continues to be benign in mostproperty classes during 2005. Outlook Due to the impact of the losses from the US hurricanes in 2004 and 2005 weexpect rates to increase substantially in catastrophe exposed areas, with agreater stability in pricing in other areas. Terms and conditions, such asdeductibles, are also expected to tighten as the supply of catastrophe insuranceand reinsurance cover contracts and demand increases. We expect rates to remain firm in the types of risk that Beazley target in theengineering and construction market, with no reduction in deductibles orwidening of terms. In the small risk accounts, such as the homeowners' andjewellers block, we anticipate that rates will remain stable. Further expansion is planned for the high-value homeowners' account written byour surplus lines office in Florida with additional states being rolled outduring 2006. Commercial auto mobile physical damage and cargo insurance areadditional classes of business designed for small to medium sized trucking firmsto provide cover for over the road equipment and cargo legal liability exposure.These will be written in 2006 following the recruitment of a specialistunderwriter. Also in the US, our admitted carrier BICI, has recently recruited a highlyrespected underwriter to lead the development of our mid-market commercialproperty account, which will focus on the needs of our clients seeking coverageon an admitted basis. We expect to start underwriting this business in the lastquarter of 2006. SPECIALTY LINES Profile Specialty lines generated 48% of the group's gross written premiums. Specialtylines is a market leader in many of its lines of business that comprises ofthree product groups; management liability, professional liability and thepolitical and contingency. Each of these three groups are then segmented by thesize of the business written, namely large risk, middle market and small risk/private enterprise. The new structure for the division came into effect in thesecond quarter of 2005 and is designed to promote consistency of approach andspecialisation within the teams in both class of business and customer segments.It also effectively integrates the UK and US teams enabling us to leverage ourunderwriting expertise across the business. Market Overview In 2005, the rating environment broadly met our expectations. The teamconsolidated its position as rate increases flattened as predicted. The impactof the hurricane activity on the portfolio eased pressure on pricing, which islikely to continue into 2006. We don't expect the mix of business we write tovary significantly from that written in 2005. This suggests that the content ofthe book is expected to be stable for its fourth consecutive year. The team have set key themes for 2006 which include the continued focus onproviding clients with ready access to experienced underwriters, the evolutionof our claims management strategy, and seeking and implementing operationalefficiencies and automation where this can improve our service, costs andcontrol. Performance We expect another year of stability in the proportion of business we write for2006. The income produced by our brokers remains stable, with our top fivebrokers producing 53% of our income in 2005, compared to 52% for 2004. We continue to lead business where appropriate with 2005 seeing us as theinsurer setting the terms for 72% of the polices we wrote (78% by premium)against 72% for 2004 (73% by premium). Geographically our book is still predominately US domiciled with 62% of premiumemanating from that territory compared to 63% in 2004. 20% of our premium comesfrom Europe which sees no change from 2004. The way in which the business is written has slightly changed from 2004, withfacultative business accounting for 68% of our premiums in 2005, against 73% for2004, whilst binder income was up to 24% for 2005 (20% for 2004). Outlook We will continue our policy of recruiting high calibre employees with theemphasis on US underwriters, claims, and business management teams in 2006. Weare also focusing on the retention and development of existing employees.Underwriting continues to be the nucleus of our business, which we support withthe continued development of our claims, financial, operations and projectmanagement expertise. We believe our commitment to service excellence, riskanalysis and the understanding, and delivery of products that meet our brokerand client needs will drive the business towards sustainable long termprofitability. REINSURANCE Profile The reinsurance team represents 12% of the group's 2005 gross premiums written.The team maintains a well established lead position in the market and providescapacity predominantly to cedents operating in major non-life insurance markets.We specialise in writing property catastrophe, property risk excess, casualtycatastrophe, aggregate excess of loss and pro-rata business. The department'smain exposures outside of the US emanate from the UK, Europe, Japan, Canada andAustralasia. Market overview The reinsurance market saw the first half of the year begin with reinsuranceratings slightly declining. As such many of the Lloyd's participants wereanticipating a softening market and were planning to reduce capacity. In the second half of 2005, we saw an unprecedented level of hurricane activityin the US. To put these losses in context, we witnessed 6 out of the 10 largestUS insured losses in history, just in the past two years. Unlike the hurricaneseason in 2004, which primarily affected direct insurers, the losses fromHurricane Katrina resulted in reinsurers bearing the largest share of theinsured loss. Current performance Over the past year, we saw gross premiums written increase considerably from£43.4m in 2004 to £65.5m in 2005, which is an increase of 51%. This was partlydue to the group increasing its share of the combined syndicates from 54% in2004 to 70% in 2005 and partly due to real growth in the business. Furtherincreases were due to reinstatement premiums accrued after the hurricanes. Many of our clients have been with us for at least 10 years with the renewalretention ratio remaining high in 2005. In addition we successfully increasedour share of target business. Western Europe, in particular Germany, France andItaly have yielded opportunities for new business along with Australasia andCanada. We have increased our profile in Central and Eastern Europe and thisremains an area of potential development in the future. Outlook There is likely to be stronger demand for risk transfer in 2006. However, wealso expect the supply of reinsurance to contract leading to a hardening of thereinsurance market. This may translate into either higher premiums or tighteningof terms and conditions or a combination of both. The January 2006 renewal season has demonstrated some of the opportunitiesavailable from these market conditions, particularly on accounts which sufferedlosses in 2005. Rates, terms and conditions are expected to remain at a levelthat will allow Beazley to continue to promote our strengths with both brokersand clients alike. To this end the estimated premiums for 2006 will build uponthe portfolio development achieved in 2005. We will continue to use modelled data with a due level of caution andunderstanding and combine it with other tools prior to making underwritingdecisions. The team will also continue to advance our long-term objective of developing awell diversified portfolio focusing on larger non-life insurance markets. Theteam intends to take advantage of its position in the Lloyd's market during thecurrent cycle, with targeted development particularly in Europe, thus increasingportfolio efficiency. CONSOLIDATED INCOME STATEMENTFOR THE YEAR ENDED 31 DECEMBER 2005 Note 2005 2004 £m £m Gross premiums written 3 558.0 402.3Written premiums ceded to reinsurers (132.2) (73.3) Net premiums written 3 425.8 329.0 Change in gross provision for unearned premiums (73.7) (28.2)Reinsurer's share of change in the 20.2 1.9provision for unearned premiumsChange in net provision for unearned premiums (53.5) (26.3)Net earned premiums 3 372.3 302.7 Net investment income 4 31.6 11.3Other income 5 6.9 11.2 38.5 22.5 Revenue 410.8 325.2 Insurance claims 463.7 224.8Insurance claims recovered from reinsurers (190.7) (42.8)Net insurance claims 273.0 182.0 Expenses for the acquisition of insurance contracts 95.5 71.4Administrative expenses 23.0 17.6Other expenses 1.4 17.8Operating expenses 6 119.9 106.8 Expenses 392.9 288.8 Results of operating activities 17.9 36.4 Finance costs 8 (1.8) (1.1)Share of profit of associates 14 - 0.1 Profit before tax 16.1 35.4 Income tax expense 9 (5.0) (10.6) Profit after tax 11.1 24.8 Earnings per share (pence per share):Basic 10 3.1 9.9Diluted 10 3.1 9.9 BALANCE SHEETAS AT 31 DECEMBER 2005 2005 2004 Note Group Company Group Company £m £m £m £m AssetsIntangible assets 12 18.2 - 8.1 -Plant and equipment 13 2.5 - - -Investment in subsidiaries - 31.7 - 5.1Investments in associates 14 1.3 - 1.3 -Deferred acquisition costs 15 52.7 - 38.3 -Financial investments 16 771.9 221.9 469.9 228.0Insurance receivables 17 158.9 - 89.0 -Deferred income tax 25 2.4 - 0.4 -Reinsurance assets 18,23 394.5 - 98.3 -Other receivables 28.4 48.4 25.4 26.6Cash and cash equivalents 19 112.6 6.7 81.5 1.7 Total assets 1,543.4 308.7 812.2 261.4 EquityShare capital 20 18.0 18.0 18.0 18.0Reserves 21,22 232.1 229.4 232.5 230.5Retained earnings 30.3 16.1 27.1 2.1 Total equity 280.4 263.5 277.6 250.6 LiabilitiesInsurance liabilities 23 1,096.4 - 460.5 -Borrowings 24 29.1 10.5 9.4 9.4Deferred income tax 25 6.0 - 6.0 -Current income tax liabilities 4.5 1.3 3.2 0.7Creditors 26 124.1 33.4 51.6 0.7Retirement benefit obligations 27 2.9 - 3.9 - Total liabilities 1,263.0 45.2 534.6 10.8 Total equity and 1,543.4 308.7 812.2 261.4liabilities STATEMENT OF MOVEMENTS IN EQUITYFOR THE YEAR ENDED 31 DECEMBER 2005 Group Note Share Reserves Retained Total Capital £m Earnings £m £m £m Balance at 1 January 2004 11.5 134.2 4.1 149.8 Retained profits for the - - 24.8 24.8yearDividends paid 11 - - (1.8) (1.8) Increase in employee 21 - 0.2 - 0.2share optionsIssue of shares 6.5 - - 6.5 Share premium on issue of - 103.6 - 103.6sharesCapitalised listing costs - (5.5) - (5.5) Balance at 31 December 18.0 232.5 27.1 277.62004 Retained profits for the - - 11.1 11.1yearDividends paid 11 - - (7.9) (7.9) Increase in employee 21 - 0.4 - 0.4share optionsAcquisition of own shares 21 - (1.6) - (1.6)in trustForeign exchange - 0.8 - 0.8translation differences Balance at 31 December 18.0 232.1 30.3 280.42005 Company Note Share Reserves Retained Total Capital £m Earnings £m £m £m Balance at 1 January 2004 11.5 132.4 1.3 145.2 Retained profits for the year - - 2.6 2.6Dividends paid 11 - - (1.8) (1.8)Issue of shares 6.5 - - 6.5Share premium on issue of shares - 103.6 - 103.6Capitalised listing costs - (5.5) - (5.5) Balance at 31 December 18.0 230.5 2.1 250.62004 Retained profits for the year - - 21.9 21.9Dividends paid 11 - - (7.9) (7.9)Foreign exchange translation differences - (1.1) - (1.1) Balance at 31 December 18.0 229.4 16.1 263.52005 CASH FLOW STATEMENTFOR THE YEAR ENDED 31 DECEMBER 2005 2005 2004 Note Group Company Group Company £m £m £m £m Cash flow from operatingactivitiesProfit before tax 16.1 23.6 35.4 4.3Adjustments for non-cashitems:Amortisation of intangibles 0.3 - - -Equity settled share based compensation 0.4 - 0.2 -Foreign exchange translation of foreign subsidiary 1.9 - - -Net fair value losses/ (gains) on financialassets (3.0) 0.7 0.5 (0.4)Share in profit of associates - - (0.1) - Changes in operatingassets and liabilities:Increase in insurance liabilities 635.9 - 202.0 -Increase in insurance receivables (69.9) - (6.4) -Increase in other receivables (3.0) (21.8) (16.0) 8.0Increase in deferred acquisition costs (14.4) - (6.1) -Increase in reinsurance assets (296.2) - (39.4) -Increase in creditors 69.0 32.7 14.1 (0.6)Income tax paid (5.8) (1.1) (3.3) (1.0)Contribution to pension fund (1.0) - - -Acquisition of own shares in trust 21 (1.6) - - -Net cash from operating activities 328.7 34.1 180.9 10.3 Cash flow from investingactivitiesPurchase of plant and equipment 13 (2.5) - - -Purchase of syndicate capacity 12 (1.6) - (1.0) -Purchase of licences 12 (5.1) - - -Purchase of investments (1,419.3) 211.1 (663.5) (201.9)Purchase of software development (3.6) - - -Proceeds from sale of investments 1,120.2 (205.7) 434.1 106.0Capital injection in subsidiary - (26.6) - - Net cash used in investing activities (311.9) (21.2) (230.4) (95.9) Cash flow from financingactivitiesProceeds from issue of shares - - 104.6 104.6Proceeds from borrowings 18.6 - 9.4 9.4Inter-group balances - - - (25.3)Dividends paid 11 (7.9) (7.9) (1.8) (1.8) Net cash used in 10.7 (7.9) 112.2 86.9financing activitiesNet increase in cash and 27.5 5.0 62.7 1.3cash equivalentsCash and cash equivalents 81.5 1.7 19.4 0.4at beginning of yearEffect of exchange rate changes on cash and cash equivalents 3.6 - (0.6) - Cash and cash equivalents 19 112.6 6.7 81.5 1.7at end of year NOTES FOR THE YEAR ENDED 31 DECEMBER 2005 1. Statement of accounting policies Beazley Group plc is a group domiciled in England and Wales. The consolidatedfinancial statements of the group for the year ended 31 December 2005 comprisethe parent company and its subsidiaries and the group's interest in associates. Both the parent company financial statements and the group financial statementshave been prepared and approved by the directors in accordance withInternational Financial Reporting Standards as adopted by the EU ("AdoptedIFRSs"). On publishing the parent company financial statements here togetherwith the group financial statements, the company is taking advantage of theexemption in s230 of the Companies Act 1985 not to present its individual incomestatement and related notes that form a part of these approved financialstatements. The group and parent company have applied IFRS 1 First-time Adoption ofInternational Financial Reporting Standards. These consolidated financialstatements have been prepared on the basis of adopted IFRSs in issue that areeffective or available for early adoption at 31 December 2005. Based on theseadopted IFRSs, the directors have applied the accounting policies, as set outbelow. An explanation of how the transition to IFRSs has affected the reported incomestatement, balance sheet and cash flows of the group is provided in note 33. Thenote includes reconciliations of equity and profit and loss for the comparativeperiods reported under UK GAAP to those reported for those periods under IFRSs.The group's transition date is 1 January 2004 and it has prepared its openingIFRS balance sheet at that date. The principal accounting policies applied in the preparation of theseconsolidated financial statements are set out below. The policies have beenconsistently applied to all periods presented, unless otherwise stated. Basis of presentation The financial information set out in this statement is extracted from thestatutory accounts for the year ended 31 December 2005. The financialinformation for 2004 is derived from the IFRS restatement document published bythe group on 1 July 2005. Consequently the 2004 comparative informationpublished herein does not constitute the statutory accounts of the group forthat year. The auditors have reported on the 2005 and the original 2004 UK GAAPaccounts; their reports were unqualified and do not contain a statement undersection 237(2) or (3) or the Companies Act 1985. The statutory accounts for 2005will be delivered to the registrar of companies following the annual generalmeeting. First time adoption of IFRS The group has taken advantage of the following exemptions set out in IFRS 1. a) Business combinations The group has elected not to retrospectively apply IFRS 3 - BusinessCombinations. It has not restated business combinations that occurred prior to 1January 2004. b) Employee benefits The group has elected to recognise all actuarial losses under the definedbenefit pension scheme as at 1 January 2004. c) Share based payments The group has not applied the requirements of IFRS 2 - Share Based Payments toshare options granted before 7 November 2002. Estimates Estimates included in the opening balance sheet at 1 January 2004 and 31December 2004 are consistent with the underlying estimates made at the same dateunder UK GAAP. The exemptions for IFRS 4 - Insurance Contracts, IAS 32 - Financial Instruments:Disclosure and Presentation and IAS 39 - Financial Instruments: Recognition andMeasurement have not been taken as the group has applied these standards inpreparing the comparatives. Use of estimates The preparation of the financial statements requires the group to make certaincritical estimates and assumptions. Although these estimates are based onmanagement's best knowledge of current facts, circumstances and to some extentfuture events and actions, actual results ultimately may differ from thoseestimates, possibly significantly. Consolidation a) Subsidiary undertakings Subsidiary undertakings, which are those entities in which the group directly orindirectly, has the power to exercise control over financial and operatingpolicies, have been consolidated. They are consolidated from the date on whichcontrol is transferred to the group and cease to be consolidated from the dateon which control ceases. The group has used the purchase method of accounting for the acquisition ofsubsidiaries. Under purchase accounting, the cost of acquisition is measured asthe fair value of assets given, shares issued or liabilities undertaken at thedate of acquisition plus costs directly attributable to the acquisition. Theexcess of the cost of an acquisition over the fair value of the net assets ofthe subsidiary acquired is recorded as goodwill. Certain group subsidiaries underwrite as corporate members of Lloyd's on asyndicate managed by Beazley Furlonge Limited. In view of the several liabilityof underwriting members at Lloyd's for the transactions of syndicates in whichthey participate, only attributable share of transactions, assets andliabilities of that syndicate have been included in the financial statements. b) Associates Associates are those entities in which the group has power to exert significantinfluence, but which it does not control. Significant influence is generallypresumed if the group has between 20% and 50% of voting rights. Investments in associates are accounted for using the equity method ofaccounting. Under this method, the group's share of post acquisition profits orlosses is recognised in the income statement and its share of post acquisitionmovements in reserves are recognised in reserves. The cumulative postacquisition movements are adjusted against the cost of the investment. When the group's share of loss equals or exceeds the carrying amount of theassociate, the carrying amount is reduced to nil and recognition for the loss isdiscontinued except to the extent that the group has incurred obligations inrespect of the associate. Equity accounting is discontinued when the group no longer has significantinfluence over the investment. c) Intercompany balances and transactions All intercompany transactions, balances and unrealised gains or losses ontransactions between group companies have been eliminated. All accounting policies have been consistently applied throughout the group. Foreign currency translation a) Functional and presentation currency Items included in the financial statements of the parent and the subsidiariesare measured using the currency of the primary economic environment in which itoperates (the 'functional currency'). The consolidated financial statements arepresented in GBP, which is the group's presentation currency and functionalcurrency. b) Transactions and balances Foreign currency transactions are translated into the functional currency usingaverage exchange rates applicable to this period and which the group considersto be reasonable approximation of the historic rate. Foreign exchange gains andlosses resulting from the settlement of such transactions and from translationat the period end of monetary assets and liabilities denominated in foreigncurrencies are recognised in the income statement. Non monetary items recordedat historical cost in foreign currencies are translated using the exchange rateon the date of the transaction. c) Group companies The results and financial position of the group companies that have a functionalcurrency different from the presentation currency are translated into thepresentation currency as follows: i) assets and liabilities are translated at the closing rate at the date of that balance sheet;ii) income and expenses for each income statement are translated at average exchange rates in the period;iii) all resulting exchange differences are recognised as a separate component of equity. The exchange differences on disposal of foreign entities are recognised in theincome statement as part of the gain or loss on disposal. Insurance contracts Insurance contracts (including inwards reinsurance contracts) are defined asthose containing significant insurance risk. Insurance risk is consideredsignificant if and only if, an insured event could cause an insurer to paysignificant additional benefits in any scenario, excluding scenarios that lackcommercial substance. Such contracts remain insurance contracts until all rights and obligations areextinguished or expire. Net earned premiums a) Premiums Gross premiums written represent premiums on business incepting in the financialyear together with adjustments to premiums written in previous accountingperiods and estimates for pipeline premiums. Gross premiums written are statedbefore deduction of brokerage, taxes, duties levied on premiums and otherdeductions. b) Unearned premiums A provision for unearned premium (gross of reinsurance) is made which representsthat part of the gross premiums written that is estimated will be earned in thefollowing financial periods. It is calculated using the daily pro rata methodwhere the premium is apportioned over the period of risk. Deferred acquisition costs (DAC) Acquisition costs comprise brokerage, premium levy and staff related costs ofthe underwriters acquiring new business and renewing existing contracts. Theproportion of acquisition costs in respect of unearned premiums are deferred atbalance date and recognised in later periods when the related premiums areearned. Claims These include the cost of claims and claims handling expenses paid during theperiod, together with the movements in provisions for outstanding claims, claimsincurred but not reported (IBNR) and future claims handling provisions. Theprovision for claims comprises amounts set aside for claims advised and IBNR. The IBNR amount is based on estimates calculated using widely accepted actuarialtechniques which are reviewed quarterly by the group actuary and annually byBeazley's independent consulting actuary. The techniques generally useprojections, based on past experience of the development of claims over time, toform a view on the likely ultimate claims to be experienced. For more recentunderwriting years, regard is given to the variations in the business portfolioaccepted and the underlying terms and conditions. Thus, the critical assumptionsused when estimating provisions are that past experience is a reasonablepredictor of likely future claims development and that the rating and businessportfolio assumptions are a fair reflection of the likely level of ultimateclaims to be incurred for the more recent years. Liability adequacy testing At each balance sheet date, liability adequacy tests are performed to ensure theadequacy of the insurance liabilities net of DAC. In performing these tests,current best estimates of future contractual cash flows, claims handling andadministration expenses as well as investment income from the assets backingsuch liabilities are used. Any deficiency is immediately charged to the profitor loss initially by writing off DAC and by subsequently establishing aprovision for losses arising from liability adequacy tests ('unexpired riskprovision'). Reinsurance These are contracts entered into by the group with reinsurers under which thegroup is compensated for losses on contracts issued by the group and that meetthe definition of an insurance contract. Insurance contracts entered into by thegroup under which the contract holder is another insurer (inwards reinsurance)are included with insurance contracts. Any benefits to which the group is entitled under its reinsurance contracts heldare