AXIS Capital - 10-Q quarterly report FY

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2004

Commission file number 001-31721

AXIS CAPITAL HOLDINGS LIMITED

(Exact name of registrant as specified in its charter)

106 Pitts Bay Road, Pembroke HM 08, Bermuda

(Address of principal executive offices and zip code)

(441) 296-2600
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ý  No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes o   No ý

As of November 4, 2004, there were 154,907,232 Common Shares, $0.0125 par value per share, of the registrant outstanding.

AXIS CAPITAL HOLDINGS LIMITED

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME
For the quarters and nine months ended September 30, 2004 and 2003
(Expressed in thousands of U.S. dollars, except share and per share amounts)

See accompanying notes to Unaudited Condensed Consolidated Financial Statements

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AXIS CAPITAL HOLDINGS LIMITED

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN

SHAREHOLDERS’ EQUITY
For the nine months ended September 30, 2004 and 2003
(Expressed in thousands of U.S. dollars)

See accompanying notes to Unaudited Condensed Consolidated Financial Statements

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AXIS CAPITAL HOLDINGS LIMITED

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended September 30, 2004 and 2003
(Expressed in thousands of U.S. dollars)

See accompanying notes to Unaudited Condensed Consolidated Financial Statements

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of U.S. dollars, except share and per share amounts)

1.             Basis of Preparation and Consolidation

These unaudited condensed consolidated financial statements include the accounts of AXIS Capital Holdings Limited (“AXIS Capital”) and its subsidiaries (collectively referred to as the “Company”) and have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, these unaudited condensed consolidated financial statements reflect all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of financial position and results of operations as at the end of and for the periods presented. The results of operations for any interim period are not necessarily indicative of the results for a full year. All significant intercompany accounts and transactions have been eliminated. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. The major estimates reflected in the Company’s condensed consolidated financial statements include, but are not limited to, the reserve for losses and loss expenses, premium estimates for business written on a line slip or proportional basis and the estimation of fair values for contracts that meet the definition of derivatives under FAS 133. Some items in the financial statements have been reclassified to conform to the current period classification.

2.             New Accounting Pronouncements

EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” was issued in late 2003. It contains two aspects that impact the Company. Firstly, it provides details regarding disclosures about unrealized losses on available-for-sale debt and equity securities accounted for under FASB Statements No. 115, Accounting for Certain Investments in Debt and Equity Securities. These disclosures were effective in annual financial statements for fiscal years ended after December 15, 2003 and, accordingly, were provided in our financial statements for the year ended December 31, 2003. Secondly, it provides additional guidance for evaluating whether an investment is other-than-temporarily impaired. This guidance was scheduled to be effective for reporting periods beginning after June 30, 2004. However, the FASB has since determined that a delay in the effective date of these provisions was necessary until it can issue additional guidance on the application of EITF Issue No. 03-1. The Company will assess whether this guidance will have a material impact on the Company’s results of operations or financial condition once it is released.

3.             Stock-Based Compensation

On June 30, 2003, the FASB issued FAS No.148 “Accounting for Stock-Based Compensation – Transition and Disclosure.” FAS 148 amends FAS 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, FAS 148 amends the existing disclosure to require more prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based compensation and the

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effect of the method used on reported results. The additional disclosure requirements are effective for fiscal quarters ended after December 15, 2002. The Company adopted FAS No. 123 effective January 1, 2003 by applying the prospective method permitted under FAS No. 148. Prior to 2003, the Company followed Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” and related interpretations in accounting for its employee stock compensation. With respect to unvested restricted stock awards, the amount of deferred compensation is eliminated from share capital and additional paid in capital. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FAS 123 to stock-based compensation prior to January 1, 2003.

