7th Mar 2007 07:04
Beazley Group PLC07 March 2007 NOTES TO THE FINANCIAL STATEMENTS 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 2006 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 with IFRSs asadopted by the EU ('Adopted IFRSs). On publishing the parent company financialstatements here together with the group financial statements, the company istaking advantage of the exemption in s230 of the Companies Act 1985 not topresent its individual income statement and related notes that form a part ofthese approved financial statements. These consolidated financial statements have been prepared on the basis ofadopted IFRSs in issue that are effective or available for early adoption at 31December 2006. Based on these adopted IFRSs, the directors have applied theaccounting policies, as set out below. In preparing these consolidated financial statements, the group and the parentcompany have adopted IFRS 7 Financial Instruments: Disclosures and IAS 1Presentation of Financial Statements - Capital Disclosures prior to theirrequired application date of 1 January 2007. The group and the parent companyhave also adopted the amendments to IAS 19 Employee Benefits, in relation todefined benefit plans and the amendment to IAS 39 The Fair Value Option. The adoption of IFRS 7 and the amendments to IAS 1 and IAS 19 impacted the typeand amount of disclosures made in these financial statements, but had no impacton the reported profits or financial position of the group or the parentcompany. In accordance with the transitional requirements of the standards, thegroup and the parent company have provided full comparative information. The fair value option in IAS 39 has been used to eliminate measurement orrecognition inconsistency that would result from measuring assets or liabilitiesor recognising gains or losses on them on different bases. The principal accounting policies applied in the preparation of these financialstatements are set out below. The policies have been consistently applied to allperiods presented, unless otherwise stated. Basis of presentation The consolidated financial statements are prepared using the historical costconvention except that financial instruments are stated at their fair value. Allamounts presented are stated in sterling and millions, unless noted otherwise. Use of estimates The preparation of the financial statements in conformity with IFRSs requiresthe group to make certain critical estimates and assumptions. Although theseestimates are based on management's best knowledge of current facts,circumstances and to some extent future events and actions, actual resultsultimately may differ from those estimates, possibly significantly. Consolidation a) Subsidiary undertakings Subsidiary undertakings, which are those entities in which the group, directlyor indirectly, 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 has 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 are recognised in reserves. The cumulative post-acquisition movementsare 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 sterling, which is the group's presentation currency. 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 a reasonable approximation of the historic rate. Foreign exchange gainsand losses resulting from the settlement of such transactions and fromtranslation at the period end of monetary assets and liabilities denominated inforeign currencies are recognised in the income statement. Non-monetary itemsrecorded at historical cost in foreign currencies are translated using theexchange rate on the date of the initial 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: • assets and liabilities are translated at the closing rate ruling atthe balance sheet date; • income and expenses for each income statement are translated ataverage exchange rates for the reporting period; and • all resulting exchange differences are recognised as a separatecomponent 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 commencing in thefinancial year together with adjustments to premiums written in previousaccounting periods and estimates for premiums from contracts entered into duringthe course of the year. Gross premiums written are stated before deduction ofbrokerage, taxes, duties levied on premiums and other deductions. b) Unearned premiums A provision for unearned premiums (gross of reinsurance) represents that part ofthe gross premiums written that is estimated will be earned in the followingfinancial periods. It is calculated using the daily pro-rata method where thepremium 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 is deferred atbalance sheet 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 claims handling provisions. The provisionfor 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 syndicate reporting 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 claims 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 incomestatement 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. 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 yearsComputer 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 consultants' fees, certain qualifying internal staff costs andother costs incurred to develop software programs. These costs are amortisedover their estimated useful life (three years). Other non-qualifying costs havebeen expensed as incurred. Financial instruments Financial instruments are recognised in the balance sheet at such time that thegroup becomes a party to the contractual provisions of the financial instrument.A financial asset is derecognised when the contractual rights to receive cashflows from the financial assets expire, or where the financial assets have beentransferred, together with substantially all the risks and rewards of ownership.Financial liabilities are derecognised if the group's obligations specified inthe contract expire, are discharged or cancelled. Purchases and sales of financial assets are recognised on the trade date, whichis the date the group commits to purchase or sell the asset. Financial assets On acquisition of a financial asset, the group is required to classify the assetinto the following categories: financial assets at fair value through profit orloss, loans and receivables, held to maturity and available for sale. The groupdoes not make use of the held to maturity and available for saleclassifications. Financial assets at fair value through profit or loss This category has two sub-categories: financial assets held for trading andthose designated at fair value through profit or loss at inception. Trading assets are those assets which are acquired principally for the purposeof selling in the short term, or which are held as part of a portfolio in whichthere is evidence of short-term profit taking or if it is designated so bymanagement. Derivatives are classified as held for trading unless they aredesignated as hedges. A financial asset is designated as fair value through profit or loss uponinitial recognition if it is managed and its performance is evaluated on a fairvalue basis. Information about these financial assets is provided internally ona fair value basis to the group's key management. The group's investmentstrategy is to invest and evaluate their performance with reference to theirfair values. Upon initial recognition, attributable transaction costs are recognised in theincome statement when incurred. Financial assets at fair value through profit orloss are measured at fair value, and changes therein are recognised in profit orloss. Net changes in the fair value of financial assets at fair value throughprofit or loss exclude interest and dividend income. The fair values of these assets are based on quoted bid price. Insurance receivables and payables Insurance receivables and payables are recognised when due. These includeamounts due to and from agents, brokers and insurance contract holders. Theseare classified as "loans and receivables" as they are non-derivative financialassets with fixed or determinable payments that are not quoted on an activemarket. Insurance receivables are measured at amortised cost less any provisionfor impairments. Other receivables Other receivables principally consist of prepayments, accrued income and sundrydebtors and are carried at amortised cost. Investment income Investment income consists of dividends, interest, realised and unrealised gainsand losses on financial assets at fair value through profit or loss. Dividendson equity securities are recorded as revenue on the ex-dividend date. Interestis recognised on an accruals basis for financial assets at fair value throughprofit or loss. Realised gain or loss on disposal of an investment is thedifference between the proceeds 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. Borrowings Borrowings are initially recorded at fair value 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. Finance costs comprise interest payable, fees paid for the arrangement of debtand letter of credit facility and commissions charged for the utilisation ofletters of credit. These costs are incurred on borrowings on initial recognitionand they are recognised in the income statements using an effective interestmethod. Other payables Other payables are stated at amortised cost. Hedge accounting and derivative