recognised as reinsurance assets. These assets consist of balances due fromreinsurers and include reinsurers' share of provisions for claims. Thesebalances are based on calculated amounts of outstanding claims and projectionsfor IBNR, net of estimated irrecoverable amounts having regard to thereinsurance programme in place for the class of business, the claims experiencefor the period and the current security rating of the reinsurer involved.Reinsurance liabilities are primarily premiums payable for reinsurance contractsand are recognised as an expense when due. The group assesses its reinsurance assets for impairment. If there is objectiveevidence of impairment, then the carrying amount is reduced to its recoverableamount and the impairment loss is recognised in the income statement. Revenue Revenue consists of net earned premium, net investment income, profitcommissions earned and managing agent's fees. Profit commissions and managing agent's fees are recognised as the services areprovided. Insurance receivables and payables Receivables and payables are recognised when due. These include amounts due toand from agents, brokers and insurance contract holders. Dividends paid Dividend distribution to the shareholders of the group is recognised in theperiod in which the dividends are approved by the shareholders in the group'sannual general meeting. Interim dividends are recognised in the period in whichthey are paid and approved by the board of directors. Plant and equipment All fixed assets are recorded at cost less accumulated depreciation.Depreciation is calculated using the straight line method to allocate the costof the assets to their residual values over their estimated useful lives asfollows: Fixtures and fittings Three to five years Computer equipment Three years These assets' residual value and useful lives are reviewed at each balance sheetdate and adjusted if appropriate. Intangible assets a) Goodwill Goodwill represents the excess of the cost of an acquisition over the fair valueof the group's share of the net assets of the acquired subsidiary/associate atthe date of acquisition. Goodwill is carried at cost less accumulated impairmentlosses. Goodwill has an indefinite life and is annually tested for impairment. Goodwillis allocated to each cash generating unit for the purpose of impairment testing.Goodwill is impaired when the net present value of the forecast future cashflows is insufficient to support its carrying value. b) Licences Licences are shown at historical cost. They have an indefinite useful life andare carried at cost less accumulated impairment. Licences are annually testedfor impairment and provision is made for any impairment when the net presentvalue of future cash flows is less than the carrying value. c) Syndicate capacity The syndicate capacity represents the cost of purchasing the group'sparticipation in syndicate 2623. The capacity is capitalised at cost in thebalance sheet. It has an indefinite useful life and is carried at cost lessaccumulated impairment. It is annually tested for impairment and provision ismade for any impairment. d) Computer software Costs that are directly associated with the development of identifiable andunique software products and that will probably generate economic benefitsexceeding costs beyond one year, are recognised as intangible assets. Costsinclude external consultant's fees, certain qualifying internal staff costs andother costs incurred to develop and maintain software programmes. These costsare amortised over their estimated useful life (3 years). Other non-qualifyingcosts have been expensed as incurred. Investments Investments are recognised in the balance sheet at such time that the groupbecomes a party to the contract of the financial instrument. An investment isderecognised when the contractual rights to receive cash flows from thefinancial assets expire, or where the financial assets have been transferred,together with substantially all the risks and rewards of ownership. On acquisition of the investment, the group is required to classify itsinvestments into the following categories: financial assets at fair valuethrough income, loans and receivables, held to maturity and available for sale.At balance date the group had all investments classified as fair value throughincome. Financial assets at fair value through income A financial asset is classified as fair value through income at inception if itis acquired principally for the purpose of selling in the short term, if itforms part of a portfolio in which there is evidence of short term profit takingor if it is designated so by management. Purchases and sales are recognised on the trade date, which is the date thegroup commits to purchase or sell the asset, net of transaction costs. Theseinvestments are subsequently carried at fair value. Any gains and losses arisingfrom changes in fair value are recognised in the income statement in the periodin which they arise. The fair values of investments are based on quoted bid price. Investment income Investment income consists of dividends, interest, realised and unrealised gainsand losses on trading investments. Dividends on equity securities are recordedas revenue on the ex-dividend date. Interest is recognised on an accruals basis.Realised gain or loss on disposal of an investment is the difference between theproceeds (net of transaction costs) and the carrying value of the investment.Unrealised investment gains and losses represent the difference between thecarrying value at the balance sheet date, and the carrying value at the previousperiod end or purchase value during the period. Cash and cash equivalents Cash and cash equivalents consist of cash at bank and in hand, deposits held atcall with banks, bank overdrafts and other short term highly liquid investmentswith maturities of three months or less from the date of acquisition. Operating leases Leases where a significant portion of the risks and rewards of ownership areretained by the lessor are classified as operating leases. Payments made foroperating leases are charged to the income statement on a straight line basisover the period of the lease. Employee benefits a) Annual leave and long service leave Employee entitlements to annual leave and long service leave are recognised whenthey accrue to employees. b) Pension obligations The group operates a defined benefit and a defined contribution pension scheme.The schemes are generally funded by payments from employees and the group takingaccount of the recommendations of an independent qualified actuary. A defined benefit plan is a pension plan that defines an amount of pensionbenefit that an employee will receive on retirement, usually dependent on one ormore factors like age, years of service and compensation. The pension costs areassessed using the projected unit credit method. Under this method the costs ofproviding pensions is charged to the income statement so as to spread theregular costs over the service lives of employees in accordance with the adviceof the qualified actuary, who values the plans annually. The pension obligationis measured at present value of the estimate future cash flows. The actuarialgains or losses are recognised in the profit or loss using the corridor approachover the average remaining service lives of employees. The corridor approach is defined as the excess of net cumulative unrecognisedgains and losses at the end of the previous reporting period and the greater of: i) 10% of present value of the defined benefit obligation at that date; andii) 10% of fair value of plan assets at that date. For the defined contribution plan, the group pays contributions to a privatelyadministered pension plan. Once the contributions have been paid, the group hasno further obligations. The group's contributions are charged to the incomestatement in the period to which they relate. c) Share based compensation The group offers option plans over the group's ordinary shares to certainemployees, including save as you earn plan (SAYE), details of which are includedin the directors' remuneration report. The group accounts for share compensation plans that were granted after 7November 2002. The cost of providing share based compensation is based on thefair value of the share options at grant date, which is recognised in the incomestatement over the expected service period of the related employees. The fairvalue of the share options is determined using the Black Scholes method. When the options are exercised, the proceeds received, net of any transactioncosts are credited to share capital (nominal value) and share premium. Income taxes Income tax on the profit or loss for the period presented comprises current anddeferred tax. Income tax is recognised in the income statement except to theextent that it relates to items recognised directly in equity, in which case itis recognised in equity. Current tax is the expected tax payable on the taxable income for the year usingtax rates enacted or substantially enacted at balance sheet date and anyadjustments to tax payable in respect of prior periods. Deferred tax is provided in full, using the liability method, on temporarydifferences arising between the tax bases of assets and liability and theircarrying amounts in the financial statements. The amount of deferred taxprovided is based on the expected manner of realisation or settlement of thecarrying amount of the assets and liabilities, using tax rates enacted orsubstantially enacted at balance sheet date. Deferred tax assets are recognised in the balance sheet to the extent that it isprobable that future taxable profit will be available against which thetemporary differences can be utilised. Borrowings Borrowings are initially recorded at proceeds less transaction costs incurred.Subsequently borrowings are stated at amortised cost and interest is recognisedin the income statement over the period of the borrowings using the effectiveinterest method. Earnings per share Basic earnings per share is calculated by dividing profit after tax available toshareholders by the weighted average number of ordinary shares in issue duringthe period. For diluted earnings per share, the weighted average number of ordinary sharesin issue is adjusted to assume conversion of all dilutive potential ordinaryshares such as share options granted to employees. Provisions and contingencies Provisions are recognised when the group has a present legal or constructiveobligation as a result of past event, it is probable that an outflow ofresources of economic benefits will be required to settle the obligation and areliable estimate of the obligation can be made. Where the group expects aprovision to be reimbursed, the reimbursement is recognised as a separate assetbut only when the reimbursement is virtually certain. Contingencies are disclosed if there is a present obligation that may, butprobably will not require an outflow of resources. 