4.             Segment Information

The Company’s business consists of four underwriting segments: global insurance, global reinsurance, U.S. insurance and U.S. reinsurance. The Company evaluates the performance of each underwriting segment based on underwriting results. Most business written by the Company has loss experience generally characterized as low frequency and high severity.  This may result in volatility in both the Company’s and an individual segment’s operating results and cash flows. With effect from January 1, 2004, the Company included the personnel expenses of its underwriters in general and administrative expenses; prior to that date, they were included in acquisition costs. Disclosures relating to prior periods have been restated to reflect this change. In addition, with effect from January 1, 2004, the Company allocated all of its general and administrative costs, except for its corporate expenses, to its underwriting segments. The Company’s corporate costs include holding company costs necessary to support the Company’s worldwide insurance and reinsurance operations and costs associated with operating as a publicly-traded company.  Prior periods have not been restated to reflect the full allocation of general and administrative costs, as the Company’s business segments were not fully operational throughout 2003. The Company does not allocate its assets by segment as it evaluates the underwriting results of each segment separately from the results of its investment portfolio.

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Quarter ended September 30, 2003

(1)For the quarter ended September 30, 2003, the Company did not allocate any of its general and administrative expenses, except for the personnel expenses of its underwriters.

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Nine months ended September 30, 2003

(1)For the nine months ended September 30, 2003, the Company did not allocate any of its general and administrative expenses, except for the personnel expenses of its underwriters.

5.             Securities Lending

The Company participates in a securities lending program whereby the Company’s securities, which are included in investments, are loaned to third parties, primarily major brokerage firms. The Company maintains control over the securities it lends, retains the earnings and cash flows associated with the loaned securities and receives a fee from the borrower for the temporary use of the securities. Collateral in the form of cash, government securities and letters of credit is required at a rate of 102% of the market value of the loaned securities and is monitored and maintained by the lending agent. The Company had $748.8 million and $nil million in securities on loan at September 30, 2004 and December 31, 2003, respectively.

6.             Other Investments

The Company has invested $15.7 million in the senior preferred shares of a collateralized loan obligation, $42.4 million in combination notes of several collateralized loan obligations and $25.0 million in a medium term note representing an interest in a pool of European fixed income securities.  The Company carries these investments at fair value, which currently approximates cost.

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The collateral manager for the senior preferred shares investment is Blackstone Debt Advisors L.P., which is a related party as one of its affiliates beneficially owns more than 5% of the Company’s common shares. The collateral manager is entitled to management fees payable by the collateralized loan obligation in the ordinary course of business.  The Company does not have significant influence and does not participate in the management of this investment.

The underwriter for several collateralized loan obligations was Credit Suisse First Boston LLC, which is a related party as one of its affiliates beneficially owns more than 5% of the Company’s common shares. The underwriter was entitled to organization and closing fees payable by the collateralized loan obligations in the ordinary course of business.  The collateralized loan obligations are managed by third parties. The Company does not have significant influence and does not participate in the management of these investments.

7.             Benefit Plans

The following table presents the components of the Company’s defined benefit pension expense for the quarter and nine months ended September 30, 2004 and 2003.

8.             Commitments and contingencies

On March 25, 2004, the Company renewed its credit facility by entering into a three-year $750 million credit facility with a syndicate of commercial banks led by JPMorgan Chase Bank, as administrative agent and lender. Under the terms of the new credit facility, up to $750 million may be used by the Company and its subsidiaries, AXIS Specialty Limited, AXIS Re Limited, AXIS Specialty Europe Limited, AXIS Reinsurance Company, AXIS Specialty Insurance Company and AXIS Surplus Insurance Company, to issue letters of credit and up to $300 million may be used by these entities for general corporate purposes, with total borrowings not to exceed $750 million. The credit facility contains various loan covenants with which the Company must comply, including limitations on the incurrence of future indebtedness, future liens, fundamental changes, investments and certain transactions with affiliates. The credit facility also requires that the Company maintain (1) a minimum amount of consolidated shareholders’ equity equal to or greater than the sum of $1.975 billion plus (A) 50% of consolidated net income for each fiscal quarter beginning with the fiscal quarter ending March 31, 2005 and (B) 100% of the net cash proceeds received after March 25, 2004 from any issuance of our capital stock, and (2) a debt to total capitalization ratio not greater than 0.35:1.00. The credit facility contains restrictions on the Company’s ability to make acquisitions, except that it may, among other things, acquire assets and entities in the insurance and reinsurance business for consideration in an aggregate amount not in excess of $250 million. The Company’s ability to pay dividends or make other restricted payments is also limited, except that it may, among other things, pay cash dividends to shareholders in an