financial instruments Derivatives are initially recognised at fair value on the date on which aderivative contract is entered into and are subsequently re-measured at theirfair value. The method of recognising the resulting fair value gains or lossesdepends on whether the derivative is designated as a hedging instrument and, ifso, the nature of the item being hedged. Fair values are obtained from quotedmarket prices in active markets, recent market transactions, and valuationtechniques which include discounted cash flow models. All derivatives arecarried as assets when fair value is positive and as liabilities when fair valueis negative. The best evidence of fair value of a derivative at initial recognition is thetransaction price. The group designates certain derivatives as cash flow hedges or net investmenthedges. The group documents at the inception of the transaction the relationship betweenhedging instruments and hedged items, as well as its risk management objectiveand strategy for undertaking various hedging transactions. The group alsodocuments its assessment, both at hedge inception and on an ongoing basis, ofwhether the derivatives that are being used in hedging transactions are expectedto be and have been highly effective in offsetting changes in fair values orcash flows of hedged items. a) Cash flow hedges The effective portion of changes in the fair value of derivatives that aredesignated and qualify as cash flow hedges is recognised in equity. The gain orloss relating to any ineffective portion is recognised immediately in the incomestatement within "net fair value gains/(losses) on derivative financialinstruments". If the derivative expires or is sold, terminated, exercised, or no longer meetsthe criteria for cash flow hedge accounting, or the designation is revoked, thenhedge accounting is discontinued and the amount recognised in equity remains inequity until the forecast transaction affects profit or loss. If the forecasttransaction is no longer expected to occur, then the hedge accounting isdiscontinued and the balance in equity is recognised immediately in the incomestatement. b) Fair value hedges When a derivative is designated as a hedge of the change in fair value of arecognised asset or liability or a firm commitment, changes in the fair value ofthe derivative are recognised immediately in the income statement together withthe changes in the fair value of the hedged item that are attributable to thehedged risk. If the derivative expires or is sold, terminated, exercised, or no longer meetsthe criteria for fair value hedge accounting, or the designation is revoked,hedge accounting is discontinued. Any adjustment up to that point, to a hedgeditem for which the effective interest method is used, is amortised to profit orloss as part of the recalculated effective interest rate of the item over itsremaining life. c) Net investment hedges Hedges of net investments in foreign operations are accounted for similarly tocash flow hedges. Any gain or loss on the hedging instrument relating to theeffective portion of the hedge is recognised in equity; the gain or lossrelating to the ineffective portion is recognised immediately in the incomestatement within "net fair value gains/(losses) on financial investments"through profit or loss. Gains and losses accumulated in equity are included in the income statement ondisposal of the foreign operation. Impairment of assets The group assesses at each balance sheet date whether there is objectiveevidence that a financial asset or group of financial assets is impaired. Afinancial asset or group of financial assets is impaired and impairment lossesare incurred only if there is objective evidence of impairment as a result ofone or more events that have occurred after the initial recognition of theassets and that event has an impact on the estimated cash flows of the financialasset or group of financial assets that can be reliably estimated. If there is objective evidence that impairment exists, the amount of the loss ismeasured as the difference between the asset's carrying amount and the value ofthe estimated future cash flows. The amount of the loss is recognised in theincome statement. 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 pension plan that is now closed to futureservice accruals. The scheme is generally funded by payments from the grouptaking account of the recommendations of an independent qualified actuary. Allemployees now participate in a defined contribution pension funded by the group. 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 are 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 estimated 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;and ii) 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 the SAYE scheme, details of which are included in thedirectors' 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 and acorresponding entry in reserves. The fair value of the share options isdetermined 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 substantively 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 orsubstantively 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. Earnings per share Basic earnings per share are calculated by dividing profit after tax availableto shareholders by the weighted average number of ordinary shares in issueduring the 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. The shares held in the employee share options plan (ESOP) have been excludedfrom both the calculations, until such time as they vest unconditionally withthe employees. Provisions and contingencies Provisions are recognised when the group has a present legal or constructiveobligation as a result of a 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. Contingent liabilities are present obligations that are not recognised becauseit is not probable that an outflow of resources will be required to meet theliabilities or if the amount of the obligation cannot be measured withsufficient reliability. 2. Risk management The group has identified the risks arising from its activities and hasestablished policies and procedures to manage these items in accordance with itsrisk appetite. The group categorises its risks into six areas: insurance,credit, market, liquidity, operational and group risk. The sections belowoutline the group's risk appetite and explain how it defines and manages eachcategory of risk. 2.1 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 leadto claims that are higher than anticipated in plans and pricing; - Pricing risk - the risk that the level of expected loss is understatedin the pricing process; - Cycle risk - the risk that business is written in a soft market withoutfull knowledge as to the (in)adequacy of rates, terms and conditions; and - Expense risk - the risk that the allowance for expenses and inflationin 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, the territories inwhich business is to be written and the industry sectors to which the group isprepared to expose itself. These plans are approved by the board and monitoredby the monthly underwriting committee. Our underwriters calculate premiums for risks written based on a range ofcriteria tailored specifically to each individual risk. These factors includebut are not limited to the financial exposure, loss history, riskcharacteristics, limits, deductibles, terms and conditions and acquisitionexpenses. 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 exposure that it is prepared to acceptin certain territories to a range of events such as natural catastrophes andspecific scenarios which may result in large industry losses. This is monitoredthrough regular calculation of realistic disaster scenarios (RDS). The aggregateposition is monitored at the time of underwriting a risk, and reports areregularly produced to highlight the key aggregations to which the group isexposed. 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 range of scenarios considered include natural catastrophes, marine,liability, political, terrorism and war events. The greatest likelihood of significant losses to the group arises from naturalcatastrophe events, such as flood damage, windstorm or earthquake. Wherepossible the group measures geographic accumulations and uses its 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's high level catastrophe risk appetite is set by the board and thebusiness plans of each team are determined within these parameters. The boardmay adjust these limits during the cause of the year as conditions change.Currently, the group operates to catastrophe risk appetite for a 1 in 250modelled event of 20% of underwriting capacity. Lloyd's has defined its own specific set of RDS events for which all syndicateswith relevant exposures must report. The group's three largest Lloyd's specifiednatural catastrophe stress events are: 2006 2005 Lloyd's prescribed natural Modelled PML Modelled PML Modelled PML Modelled PMLcatastrophe event (before (after (before (after reinsurance) reinsurance) reinsurance) reinsurance) US$m US$m US$m US$mSan Francisco quake (US$65bn, 384.4 161.4 361.7 133.62005: US$54bn) Gulf of Mexico windstorm 336.3 149.9 306.5 102.3(US$100bn, 2005: US$60bn) Florida Pinellas windstorm 331.8 190.1 324.7 175.6(US$100bn, 2005: US$70bn) The group has developed limits of authority and business plans which are bindingupon all staff authorised to underwrite and are specific to underwriters,classes of business and industry. In 2006, the normal maximum gross PML linethat any one underwriter could commit the managed syndicate to was US$50m. Inmost cases, maximum lines for classes of business were much lower than this. These authority limits are enforced through a comprehensive sign-off process forunderwriting transactions including dual sign-off for all line underwriters.Exception reports are also run regularly to monitor compliance. 