2. Risk management The group has identified the risks arising from its activities and hasestablished risk management policies and procedures to manage these risks inaccordance with its risk appetite. The group categorises its risks into sixareas; insurance, credit, market, liquidity, operational and group risk. Thesections below outline the group's risk appetite and explain how it defines andmanages each category of risk. Insurance risk The group's insurance business assumes the risk of loss from persons ororganisations that are directly exposed to an underlying loss. Insurance riskarises from this risk transfer due to inherent uncertainties about theoccurrence, amount and timing of insurance liabilities. The four key componentsof insurance risk are underwriting, reinsurance, claims management, reservingand ultimate reserves. Each element is considered below. a) Underwriting risk Underwriting risk comprises four elements that apply to all insurance productsoffered by the group: • Event risk - the risk that individual risk losses or catastrophes lead to claims that are higher than anticipated in plans and pricing;• Pricing risk - the risk that the level of expected loss is understated in the pricing process;• Cycle risk - the risk that business is written in a soft market without full knowledge as to the (in)adequacy of rates, terms and conditions; and• Expense risk - the risk that the allowance for expenses and inflation in pricing is inadequate. The group's underwriting strategy is to seek a diverse and balanced portfolio ofrisks in order to limit the variability of outcomes. This is achieved byaccepting a spread of business over time, segmented between different classes ofbusiness. The annual business plans for each underwriting team reflect the group'sunderwriting strategy, and set out the classes of business to be written, theterritories in which business is to be written and the industry sectors to whichthe group is prepared to expose itself. These plans are approved and monitoredby the underwriting committee which meets monthly. The group also recognises that insurance events are, by their nature, random,and the actual number and size of events during any one year may vary from thoseestimated using established statistical techniques. To address this, the group sets out the realistic disaster scenario (RDS)exposure that it is prepared to accept in certain territories to a range ofevents such as natural catastrophes and terrorism losses. The current aggregateposition is monitored at the time of underwriting a risk, and reports areproduced to highlight the key aggregations to which the group is exposed. The group uses a number of modelling tools to monitor aggregation and tosimulate catastrophe losses in order to measure the effectiveness of itsreinsurance programmes. Stress and scenario tests are also run using thesemodels. The greatest likelihood of significant losses to the group arises fromcatastrophe events, such as flood damage, windstorm or earthquake. Wherepossible the group measures geographic accumulations and uses their knowledge ofthe business, historical loss behaviour and commercial catastrophe modellingsoftware to assess the probable maximum loss (PML). Upon application of thereinsurance coverage purchased, the key gross and net exposures are calculatedon the basis of a 1 in 250 year event. The group regularly models and monitorsknown accumulations of risks including natural catastrophes, marine, liabilityand political events. The group's largest Lloyd's specified natural catastrophe 1 in 250 year stressevents are: 2005 2004 Lloyd's prescribed 1 in Modelled PML Modelled PML Modelled PML Modelled PML250 year natural (before (after (before (aftercatastrophe event reinsurance) reinsurance) reinsurance) reinsurance) £m £m £m £mSan Francisco Quake ($54bn) 210.3 77.7 123.4 34.6Gulf of Mexico Windstorm ($60bn) 178.2 59.5 133.3 51.8Florida Pinellas Windstorm ($70bn) 188.8 102.1 114.3 53.2 The group share of the combined syndicate increased from 54% in 2004 to 70% in2005 which is the main reason for the increases above. These events reflectavailable reinsurance programmes at the assumed loss date. In 2005, the normal maximum gross PML line that any one underwriter could committhe managed syndicate to was $50m. In many cases, maximum lines for classes ofbusiness were much lower than this. These authority limits are enforced througha comprehensive sign off process for underwriting transactions including dualsignoff for all line underwriters. Automated exception reports are also runregularly covering line size, class and industry. All underwriters also have a right to refuse renewal or change the terms andconditions of insurance contracts upon renewal. Rate monitoring details,including limits, deductibles, exposures, terms and conditions and riskcharacteristics are also captured and the results are combined to monitor therating environment for each class of business. Terms and conditions of insurance risks The group's business is structured as a confederation of four independentbusiness segments utilising the same capital base and central services. Thegroup has recognised risk features specific to the main insurance productsoffered by the group, and these are explained below. Specialty lines This segment mainly underwrites professional lines, employment practicesliability, specialty liability, political risk, directors and officersliability, healthcare and contingency. Whilst most of this business is domiciledin the US, the team also has a presence in continental Europe and the UK. The liability insurance which is written on a worldwide basis is consideredmedium tail because claims in this class typically take 3 to 9 years before theyare fully reported and paid by the group for a given accident year. The speed ofclaim reporting and claim settlement is a function of the specific coverageprovided, the jurisdiction and specific policy provisions such as self-insuredretentions. Other inherent uncertainties encountered through this class include: • Whether the "event" triggering coverage is confined to only one time period or is spread over multiple time periods;• The potential financial costs arising from individual claim actions;• Whether such claims were reasonably foreseeable and intended to be covered at the time the contracts were written; and• The potential for mass claim actions. Marine This segment underwrites a broad spectrum of marine classes. Specialised coveroffered includes hull, energy, cargo & specie and war risks and the majority ofthese risks are exposed to catastrophes. For example, a significant portion ofthe energy business is exposed to the Gulf of Mexico and thus has significanthurricane exposure. Some areas of the marine business overlaps with other segments which can resultin accumulation of losses. These accumulations including exposures tocatastrophes are regularly monitored and managed by our reinsurance programmes. Reinsurance This division specialises in writing property catastrophe, property per risk,aggregate excess of loss and pro rata business. The two primary risks in this business are: • The risk that a catastrophe event does or does not occur; and• That future catastrophe experience may turn out to be inconsistent with the assumptions used in the industry-wide pricing models, causing claims experience to be higher than expected. Property Our property segment underwrites property insurance on a worldwide basis.Property insurance indemnifies, subject to any limits or excesses, thepolicyholder against loss or damage to their own material property and businessinterruption arising from this damage. The event giving rise to a claim fordamage to buildings or contents usually occurs suddenly (as for fire andburglary) and the cause is easily determinable. The claim will thus be notifiedpromptly and can be settled without delay (an exception to this is subsidenceclaims). Significant geographical concentrations of risk can exist within propertyportfolios meaning that natural perils such as adverse windstorms or earthquakesmay expose large segments of the group's property risks. In the event of anearthquake, the property portfolio expects to receive claims for both structuraldamage and business interruption. b) Reinsurance risk Reinsurance risk to the group arises where reinsurance contracts put in place toreduce gross insurance risk do not perform as anticipated, result in coveragedisputes or prove inadequate in terms of the vertical or horizontal limitspurchased. The group's reinsurance programmes are determined from the underwriting teambusiness plans and seek to protect group capital from an adverse volume orvolatility of claims on both a per risk and per event basis. In 2005, the groupbought a combination of proportional and non-proportional reinsurance treatiesand facultative reinsurance to reduce the maximum net exposure on any one riskfor the managed syndicates to $22.5m. In most classes of business the maximumnet exposure is much lower than this. The group aims to establish appropriateretention levels and limits of protection that are consistent with keepingwithin the board's risk tolerance and achieving the target rates of return. Theefficacy of protection sought is assessed against the cost of reinsurance,taking into consideration current and expected market conditions. The reinsurance security committee (RSC) examines and approves all reinsurers toensure that they possess suitable security. The RSC also establish limits forthe reinsurance programme regarding quality and quantity. The group's cededreinsurance team maintain the list of these approved reinsurers and no treatyreinsurance is placed without prior referral from this team. This team alsomonitors erosion of the reinsurance programme and its ongoing adequacy. c) Claims management risk Claims management risk may arise within the group in the event of inaccurate orincomplete case reserves and claims settlements, poor service quality orexcessive claims handling costs. Such risks may damage the group brand andundermine its ability to win and retain business. These risks can occur at anystage of the claims life-cycle. The group's claims teams are focused upon delivering quality, reliability andspeed of service to both internal and external clients. Their aim is to adjustand process claims in a fair, efficient and timely manner, in accordance withthe policy's terms and conditions, the regulatory environment, and the business'broader interests. Prompt and accurate case reserves are set for all knownclaims liabilities, including provisions for expenses. d) Reserving and ultimate reserves risk Reserving and ultimate reserves risk occurs within the group where establishedinsurance liabilities are insufficient through poor forecasting, or where thereis inadequate allowance for expenses and reinsurance bad debts in provisions. To address reserving and ultimate reserves risk we have an experienced actuarialdepartment. An external independent actuary also performs an annual review toproduce a statement of actuarial opinion for syndicates 2623 and 623. The group's reserving policy is to use recognised actuarial techniques toproject gross premiums written and insurance liabilities. The objective is toproduce reliable and appropriate estimates that are consistent over time andacross classes of business. Estimates of gross premiums written and claims areprepared by the actuarial department, and are used through a formal quarterlypeer review process to independently check the integrity of the estimatesproduced by the underwriting teams for each class of business. These meetingsare attended by senior management, senior underwriters, actuarial, claims, andfinance representatives. 2.2 Credit risk Credit risk arises where counterparties fail to meet their financial obligationsin full as they fall due. The primary sources of credit risk for the group are: • Reinsurers - whereby reinsurers may fail to pay valid claims against a reinsurance contract held by the group;• Brokers and intermediaries - whereby counterparties fail to pass on premium or claims collected or paid on behalf of the group; and• Investments - whereby issuer default results in the group losing all or part of the value a financial instrument. The group's core business is to accept significant insurance risk and theappetite for other risks is low. This protects the group's capital from erosionso that it can meet its insurance liabilities. To assist in the understanding of credit risks, A.M. Best, Moody's and Standard& Poor's (S&P) ratings are used. These ratings have been categorised below asused for Lloyd' reporting: A.M. Best Moody's S&P Tier 1 A++ to A- Aaa to A3 AAA to A-Tier 2 B++ to B- Baa1 to Ba3 BBB+ to BB-Tier 3 C++ to C- B1 to Caa B+ to CCCTier 4 D,E,F,S Ca to C R,(U,S) 3 The following tables summarise the group's significant concentrations of creditrisk: 31 December 2005 Tier 1 Tier 2 Tier 3 Tier 4 Unrated Total £m £m £m £m £m £m Financial investments 684.9 38.4 2.8 - 45.8 771.9Insurance receivables 17.3 - - - 141.6 158.9Reinsurance assets 347.3 1.9 - - 45.3 394.5Cash and cash equivalents 106.8 - - - 5.8 112.6 Total 1,156.3 40.3 2.8 - 238.5 1,437.9 31 December 2004 Tier 1 Tier 2 Tier 3 Tier 4 Unrated Total £m £m £m £m £m £m Financial investments 414.6 29.2 - - 26.1 469.9Insurance receivables 12.7 0.1 - - 76.2 89.0Reinsurance assets 88.2 0.7 - - 9.4 98.3Cash and cash equivalents 81.5 - - - - 81.5 Total 597.0 30.0 - - 111.7 738.7 Key controls operated by the group to address credit risk are set out below. The group has developed processes to formally examine all reinsurers beforeentering into new business arrangements. New reinsurers are approved by the RSC,which also reviews arrangements with all existing reinsurers at least annually.Vulnerable or slow paying reinsurers are examined more frequently. An approval system also exists for new brokers, and broker performance isregularly reviewed. System exception reports highlight trading with non-approvedbrokers, and the group's credit control team regularly monitors the aging andcollectibility of debtor balances. Large and aged items are prioritised. The investments committee has established guidelines for the group's investmentmanagers regarding the type, duration and quality of investments acceptable tothe group. The performance of investment managers is regularly reviewed toconfirm adherence to these guidelines. 