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amount not exceeding $150 million for any fiscal year and it may repurchase shares of its capital stock for consideration in an aggregate amount not exceeding $500 million. There was no debt outstanding under the credit facility at September 30, 2004 or December 31, 2003. At September 30, 2004, the Company had letters of credit of $133.9 million outstanding under the credit facility. At December 31, 2003, the Company had letters of credit of $127.3 million outstanding under its then existing credit facility.

The Company has invested $15.7 million in the senior preferred shares of a collateralized loan obligation included in other investments. See note (6).  In connection with this investment, the Company has commitments that may require additional funding of up to $9.3 million over the next two years.

9.             Net income per share

The following table sets forth the calculation of basic and diluted earnings per share:

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Because we have a limited operating history, period to period comparisons of our results of operations may not be meaningful and there may be volatility in both our results of operations and financial condition. In addition, the amount of premiums written with respect to any particular segment or line of business may vary from quarter to quarter and period to period as a result of changes in market conditions.

Acquisition History

On February 28, 2003, we completed the acquisition of Sheffield Insurance Corporation for $34.7 million and subsequently renamed it AXIS Surplus Insurance Company. At the time of purchase, Sheffield Insurance Corporation was licensed to write insurance in Illinois and Alabama and eligible to write surplus lines insurance in 39 states and the District of Columbia. In addition, we added a team of insurance professionals from Combined Specialty Group, Inc. In the first half of 2003, we acquired the renewal rights to a book of directors’ and officers’ liability insurance and related lines business written by the Financial Insurance Solutions (“FIS”) group of The Kemper Insurance Companies (“Kemper”) in exchange for an agreement to make an override payment. The override payment is based on a percentage of gross written premiums of all FIS accounts that are renewed by the Company. We purchased this company and agreed to acquire these rights as the foundation for commencing our U.S. insurance operations.

Critical Accounting Policies

The Company’s critical accounting policies are discussed in Managements’ Discussion and Analysis of Results of Operations and Financial Condition contained in our Annual Report on Form 10-K dated February 26, 2004.

Results of Operations

Quarters ended September 30, 2004 and 2003

Premiums.  In the quarter ended September 30, 2004, gross premiums written were $687.7 million compared with $633.9 million for the quarter ended September 30, 2003, an increase of $53.8 million. The increase was generated by our global reinsurance segment, which experienced an increase in gross premiums written of $49.3 million, and our U.S. insurance segment, which experienced an increase in gross premiums written of $39.3 million. The increase in gross premiums written in our global reinsurance segment was partly due to new business written by our Zurich office and an increase in property pro rata gross premiums written. The increase in gross premiums written in our U.S. segment was primarily due to greater market penetration.  The increases in gross premiums written were partially offset by a reduction of $35.0 million in gross premiums written by our global insurance segment. This reduction was partially due to a refinement in the method of estimating gross written premiums in our

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property line of business that occurred in the quarter ended December 31, 2003. This refinement more closely aligned the Company’s estimation and recording of gross premiums written with activity reported by ceding companies and increased gross premiums written for the quarter ended September 30, 2003.  We expect the mix of business within and between our segments to change over time based on market conditions and our view of the long term profit potential of individual lines of business.

Premiums ceded for the quarter ended September 30, 2004 were $125.7 million compared with $99.6 million for the quarter ended September 30, 2003, an increase of $26.1 million.  Of this increase, approximately 38% related to additional protections purchased to reinstate coverages exhausted by losses from Hurricanes Charley, Frances, Ivan and Jeanne. We purchase reinsurance to reduce our exposure to risk of loss on some lines of business written primarily within our global insurance and U.S. insurance segments. The remaining increase in ceded premiums was generated primarily within these segments.

