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 June 30, 2005

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 ýNo o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes ýNo o

As of August 3, 2005, there were 143,196,250 Common Shares, $0.0125 par value per share, of the registrant outstanding.

PART 1 - FINANCIAL INFORMATION

Item 1. Financial Statements

AXIS CAPITAL HOLDINGS LIMITED

CONDENSED CONSOLIDATED BALANCE SHEETS
As at June 30, 2005 and December 31, 2004
(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 OPERATIONS AND
COMPREHENSIVE INCOME
For the Quarters and Six Months ended June 30, 2005 and 2004
(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 Six Months ended June 30, 2005 and 2004
(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 Six Months ended June 30, 2005 and 2004
(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 (together, the “Company”) and have been prepared in accordance with U.S. Generally Accepted Accounting Principles (“U.S. 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 U.S. 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 U.S. 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 the reserve for losses and loss expenses, premium estimates for business written on a line slip or proportional basis, the estimation of accruals for amounts due under incentive commission agreements and the estimation of fair values for derivative contracts. The terms “FAS” and “FASB” used in these notes refer to Statements of Financial Accounting Standards issued by the United States Financial Accounting Standards Board. To facilitate period-to-period comparisons, reclassifications have been made to prior period consolidated financial statement amounts to conform to current period presentation. There was no effect on net income from these changes in presentation.

This Quarterly Report in Form 10-Q should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 filed with the Securities and Exchange Commission (the “SEC”) on March 1, 2005.

2.             New Accounting Pronouncements

In June 2005, the FASB directed the staff to issue the proposed FSP EITF Issue 03-1-a as final and it will be retitled FSP FAS 115-1 “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments”.  It replaces existing guidance and clarifies that an impairment should be recognized as a loss at a date no later than the impairment is deemed other-than-temporary, even if the decision to sell has not been made. FSP FAS 115-1 is effective for other-than-temporary impairment analysis conducted in periods beginning after September 15, 2005. The Company believes that its current policy on other-than-temporary impairments complies with FSP FAS 115-1. Accordingly, the adoption of this standard has no impact on the Company’s results of operations or financial condition.

In June 2005, the FASB issued as final FSP No. FAS 150-5 “Issuers Accounting under FASB Statement No.150 for Freestanding Warrants and Other Similar Instruments on Shares that are Redeemable”. The FSP clarifies that freestanding warrants and similar instruments on shares that are redeemable should be accounted for as liabilities under FASB Statement No. 150 “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” regardless of the timing of the redemption feature or price, even though the underlying shares may be classified as equity. The FSP is effective for the first reporting period beginning after June 30, 2005. Although the Company does have outstanding warrants, the shares issued upon exercise of the warrants are not redeemable; consequently, FSP No. FAS 150-5 has no impact on the Company’s results of operations or financial condition.

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In December 2004, the FASB issued Statement No 123 (revised 2004), Share-Based Payment (“FAS 123R”).  FAS 123R replaces FASB Statement No. 123 “Accounting for Stock-Based Compensation” and supersedes APB opinion No.25 “Accounting for Stock Issued to Employees”. The statement requires all entities to recognize compensation expense in an amount equal to the fair value of share-based payments granted to employees and is effective for the first quarter of 2006. The Company already records compensation expense for awards of stock options and restricted stock to employees based on the fair value of the awards; consequently, this statement will not have a material impact on the Company’s results of operations or financial condition.

3.             Stock-Based Compensation

The Company accounts for stock compensation in accordance with FAS No. 123, “Accounting for Stock-Based Compensation.” Compensation expense for stock options and for restricted stock awards granted to employees is recorded over the vesting period using the fair value method. The Company adopted FAS No. 123 effective January 1, 2003 by applying the prospective method permitted under FAS No. 148 “Accounting for Stock Based Compensation – Transition and Disclosure”. 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. 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

Through December 31, 2004, the Company’s business consisted of five reportable operating segments: global insurance; global reinsurance; U.S. insurance; U.S. reinsurance; and corporate. Effective January 1, 2005, the Company created two distinct global underwriting platforms, AXIS Insurance and AXIS Re. Following this strategic realignment of its organizational structure, the Company has re-evaluated its operating and reportable segments and determined that it has three reportable operating segments: insurance, reinsurance and corporate. The Company’s insurance segment is further divided into two sub-segments: global insurance and U.S. insurance. The Company’s segments and sub-segments have been determined on the basis of underlying information reviewed by the chief decision maker, the Chief Executive Officer.

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5.             Benefit Plans

The following table shows the components of expense for the quarter and six months ended June 30, 2005 and 2004 and the amounts included in the Company’s Condensed Consolidated Balance Sheet as of June 30, 2005 and December 31, 2004 for the supplemental retirement plans (“SERPS”):

The weighted-average assumptions used to determine net periodic pension cost and benefit obligations for the quarter and six months ended June 30, 2005 and 2004 were:

6.             Debt and Financing Arrangements

a)             Senior Notes

On November 15, 2004, the Company issued $500.0 million of senior unsecured debt (“Senior Notes”) at an issue price of 99.785%, generating net proceeds of $495.7 million. The Senior Notes bear interest at a rate of 5.75% payable semi-annually in arrears on June 1 and December 1 of each year, beginning on June 1, 2005. Unless previously redeemed, the Senior Notes will mature on December 1, 2014. The Company may redeem the Senior Notes at any time, in whole or in part, at a “make-whole” redemption price, however, the Company has no current intentions of calling the Senior Notes. The Senior Notes contain various covenants, including limitations on liens on the stock of restricted subsidiaries, restrictions as to the disposition of the stock of restricted subsidiaries, and limitations on mergers and consolidations. The Company was in compliance with all covenants contained in the Senior Notes at June 30, 2005. The market value of the Senior Notes at June 30, 2005 was $515.9 million. For the quarter ended June 30, 2005, the Company incurred interest expense of $7.2 million for the Senior Notes.  Interest payments commenced on June 1, 2005.

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b)             Credit Facilities

As at June 30, 2005, the Company had a $750 million revolving credit facility available from a syndicate of commercial banks. Up to $750 million may be used to issue letters of credit and up to $300 million for general corporate purposes with total borrowing not to exceed $750 million. As at June 30, 2005, the Company had letters of credit of $433.7 million (2004: $421.7 million) outstanding. There was no debt outstanding under the credit facility as at June 30, 2005 or December 31, 2004. The credit facility contains various loan covenants that include, among other things, the requirement that the Company maintain a minimum level of capital and surplus and a maximum debt to total capitalization ratio. The Company was in compliance with all covenants contained in the credit facility at June 30, 2005.

The Company is currently re-negotiating its credit facility in order to increase the facility size and extend the tenure.

7.             Share Repurchase

On February 16, 2005, the Company repurchased 12,783,094 common shares owned by initial investors at the formation of the Company pursuant to its repurchase program. The average purchase price was $27.38 per common share and the aggregate price was $350.0 million.

8.             Earnings Per Share

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

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Securities that will result in the issuance of common shares of 3,615,618, 1,735,875, 3,630,618 and 1,671,875 were outstanding for the quarters and the six months ended June 30, 2005 and 2004, respectively, but were not included in the computation of diluted earnings per share because the exercise prices were greater than the average market price of the common shares and, therefore, the effect would be antidilutive.

9.             Subsequent Event

On August 1, 2005, the Company acquired all the outstanding shares of Fireman’s Fund Insurance Company of Wisconsin, an admitted insurance company, for approximately $28.3 million in cash.

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Business Overview

The following is a discussion of the Company’s financial condition, liquidity and results of operations. This discussion should be read in conjunction with the Management’s Discussion and Analysis of Financial Condition and Results of Operations and the audited Consolidated Financial Statements and notes thereto presented under Item 7 and Item 8, respectively, of the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 filed with the SEC on March 1, 2005.

The markets in which we operate have historically been cyclical. During periods of excess underwriting capacity, as defined by availability of capital, competition can result in lower pricing and less favorable policy terms and conditions for insurers and reinsurers. During periods of reduced underwriting capacity, pricing and policy terms and conditions are generally more favorable for insurers and reinsurers. Historically, underwriting capacity has been impacted by several factors, including industry losses, catastrophes, changes in legal and regulatory guidelines, investment results and the ratings and financial strength of competitors.

We believe that we are currently operating in a marketplace that, with appropriate risk selection, can offer favorable pricing and/or terms and conditions in our business segments. In general, pricing in our insurance segment is stable to declining for many classes of business. Terms and conditions, however, remain relatively attractive. In our reinsurance segment, we have experienced moderate price softening, particularly in short-tail lines of business (with the exception of Florida-exposed business). Terms and conditions have remained firm across most lines of business.

We derive our revenues primarily from the sale of our insurance policies and reinsurance contracts. Insurance and reinsurance premiums are a function of the number and type of contracts we write, as well as prevailing market prices. Our expenses primarily consist of net losses and loss expenses, acquisition costs, general and administrative expenses and interest expense.

Financial Measures

Our objective as an insurance and reinsurance company is to generate superior returns on capital that appropriately reward us for the risks we assume and to grow revenue only when we deem the returns meet or exceed our requirements. To achieve this objective, we must be able to accurately assess the potential losses associated with the risks that we insure and reinsure, to manage our investment portfolio risk appropriately, and to control acquisition costs and infrastructure throughout the organization.  Three financial measures that are meaningful in analyzing our performance are return on equity, combined ratio and underwriting income. Our return on equity calculation is based on the level of net income generated from the average of the opening and closing shareholders’ equity during the period. The combined ratio is a formula used by insurance and reinsurance companies to relate net premiums earned during a period to net losses and loss expenses, acquisition costs and general and administrative expenses during a period. A combined ratio above 100% indicates that a company is incurring more in net losses and loss expenses, acquisition costs and general and administrative expenses than it is earning in net premiums. We consider the combined ratio an appropriate indicator of our underwriting performance, particularly given the relatively short tail orientation of our overall portfolio of risks.  Underwriting income is a measure of underwriting profitability that takes into account net premiums earned and other insurance related income as revenue and net losses and loss expenses, acquisition costs and underwriting related general and administrative expenses as expenses. Underwriting income is the difference between these revenue and expense items.

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The following table details our key performance indicators for the periods indicated:

Because we have a limited operating history and are exposed to volatility in our results of operations, period-to-period comparisons of our results of operations may not be meaningful. In addition, the amount of premiums written with respect to any particular segment or line of business may vary from quarter to quarter as a result of changes in market conditions and our view of the long-term profit potential of individual lines of business.

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 for the year ended December 31, 2004 filed with the SEC on March 1, 2005.

Results of Operations

Quarters ended June 30, 2005 and 2004

Premiums.  The $138.0 million increase in gross written premium was generated by both our insurance and reinsurance segments, which experienced increases in gross premiums written of $76.9 million and $61.1 million, respectively. This increase was primarily due to greater market penetration in existing lines of business together with the generation of new business.

The increase of $10.1 million in premiums ceded was primarily due to an increase in premiums ceded by our insurance segment.  This was primarily a result of increased premiums ceded by U.S. insurance.

The $138.0 million increase in net premiums earned was primarily generated by our reinsurance segment, which reported an increase of $105.2 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 over the rolling twelve-month period ended June 30, 2005 compared to the rolling twelve-month period ended June 30, 2004, our net premiums earned increased.

Net Investment Income. Net investment income increased by $24.7 million due to a combination of higher investment balances and higher investment yields.  Net investment income for the quarter ended June 30, 2005 consisted of $54.6 million of interest on cash and fixed maturity investments and $5.0 million of income from other investments, offset by $1.6 million of net investment expenses. Included in

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net investment income for the quarter ended for June 30, 2005, was $0.6 million of unrealized gains from other investments. Net investment income for the quarter ended June 30, 2004 consisted of $34.8 million of interest on cash and fixed maturity investments offset by $1.5 million of net investment expenses.

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) increased by 0.8%. The increase in the effective yield was primarily due to higher U.S. interest rates at the short end of the yield curve. 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 Losses/Gains. Net realized gains increased by $6.2 million. The increase was generated by net realized gains of $3.5 million from sale of investments and net realized and unrealized gains of $2.7 million from investment derivatives that we use to hedge the foreign exchange risk of the investment portfolio. 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.

The total return for our investment portfolio for the quarter ended June 30, 2005 (calculated using beginning and ending market portfolio values, adjusted for external cash flows) was 2.2% versus (1.7%) for the quarter ended June 30, 2004. 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 higher during the quarter ended June 30, 2005 due to a combination of higher investment yields obtained during the quarter versus the comparable prior period and a change in the U.S. interest rates that positively impacted the price of fixed income securities.

Other Insurance Related Income/Loss.  The decrease of $5.6 million in other insurance related income/loss primarily related to the movement in the fair value of insurance contracts that meet the definition of a derivative. During the quarter ended June 30, 2005, the principal contract that was accounted for as a derivative expired.

Net Losses and Loss Expenses.  The increase of $65.0 million in net losses and loss expenses was primarily generated by an increase in the volume of gross premiums earned and an increase in the net loss and loss expense ratio for our reinsurance segment. The net loss and loss expense ratio for the quarter ended June 30, 2005, was 51.7% compared to 53.0% for the quarter ended June 30, 2004. During the quarter ended June 30, 2005, we experienced favorable prior period development of $74.0 million, or 11.9 percentage points, compared with $43.2 million, or 8.9 percentage points, for the quarter ended June 30, 2004.

Acquisition Costs.  The increase of $20.0 million in acquisition costs primarily resulted from an increase in the volume of gross premiums earned. The acquisition cost ratio for the quarter ended June 30, 2005 was 13.7% compared to 13.5% for the quarter ended June 30, 2004. We experienced an increase in the ratio principally as a result of a change in our business mix, with a higher percentage of net earned premiums generated by our reinsurance segment, which has a higher acquisition cost ratio. This impact was partially offset by a reduction in the acquisition cost ratio in our insurance segment generated on business earned by global insurance.

As we have not entered into any incentive commission arrangements with brokers for 2005, we have not accrued any fees regarding these arrangements for the quarter ended June 30, 2005. We have accrued liabilities for amounts due under incentive arrangements with brokers entered into for 2004; however, given the uncertainties that exist surrounding the calculation and payment of these incentive commissions, this estimate is subject to change. Any changes in the estimate are recorded during the

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period in which the change is identified. To date, the level of commissions charged in 2005 by brokers has generally remained consistent with prior periods.