2.3 Liquidity risk The group is exposed to daily calls on its available cash resources, principallyfrom claims arising from its insurance business. Liquidity risk arises wherecash may not be available to pay obligations when due at a reasonable cost. The group's approach is to manage its liquidity position so that it canreasonably survive a significant loss event. This means that the group maintainssufficient liquid assets, or assets that can be translated into liquid assets atshort notice and without capital loss, to meet expected cash flow requirements.These liquid funds are regularly monitored using cash flow forecasting to ensurethat surplus funds are invested to achieve a higher rate of return. 2.4 Market risk Market risk arises where the value of assets and liabilities change as a resultof movements in foreign exchange rates, interest rates and market prices. a) Foreign exchange risk The group is exposed to changes in the value of assets and liabilities due tomovements in foreign exchange rates. The group deals in four main currencies, US$, UK £, CAD $ and Euro •. Transactions in all other currencies are converted toUK £ on initial recognition. The group manages foreign exchange exposure by projecting forward our US $profits for each calendar year and selling one twelfth of the expected amounteach month. The amounts sold are periodically validated against actual exposureand additional 'top up' trades of US dollars are made if required. The foreignexchange exposure to CAD $ and Euro • are closely monitored by the group and asimilar approach will be taken to manage the risk as our exposure grows in thefuture. The following table summarises the carrying value of total assets and totalliabilities categorised by currency: 31 December 2005 US $ CAD $ EUR • Subtotal UK £ Total £m £m £m £m £m £m Total assets 940.0 38.4 54.3 1,032.7 525.0 1,557.7 Total liabilities (928.3) (32.8) (46.0) (1,007.1) (255.9) (1,263.0) 11.7 5.6 8.3 254.8 280.4 25.6 31 December 2004 US $ CAD $ EUR • Subtotal UK £ Total £m £m £m £m £m £m Total assets 351.3 21.3 20.9 393.5 418.7 812.2 Total liabilities (364.6) (14.2) (18.2) (397.0) (137.6) (534.6) (13.3) 7.1 2.7 3.5 281.1 277.6 b) Interest rate risk Some of the group's financial instruments including financial investments, cashand cash equivalents and borrowings, are exposed to movements in market interestrates. The group manages interest rate risk by investing in short duration financialinvestments and cash and cash equivalents. The investment committee monitors theduration of these assets on a regular basis. The following summarises the effective interest rate of the group's financialinstruments exposed to interest rate risk at the balance sheet date. 2005 2004 % % Debt securities 4.6 2.7 Cash and cash equivalents 3.4 2.5 Borrowings 8.1 7.1 The following table shows the average duration of the financial instruments.Duration is a commonly used measure of volatility and we believe gives a betterindication than maturity of the likely sensitivity of our portfolio to changesin interest rates. Duration31 December 2005 10 yrs Total yrs Debt securities 505.4 188.3 15.1 12.5 2.7 0.9 - 724.9Cash and cash equivalents 112.6 - - - - - - 112.6Borrowings - - (18.6) - - - (10.5) (29.1)Total 618.0 188.3 (3.5) 12.5 2.7 0.9 (10.5) 808.4 31 December 2004 10 yrs Total yrs Debt securities 423.8 21.1 3.3 1.5 - - - 449.7Cash and cash equivalents 81.5 - - - - - - 81.5Borrowings - - - - - - (9.4) (9.4)Total 505.3 21.1 3.3 1.5 - - (9.4) 521.8 The next two tables summarise the carrying amount of financial instrumentsexposed to interest rate risk by maturity at balance sheet date. Maturity31 December 2005 10 yrs Total yrs Debt securities 319.7 284.6 11.6 50.1 17.8 40.5 0.6 724.9Cash and cash equivalents 112.6 - - - - - - 112.6Borrowings - - (18.6) - - - (10.5) (29.1)Total 432.3 284.6 (7.0) 50.1 17.8 40.5 (9.9) 808.4 31 December 2004 10 yrs Total yrs Debt securities 301.9 69.9 35.7 1.1 8.2 25.5 7.4 449.7Cash and cash equivalents 81.5 - - - - - - 81.5Borrowings - - - - - - (9.4) (9.4)Total 383.4 69.9 35.7 1.1 8.2 25.5 (2.0) 521.8 c) Price risk The equity securities and hedge funds that are recognised on the balance sheetat their fair value are susceptible to losses due to adverse changes in prices.This is referred to as price risk. Investments are made in equity and hedge funds depending on the group's appetitefor risk. These investments are well diversified with high quality, liquidsecurities. The investment committee has established guidelines with investmentmanagers setting out maximum investment limits, diversification acrossindustries and concentrations in any one industry or company. Listed investments are recognised on the balance sheet at quoted bid price. Ifthe market for the investment is not considered to be active, then the group hasestablished fair value using valuation techniques. This includes using recentarm's length market transactions, reference to current fair value of otherinvestments that are substantially the same, discounted cash flow models andother valuation techniques that are commonly used by market participants. Thetotal change in fair value using these valuation techniques that was recognisedin the income statement during the year is £4.1m (2004: £0.8m). At 31 December 2005, the fair value of hedge funds recognised on the balancesheet was £42.5m (2004: £18.2 m). 2.5 Operational risk Operational risk arises from the risk of losses resulting from inadequate orfailed internal processes, people and systems or from external events. The group actively manages these risks and minimises them where appropriate.This is achieved by implementing and communicating guidelines to staff and otherthird parties. The group also regularly monitors the performance of its controlsand adherence to these guidelines through the risk management reporting process. Key components of the group control environment include:• ICA modeling of operational risk exposure and scenario testing;• Management review of activities;• Documentation of policies and procedures;• Contingency planning; and• Other systems controls. 2.6 Group risk Group risk occurs where business units fail to consider the impact of theiractivities on other parts of the group, as well as the risks arising from theseactivities. There are three main components of group risk which are explainedbelow. Strategic This is the risk that the group's strategy is inappropriate or that the group isunable to implement its strategy. There is no tolerance for any breach ofguidance issued by the board, and where events supersede the group strategicplan this is escalated at the earliest opportunity through the group'smonitoring tools and governance structure. Reputation Reputation risk is the risk of negative publicity as a result of the group'scontractual arrangements, customers, products and services. Key sources ofreputation risk include operation of a Lloyd's franchise, interaction withcapital markets since the group's IPO during 2002, and reliance upon the Beazleybrand in the US. The group's preference is to minimise reputation risks. Where it is not possibleto fully eliminate reputation risks, the group seeks to minimise their frequencyand severity and manage reputation risk through public relations andcommunication channels. Management stretch Management stretch is the risk that business growth might cause the group'smatrix management structure to become overly complex, and undermineaccountability and control within the group. As the group expands its world-widebusiness both in the UK and US, management stretch may make the identification,analysis and control of group risks more complex. On a day-to-day basis, operation of the matrix management structure encouragesorganisational flexibility and adaptability, while ensuring that activities areappropriately coordinated and controlled. By focussing upon the needs of theircustomers and demonstrating both progressive and responsive abilities, staff,management and outsourced service providers are expected to excel in service andquality. Individuals and teams are also expected to transact their activities inan open and transparent way. These behavioural expectations reaffirm low grouprisk tolerance by aligning interests to ensure that routine activities, projectsand other initiatives are implemented to benefit and protect both local andgroup resources. 3 Segment analysis Segment information is presented in respect of business segments (primary) andLloyd's/Non-Lloyd's (secondary) segments. This is based on the group'smanagement and internal reporting structures. Segment results, assets and liabilities include items directly attributable to asegment as well as those that can be allocated on a reasonable basis. All inter-segment transactions are determined on an arm's length basis. a) Primary reporting segment - business segments The group is organised into four business segments, marine, property, specialtylines and reinsurance. A description of the business undertaken by each segmentis given in note 2. All foreign exchange differences on non-monetary items have been leftunallocated. This has been separately disclosed as it provides a fairerrepresentation of the loss ratios, which would otherwise be distorted by themismatch arising under IFRS whereby unearned premium reserve and DAC are treatedas non monetary items and claims reserves are treated as monetary items. 2005 Marine Property Specialty Reinsurance Unallocated Total £m £m Lines £m £m £m £mSegment resultsGross premiums written 93.5 128.1 270.9 65.5 - 558.0Net premiums written 78.6 98.5 207.7 41.0 - 425.8 Net earned premiums 64.5 81.2 192.2 37.2 (2.8) 372.3Net investment income 3.3 5.8 19.5 3.0 - 31.6Other income 2.9 1.4 2.4 0.2 - 6.9 Revenue 70.7 88.4 214.1 40.4 (2.8) 410.8 Net insurance claims 32.1 49.1 135.8 56.0 - 273.0Expenses for the acquisition of insurancecontracts 17.8 27.9 39.4 10.1 0.3 95.5Administrative expenses 2.2 5.7 12.8 2.3 - 23.0Other expenses 2.4 3.2 5.9 1.2 (11.3) 1.4 Operating expenses 54.5 85.9 193.9 69.6 (11.0) 392.9 Results from operating activities 16.2 2.5 20.2 (29.2) 8.2 17.9Finance costs (1.8) Share of profit -of associatesProfit before tax 16.1 Tax expense (5.0) Profit after tax 11.1 Claims ratio 50% 60% 71% 151% - 73%Expense ratio 31% 41% 27% 33% - 32%Combined ratio 81% 101% 98% 184% - 105% Segment assets and liabilities Segment assets 178.1 282.9 895.8 186.6 - 1,543.4Segment liabilities 161.6 185.3 722.2 193.9 - 1,263.0 Additional information Capital expenditure 1.3 1.8 3.8 0.9 5.2 13.0Depreciation 0.1 0.1 0.1 - - 0.3Net cash flow 3.7 7.8 15.4 0.6 - 27.5 2004 Marine Property Specialty Reinsurance Unallocated Total £m £m Lines £m £m £m £mSegment resultsGross premiums written 62.1 93.1 203.7 43.4 - 402.3Net premiums written 50.8 77.0 168.4 32.8 - 329.0 Net earned premiums 43.5 72.6 143.7 33.9 9.0 302.7Net investment income 1.1 2.1 7.0 1.1 - 11.3Other income 3.5 4.3 1.0 2.4 - 11.2 Revenue 48.1 79.0 151.7 37.4 9.0 325.2 Net insurance claims 20.9 38.9 98.0 24.2 - 182.0Expenses for the acquisition ofinsurance contracts 11.5 19.7 31.6 7.0 1.6 71.4Administrative expenses 2.9 5.0 8.0 1.7 17.6Other expenses 2.5 3.4 5.8 1.0 5.1 17.8 Operating expenses 37.8 67.0 143.4 33.9 6.7 288.8 Results from operatingactivities 10.3 12.0 8.3 3.5 2.3 36.4 Finance costs (1.1)Share of profit of associates 0.1 Profit before tax 35.4 Tax expense (10.6) Profit after tax 24.8 Claims ratio 48% 54% 68% 71% - 60%Expense ratio 33% 34% 28% 26% - 29%Combined ratio 81% 88% 96% 97% - 89% Segment assets andliabilitiesSegment assets 93.3 148.3 474.7 95.9 - 812.2Segment liabilities 67.8 112.9 297.2 56.7 - 534.6 AdditionalinformationCapital expenditure 0.1 0.3 0.5 0.1 - 1.0 Net cash flow 6.1 8.3 40.5 7.8 - 62.7 As the group had no material plant and equipment at 31 December 2004, there isno depreciation. b) Secondary reporting segment - geographical segments The group's four business segments are managed geographically by placement ofrisk i.e. Lloyd's and Non Lloyd's. 2005 2004 £m £mNet earned premiums Lloyd's 372.3 302.7Non Lloyd's - - 372.3 302.7 2005 2004 £m £mSegment assets Lloyd's 1,494.2 810.2Non Lloyd's 49.2 2.0 1,543.4 812.2 Segment assets are allocated based on where the assets are located. Capital expenditure Lloyd's 7.5 1.0Non Lloyd's 5.4 - 12.9 1.0 Capital expenditure is allocated based on where the assets are located. 