Net premiums earned for the quarter ended September 30, 2004 were $521.8 million compared with $397.5 million for the quarter ended September 30, 2003, an increase of $124.3 million. Premiums are earned over the term of the policies in proportion to the risks to which they relate. As the level of net premiums written increases, the level of net premiums earned also increases. As we experienced an increase in net premiums written in all of our segments over the rolling twelve-month period ended September 30, 2004 compared to the rolling twelve-month period ended September 30, 2003, our net premiums earned increased.

Net Investment Income and Net Realized Gains/Losses.  Net investment income, including realized gains/losses, for the quarter ended September 30, 2004 was $43.7 million compared with $13.6 million for the quarter ended September 30, 2003, an increase of $30.1 million.

Net Investment Income. Net investment income for the quarter ended September 30, 2004 was $40.0 million compared with $19.3 million for the quarter ended September 30, 2003, an increase of $20.7 million. This was due to a combination of higher investment balances and higher investment yields.  Net investment income consisted primarily of interest on fixed income securities that was partially offset by net investment expenses of $1.8 million for the quarter ended September 30, 2004 compared with $1.6 million for the quarter ended September 30, 2003. The higher expenses were a result of an increase in our assets managed by external portfolio managers.

The annualized effective yield (calculated by dividing the net investment income generated from invested assets by the average balance of the assets managed by our portfolio managers) for the quarter ended September 30, 2004 was 3.5% compared with 2.6% for the quarter ended September 30, 2003. The increase in the effective yield was primarily due to higher U.S. interest rates. The yield may vary significantly from period to period due primarily to the timing of cash flows, changes in interest rates and changes in asset allocation.

Net Realized Gains/Losses. Net realized gains for the quarter ended September 30, 2004 were $3.7 million compared with net realized losses of $5.7 million for the quarter ended September 30, 2003, a increase of $9.4 million. We invest our portfolios to produce a total return. In assessing returns under this approach, we include investment income, realized gains and losses and unrealized gains and losses generated by the investment portfolios. As a result, there can be significant changes in the levels of our net realized gains/losses from quarter to quarter. Some of our mortgage-backed securities are required to be classified as derivatives; included within net realized gains was $0.3 million in realized gains and a negligible amount in unrealized losses relating to these securities.

The total return for our investment portfolio (calculated using beginning and ending market portfolio values, adjusted for external cash flows) for the quarter ended September 30, 2004 was 2.4%

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compared with 0.3% for the quarter ended September 30, 2003. The total return for an investment portfolio consists of price and income return. These components are affected primarily by the timing of cash flows, changes in interest rates and changes in asset allocation. Our total return was higher during the quarter ended September 30, 2004 due to changes in U.S. interest rates that positively impacted prices of fixed income securities and higher investment yields.

Other Insurance Related Income.  Other insurance related income for the quarter ended September 30, 2004 was $7.2 million compared with income of $8.5 million for the quarter ended September 30, 2003, a decrease of $1.3 million. This income related to the movement in the fair value of our insurance and reinsurance contracts that meet the definition of a derivative.

Net Losses and Loss Expenses.  Net losses and loss expenses for the quarter ended September 30, 2004 were $445.6 million compared to $184.2 million for the quarter ended September 30, 2003, an increase of $261.4 million.  The net loss and loss expense ratio for the quarter ended September 30, 2004 was 85.4% compared to 46.3% for the quarter ended September 30, 2003. The increase in net losses and loss expenses and the net loss and loss expense ratio was primarily driven by an active hurricane season.  We incurred net losses and loss expenses of $227.4 million from Hurricanes Charley, Frances, Ivan and Jeanne, which swept across the Caribbean and South Eastern United States in August and September 2004.  Our estimates for the losses incurred from these hurricanes were derived from formal loss advices, the output of industry models, a review of in-force contracts and preliminary indications from clients. Consequently, actual losses from these hurricanes may vary materially from estimated losses. During the quarter ended September 30, 2003, we did not experience any major catastrophe losses.  The impact of the hurricane-related losses was partially mitigated by favorable prior period development of $49.6 million or 9.5 percentage points, compared to $31.2 million or 7.8 percentage points for the quarter ended September 30, 2003.