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. A proportion of the group's insurance risks is written by third parties underdelegated underwriting authorities. Each third party is thoroughly vetted by ourcoverholder approval group before we transact with them, and is subject torigorous monitoring to maintain underwriting quality and ensure ongoingcompliance with contractual guidelines. 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 officers'liability, healthcare, stand-alone terrorism and contingency. Whilst most ofthis business is domiciled in the US, the team also has a presence in the UK,continental Europe and the Far East. The liability insurance which is written on a worldwide basis is consideredmedium tail because claims in this class typically take three to nine yearsbefore they are fully assessed and paid by the group for a given accident year.The speed of claim reporting and claim settlement is a function of the specificcoverage provided, the jurisdiction and any policy provisions applied such asself-insured retentions. Other inherent uncertainties encountered through thisclass include: - Whether the "event" triggering coverage is confined to only one-timeperiod 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 becovered at the time the contracts were written; and - The potential for mass claim actions. Property Our property segment underwrites commercial, high-value homeowners andengineering property insurance on a worldwide basis. Property insuranceindemnifies, subject to any limits or excesses, the policyholder against loss ordamage to their own material property and business interruption arising fromthis damage. The event giving rise to a claim for damage to buildings orcontents usually occurs suddenly (as for fire and burglary) and the cause iseasily determinable. The claim will thus be notified promptly and can be settledwithout delay (an exception to this is subsidence claims). 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. Marine This segment underwrites a broad spectrum of marine classes. Specialist coverincludes hull, energy, cargo & specie and war risks, and the majority of theserisks are exposed to catastrophes. For example, a significant portion of theenergy business is exposed to the Gulf of Mexico and thus has substantialhurricane exposure. Some areas of the marine business overlap with other segments which can resultin loss accumulations. These accumulations, including exposures to catastrophes,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 withthe assumptions used in the industry-wide pricing models, causing claimsexperience to be higher than expected. 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. Failure of a reinsurer to pay a valid claim is considered a creditrisk which is detailed separately below. 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 per risk and per event basis. In some cases thegroup deems it more economic to hold capital than purchase reinsurance. This isregularly reviewed as an integral part of the business planning and performancemonitoring process. In 2006, the group bought a combination of proportional and non-proportionalreinsurance treaties and facultative reinsurance to reduce the maximum netexposure on any one risk for the managed syndicates to US$25m. In most classesof business the maximum net exposure is much lower than this. The group aims toestablish appropriate retention levels and limits of protection to achieve thetarget rate of return and remain within the board's risk tolerance limits. 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 establishes limits forthe reinsurance programme regarding quality and quantity. The group's cededreinsurance team maintains the list of these approved reinsurers and noreinsurance 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. These risks may damage the group brand andundermine its ability to win and retain business or incur punitive damages.These risks can occur at any stage of the claims life-cycle. The group's claims teams are focused on 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 inaccurate forecasting, or wherethere is inadequate allowance for expenses and reinsurance bad debts inprovisions. To manage reserving and ultimate reserves risk, our experienced actuarial teamuses a range of recognised techniques to project gross premiums written, monitorclaims development patterns and stress test ultimate insurance liabilitybalances. An external independent actuary also performs an annual review toproduce a statement of actuarial opinion for reporting entities within thegroup. The objective of the group's reserving policy is to produce accurate andreliable estimates that are consistent over time and across classes of business.The estimates of gross premiums written and claims prepared by the actuarialdepartment are used through a formal quarterly peer review process toindependently check the integrity of the estimates produced by the underwritingteams for each class of business. These meetings are attended by seniormanagement, senior underwriters, actuarial, claims, and finance 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 areinsurance contract held by the group; - Brokers and intermediaries - whereby counterparties fail to pass onpremiums or claims collected or paid on behalf of the group; and - Investments - whereby issuer default results in the group losing all orpart of the value of 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's 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 2006 Tier 1 Tier 2 Tier 3 Unrated Total £m £m £m £m £m Financial investments 788.7 64.6 5.2 99.9 958.4 Insurance receivables - - - 244.0 244.0 Reinsurance assets 319.9 5.0 - 20.4 345.3 Cash and cash equivalents 209.4 - - - 209.4 Total 1,318.0 69.6 5.2 364.3 1,757.1 31 December 2005 Tier 1 Tier 2 Tier 3 Unrated Total £m £m £m £m £m Financial investments 684.9 38.4 2.8 45.8 771.9 Insurance receivables 17.3 - - 141.6 158.9 Reinsurance assets 347.3 1.9 - 45.3 394.5 Cash and cash equivalents 106.8 - - 5.8 112.6 Total 1,156.3 40.3 2.8 238.5 1,437.9 The carrying amount of financial assets at the balance sheet date represents themaximum credit exposure. The group has insurance receivables that are past due but not impaired at thereporting date. The group believes that impairment of these receivables is notappropriate on the basis of stage of collection of amounts owed. An agedanalysis of insurance receivables that are past due but not impaired ispresented below: Overdue debtors Up to 30 30 - 60 60 - 90 Greater Total days days days than 90 days 31 December 2006 67% 15% 6% 12% 100%31 December 2005 77% 8% 3% 12% 100% This analysis excludes binder and treaty reinsurance receivables. An analysis of the overall credit risk exposure indicates that the group hasreinsurance assets, insurance receivables and other debtors that are impaired atthe reporting date. Some reinsurance assets that are individually impaired at 31December 2006 total £4.8m (2005: £5.2m). These assets have been individually impaired after considering information suchas the occurrence of significant changes in the counterparty's financialposition, pattern of historical payment information and disputes withcounterparties. 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 all new brokers, and broker performance isregularly reviewed. Regular exception reports highlight trading withnon-approved brokers, and the group's outsourced credit control functionfrequently monitors the ageing and collectibility of debtor balances. Any large,aged items are prioritised and the outsourced credit controllers have incentivesfor collecting these debts. 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 Liquidity risk arises where cash may not be available to pay obligations whendue at a reasonable cost. The group is exposed to daily calls on its availablecash resources, principally from claims arising from its insurance business. Inthe majority of the cases, these claims are settled from the premiums received. The group's approach is to manage its liquidity position so that it canreasonably survive a significant individual or market loss event. This meansthat the group maintains sufficient liquid assets, or assets that can betranslated into liquid assets at short notice and without any significantcapital loss, to meet expected cash flow requirements. These liquid funds areregularly monitored using cash flow forecasting to ensure that surplus funds areinvested to achieve a higher rate of return. The following is an analysis by business segment of the estimated timing of thenet cash flows based on the claims liabilities balance held at 31 December 2006: Weighted average Greater term to Within 1 than 5 settlement31 December 2006 year 2-3 years 4-5 years Total (years) years Specialty lines 20% 40% 27% 13% 100% 2.7Property 53% 38% 7% 2% 100% 1.4Reinsurance 48% 40% 12% - 100% 1.5Marine 41% 43% 15% 1% 100% 1.6 Weighted average Greater term to Within 1 than 5 settlement31 December 2006 year 2-3 years 4-5 years Total (years) years Specialty lines 17% 38% 30% 15% 100% 3.0Property 46% 45% 6% 3% 100% 1.4Reinsurance 41% 43% 14% 2% 100% 1.6Marine 41% 43% 15% 1% 100% 1.7 2.4 Market risk Market risk arises where the value of assets and liabilities changes as a resultof movements in foreign exchange rates, interest rates and market prices. 