4 Net investment income 2005 2004 £m £m Investment income at fair value throughincome statement- Dividend income - 0.1- Interest income 31.3 12.9 Realised gains/(losses) on financialinvestments at fair value through incomestatement- Realised gains 1.8 0.5- Realised losses (3.6) (1.1) Net fair value gains/(losses) on financialinvestments through income statement- Fair value gains 5.7 1.5- Fair value losses (2.7) (2.0) Investment management expenses (0.9) (0.6) Net investment income 31.6 11.3 5 Other income 2005 2004 £m £m Profit commissions 4.9 8.7Agency fees 1.3 2.0Other income 0.7 0.5 6.9 11.2 6 Operating expenses 2005 2004 £m £m Auditors remuneration- Company audit fees 0.1 0.1- Group audit fees 0.2 0.1- Tax service 0.1 0.2- Non-audit service - -Other operating leases 0.7 0.5Profit commission related bonus payments- 2002 year of account - 2.6- 2003 year of account 2.0 4.2- 2004 year of account 1.3 -Foreign exchange loss/(gain) (11.7) 5.3 7 Employee benefit expenses 2005 2005 2004 2004 £m £m £m £m Group Company Group Company Wages and salaries 15.4 0.2 11.6 0.4Short-term incentive payments 5.8 - 7.5 -Social security 2.4 - 2.5 -Share based remunerations 0.8 - 0.2 -Pension costs 2.9 - 2.5 - 27.3 0.2 24.3 0.4Recharged to syndicate 623 (7.8) (8.7) - - 19.5 0.2 15.6 0.4 8 Finance costs 2005 2004 £m £m Interest expense 1.2 0.6Arrangement fees 0.6 0.5 1.8 1.1 9 Income tax expense 2005 2004 £m £mCurrent tax expenseCurrent year 6.2 4.9Prior year adjustments 0.8 1.4 7.0 6.3 Deferred tax expenseOrigination and reversal of temporary (1.0) 6.2differencesPrior year adjustments (1.0) (1.9) (2.0) 4.3 Income tax expense 5.0 10.6 Profit before tax 16.1 35.4 Tax calculated at domestic tax rates 4.8 10.6 Effects of:- Effect of tax rates in foreign 0.3 (0.1) jurisdictions- Non-deductible expenses 0.1 0.6- Income not subject to tax - -- Under/(over) provided in prior years (0.2) (0.5) Tax charge for the period 5.0 10.6 The weighted average applicable tax rate was 30% (2004: 30%). 10 Earnings per share 2005 2004 Basic 3.1p 9.9 pDiluted 3.1p 9.9 p Basic Basic earnings per share is calculated by dividing profit after tax of £11.1m(2004: £24.8m) by the weighted average number of issued shares during the yearof 360.6m (2004: 251.1m). Diluted Diluted earnings per share is calculated by dividing profit after tax of £11.1m(2004: £24.8m) by the adjusted weighted average number of shares of 363.9m(2004: 251.6m). The adjusted weighted average number of shares assumesconversion of dilutive potential ordinary shares, being shares from the save asyou earn, retention and deferred share schemes. 11 Dividends per share .A final dividend of 2.5p (2004: 0.7p) per ordinary share is payable on 12 May2006 to shareholders registered on 18 April 2006 in respect of the year ended 31December 2005. Together with the interim dividend of 1.5p (2004: 0.3p) thisbrings the total to 4.0p (2004: 1.0p). These financial statements do not providefor the final dividend as a liability. 12 Intangible assets Goodwill Syndicate Licences IT Total capacity development costs Cost Balance at 1 January 2004 6.0 1.1 - - 7.1 Additions - 1.0 - - 1.0Disposals - - - - - Balance at 31 December 2004 6.0 2.1 - - 8.1 Balance at 1 January 2005 6.0 2.1 - - 8.1 Additions - 1.6 5.1 3.6 10.3Disposals - - - - -Foreign exchange - - 0.1 - 0.1 Balance at 31 December 2005 6.0 3.7 5.2 3.6 18.5 Amortisation Balance at 1 January 2005 - - Amortisation for the year 0.3 0.3 Balance at 31 December 2005 0.3 0.3 Carrying amount 31 December 2004 6.0 2.1 - - 8.1 31 December 2005 6.0 3.7 5.2 3.3 18.2 Impairment tests Goodwill, syndicate capacity and licences are deemed to have indefinite life.Consequently, they are not amortised but annually tested for impairment. Theyare allocated to the group's cash generating units (CGUs) as follows: 2005 £m 2004 £m Lloyd's Non-Lloyd's Lloyd's Non-Lloyd's Goodwill 6.0 - 6.0 -Syndicate capacity 3.7 - 2.1 -Licences - 5.2 - - When testing for impairment, the recoverable amount of a CGU is determined basedon value in use. Value in use is calculated using projected cash flows based onfinancial budgets approved by management covering a three year period. Cashflows beyond a three year period are extrapolated using an estimated growth rateof 2% (2004: 2%). This growth rate is consistent with the long term averagegrowth rate for the industry. A pre-tax discount rate of 8% (2004: 8%) has beenused to discount the projected cash flows. 13 Plant and equipment Fixtures & Computer Total Fittings equipment CostBalance at 1 January 2005 - - - Additions 2.4 0.1 2.5Disposals - - - Balance at 31 December 2005 2.4 0.1 2.5 Accumulated depreciationBalance at 1 January 2005 - - - Depreciation charge for the year - - -Disposals - - - Balance at 31 December 2005 - - - Carrying amounts 2.4 0.1 2.5 The group did not have any material plant and equipment at 31 December 2004. 14 Investment in associates The group has the following interests in associates: Ownership Country 2005 2004 Beazley Finance Limited UK 22.7% 22.7%Beazley Dedicated Limited UK 22.7% 22.7%Asia Pacific Underwriting Agency HK 79.8% 40.0%Limited Summary financial information on associates - 100 per cent: Assets Liabilities Equity Income Profit £m £m £m £m £m 2005 Beazley Finance Limited 0.4 (0.5) (0.1) - - Beazley Dedicated Limited 4.2 (1.6) 2.6 - - 4.6 (2.1) 2.5 - - 2004 Beazley Finance Limited 0.4 (0.5) (0.1) - - Beazley Dedicated Limited 31.7 (29.1) 2.6 0.2 2.5 Asia Pacific Underwriting Agency Limited 1.3 (1.1) 0.2 0.4 - 33.4 (30.7) 2.7 0.6 2.5 On 26 January 2006, the group increased its shareholding in Asia PacificUnderwriting Agency Limited to 100% from 79.8% at 31 December 2005 (2004:40.0%). At 31 December 2005 the group controlled Asia Pacific UnderwritingAgency Limited so it is treated as a subsidiary. Beazley Furlonge Holdings Limited owns 5,000,000 ordinary shares in BeazleyFinance Limited, the holding company of Beazley Dedicated Limited, a dedicatedcorporate member of syndicate 623. This share represents 22.7% of the entireshare capital of Beazley Finance Limited. Beazley Furlonge Holdings Limited hasguaranteed a letter of credit of £2m to support underwriting of BeazleyDedicated Limited on syndicate 623. The proportion of profits receivable by thegroup is determined by agreement between AON (the majority shareholder inBeazley Finance Limited) and the group and varies by year of account. Beazley Dedicated Limited participated in syndicate 623 for all years of accountup to 2002. Reflected in these accounts are the results for the 2002 year ofaccount together with the results of Beazley Finance Limited to 31 December2005. 15 Deferred acquisition costs 2005 2004 £m £m Balance at 1 January 38.3 32.2Additions 126.0 65.0Amortisation charge (111.6) (58.9) Balance at 31 December 52.7 38.3 16 Financial investments 2005 2004 Group Company Group Company £m £m £m £mFinancial investments atfair value through income Equity securities- listed 4.5 - 2.0 - Hedge funds 42.5 - 18.2 - Debt securities 286.4- Fixed interest 396.2 111.6 279.8 138.0- Floating interest 328.7 110.3 163.3 90.0 Total financial investments at fair value throughincome 771.9 221.9 469.9 228.0 Current 366.7 151.5 322.1 155.6Non current 405.2 70.4 147.8 72.4 771.9 221.9 469.9 228.0 All investments were classified as fair value through income. The group has given a fixed and floating charge over its investments and otherassets to secure obligations to Lloyd's in respect of its corporate membersubsidiary. Further details are provided in note 32. 17 Insurance receivables 2005 2004 £m £m Debtors arising out of direct insurance contracts 139.2 74.8Debtors arising out of reinsurance operations 19.7 14.2 158.9 89.0 Current 158.9 89.0Non current - - 158.9 89.0 All insurance debtors relate to business translated with brokers andintermediaries. 18 Reinsurance assets 2005 2004 £m £m Reinsurers' share of claims 344.5 64.5Impairment provision (5.2) (1.2) 339.3 63.3 Reinsurers' share of unearned premium reserve 55.2 35.0 394.5 98.3 19 Cash and cash equivalents 2005 2004 Group Company Group Company £m £m £m £m Cash at bank and in hand 6.2 0.7 3.9 1.7Short term deposits 106.4 6.0 77.6 - Cash and cash equivalent 112.6 6.7 81.5 1.7 20 Share capital 2005 2004 Issued no. of £m Issued no. of £ m shares ( m) shares (m) 450,000,000 ordinary shares of 5p each 360.6 18.0 360.6 18.0 Balance at 1 January 360.6 18.0 229.5 11.5Issue of shares - - 131.1 6.5 Balance at 31 December 360.6 18.0 360.6 18.0 21 Reserves Group Foreign Employee Employee currency share share Share Merger translation options trust premium reserve reserve reserve reserve Total £m £m £m £m £m £m Balance at 1 January 2004 132.4 1.6 - 0.2 - 134.2 Share premium on issue of shares 103.6 - - - - 103.6 Capitalised listing costs (5.5) - - - - (5.5) Increase in employee share options - - - 0.2 - 0.2 Balance at 31 December 2004 230.5 1.6 - 0.4 - 232.5 Increase in employee share options - - - 0.4 - 0.4 Acquisition of own shares held in trust - - - - (1.6) (1.6) Foreign exchange translation differences - - 0.8 - - 0.8 Balance at 31 December 2005 230.5 1.6 0.8 0.8 (1.6) 232.1 Company Foreign Employee Employee currency share share Share Merger translation options trust premium reserve reserve reserve reserve Total £m £m £m £m £m £m Balance at 1 January 2004 132.4 - - - - 132.4 Share premium on issue of shares 103.6 - - - - 103.6 Capitalised listing costs (5.5) - - - - (5.5) Balance at 31 December 2004 230.5 - - - - 230.5 Foreign exchange translation differences - - (1.1) - - (1.1) Balance at 31 December 2005 230.5 - (1.1) - - 229.4 22 Equity compensation plans 22.1 Employee share trust 2005 2004 Number (m) £m Number (m) £m Costs debited to employeeshare trust reserve Balance at 1 January - - - - Additions 1.9 1.6 - - Balance at 31 December 1.9 1.6 - - The shares are owned by the employee share trust, to satisfy awards under thegroup's deferred share plan and retention plan. These shares are purchased onthe market and carried at cost. On the third anniversary of an award the shares under the deferred share planare transferred from the trust to the employees. Under the retention plan, onthe third anniversary, and each year after that, 15.0% of the shares awarded aretransferred to the employees. The deferred share plan is recognised in the income statement on a straight linebasis over a period of 3 years, while the retention share plan is recognised inthe income statement on a straight line basis over a period of 6 years. 