Acquisition Costs.  Acquisition costs for the quarter ended September 30, 2004 were $79.2 million compared to $56.1 million for the quarter ended September 30, 2003, an increase of $23.1 million. This increase primarily resulted from an increase in the volume of net premiums earned. The acquisition cost ratio for the quarter ended September 30, 2004 was 15.2% compared to 14.1% for the quarter ended September 30, 2003. The increase in the ratio was principally a result of higher amortized ceded premiums which reduced the level of net premiums earned. As a percentage of gross premiums earned, the level of acquisition costs was 12.1% for the quarter ended September 30, 2004 and 11.6% for the quarter ended September 30, 2003. With effect from January 1, 2004, we included the personnel expenses of our underwriters in general and administrative expenses; prior to that date, they were included in acquisition costs. Our disclosures for prior periods have been restated to reflect this change.

General and Administrative Expenses.  General and administrative expenses for the quarter ended September 30, 2004 were $47.5 million, compared to $34.8 million for the quarter ended September 30, 2003, an increase of $12.7 million. This increase was primarily driven by the establishment and expansion of operations in the U.S. and Europe. In addition, we incurred $1.5 million of fees in connection with our preparation for compliance with section 404 of the Sarbanes-Oxley Act of 2002. The general and administrative expense ratio for the quarter ended September 30, 2004 was 9.1% compared to 8.8% for the quarter ended September 30, 2003.

Foreign Exchange.  Our functional currency is the U.S. dollar; however, some of our business is written in other currencies. For the quarter ended September 30, 2004, we experienced a gain of $3.5 million compared to $4.6 million for the quarter ended September 30, 2003, a decrease of $1.1 million. The gain was principally attributable to asset balances denominated in Euros following an increase in the level of gross premiums written in this currency in our global reinsurance segment.

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Income Tax (Expense) Recovery.  The income tax recovery for the quarter ended September 30, 2004 was $2.4 million compared to an expense of $2.1 million for the quarter ended September 30, 2003 a decrease of $4.5 million. The income tax recovery of $2.4 million was driven by our U.S. operations which sustained net losses from Hurricanes Charley, Frances, Ivan and Jeanne.

Net Income.  Net income for the quarter ended September 30, 2004 was $6.3 million compared to $147.0 million, a decrease of $140.7 million. Net income for the quarter ended September 30, 2004 consisted of a net underwriting loss of $43.3 million, net investment income and net realized gains of $43.7 million, foreign exchange gains of $3.5 million and tax recovery of $2.4 million. Net income for the quarter ended September 30, 2003 consisted of net underwriting income of $130.9 million, net investment income and net realized gains of $13.6 million, foreign exchange gains of $4.6 million and a tax expense of $2.1 million.

Comprehensive Income.  Comprehensive income for the quarter ended September 30, 2004 was $60.5 million compared to $148.9 million for the quarter ended September 30, 2003, a decrease of $88.4 million. Comprehensive income represents net income adjusted for changes in the unrealized position in our investment portfolio. For the quarter ended September 30, 2004, we experienced an increase of $54.2 million in the unrealized position in our investment portfolio compared to an increase of $1.9 million during the quarter ended September 30, 2003.

Nine months ended September 30, 2004 and 2003

Premiums.  In the nine months ended September 30, 2004, gross premiums written were $2,361.1 million compared with $1,794.0 million for the nine months ended September 30, 2003, an increase of $567.1 million. Of this increase, 48.8% was generated by our global reinsurance segment, 25.5% by our U.S. insurance segment, 20.4% by our U.S. reinsurance segment and 5.3% by our global insurance segment. The increase in gross premiums written in our global reinsurance segment was primarily driven by our expansion into continental Europe in November 2003. The increases in gross premiums written in our U.S. segments were primarily due to greater market penetration and our ability to participate fully in the first quarter’s renewal season. We expect the mix of business within and between our segments to change over time based on market conditions and our view of the long term profit potential of individual lines of business.