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, USdollars, UK sterling, Canadian dollars and Euros. Transactions in all othercurrencies are converted to UK sterling on initial recognition. The group manages foreign exchange exposure by projecting forward its US dollarprofits 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 Canadian dollars and Euros are closely monitored by thegroup and a similar approach will be taken to manage the risk as our exposuregrows in the future. The group also has investment in foreign subsidiaries with functional currenciesthat are different from the presentational currency. This gives rise to anexposure to US dollars, Hong Kong dollars and Singapore dollars, although theexposures to Hong Kong dollars and Singapore dollars are minimal. The US dollarexposure is managed by borrowing funds denominated in the same currency. The following table summarises the carrying value of total assets and totalliabilities categorised by currency: 31 December 2006 US $ CAD $ EUR • Subtotal UK £ Total £m £m £m £m £m £m Total assets 1,035.8 49.1 85.8 1,170.7 713.5 1,884.2 Total liabilities (985.0) (36.0) (68.3) (1,089.3) (475.4) (1,564.7) 50.8 13.1 17.5 81.4 238.1 319.5 31 December 2005 US $ CAD $ EUR • Subtotal UK £ Total £m £m £m £m £m £m Total assets 940.0 38.4 54.3 1,032.7 510.7 1,543.4 Total liabilities (928.3) (32.8) (46.0) (1,007.1) (255.9) (1,263.0) 11.7 5.6 8.3 25.6 254.8 280.4 The net assets have been stated net of the cross-currency swap as explained innote 24. Sensitivity analysis If the US dollar, Canadian dollar, Euro weakened against the UK sterling by 10%,with all other variables constant, pre-tax profit would have been lower by anestimated £12.4m (2005: £5.5m) and net assets would have decreased by anestimated £10.8m (2005: £5.0m). The analysis is based on the current informationavailable and our assumptions in performing this analysis are: - the closing year end spot rates and the average rates throughout theyear were 10% higher; - no hedging of currency during the period; - the analysis includes an estimate of the impact on our foreignborrowings and cross currency swaps; and - the impact of foreign exchange on non-monetary items will be nil. 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 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 2006 < 1 yr 1-2 2-3 3-4 4-5 5-10 > 10 Total yrs yrs yrs yrs yrs yrs £m £m £m £m £m £m £m £m Debt securities 568.0 190.8 69.1 26.2 12.6 0.7 - 867.4Cash and cash equivalents 209.4 - - - - - - 209.4Derivative financial - - - - - (2.4) - (2.4)instrumentsBorrowings - - - - - (145.7) (9.2) (154.9)Total 777.4 190.8 69.1 26.2 12.6 (147.4) (9.2) 919.5 31 December 2005 < 1 yr 1-2 2-3 3-4 4-5 5-10 > 10 Total yrs yrs yrs yrs yrs yrs £m £m £m £m £m £m £m £m 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 The next two tables summarise the carrying amount of financial instrumentsexposed to interest rate risk by maturity at balance sheet date. Maturity31 December 2006 < 1 yr 1-2 2-3 3-4 4-5 5-10 > 10 Total yrs yrs yrs yrs yrs yrs £m £m £m £m £m £m £m £m Debt securities 522.1 229.3 61.8 27.1 23.4 1.1 2.6 867.4Cash and cash equivalents 209.4 - - - - - - 209.4Derivative financial - - - - - (2.4) - (2.4)instrumentsBorrowings - - - - - (145.7) (9.2) (154.9)Total 731.5 229.3 61.8 27.1 23.4 (147.0) (6.6) 919.5 31 December 2005 < 1 yr 1-2 2-3 3-4 4-5 5-10 > 10 Total yrs yrs yrs yrs yrs yrs £m £m £m £m £m £m £m £m 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 The group makes annual interest payments for derivative financial instrumentsand borrowings. Further details are provided in notes 24 and 25. Sensitivity analysis The group holds financial assets and liabilities that are exposed to interestrate risk. An increase in 100 basis points in interest yields, with all othervariables constant, would result in a loss of capital on debt securities and achange in value of borrowings and derivative financial instruments. This willdecrease pre-tax profits for the period by an estimated £10.7m (2005: £4.2m) andnet assets would have decreased by an estimated £7.5m (2005: £2.5m). 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 £1.8m (2005: £4.1m). Sensitivity analysis At 31 December 2006, the fair value of hedge funds recognised on the balancesheet was £50.3m (2005: £42.5m). If the fair value of the group's hedge fundportfolio were to fall by 10%, then the overall pre-tax impact on net assetswould be a decline of £5.0m (2005: £4.3m). At 31 December 2006, the fair value of equities recognised on the balance sheetwas £40.7m (2005: £4.5m). These equities are listed on various global stockexchanges and a 10% fall in the global equity market will result in a pre-taximpact on net assets of £4.1m (2005: £0.5m). 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 modelling 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, Europe and Asia. The group's preference is to minimisereputation risks. Where it is not possible to avoid all events which can resultin reputation risks, the group seeks to minimise their frequency and severity bymanaging these topics through public relations and communication 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 worldwidebusiness in the US, Europe and Asia, management stretch may make theidentification, 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 focusing on 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. Capital management The group has two requirements for capital that it complied with during theyear: • To support underwriting at Lloyd's through syndicate 2623. This isbased on the group's own individual capital adequacy (ICA); and • To support it's underwriting in BICI in the US. 2006 2005 £m £m Underwriting at Lloyd's through syndicate 2623 (ICA) 292.0 301.7Underwriting in US through BICI 30.6 32.6 322.6 334.3 BICI holds adequate capital to meet US regulatory and credit ratingrequirements. ICA We use stochastic modelling techniques to regularly assess our ICA for ourLloyd's underwriting operations. Through detailed measurement of risk exposures,we allocate capital to support business activities according to risk profile.Stress and scenario analysis is performed and the results are documented andreconciled to the board's risk appetite. Prudential Importance Comment risk type to groupInsurance 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 on 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 and groupactuary to independently determine required movements. 3 Segmental 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: specialty lines, property,reinsurance and marine. 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 IFRSs whereby unearned premium reserve, reinsurance shareof unearned premium reserve and DAC are treated as non-monetary items and claimsreserves are treated as monetary items. 2006 Specialty Property Reinsurance Marine Unallocated Total lines £m £m £m £m £m £mSegment results Gross premiums 361.0 187.8 58.4 137.9 - 745.1written Net premiums written 267.3 149.9 40.5 116.6 - 574.3 Net earned premiums 234.6 123.1 42.1 101.5 8.3 509.6 Net investment income 35.9 4.2 4.1 4.1 - 48.3 Other income 4.0 1.3 0.7 1.1 - 7.1 Revenue 274.5 128.6 46.9 106.7 8.3 565.0 Net insurance claims 146.3 66.3 13.7 44.4 - 270.7 Expenses for the acquisition ofinsurance contracts 50.8 39.9 10.3 28.5 0.1 129.6 Administrative 21.8 9.9 3.3 3.8 - 38.8expenses Other expenses 7.8 4.0 1.5 2.6 17.6 33.5 Expenses 226.7 120.1 28.8 79.3 17.7 472.6 Results from 47.8 8.5 18.1 27.4 (9.4) 92.4operating activities Finance costs (5.6) Profit before tax 86.8 Tax expense (26.9) Profit after tax 59.9 Claims ratio 62% 54% 33% 44% - 53% Expense ratio 31% 40% 32% 32% - 33% Combined ratio 93% 94% 65% 76% - 86% Segment assets and liabilities Segment assets 1,120.6 367.9 150.2 245.4 0.1 1,884.2Segment liabilities (925.4) (266.7) (149.3) (216.5) (6.8) (1,564.7)Net assets 195.2 101.2 0.9 28.9 (6.7) 319.5 Additional information Capital expenditure 5.7 3.0 1.0 2.3 - 12.0Depreciation 0.7 0.3 0.1 0.3 - 1.4Net cash flow 64.7 17.0 8.9 14.5 - 105.1 2005 Specialty Property Reinsurance Marine Unallocated Total lines £m £m £m £m £m £mSegment results Gross premiums 270.9 128.1 65.5 93.5 - 558.0writtenNet premiums 207.7 98.5 41.0 78.6 - 425.8written Net earned premiums 192.2 81.2 37.2 64.5 (2.8) 372.3Net investment 19.5 5.8 3.0 3.3 - 31.6incomeOther income 2.4 1.4 0.2 2.9 - 6.9Revenue 214.1 88.4 40.4 70.7 (2.8) 410.8 Net insurance 135.8 49.1 56.0 32.1 - 273.0claimsExpenses for the acquisition ofinsurance contracts 39.4 27.9 10.1 17.8 0.3 95.5Administrative expenses 12.8 5.7 2.3 2.2 - 23.0Other expenses 5.9 3.2 1.2 2.4 (11.3) 1.4Expenses 193.9 85.9 69.6 54.5 (11.0) 392.9 Results from operatingactivities 20.2 2.5 (29.2) 16.2 8.2 17.9 Finance costs (1.8) Profit before tax 16.1 Tax expense (5.0) Profit after tax 11.1 Claims ratio 71% 60% 151% 50% - 73%Expense ratio 27% 41% 33% 31% - 32%Combined ratio 98% 101% 184% 81% - 105% Segment assets andliabilities Segment assets 895.8 282.9 186.6 178.1 - 1,543.4Segment liabilities (722.2) (185.3) (193.9) (161.6) - (1,263.0)Net assets 173.6 97.6 (7.3) 16.5 - 280.4 Additional information Capital expenditure 3.8 1.8 0.9 1.3 5.2 13.0Depreciation 0.1 0.1 - 0.1 - 0.3Net cash flow 15.4 7.8 0.6 3.7 - 27.5 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. 