22.2 Employee share option plans The group has long term incentive plan, approved share option plan, unapprovedshare option plan, phantom share option and save as you earn (SAYE) that entitleemployees to purchase shares in the group. In accordance with these plans,options are exercisable at the market price of the shares at the date of thegrant. In addition, the group further granted share options before 7 November 2002. Therecognition and measurement principles in IFRS 2 have not been applied to thesegrants in accordance with the transitional provisions in IFRS 1 and IFRS 2. The terms and conditions of the grants are as follows: +--------------+------------+-------+-----------------------------+-----------+ |Share Option |Grant Date |No. of | Vesting Conditions |Contractual| |Plan | |Options| |Life of | | | | (m) | |Options | +--------------+------------+-------+-----------------------------+-----------+ | | | | | | | | | | | | +--------------+------------+-------+-----------------------------+-----------+ |Long term |15/05/2003 | 0.6 | Three years service + NAV + | 10 years | |incentive plan| | | TSR comparator | | | +------------+-------+ | | | |13/06/2003 | 0.1 | | | | +------------+-------+ | | | |29/03/2004 | 0.4 | | | | +------------+-------+ | | | |06/12/2004 | 0.1 | | | | +------------+-------+ | | | |21/03/2005 | 2.0 | | | +--------------+-----+------+-------+-----------------------------+-----------+ |Approved share|13/11/2002 | 0.9 | Three years service + NAV | 10 years | |option plan +------------+-------+ | | | |15/05/2003 | 0.3 | | | | +------------+-------+ | | | |29/03/2004 | 0.5 | | | +--------------+-----+------+-------+-----------------------------+-----------+ |Unapproved |15/05/2003 | 1.1 |Three years of service + NAV | 10 years | |share option +------------+-------+ | | |plan |13/06/2003 | 0.2 | | || +------------+-------+ | | | |29/03/2004 | 0.7 | | || +------------+-------+ | | | |06/12/2004 | 0.3 | | |+--------------+------------+-------+-----------------------------+-----------+ |Phantom share |08/07/2003 | 0.4 |Three years of service + NAV | 10 years | |option | | | + TSR comparator | | +--------------+------------+-------+-----------------------------+-----------+ |Save as you |15/05/2003 | 0.4 | Three years of service | 10 years | |earn +------------+-------+ | | | |20/04/2004 | 0.5 | | || +------------+-------+ | | | |14/04/2005 | 0.3 | | |+--------------+-----+------+-------+-----------------------------+-----------+ |Total share options | | 8.8 | | | | | | | | | +--------------+-----+------+-------+-----------------------------+-----------+ Vesting conditionsIn summary the vesting conditions are defined as: Three years of service An employee has to remain in employment until the third anniversary from the grant date.Net asset value (NAV) The NAV growth is greater than the risk free rate of return plus a premium per year.Total shareholder The group's TSR growth is compared with that of members ofreturn (TSR) comparator a comparator group comprising of 12 companies from the insurance sector (the "comparator group") over a three year period starting with the year in which the award is made. The number and weighted average exercise prices of share options are as follows: 2005 2004 Weighted No. of Weighted average Options average No. of exercise price (m) exercise price Options (pence per (pence per (m) share) share) Outstanding at 1 January 65.4 6.5 64.3 4.4Forfeited during the year 62.3 (0.1) 69.5 (0.4)Exercised during the year - - - -Granted during the year 10.2 2.4 70.2 2.5Outstanding at 31 December 8.8 65.4 6.5 50.4Exercisable at 31 December - - The share option program allows group employees to acquire shares of thecompany. The fair value of options granter is recognised as an employee expensewith a corresponding increase in employee share options reserve. The fair valueis measured at grant date and spread over the period during which the employeesbecome unconditionally entitled to the options. The fair values of the optionsgranted is measured at grand date and spread over the period in which theemployees become unconditionally entitled to the options. The fair value of theoptions granted is measured using the Black-Scholes model, taking into accountthe terms and conditions upon which the options were granted. The amountrecognised as an expense is adjusted to reflect the actual number of shareoptions that vest, except where forfeiture is due to the share option achievingthe vesting conditions. The following is a summary of the assumptions used to calculate the fair value. 2005 2004 £m £m Share options charge to income statement 0.4 0.2 Weighted average share price (pence per option) 90.1 90.7Weighted average exercise price (pence per 50.4 65.4option)Weighted average expected life of options 6.0 yrs 6.0 yrsExpected volatility 25.0% 25.0%Expected dividend yield 4.0% 4.0%Average risk free interest rate 4.0% 4.0% The expected volatility is based on historic volatility over a period of atleast 2 years. 23 Insurance liabilities and reinsurance assets 2005 2004 £m £mGrossClaims reported and loss adjustment expenses 349.3 57.4Claims incurred but not reported 479.5 209.8 Gross claims liabilities 828.8 267.2Unearned premiums 267.6 193.3 Total insurance liabilities, gross 1,096.4 460.5 Recoverable from reinsurersClaims reported and loss adjustment expenses 198.5 12.2Claims incurred but not reported 140.8 51.1 Reinsurers share of claims liabilities 339.3 63.3Unearned premiums 55.2 35.0 Total reinsurers' share of insurance liabilities 394.5 98.3 NetClaims reported and loss adjustment expenses 150.8 45.2Claims incurred but not reported 338.7 158.7 Net claims liabilities 489.5 203.9Unearned premiums 212.4 158.3 Total insurance liabilities, net 701.9 362.2 The gross claims reported, the loss adjustment liabilities and the liabilitiesfor claims incurred but not reported are net of expected recoveries from salvageand subrogation. The amounts for salvage and subrogation at the end of 2005 and2004 are not material. 23.1 Movements in insurance liabilities and reinsurance assets a) Claims and loss adjustment expenses +-------------------------+------------------------------+-+------------------------------+| | 2005 | | 2004 |+-------------------------+--------+------------+--------+-+---------+-----------+--------+| | Gross | Reinsurance| Net| | Gross|Reinsurance| Net|+-------------------------+--------+------------+--------+-+---------+-----------+--------+|Claims reported and loss | 57.4| (12.2)| 45.2| | 12.5| (0.6)| 11.9||adjustment expenses | | | | | | | |+-------------------------+--------+------------+--------+-+---------+-----------+--------+|Claims incurred but not | 209.8| (51.1)| 158.7| | 80.9| (25.2)| 55.7||reported | | | | | | | |+-------------------------+--------+------------+--------+-+---------+-----------+--------+|Balance at 1 January | 267.2| (63.3)| 203.9| | 93.4| (25.8)| 67.6|+-------------------------+--------+------------+--------+-+---------+-----------+--------+|Claims paid | (140.4)| 30.5| (109.9)| | (40.4)| 2.2| (38.2)|+-------------------------+--------+------------+--------+-+---------+-----------+--------+|Increase in claims | | | | | | | |+-------------------------+--------+------------+--------+-+---------+-----------+--------+|- Arising from current | 683.4| (300.6)| 382.8| | 243.1| (53.6)| 189.5||year claims | | | | | | | |+-------------------------+--------+------------+--------+-+---------+-----------+--------+|- Arising from prior year| (21.8)| 9.6| (12.2)| | (18.3)| 10.8| (7.5)||claims | | | | | | | |+-------------------------+--------+------------+--------+-+---------+-----------+--------+|Net exchange differences | 40.4| (15.5)| 24.9| | (10.6)| 3.1| (7.5)|+-------------------------+--------+------------+--------+-+---------+-----------+--------+|Balance at 31 December | 828.8| (339.3)| 489.5| | 267.2| (63.3)| 203.9|+-------------------------+--------+------------+--------+-+---------+-----------+--------+|Claims reported and loss | 349.3| (198.5)| 150.8| | 57.4| (12.2)| 45.2||adjustment expenses | | | | | | | |+-------------------------+--------+------------+--------+-+---------+-----------+--------+|Claims incurred but not | 479.5| (140.8)| 338.7| | 209.8| (51.1)| 158.7||reported | | | | | | | |+-------------------------+--------+------------+--------+-+---------+-----------+--------+|Balance at 31 December | 828.8| (339.3)| 489.5| | 267.2| (63.3)| 203.9|| | | | | | | | |+-------------------------+--------+------------+--------+-+---------+-----------+--------+ b) Unearned premiums reserve 2005 2004 Gross Reinsurance Net Gross Reinsurance Net Balance at 1 January 193.3 (35.0) 158.3 165.1 (33.1) 132.0 Increase in the year 564.6 (38.7) 525.9 422.0 (69.9) 352.1 Release in the year (490.3) 18.5 (471.8) (393.8) 68.0 (325.8) Balance at 31 December 267.6 (55.2) 212.4 193.3 (35.0) 158.3 23.2 Assumptions, changes in assumptions and sensitivity a) Process used to decide on assumptions The peer review reserving processBeazley uses a dual track process to set its reserve: • The actuarial team uses several actuarial and statistical methods toestimate the ultimate premium and claims costs. The most appropriate methods areselected depending on the nature of each class of business; and• The underwriting teams concurrently review the development of theincurred loss ratio over time and utilise their detailed understanding of therisks underwritten to establish an alternative• Estimate of ultimate claims cost which are compared to the actuariallyestablished figures. A formal peer review process is then undertaken to determine the reserves heldfor accounting purposes which, in totality, is not lower than the actuariallyestablished figure (as required by the Statement of Actuarial Opinions). Thegroup also commissions an annual independent review by an external actuarialconsultancy to ensure that the reserves established are reasonable. Actuarial assumptionsChain-ladder techniques are applied to premiums, paid claims or incurred claims(i.e. paid claims plus case estimates). The basic technique involves theanalysis of historical claims development factors and the selection of estimateddevelopment factors based on historical patterns. The selected developmentfactors are then applied to cumulative claims data for each underwriting yearthat is not yet fully developed to produce an estimated ultimate claims cost foreach underwriting year. Chain-ladder techniques are most appropriate for classes of business that have arelatively stable development pattern. Chain-ladder techniques are less suitablein cases in which the insurer does not have a developed claims history for aparticular class of business or for years of account that are still at immaturestages of development where there is a relatively higher level of assumptionvolatility. The Bornhuetter-Ferguson method uses a combination of a benchmark/market basedestimate and an estimate based on claims experience. The former is based on ameasure of exposure such as premiums; the latter is based on the paid orincurred claims observed to date. The two estimates are combined using a formulathat gives more weight to the experience based estimate as time passes. Thistechnique has been used in situations where developed claims experience was notavailable for the projection (i.e. recent underwriting years or new classes ofbusiness). The expected loss ratio method uses a benchmark/market based estimate applied tothe expected premium and is used for classes with little or no relevanthistorical data. The choice of selected results for each underwriting year of each class ofbusiness depends on an assessment of the technique that has been mostappropriate to observed historical developments. In certain instances, this hasmeant that different techniques or combinations of techniques have been selectedfor individual underwriting years or groups of underwriting years within thesame class of business. As such, there are many assumptions used to estimategeneral insurance liabilities. Where a significantly large loss impacts an underwriting year (e.g. the eventsof 11 September 2001 and the hurricanes in 2004 and 2005), its development isusually very different to the attritional losses. In these situations, the largeloss is extracted from the remainder of the data and analysed separately usingexposure analysis of the policies in force in the areas affected. Further assumptions are required to convert gross of reinsurance estimates ofultimate claims cost to a net of reinsurance level and to established reservesfor unallocated claims handling expenses and reinsurance bad debt. b) Major assumptions The main assumption underlying these techniques is that the group's past claimsdevelopment experience (with appropriate adjustments for known changes) can beused to project future claims development and hence ultimate claims costs. Assuch these methods extrapolate the development of paid and incurred losses,average costs per claim and claim numbers for each underwriting year based onthe observed development of earlier years. Throughout, judgement is used to assess the extent to which past trends may notapply in the future, for example, to reflect changes in external or marketfactors such as economic