Premiums ceded for the nine months ended September 30, 2004 were $412.1 million compared with $269.6 million for the nine months ended September 30, 2003, an increase of $142.5 million. We purchase reinsurance to reduce our exposure to risk of loss on some lines of business written primarily within our global insurance and U.S. insurance segments. The increase in ceded premiums was generated primarily within these segments.

Net premiums earned for the nine months ended September 30, 2004 were $1,479.4 million compared with $1,035.5 million for the nine months ended September 30, 2003, an increase of $443.9 million. Premiums are earned over the term of the policies in proportion to the risks to which they relate. As the level of net premiums written increases, the level of net premiums earned also increases. As we experienced an increase in net premiums written in all of our segments over the rolling twelve-month period ended September 30, 2004 compared to the rolling twelve-month period ended September 30, 2003, our net premiums earned increased.

Net Investment Income and Net Realized Gains.  Net investment income, including realized gains, for the nine months ended September 30, 2004 was $114.0 million compared with $67.8 million for the nine months ended September 30, 2003, an increase of $46.2 million.

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Net Investment Income. Net investment income for the nine months ended September 30, 2004 was $104.6 million compared with $46.6 million for the nine months ended September 30, 2003, an increase of $58.0 million. This was due to a combination of higher investment balances and higher investment yields. The 2003 amount also included an additional charge to the amortization expense on our mortgage-backed securities portfolio. Net investment income consisted primarily of interest on fixed income securities that was partially offset by net investment expenses of $5.0 million for the nine months ended September 30, 2004 compared with $4.0 million for the nine months ended September 30, 2003. The higher expenses were a result of an increase in our assets managed by external portfolio managers.

The annualized effective yield (calculated by dividing the net investment income generated from invested assets by the average balance of the assets managed by our portfolio managers) for the nine months ended September 30, 2004 was 3.3% compared with 2.4% for the nine months ended September 30, 2003. The increase in the effective yield was primarily due to higher U.S. interest rates. The 2003 yield also was reduced by the additional charge to the amortization expense on our mortgage-backed securities portfolio. The yield may vary significantly from period to period due primarily to the timing of cash flows, changes in interest rates and changes in asset allocation.

Net Realized Gains. Net realized gains for the nine months ended September 30, 2004 were $9.4 million compared with $21.2 million for the nine months ended September 30, 2003, a decrease of $11.8 million. We invest our portfolios to produce a total return. In assessing returns under this approach, we include investment income, realized gains and losses and unrealized gains and losses generated by the investment portfolios. As a result, there can be significant changes in the levels of our net realized gains (losses) from quarter to quarter. Some of our mortgage-backed securities are required to be classified as derivatives; included within net realized gains was $0.2 million in realized gains and a negligible amount in unrealized losses relating to these securities.

The total return for our investment portfolio (calculated using beginning and ending market portfolio values, adjusted for external cash flows) for the nine months ended September 30, 2004 was 2.7% compared with 3.1% for the nine months ended September 30, 2003. The total return for an investment portfolio consists of price and income return. These components are primarily affected by the timing of cash flows, changes in interest rates and changes in asset allocation. Our total return was lower in the nine months ended September 30, 2004 due to an increase in U.S. interest rates, which negatively impacted fixed income security prices; this was partially mitigated by higher investment yields.

Other Insurance Related Income.  Other insurance related income for the nine months ended September 30, 2004 was $7.7 million compared with income of $19.8 million for the nine months ended September 30, 2003, a decrease of $12.1 million. This income related to the movement in the fair value of our insurance and reinsurance contracts that meet the definition of a derivative.

Net Losses and Loss Expenses.  Net losses and loss expenses for the nine months ended September 30, 2004 were $946.0 million compared to $526.1 million for the nine months ended September 30, 2003, an increase of $419.9 million. The net loss and loss expense ratio for the nine months ended September 30, 2004 was 63.9% compared to 50.8% for the nine months ended September 30, 2003. The increase in net losses and loss expenses and the net loss and loss expense ratio was primarily driven by an active hurricane season.  We incurred net losses and loss expenses of $227.4 million from Hurricanes Charley, Frances, Ivan and Jeanne, which swept across the Caribbean and South Eastern United States in August and September 2004.  Our estimates for the losses incurred from these hurricanes were derived from formal loss advices, the output of industry models, a review of in-force contracts and preliminary indications from clients. Consequently, actual losses from these hurricanes may

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vary materially from estimated losses.  During the nine months ended September 30, 2003, we did not experience a major loss as a result of hurricane activity.  The impact of the hurricane-related losses was partially mitigated by favorable prior period development of $141.4 million, or 9.6 percentage points, compared to $51.8 million, or 5.0 percentage points, for the nine months ended September 30, 2003.