2006 2005 £m £mNet earned premiums Lloyd's 507.1 372.3Non-Lloyd's 2.5 - 509.6 372.3 2006 2005 £m £m Segment assets Lloyd's 1,810.9 1,494.2Non-Lloyd's 73.7 49.2 1,884.2 1,543.4 Segment assets are allocated based on where the assets are located. Capital expenditure Lloyd's 10.6 7.5Non-Lloyd's 1.4 5.4 12.0 12.9 Capital expenditure is allocated based on where the assets are located. 4 Net investment income 2006 2005 £m £m Investment income at fair value through incomestatement - Dividend income - -- Interest income 28.0 31.3 Realised gains/(losses) on financialinvestments at fair value through incomestatement- Realised gains 22.9 1.8- Realised losses (9.9) (3.6) Net fair value gains/(losses) on financialinvestments through income statement - Fair value gains 24.4 5.7- Fair value losses (15.6) (2.7) Net fair value gains/(losses) on fair value -hedge - Change in interest rate swap (3.0) -- Change in borrowings 3.0 - Investment management expenses (1.5) (0.9)Net investment income 48.3 31.6 5 Other income 2006 2005 £m £m Profit commissions 5.5 4.9Agency fees 1.1 1.3Other income 0.5 0.7 7.1 6.9 6 Operating expenses 2006 2005 £m £m Fees payable to the company's auditor for the 0.2 0.2audit of the company's annual accountsFees payable to the company's auditor and itsassociates for other services: - Audit of the company's subsidiaries 0.1 0.1- Tax services 0.1 0.1- other services 0.1 -Operating leases 1.7 0.7Profit commission related bonus payments - 2003 year of account - 2.0- 2004 year of account 4.2 1.3- 2006 year of account 0.8 -Foreign exchange loss/(gain) 22.3 (11.7) 7 Employee benefit expenses 2006 2005 Group Company Group Company £m £m £m £m Wages and salaries 22.2 0.3 15.4 0.2Short-term incentive payments 8.1 - 5.8 -Social security 2.8 - 2.4 -Share-based remunerations 1.3 - 0.8 -Pension costs 3.7 - 2.9 - 38.1 0.3 27.3 0.2 Recharged to syndicate 623 (7.8) - (7.8) - 30.3 0.3 19.5 0.2 8 Finance costs 2006 2005 £m £m Interest expense 5.5 1.2Arrangement fees 0.1 0.6 5.6 1.8 9 Income tax expense 2006 2005 £m £mCurrent tax expense Current year 21.4 6.2Prior year adjustments 1.4 0.8 22.8 7.0 Deferred tax expense Origination and reversal of temporary 5.6 (1.0)differencesPrior year adjustments (1.5) (1.0) 4.1 (2.0) Income tax expense 26.9 5.0 Profit before tax 86.8 16.1 Tax calculated at domestic tax rates 26.0 4.8 Effects of: - Tax rates in foreign jurisdictions 0.6 0.3- Non-deductible expenses 0.2 0.1- Under/(over) provided in prior years 0.1 (0.2)Tax charge for the period 26.9 5.0 The weighted average applicable tax rate was 30% (2005: 30%). 10 Earnings per share 2006 2005 £m £m Basic 16.8p 3.1pDiluted 16.7p 3.1p Basic Basic earnings per share are calculated by dividing profit after tax of £59.9m(2005: £11.1m) by the weighted average number of issued shares during the yearof 355.8m (2005: 358.8m). The shares held in the Employee Share Options Plan(ESOP) have been excluded from the calculation, until such time as they vestunconditionally with the employees. Diluted Diluted earnings per share are calculated by dividing profit after tax of £59.9m(2005: £11.1m) by the adjusted weighted average number of shares of 359.3m(2005: 362.1m). The adjusted weighted average number of shares assumesconversion of dilutive potential ordinary shares, being shares from the SAYE,retention and deferred share schemes. The shares held in the ESOP have beenexcluded from the calculation, until such time as they vest unconditionally withthe employees. 11 Dividends per share A final dividend of 3.2p (2005: 2.5p) per ordinary share is payable on 10 May2007 to shareholders registered on 13 April 2007 in respect of the year ended 31December 2006. Together with the interim dividend of 1.6p (2005: 1.5p) thisbrings the total to 4.8p (2005: 4.0p). These financial statements do not providefor the final dividend as a liability. 12 Intangible assets Goodwill Syndicate Licences IT Total capacity development costs £m £m £m £m £m Cost Balance at 1 January 2005 6.0 2.1 - - 8.1 Acquisition of subsidiary - - 5.1 - 5.1Additions - 1.6 - 3.6 5.2Disposals - - - - -Foreign exchange - - 0.1 - 0.1Balance at 31 December 2005 6.0 3.7 5.2 3.6 18.5 Balance at 1 January 2006 6.0 3.7 5.2 3.6 18.5 Acquisition of subsidiary 1.9 0.7 - - 2.6Additions - - - 3.7 3.7Disposals - - - (0.8) (0.8)Foreign exchange - (0.6) - (0.6) Balance at 31 December 2006 7.9 4.4 4.6 6.5 23.4 Amortisation Balance at 1 January 2005 - - Amortisation for the year 0.3 0.3 Balance at 31 December 2005 0.3 0.3 Balance at 1 January 2006 0.3 0.3 Disposals for the year (0.2) (0.2) Amortisation for the year 1.4 1.4 Balance at 31 December 2006 1.5 1.5 Carrying amount 31 December 2006 7.9 4.4 4.6 5.0 21.931 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: 2006 2005 Lloyd's Non-Lloyd's Lloyd's Non-Lloyd's £m £m £m £m Goodwill 7.9 - 6.0 -Syndicate capacity 4.4 - 3.7 -Licences - 4.6 - 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% (2005: 2%). This growth rate is consistent with the long-term averagegrowth rate for the industry. A pre-tax discount rate of 8% (2005: 8%) has beenused to discount the projected cash flows. 13 Plant and equipment Fixtures & Computer Total fittings equipment £m £m £m Cost Balance at 1 January 2005 - - - Additions 2.4 0.1 2.5Disposals - - -Balance at 31 December 2005 2.4 0.1 2.5 Balance at 1 January 2006 2.4 0.1 2.5 Additions 4.9 0.8 5.7Disposals - - -Balance at 31 December 2006 7.3 0.9 8.2 Accumulated depreciation Balance at 1 January 2005 - - - Depreciation charge for the year - - -Disposals - - -Balance at 31 December 2005 - - - Balance at 1 January 2006 - - - Depreciation charge for the year (1.0) (0.2) (1.2)Disposals - - -Balance at 31 December 2006 (1.0) (0.2) (1.2) Carrying amounts 31 December 2006 6.3 0.7 7.031 December 2005 2.4 0.1 2.5 14 Investment in associates The group has the following interests in associates: Ownership Country 2006 2005 Beazley Finance Limited UK 22.7% 22.7%Beazley Dedicated Limited UK 22.7% 22.7% Summary financial information on associates - 100%: Assets Liabilities Equity Profit £m £m £m £m2006 Beazley Finance Limited 0.2 (0.2) - 0.1Beazley Dedicated Limited 2.6 - 2.6 - 2.8 (0.2) 2.6 0.1 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 - On 26 January 2006, the group increased its shareholding in Asia PacificUnderwriting Agency Limited to 100% from 79.8% at 31 December 2005. The companyhas been renamed Beazley Limited. 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 December2006. 15 Deferred acquisition costs 2006 2005 £m £m Balance at 1 January 52.7 38.3 Additions 155.8 109.9 Amortisation charge (129.6) (95.5) Balance at 31 December 78.9 52.7 16 Financial investments 2006 2005 Group Company Group Company £m £m £m £mFinancial investments at fairvalue through income Equity securities-listed 40.7 - 4.5 - Hedge funds 50.3 - 42.5 - Debt securities - Fixed interest 672.3 287.2 396.2 111.6 - Floating interest 195.1 52.8 328.7 110.3 Total financial investments at 958.4 340.0 771.9 221.9fair value through income Current 538.8 297.0 366.7 151.5 Non-current 419.6 43.0 405.2 70.4 958.4 340.0 771.9 221.9 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 33. 17 Insurance receivables 2006 2005 £m £m Insurance receivables 244.0 158.9 244.0 158.9 These are receivable within one year and relate to business transacted withbrokers and intermediaries. All insurance receivables are designated as loansand receivables. 18 Reinsurance assets 2006 2005 £m £m Reinsurers' share of claims 274.7 344.5 Impairment provision (4.8) (5.2) 269.9 339.3 Reinsurers' share of unearned premium reserve 75.4 55.2 345.3 394.5 19 Cash and cash equivalents 2006 2005 Group Company Group Company £m £m £m £m Cash at bank and in hand 16.3 0.6 6.2 0.7 Short-term deposits 131.7 29.2 51.8 6.0 Overseas deposits 61.4 - 54.6 - Cash and cash equivalent 209.4 29.8 112.6 6.7 20 Share capital 2006 2005 No. of shares £m No. of shares £ m (m) (m)Authorised, issued and fullypaid 450,000,000 ordinary shares of 361.0 18.1 360.6 18.05p each Balance at 1 January 360.6 18.0 360.6 18.0 Issue of shares 0.4 0.1 - - Balance at 31 December 361.0 18.1 360.6 18.0 21 Reserves Foreign Employee Employee currency share share Group Share Merger translation options trust premium reserve reserve reserve reserve Total £m £m £m £m £m £m Balance at 1 January 2005 230.5 1.6 - 0.4 - 232.5Increase in employee share - - - 0.4 - 0.4options Acquisition of own shares - - - - (1.6) (1.6)held in trust Foreign exchange translation - - 0.8 - - 0.8differences Balance at 31 December 2005 230.5 1.6 0.8 0.8 (1.6) 232.1 Issue of shares 0.3 - - - - 0.3Increase in employee share - - - 0.8 - 0.8options Acquisition of own shares - - - - (4.0) (4.0)held in trust Change in net investment - - (0.6) - - (0.6)hedge Foreign exchange translation - - (2.8) - - (2.8)differences Balance at 31 December 2006 230.8 1.6 (2.6) 1.6 (5.6) 225.8 Foreign Employee Employee currency share share Company Share Merger translation options trust premium reserve reserve reserve reserve Total £m £m £m £m £m £m Balance at 1 January 2005 230.5 - - - - 230.5Foreign exchange translation - - (1.1) - - (1.1)differences Balance at 31 December 2005 230.5 - (1.1) - - 229.4Issue of shares 0.3 - - - - 0.3Foreign exchange translation - - 1.2 - - 1.2differences Balance at 31 December 2006 230.8 - 0.1 - - 230.9 22 Equity compensation plans 22.1 Employee share trust 2006 2005 Number (m) £m Number (m) £m Costs debited to employee sharetrust reserve Balance at 1 January 1.9 1.6 - - Additions 3.3 4.0 1.9 1.6Balance at 31 December 5.2 5.6 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 three years, while the retention share plan is recognisedin the income statement on a straight-line basis over a period of six years. 22.2 Employee share option plans The group has a long term incentive plan (LTIP), approved share option plan,unapproved share option plan, phantom share option and 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 "Share-based payment" have notbeen applied to these grants in accordance with the transitional provisions inIFRS 1 "First-time Adoption"and IFRS 2. The terms and conditions of the grants are as follows: Share option Grant date No. of Vesting conditions Contractualplan options (m) life of optionsLTIP 15/05/2003 0.6 Three year's service + NAV + 10 years 13/06/2003 0.1 TSR comparator 29/03/2004 0.4 06/12/2004 0.1 21/03/2005 2.0 21/03/2006 1.7 Approved share option plan 13/11/2002 0.8 Three year's service + NAV 10 years 29/03/2004 0.5 Unapproved share option plan 15/05/2003 1.1 Three year's service + NAV 10 years 13/06/2003 0.2 29/03/2004 0.7 06/12/2004 0.3Phantom share option 08/07/2003 0.4 Three year's service + NAV + 10 years TSR comparator SAYE 20/04/2004 0.4 Three year's service 14/04/2005 0.3 13/04/2006 0.6Total share options 10.2outstanding Vesting conditions In summary the vesting conditions are defined as: Three year's service An employee has to remain in employment until the third anniversary from the grant date.NAV The NAV growth is greater than the risk-free rate of return plus a premium per year. TSR comparator The group's TSR growth is compared with that of members of 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: 2006 2005 Weighted No. of Weighted average options average exercise price exercise price No. of (pence per (m) (pence per options share) share) (m) Outstanding at 1 January 50.4 8.8 65.4 6.5Forfeited during the year 73.2 (0.4) 62.3 (0.1)Exercised during the year 73.0 (0.4) - -Granted during the year 115.0 2.2 10.2 2.4 Outstanding at 31 December 43.2 10.2 50.4 8.8 Exercisable at 31 December - - The share option programme allows group employees to acquire shares of thecompany. The fair value of options granted is recognised as an employee expensewith a corresponding increase in employee share options reserve. The fair valueof the options granted is measured at grant date and spread over the period inwhich the employees become unconditionally entitled to the options. The fairvalue of the options granted is measured using the Black Scholes model, takinginto account the terms and conditions upon which the options were granted. Theamount recognised as an expense is adjusted to reflect the actual number ofshare options that vest, except where forfeiture is due to the share optionachieving the vesting conditions. The following is a summary of the assumptions used to calculate the fair value: 2006 2005 £m £m Share options charge to income statement 1.0 0.4 Weighted average share price (pence per option) 95.9 90.1 Weighted average exercise price (pence per 43.2 50.4option) Weighted average expected life of options 6.0 yrs 6.0 yrs Expected 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 two years. 23 Insurance liabilities and reinsurance assets 2006 2005 £m £mGross Claims reported and loss adjustment expenses 278.2 349.3 Claims incurred but not reported 587.8 479.5 Gross claims liabilities 866.0 828.8 Unearned premiums 359.6 267.6 Total insurance liabilities, gross 1,225.6 1,096.4 Recoverable from reinsurersClaims reported and loss adjustment expenses 103.1 198.5 Claims incurred but not reported 166.8 140.8 Reinsurers share of claims liabilities 269.9 339.3 Unearned premiums 75.4 55.2 Total reinsurers' share of insurance liabilities 345.3 394.5 Net Claims reported and loss adjustment expenses 175.0 150.8 Claims incurred but not reported 421.1 338.7 Net claims liabilities 596.1 489.5 Unearned premiums 284.2 212.4 Total insurance liabilities, net 880.3 701.9 The gross claims reported, the loss adjustment liabilities and the liabilitiesfor claims incurred but not reported are net of expected recoveries from salvageand subrogation. 23.1 Movements in insurance liabilities and reinsurance assets a) Claims and loss adjustment expenses 2006 2005 Gross Reinsurance Net Gross Reinsurance Net £m £m £m £m £m £m Claims reported and loss 349.3 (198.5) 150.8 57.4 (12.2) 45.2adjustment expenses Claims incurred but not 479.5 (140.8) 338.7 209.8 (51.1) 158.7reported Balance at 1 January 828.8 (339.3) 489.5 267.2 (63.3) 203.9 Claims paid (258.3) 132.5 (125.8) (140.4) 30.5 (109.9) Increase in claims - Arising from current year 394.6 (92.9) 301.7 498.9 (211.7) 287.1claims - Arising from prior year (36.3) 5.3 (31.0) (21.8) 9.6 (12.2)claims - Reinsurance to close 23.4 (9.9) 13.5 184.6 (88.9) 95.7 Net exchange differences (86.2) 34.4 (51.8) 40.4 (15.5) 24.9 Balance at 31 December 866.0 (269.9) 596.1 828.8 (339.3) 489.5 Claims reported and loss 272.3 (103.1) 169.2 349.3 (198.5) 150.8adjustment expenses Claims incurred but not 593.7 (166.8) 426.9 479.5 (140.8) 338.7reported Balance at 31 December 866.0 (269.9) 596.1 828.8 (339.3) 489.5 b) Unearned premiums reserve 2006 2005 Gross Reinsurance Net Gross Reinsurance Net £m £m £m £m £m £m Balance at 1 January 267.6 (55.2) 212.4 193.3 (35.0) 158.3 Increase in the year 749.5 (170.6) 578.9 564.6 (38.7) 525.9 Release in the year (657.5) 150.4 (507.1) (490.3) 18.5 (471.8) Balance at 31 December 359.6 (75.4) 284.2 267.6 (55.2) 212.4 23.2 Assumptions, changes in assumptions and sensitivity a) Process used to decide on assumptions The peer review reserving process Beazley uses a quarterly 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, work with our claims managers to set specificreserve estimates for flagged claims and utilise their detailed understanding ofthe risks underwritten to establish an alternative estimate of ultimate claimscost which are compared to the actuarially established figures. A formal internal peer review process is then undertaken to determine thereserves held for accounting purposes which, in totality, is not lower than theactuarially established. The group also commissions an annual independent reviewby the group's syndicate reporting actuary to ensure that the reservesestablished are reasonable. Actuarial assumptions Chain-ladder techniques are applied to premiums, paid claims and 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 underwriting years that are still atimmature stages of development where there is a relatively higher level ofassumption volatility. 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. We also review triangulations of the paid/outstanding claim ratios as a way ofmonitoring any changes in the strength of the outstanding claim estimatesbetween underwriting years so that adjustment can be made to mitigate anysubsequent over or under reserving. To date, this analysis indicates nosystematic change to the outstanding claim strength across underwriting years. 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 from the attritional losses. In these situations, thelarge loss is extracted from the remainder of the data and analysed separatelyby the respective claims managers using exposure analysis of the policies inforce 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 establish reserves forunallocated 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 premiums, paid and incurredlosses, average costs per claim and claim numbers for each underwriting yearbased on the 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 range 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 ICA. The net of reinsurance estimates of ultimate claims costs on the 2004 and priorunderwriting years has improved by £31.0m during 2006 (2005: £12.2m). Thismovement has arisen from a combination of better than expected claims experiencecoupled with small changes to the many assumptions reacting to the observedexperience and anticipating any changes as a result of the new business written. d) Sensitivity analysis The estimation of IBNR reserves for future claim notifications is subject to agreater degree of uncertainty than the estimation of the outstanding claimsalready notified. This is particularly true for the specialty lines business,which will typically display greater variations between initial estimates andfinal outcomes as a result of the greater degree of difficulty in estimatingthese reserves. The estimation of IBNR reserves for other business written isgenerally subject to less variability as claims are generally reported andsettled relatively quickly. As such, our reserving assumptions contain a reasonable margin for prudencegiven the uncertainties inherent in the insurance business underwritten,particularly on the longer tailed specialty lines classes. Since March 2005, we have identified a range of possible outcomes for each classand underwriting year combination directly from our ICA process. Comparing thesewith our pricing assumptions and reserving estimates gives our management teamincreased clarity into our perceived reserving strength and relativeuncertainties of the business written. To illustrate the robustness of our reserves, the loss development tables belowprovide information about historical claims development by the four segments -specialty lines, property, reinsurance and marine. The tables are byunderwriting year which in our view provides the most transparent reservingbasis. We have supplied tables for both ultimate gross claims and ultimate netclaims. 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. 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 2006 are adequate.However, due to inherent uncertainties in the reserving process, it cannot beassured that such balances will ultimately prove to be adequate. Gross ultimate claims 2002ae 2003 2004 2005 2006 % % % % Specialty lines 12 months 71.4 70.7 71.1 68.9 24 months 67.3 69.9 68.3 - 36 months 65.0 66.3 - - 48 months 57.4 - - - Property 12 months 51.1 65.2 85.5 59.3 24 months 38.3 65.1 82.9 - 36 months 35.6 65.6 - - 48 months 34.9 - - - Reinsurance 12 months 58.5 86.7 193.1 52.5 24 months 33.5 80.7 183.9 - 36 months 28.0 75.9 - - 48 months 28.2 - - - Marine 12 months 60.2 62.0 82.6 57.3 24 months 44.9 64.5 80.2 - 36 months 39.0 62.2 - - 48 months 36.2 - - - Total 12 months 62.9 69.7 90.0 63.2 24 months 52.5 69.0 87.3 - 36 months 49.4 66.5 - - 48 months 45.1 - - - Total ultimate losses (£m) 1,072.3 294.6 490.3 692.7 579.1 3,129.0 Less paid claims net of (811.8) (136.6) (227.2) (237.7) (15.1) (1,428.4)reinsurance (£m) Less unearned portion of ultimate - - - (27.0) (311.4) (338.4)losses (£m) Gross claims liabilities (100% 260.5 158.0 263.1 428.0 252.6 1,362.2level) (£m) Less unaligned share (£m) (119.8) (72.7) (121.0) (128.4) (54.3) (496.2) Gross claims liabilities, group 140.7 85.3 142.1 299.6 198.3 866.0share (£m) Net ultimate claims 2002ae 2003 % 2004 % 2005 % 2006 % Specialty lines 12 months 68.1 67.9 69.1 63.6 24 months 64.9 67.8 67.4 - 36 months 63.0 65.0 - - 48 months 55.9 - - - Property 12 months 49.0 59.7 65.0 62.3 24 months 42.4 61.6 62.9 - 36 months 40.1 60.9 - - 48 months 39.6 - - - Reinsurance 12 months 60.4 88.0 153.2 54.4 24 months 38.2 84.7 128.9 - 36 months 33.4 82.2 - - 48 months 34.1 - - - Marine 12 months 55.5 57.7 55.6 54.3 24 months 44.7 52.5 49.4 - 36 months 39.5 48.7 - - 48 months 39.2 - - - Total 12 months 60.3 66.2 73.5 61.4 24 months 53.1 65.5 69.1 - 36 months 50.5 63.1 - - 48 months 46.8 - - - Total ultimate losses (£m) 575.4 247.5 379.2 434.6 458.5 2,095.2 Less paid claims net of (455.3) (124.9) (176.4) (110.1) (14.4) (881.1)reinsurance (£m) Less unearned portion of ultimate - - - (24.1) (259.5) (283.6)losses (£m) Net claims liabilities (100% 120.1 122.6 202.8 300.4 184.6 930.5level) (£m) Less unaligned share (£m) (55.2) (56.4) (93.3) (90.1) (39.4) (334.4) Net claims liabilities, group 64.9 66.2 109.5 210.3 145.2 596.1share (£m) Analysis of movements in loss development tables Initial ultimate loss ratios (reading across the first line of each segment) The 2004 and 2005 hurricanes have increased the initial gross and net ultimateloss ratios on the 2004 and 2005 underwriting years for the property,reinsurance and marine teams compared with the initial 2003 underwriting yearratios. The initial property 2006 underwriting year gross and net ultimate loss ratiosare higher than the initial 2003 underwriting year ultimate loss ratios becauseof an increased catastrophe loading following the 2004 and 2005 hurricanes anddue to less favourable underwriting conditions in UK home-owners in 2006. The initial reinsurance 2006 underwriting year gross and net ultimate lossratios are lower than the initial 2003 underwriting year ultimate loss ratios asa result of the premium rate increases achieved and the changes made to thebusiness mix following the 2005 hurricanes. Development of ultimate loss ratios (reading down the columns of the tables) Specialty lines The gross and net ultimate loss ratios on all underwriting years have continuedto reduce as the impact of increased rates, tighter terms and conditions and animproved claims environment has become clearer. Property The 2003 underwriting year gross and net ultimate loss ratios have continued toreduce as the level of attritional losses has become clear. The 2004 underwriting year gross ultimate loss ratio has been relatively stablewith better than expected attritional claim experience and stable 2004 hurricaneestimates offsetting the increase following the 2005 hurricanes. The netultimate loss ratio has increased slightly from its 12 month position as aresult of the additional premiums paid to reinstate reinsurance cover("reinstatement premiums") following the 2005 hurricanes which reduced our netpremium estimates. The 2005 underwriting year reduction has been driven by better than expectedattritional claim experience. Reinsurance All years show reducing ultimate loss ratios over time reflecting our initiallycautious reserving philosophy. Marine The 2003 underwriting year gross and net ultimate loss ratios have continued toreduce as the level of attritional losses has become clear. During the second development year of the 2004 underwriting year we wrote morepremium than expected. At a gross of reinsurance level, the claims impact of the2005 hurricanes more than offset this additional premium thereby increasing thegross ultimate loss ratio. At a net of reinsurance level, however, the claimsimpact of the hurricanes was less than the additional premium (as a result ofthe relatively low reinsurance retention) thereby reducing the net ultimate lossratio. Thereafter, both gross and net ultimate loss ratios have reduced at theend of the third development year as a result of better than expectedattritional claims experience. The 2005 underwriting year reduction has been driven by better than expectedattritional claims experience. The table below illustrates movements in our net claims recognised in the incomestatement in 2006 by both underwriting year and by business segments: Specialty Property Reinsurance Marine Total lines 2006 £m £m £m £m £m Current year 164.3 68.2 19.6 49.6 301.7Prior year - 2003 and earlier (12.3) (0.7) (0.4) (0.4) (13.8)- 2004 year of account (4.7) (0.7) (0.8) (3.0) (9.2)- 2005 year of account (1.0) (0.5) (4.7) (1.8) (8.0) (18.0) (1.9) (5.9) (5.2) (31.0) Net insurance claims 146.3 66.3 13.7 44.4 270.7 Underwriting year Specialty Property Reinsurance Marine Total lines 2005 £m £m £m £m £m Current year 136.5 53.0 60.2 35.5 285.2Prior year - 2002 and earlier (0.5) (1.0) (2.0) (1.2) (4.7)- 2003 year of account (0.8) (1.9) (1.6) (1.6) (5.9)- 2004 year of account 0.6 (1.0) (0.6) (0.6) (1.6) (0.7) (3.9) (4.2) (3.4) (12.2) Net insurance claims 135.8 49.1 56.0 32.1 273.0 24 Borrowings The carrying amount and fair values of the non-current borrowings are asfollows: 2006 2005 Group Company Group Company £m £m £m £mCarrying value Syndicated loan - - 18.6 - Subordinated debt 9.2 9.2 10.5 10.5 Tier 2 subordinated debt 145.7 147.8 - - 154.9 157.0 29.1 10.5 Fair value Syndicated loan - - 18.6 - Subordinated debt 9.2 9.2 10.7 10.7 Tier 2 subordinated debt 150.2 148.2 - - 159.4 157.4 29.3 10.7 The fair value of the borrowings is based on quoted market prices. When quotedmarket prices are not available, a discounted cash flow model is used based on acurrent yield curve appropriate for the remaining term to maturity. The discountrates used in the valuation techniques are based on the borrowing rates. In November 2004, the group issued subordinated debt of US $18m to JPMorganChase Bank, N.A (JPMorgan). The loan was unsecured and interest was payable atthe US London interbank offered rate (LIBOR) plus a margin of 3.65% per annum.The subordinated notes are due in November 2034. In October 2006, the group issued £150m of unsecured fixed/floating ratesubordinated notes that are due in October 2026 with a first callable date ofOctober 2016. Interest of 7.25% per annum is paid annually in arrears for theperiod up to October 2016. From October 2016, the notes will bear annualinterest at the rate of 3.28% above LIBOR. The notes were assigned a creditrating of BBB- by S&P's rating services. The group entered into a cross currency swap transaction with Lloyds TSB Bankplc (Lloyds TSB) and JPMorgan in October 2006. In exchange for £42.3m the groupreceived US$40m from each party which will be finally exchanged on terminationof the contract, being October 2016. Lloyds TSB charges interest at USthree-month LIBOR plus 2.25%, while JPMorgan charges interest at US three-monthLIBOR plus 2.23%. As part of the agreement, the group receives interest at 7.25%from both parties. There is an option to terminate the swaps in October 2011 andannually thereafter until October 2016. The group also entered into an interest rate swap transaction with Lloyds TSBand JPMorgan in October 2006. Under this agreement, the fixed interest rate of7.25% on the balance of £107.7m (£53.8m from each party) is exchanged forfloating interest rate of UK LIBOR plus 2.24% with Lloyds TSB and UK LIBOR plus2.23% with JPMorgan. This agreement terminates on 17 October 2016 with anoptional early termination in October 2011 and annually thereafter. In 2005, the group had borrowing facilities of £150m available, of which £72mhad been drawn down as a letter of credit with a further £18.6m being drawn as acash borrowing. A commitment fee of 0.5% per annum was paid for any undrawn partof the facility. The utilised element of the facility drawn as cash was chargedan interest of 1.5% above UK LIBOR. The utilised element drawn down as a letterof credit was charged an annual rate of 1.5%. The facility was repayable in 2008and the group had given a fixed and floating charge over its assets to thesyndicated banks led by Lloyds TSB. The other banks participating in thesyndicate are Calyon, Bank of America N.A., HSH Nordbank AG and Commerzbank AG.The draw down part of this facility has now been replaced by the subordinatednotes issued during the year. The overall facility has been reduced to £50m,none of which was drawn at 31 December 2006. 25 Derivative financial instruments The group uses fair value interest rate hedges and net investment hedges tomanage some of its exposures. The group entered into derivative financialinstruments to manage this risk. 2006 2005 £m £mFair value Interest rate swap 3.0 - Cross currency swap (0.6) - 2.4 - a) Fair value hedges As described in note 24, the group has hedged its fixed rate borrowing usingfixed-to-floating interest rate swaps. In 2006, the hedge was deemed 100%effective and therefore the group did not recognise any portion in the incomestatement. b) Hedge of net investment in foreign entity The group's US dollar denominated borrowing is designated as a hedge of the netinvestment in the group's US subsidiaries. The foreign exchange gains of £2.1mon translation of the borrowing to sterling at the balance sheet date wasrecognised in "foreign currency translation reserve". This offsets the gain orloss on translation of the net investment in the group's US based subsidiaries.In 2006, the hedge was deemed effective and therefore the group did notrecognise any portion in the income statement. 26 Deferred income tax 2006 2005 £m £m Deferred income tax asset 3.5 2.4 Deferred income tax liability (11.6) (6.0) (8.1) (3.6) The movement in the net deferred income tax is as follows: Balance at 1 January (3.6) (5.6) Income tax charge (4.1) 2.0 Foreign exchange translation differences (0.4) - Balance at 31 December (8.1) (3.6) Balance Recognised in Balance 31 1 Jan 06 income Dec 06 £m £m £m Plant and equipment 0.4 0.8 1.2 Intangible assets (0.3) (0.4) (0.7) Other receivables (0.4) 0.3 (0.1) Trade and other payables 1.1 1.1 2.2 Syndicate profits (7.7) (7.1) (14.8) Retirement benefit obligations 0.9 (0.3) 0.6 Tax losses 2.4 1.1 3.5 Net deferred income tax account (3.6) (4.5) (8.1) Balance Recognised in Balance 31 1 Jan 05 income Dec 05 £m £m £m Plant and equipment - 0.4 0.4Intangible 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) 1.1Syndicate profits (7.3) (0.4) (7.7)Retirement benefit obligations 1.1 (0.2) 0.9Tax losses - 2.4 2.4Net 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. 27 Other payables 2006 2005 Group Company Group Company £m £m £m £m Reinsurance premiums payable 108.2 - 78.3 - Accrued expenses including 25.4 - 18.0 0.1staff bonuses Other payables 9.9 0.1 5.2 - Amounts due to subsidiaries - 37.6 - 31.5 Due to syndicate 623 and 9.2 - 22.6 1.8associates 152.7 37.7 124.1 33.4 Current 152.7 37.7 124.1 33.4 Non-current - - - - 152.7 37.7 124.1 33.4 28 Retirement benefit obligations 2006 2005 £m £m Retirement benefit obligations 1.9 2.9 Of the £1.9m (2005: £2.9m) of retirement benefit obligations £0.5m (2005: £1.3m) isrecoverable from syndicate 623. Beazley Furlonge Limited operates a funded pension scheme("the Beazley Furlonge Limited Pension Scheme") providing benefits based on finalpensionable pay, with contributions being charged to the income statement so as to spreadthe cost of pensions over employees' working lives with the company. The contributionsare determined by a qualified actuary using the projected unit method and the most recentvaluation was at 31 December 2006. Pension benefits Amount recognised in the balance sheet 2006 2005 £m £mPresent value of funded obligations 16.0 14.1 Fair value of plan assets (13.3) (10.1) 2.7 4.0 Unrecognised actuarial losses (0.8) (1.1) Liability in the balance sheet 1.9 2.9 Amounts recognised in the income statement Current service cost 0.3 0.9 Interest cost 0.6 0.6 Expected return on plan assets (0.6) (0.5) 0.3 1.0 Movement in present value of funded obligations recognised in the balance sheet Balance at 1 January 14.1 10.9 Current service cost 0.3 0.9 Interest cost 0.6 0.5 Actuarial losses 1.0 1.8 Balance at 31 December 16.0 14.1 Movement in fair value of plan assets recognised in the balance sheet Balance at 1 January 10.1 6.7 Expected return on plan assets 0.6 0.4 Actuarial gains 0.5 1.2 Employer contributions 2.1 1.8 Balance at 31 December 13.3 10.1 Plan assets are comprised as follows: Equities 10.9 8.2 Bonds 2.4 1.9 Total 13.3 10.1 The actual return on plan assets was £1.2m (2005: £1.5m). Principal actuarial assumptions Discount rate 5.2% 4.9% Inflation rate 3.2% 2.9% Expected return on plan assets 6.3% 5.8% Future salary increases 4.4% 4.4% Future pensions increases 2.7% 2.5% Life expectancy 84 years 84 years 29 Acquisition of subsidiaries On 29 December 2006, the group acquired all the shares in Santam CorporateLimited for £14.5m in cash. The company was renamed Tasman Corporate Limited. The acquisition had the following effect on the group's assets and liabilities: Fair value of net assets on acquisition £m Cash and cash equivalents 12.6 Insurance receivables 0.8 Other receivables 0.6 Other payables (1.7) Intangible assets - syndicate capacity 0.5 Intangible assets - goodwill 1.7 Consideration paid 14.5 2006 £mRevenue 2.8 Profit before tax 2.5 On 22 March 2005, the group acquired all the shares in Omaha Property andCasualty Insurance Company for US$20.5m in cash. The company was renamed 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 all 50 states in the US. The licences have anindefinite useful 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 and subsequently changed its name toBeazley Limited. The group owned 79.8% at 31 December 2005. 30 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: 2006 2005 £m £m No later than 1 year 1.3 1.2 Later than 1 year and no later than 5 years 5.3 4.8 Later than 5 years 5.3 5.8 11.9 11.8 31 Related party transactions The group has a related party relationship with syndicate 623, its subsidiaries,associates and its directors. 31.1 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: 2006 2005 £m £mServices provided: Syndicate 623 15.9 12.9 Balances due: Due to syndicate 623 (6.3) (19.7) 31.2 Key management compensation 2006 2005 £m £m Salaries and other short-term benefits 8.3 7.1 Post employment benefits 0.4 0.4 Share-based remuneration 0.5 0.3 9.2 7.8 Key management includes executives and non-executive directors and keymanagement. 31.3 Other related party transactions At 31 December 2006, the group had a balance payable to the associates of £1.8m(2005: £2.6m). All transactions with associates are priced on an arm's lengthbasis. 32 Subsidiary undertakings The following is a list of all the 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 linesBeazley Limited Hong Kong 100% Insurance servicesTasman Corporate Limited England 100% Underwriting at Lloyd'sBeazley Pte. Limited Singapore 100% Underwriting at Lloyd's 33 Contingencies 33.1 Funds at Lloyd's The following amounts are subject to a deed of charge in favour of Lloyd's tosecure underwriting commitments:Company 2006 2005 £m £m Debt securities and other fixed income securities 292.0 231.5 Letter of credit - 70.0 292.0 301.5 33.2 Collateralised guarantee at Lloyds TSB The collateralised guarantee of £0.5m that existed with Lloyds TSB at the end of2005 has been disposed of during 2006. 34 Foreign exchange rates The group used the following exchange rates to translate foreign currencyassets, liabilities, income and expenses into the group's presentation currency: 2006 2005 Average Year end spot Average Year end spot US dollar 1.84 1.96 1.82 1.72 Canadian dollar 2.09 2.28 2.21 2.01 Euro 1.47 1.48 1.46 1.46 The financial information set out above does not constitute the Company'sstatutory accounts for the year ended 31 December 2005 or 2006, but is derivedfrom those accounts. Statutory accounts for 2005 have been delivered to theRegistrar of Companies and those for 2006 will be delivered following theCompany's Annual General Meeting. The auditors have reported on those accounts;their reports were unqualified and did not contain statements under Section 237(2) or (3) of the Companies Act 1985. This information is provided by RNS The company news service from the London Stock ExchangeRelated Shares:
Beazley