conditions, public attitudes to claiming, levels ofclaims inflation, premium rate changes, judicial decisions and legislation, aswell as internal factors such as portfolio mix, policy conditions and claimshandling procedures. c) Changes in assumptions As already discussed, general insurance business requires many differentassumptions. Given the myriad of assumptions used, the group's profit or loss isrelatively insensitive to changes to a particular assumption used for anunderwriting year/class combination. However, the group's profit or loss ispotentially more sensitive to a systematic change in assumptions that affectmany classes, such as judicial changes or when catastrophes produce more claimsthan expected. The group uses a range of risk mitigation strategies to reducethe volatility including the purchase of reinsurance. In addition, the groupholds additional capital as discussed in the individual capital adequacy (ICA)section of the operating and financial review (OFR). The net of reinsurance estimates of ultimate claims costs on the 2004 and priorunderwriting years have improved by £12.2m during 2005. This movement has arisenfrom a combination of better than expected claims experience coupled with smallchanges to the many assumptions reacting to the observed experience andanticipating any changes as a result of the new business written. During 2005, the group has not revised its view of any broad category ofassumptions that materially changes the profit or loss declared. Our reserving assumptions contain a reasonable margin for prudence given theuncertainties inherent in the insurance business underwritten. The majority ofthis margin arises from our longer-tailed classes. d) Sensitivity analysis The loss development tables, that follow, are disclosed to provide informationabout historical claims development. In effect, the tables highlight the group'sability to provide a robust estimate of the claims costs. The top part of the table illustrates how the group's estimate of claims ratiofor each underwriting year has changed at successive year-ends. The bottom halfof the table reconciles the gross and net claims to the amount appearing in thebalance sheet. An underwriting year basis is considered to be the mostappropriate basis for business written by the group. While the information in the table provides a historical perspective on theadequacy of the claims liabilities established in previous years, users of thesefinancial statements are cautioned against extrapolating redundancies ordeficiencies of the past on current claims liabilities. The group believes thatthe estimate of total claims liabilities as at 31 December 2005 are adequate.However, due to the inherent uncertainties in the reserving process, it cannotbe assured that such balances will ultimately prove to be adequate. Underwriting Year - Gross 2002 and earlier 2003 2004 2005 Total 12 months 62% 68% 91%24 months 51% 69%36 months 48% Total gross claims 176.2 289.6 349.3 815.1Less paid claims (56.7) (72.6) (31.2) (160.5) Gross RITC claims provision 174.2 174.2 174.2 119.5 217.0 318.1 828.8Gross claims liabilities Underwriting Year - Net 2002 and 2003 2004 2005 Total earlier 58% 64% 72%12 months 52% 64%24 months 49%36 months Total gross claims 147.5 222.7 181.4 551.6Less paid claims (52.5) (63.7) (24.5) (140.7) Net RITC claims provision 78.6 78.6 78.6 95.0 159.0 156.9 489.5Net claims liabilities 24 Borrowings 2005 2004 Group Company Group Company £m £m £m £m Syndicated loan 18.6 - - -Subordinated debt 10.5 10.5 9.4 9.4 29.1 10.5 9.4 9.4 Current - - - -Non current 29.1 10.5 9.4 9.4 29.1 10.5 9.4 9.4 The subordinated debt is denominated in US dollar, is unsecured and interest ispayable at the US LIBOR rate plus a margin of 4.5% per annum. The subordinatednotes are due in November 2034. The group has borrowing facilities of £150m (2004: £70.0m) available to it, ofwhich £72m (2004: £2m) has been drawn down as a letter of credit with a further£18.6m (2004: -) being drawn as a cash borrowing. A commitment fee of 0.5% perannum is paid for any undrawn part of the facility. The utilised element of thefacility is charges at 1.5% above UK LIBOR. The loan is repayable in 2008 andthe group has given a fixed and floating charge over its assets to thesyndicated banks lead by Lloyds TSB plc. The other banks participating in thesyndicate are Calyon, Bank of America N.A., HSH Nordbank AG and Commerzbank AG. 25 Deferred income tax 2005 2004 £m £m Deferred income tax asset 2.4 0.4Deferred income tax liability (6.0) (6.0) (3.6) (5.6) The movement in the net deferred income tax is as follows: Balance at 1 January (5.6) (1.3)Income tax charge 2.0 (4.3) Balance at 31 December (3.6) (5.6) Balance Recognised Balance 31 1 Jan 04 in income Dec 04 Intangible assets - (0.1) (0.1) Financial investments - 0.2 0.2 Other receivables (1.9) 1.2 (0.7) Trade and other payables - 1.2 1.2 Syndicate profits (0.5) (6.8) (7.3) Retirement benefit obligations 1.1 - 1.1 Net deferred income tax account (1.3) (4.3) (5.6) Balance Recognised Balance 31 1 Jan 05 in income Dec 05 Plant and equipment - 0.4 0.4 Intangible assets (0.1) (0.2) (0.3) Financial investments 0.2 (0.2) - Other receivables (0.7) 0.3 (0.4) Trade and other payables 1.2 (0.1) 1.1 Syndicate profits (7.3) (0.4) (7.7) Retirement benefit obligations 1.1 (0.2) 0.9 Tax losses - 2.4 2.4 Net deferred income tax account (5.6) 2.0 (3.6) The group has recognised deferred tax assets on unused tax losses to the extentthat it is probable that future taxable profits will be available against whichunused tax losses can be utilised. 26 Creditors 2005 2004 Group Company Group Company £m £m £m £m Reinsurance premiums payable 78.3 - 24.3 -Accrued expenses 11.0 0.1 9.9 0.7Profit commission related 7.0 - 7.7 -bonusesOther payables 5.2 - - -Amounts due to subsidiaries - 31.5 - -Due to syndicate 623 and 22.6 1.8 9.7 -associates 124.1 33.4 51.6 0.7 Current 124.1 33.4 51.6 0.7 Non current - - - - 124.1 33.4 51.6 0.7 27 Retirement benefit obligations 2005 2004 £m £mRetirement benefit obligations 2.9 3.9 Of the £2.9m (2004: £3.9m) of retirement benefit obligations £1.3m (2004: £2.3m)is recoverable from syndicate 623. Beazley Furlonge Limited operates a funded pension scheme ("the Beazley FurlongeLimited Pension Scheme") providing benefits based on final pensionable pay, withcontributions being charged to the income statement so as to spread the cost ofpensions over employees' working lives with the company. The contributions aredetermined by a qualified actuary using the projected unit method and the mostrecent valuations was at 31 December 2005. Pension benefits Amount recognised in the balance sheet: 2005 2004 £m £mPresent value of funded obligations 14.1 10.9 Fair value of plan assets (10.1) (6.7) 4.0 4.2 Unrecognised actuarial losses (1.1) (0.3) Liability in the balance sheet 2.9 3.9 Amounts recognised in the income statement: Current service cost 0.9 0.9 Interest cost 0.6 0.5 Expected return on plan assets (0.5) (0.4) Net actuarial losses recognised during the - -year 1.0 1.0 The actual return on plan assets was £1.5m (2004: £0.7m). Movement in liability recognised in the balance sheet: Balance at 1 January (3.9) (3.9) Total expenses charged to the income (1.1) (1.0) statement Unrecognised actuarial losses 0.9 0.2 Experience gains/losses (0.6) 0.1 Contributions paid 1.8 0.7 Balance at 31 December (2.9) (3.9) Principal actuarial assumptions: Discount rate 4.9% 5.2% Inflation rate 2.9% 2.9% Expected return on plan assets 5.8% 6.1% Future salary increases 4.4% 4.4% Future pensions increases 2.5% 2.5% Life expectancy 84 years 81 years 28 Acquisition of subsidiaries On 22 March 2005, the group acquired all the shares in Omaha Property andCasualty Insurance Company for $20.5m in cash. The company was renamed BeazleyInsurance Company, Inc. (BICI). The acquisition had the following effect on the group's assets and liabilities: Acquiree's net assets at the acquisition date: £m Cash and cash equivalents 6.0 Intangible assets - licences 4.6 Consideration paid 10.6 As part of the BICI acquisition, the group acquired licences to underwriteadmitted lines business in 50 states in the US. The licences have an indefiniteuseful life and are carried at cost less accumulated impairment. In addition, the group increased its shareholding in Asia Pacific UnderwritingAgency Limited to 100% on 26 January 2006. The group owned 79.8% at 31 December2005 (2004: 40.0%). 29 Operating lease commitments The group leases land and buildings under a non cancellable operating leaseagreement. The future minimum lease payments under the non cancellable operating lease areas follows: 2005 2004 £m £m No later than 1 year 1.2 0.9 Later than 1 year and no later than 5 years 4.8 0.2 Later than 5 years 5.8 - 11.8 1.1 During the year the group entered into a 10 year lease agreement for PlantationPlace South, 60 Great Tower Street, London EC3R 5AD. 30 Related party transactions The group has a related party relationship with syndicate 623, its subsidiaries(see note 31), associates and its directors. 30.1 Syndicate 623 Beazley Furlonge Limited, a wholly owned subsidiary of the group receivedmanagement fees and profit commissions for providing a range of managementservices to syndicate 623 in which the corporate member subsidiariesparticipated. The value of the services provided and the balances with the syndicate are asfollows: 2005 2004 £m £mServices provided: Syndicate 623 12.9 10.1 Balances due: Due from/(to) syndicate 623 (19.7) (9.7) These balances are settled monthly and are non interest bearing. 30.2 Key management compensation 2005 2004 £m £m Salaries and other short term benefits 7.1 5.9 Post employment benefits 0.4 0.6 Share based remunerations 0.3 0.1 7.8 6.6 Key management include executives, non executive directors and selected seniormanagement. 30.3 Other related party transactions During the year ended 31 December 2005, the group had a balance payable to theassociates of £2.6m (2004: £0.3m receivable). All transactions with associatesare priced on an arm's length basis. 31 Subsidiary undertakings The following is a list of all subsidiaries: Country of Ownership Nature of Business Incorporation Interest Beazley Furlonge Holdings England 100% Intermediate holding companyLimitedBeazley Furlonge Limited England 100% Lloyd's underwriting agentsBFHH Limited England 100% Dormant since 30 June 1994Beazley Investments Limited England 100% Investment companyBeazley Corporate Member Limited England 100% Underwriting at Lloyd'sBeazley Dedicated No.2 Limited England 100% Underwriting at Lloyd'sGlobal Two Limited England 100% Underwriting at Lloyd'sBeazley Underwriting Limited England 100% Underwriting at Lloyd'sBeazley Management Limited England 100% Intermediate management companyBeazley Staff Underwriting England 100% Underwriting at Lloyd'sLimitedBeazley Solutions Limited England 100% Insurance servicesBeazley Corporate Member No. 2 England 100% DormantBeazley Corporate Member No. 3 England 100% DormantBeazley USA Services, Inc. USA 100% Insurance servicesBeazley Holdings, Inc. USA 100% Holding companyBeazley Group (USA) General USA 100% General partnershipPartnershipBeazley Insurance Company, Inc. USA 100% Underwrite admitted linesAsia Pacific Underwriting Agency Hong Kong 79.8% Insurance servicesLimited During the year, the group acquired Beazley Insurance Company, Inc and furthershares in Asia Pacific Underwriting Agency Limited. Further details of theseacquisitions are provided in note 28. 32 Contingencies 32.1 Funds at Lloyd'sThe following amounts are subject to a deed of charge in favour of Lloyd's tosecure underwriting commitments:Company 2005 2004 £m £m Debt securities and other fixed income 231.5 227.8securitiesLetter of credit 70.0 - 301.5 227.8 In addition to the contingencies listed above, the group has another letter ofcredit of £2m (2004: £2m) provided to Beazley Staff Underwriting Limited, asubsidiary. 32.2 Collateralised guarantee at Lloyds TSB plc An amount of £0.5m (2004: £0.5m) has been deposited with Lloyds TSB bank Plc ascollateral for the banks guarantee of a subsidiary's solvency position withLloyd's of London. This information is provided by RNS The company news service from the London Stock Exchange

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