Acquisition Costs.  Acquisition costs for the nine months ended September 30, 2004 were $201.7 million compared to $146.8 million for the nine months ended September 30, 2003, an increase of $54.9 million. This increase was primarily a result of the increase in the volume of net premiums earned. The acquisition cost ratio for the nine months ended September 30, 2004 was 13.6% compared to 14.2% for the nine months ended September 30, 2003. This decrease resulted primarily from the effects of a change in business mix; our U.S. insurance segment, which began underwriting in 2003, has a lower acquisition cost ratio than our other segments due to the receipt of ceding commissions on some outward reinsurance contracts that are recorded as an offset to acquisition costs. With effect from January 1, 2004, we included the personnel expenses of our underwriters in general and administrative expenses; prior to that date, they were included in acquisition costs. Our disclosures for prior periods have been restated to reflect this change.

General and Administrative Expenses.  General and administrative expenses for the nine months ended September 30, 2004 were $132.0 million compared to $96.5 million for the nine months ended September 30, 2003, an increase of $35.5 million. This increase was primarily driven by the establishment and expansion of operations in the U.S. and Europe. In addition, we incurred $2.9 million of fees in connection with our preparation for compliance with section 404 of the Sarbanes-Oxley Act of 2002. The general and administrative expense ratio for the nine months ended September 30, 2004 was 8.9% compared to 9.3% for the nine months ended September 30, 2003. The reduction in the ratio was caused by an increase in the volume of net premiums earned.

Foreign Exchange.  Our functional currency is the U.S. dollar; however, some of our business is written in other currencies. For the nine months ended September 30, 2004, we experienced a loss of $4.1 million compared to a gain of $19.3 million for the nine months ended September 30, 2003, a decrease of $23.4 million. This decrease was principally attributable to asset balances denominated in Euros following an increase in the level of gross premiums written in this currency in our global reinsurance segment.

Income Tax Expense.  The income tax expense for the nine months ended September 30, 2004 was $3.4 million compared to $1.1 million for the nine months ended September 30, 2003, an increase of $2.3 million.

Net Income.  Net income for the nine months ended September 30, 2004 was $313.9 million compared to $371.9 million, a decrease of $58.0 million. Net income for the nine months ended September 30, 2004 consisted of net underwriting income of $207.4 million, net investment income and net realized gains of $114.0 million, foreign exchange losses of $4.1 million and tax expense of $3.4 million. Net income for the nine months ended September 30, 2003 consisted of net underwriting income of $285.9 million, net investment income and net realized gains of $67.8 million, foreign exchange gains of $19.3 million and an overall tax expense of $1.1 million.

Comprehensive Income.  Comprehensive income for the nine months ended September 30, 2004 was $311.8 million compared to $386.0 million for the nine months ended September 30, 2003, a decrease of $74.2 million. Comprehensive income represents net income adjusted for changes in the unrealized position in our investment portfolio. For the nine months ended September 30, 2004, we experienced a decrease of $2.2 million in the unrealized position in our investment portfolio compared to an increase of $14.1 million during the nine months ended September 30, 2003.

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(1)For the quarter ended September 30, 2004, we did not allocate any of our general and administrative expenses, except for the personnel expenses of our underwriters; therefore, the general and administrative amounts and expense ratios for the two periods are not comparable.

Premiums.  In the quarter ended September 30, 2004, gross premiums written were $214.3 million compared to $249.3 million for the quarter ended September 30, 2003, a decrease of $35.0 million. The table below shows gross premiums written by line of business: