AXIS Capital - 10-Q quarterly report FY

ITEM 1. FINANCIAL STATEMENTS

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AXIS CAPITAL HOLDINGS LIMITED
CONSOLIDATED BALANCE SHEETS
MARCH 31, 2007 (UNAUDITED) AND DECEMBER 31, 2006

See accompanying notes to consolidated financial statements

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AXIS CAPITAL HOLDINGS LIMITED
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2007 AND 2006

See accompanying notes to the consolidated financial statements.

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2007 AND 2006

See accompanying notes to the consolidated financial statements.

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2007 AND 2006

See accompanying notes to consolidated financial statements.

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AXIS CAPITAL HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2007 AND 2006

See accompanying notes to the consolidated financial statements.

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.                                      BASIS OF PRESENTATION AND ACCOUNTING POLICIES

Basis of Presentation

Our consolidated balance sheet at March 31, 2007 and the consolidated statements of operations, comprehensive income, shareholders’ equity and cash flows for the three months ended March 31, 2007 and 2006 have not been audited. These statements 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 financial statements reflect all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of our 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 inter-company accounts and transactions have been eliminated. In these notes, the terms “we,” “us,” “our,” or “the Company” refer to AXIS Capital and its direct and indirect subsidiaries.

The following information is unaudited and should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2006. Tabular dollars are in thousands, except per share amounts. Certain reclassifications have been made to prior period amounts to conform to the current period presentation. In particular, we reclassified the additional capital above par value on our Series A and B preferred shares from additional paid-in capital to the preferred shares caption in our Consolidated Balance Sheets and Statements of Changes in Shareholders’ Equity.

Adoption of New Accounting Standards

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.

On July 13, 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - - An  Interpretation of FASB Statement No. 109” (“FIN 48”). This Interpretation prescribes detailed guidance for the  financial statement recognition, measurement and disclosure of uncertain tax positions recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. Under FIN 48, the tax benefits of uncertain tax positions may only be recognized when the position is more-likely-than-not to be sustained upon audit by the relevant taxing authorities. The amount recognized represents the largest amount of tax benefit that is greater than fifty percent likely of being recognized. We adopted the provisions of FIN 48 on January 1, 2007. There were no unrecognized tax benefits as of the date of adoption and there was no change in the liability for unrecognized tax benefits. Our U.S. subsidiaries are not under examination but remain subject to examination in the U.S. for tax years 2003-2006. Our various European operating subsidiaries and branch operations in Ireland, the United Kingdom, and Switzerland are not under examination in any of these tax jurisdictions, but generally remain subject to examination for tax years 2002-2006.

Accounting Standards Not Yet Adopted

In September 2006, the FASB issued FAS No. 157, Fair Value Measurement (“FAS 157”). This Statement provides guidance for using fair value to measure assets and liabilities. Under this standard, the definition of fair value focuses on the price that would be received to sell the asset or paid to transfer the liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price). FAS 157 clarifies that fair value is a marketbased measurement, not an entity-specific measurement, and sets out a fair value hierarchy with the highest priority being quoted prices in active markets and the lowest priority to unobservable data. Further, FAS 157 requires tabular disclosures of the fair value measurements by level within the fair value hierarchy. FAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Although early adoption is permitted as of January 1, 2007, we have not yet adopted FAS 157 and are evaluating the potential impact of adoption on our financial condition, results of operations and cash flows.

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.                                      BASIS OF PRESENTATION AND ACCOUNTING POLICIES (Continued)

In February 2007, the FASB issued FAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“FAS 159”). This standard permits an entity to irrevocably elect fair value on a contract-by-contract basis as the initial and subsequent measurement attribute for many financial instruments and certain other items including insurance contracts. An entity electing the fair value option would be required to recognize changes in fair value in earnings and provide disclosure that will assist investors and other users of financial information to more easily understand the effect of the company’s choice to use fair value on its earnings. Further, the entity is required to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. This standard does not eliminate the disclosure requirements about fair value measurements included in FAS 157 and FAS No. 107, Disclosures about Fair Value of Financial Instruments. FAS 159 is effective for fiscal years beginning after November 15, 2007. Although early adoption is permitted as of January 1, 2007, we have not yet adopted FAS 159 and are evaluating the potential adoption impact on our financial condition, results of operations and cash flows.

2.                                    SEGMENT INFORMATION

Our underwriting operations are organized around our two global underwriting platforms, AXIS Insurance and AXIS Re and therefore we have determined that we have two reportable segments, insurance and reinsurance. We do not allocate our assets by segment as we evaluate the underwriting results of each segment separately from the results of our investment portfolio.

Insurance

Our insurance segment provides insurance coverage on a worldwide basis. In January 2007, we announced the reorganization of AXIS Insurance to further strengthen the global operations of the segment. This reorganization reflects the management of AXIS Insurance along global product lines rather than by geographical location. The new structure enables us to design insurance programs on a global basis in alignment with the global needs of many of our clients. Through December 31, 2006, we subdivided our insurance segment into two sub-segments: global insurance and U.S insurance. However, as a result of the reorganization such sub-segment information is no longer relevant.

The following are the lines of business in our insurance segment:

·                  Property: provides physical damage and business interruption coverage for industrial and commercial properties and physical damage, business interruption and liability coverage for onshore energy properties and operations. The book consists of both primary and excess risks, some of which are catastrophe-exposed.

·                  Marine: provides coverage for hull, liability, cargo and specie and recreational marine risks. These risks include property damage or physical loss to ships, pollution damage caused by vessels on a sudden and accidental basis, protection for general cargo and the contents of armored cars, vaults, exhibitions and museums, and specific war related risks. This line of business also provides physical damage, business interruption and liability coverage for offshore energy property and operations.

·                  Terrorism: provides coverage for physical damage and business interruption of an insured following an act of terrorism.

·                  Aviation: includes hull and liability and specific war coverage for passenger and cargo airlines and privately owned aircraft as well as select aviation product liability coverage.

·                  Political risk: generally provides protection against sovereign default or sovereign actions resulting in impairment of cross-border investments for banks and major corporations. It also provides protection on structured credit based transactions where lenders seek to mitigate some of the non-payment risk of their borrowers, both public and private.

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

2. SEGMENT INFORMATION (Continued)

·                  Professional lines: primarily consists of coverage for directors’ and officers’ liability, errors and omissions
liability and employment practices liability.

·                  Liability: primarily targets general liability and umbrella and excess liability in the U.S. excess and surplus lines markets. Target classes include mercantile, manufacturing and building/premises, with particular emphasis on commercial and consumer products, commercial construction and miscellaneous general liability.

·                  Accident & Health: primarily provides employee medical coverage for self-insured, small and medium sized employers for losses in excess of a retention.

Reinsurance

Our reinsurance segment provides property and casualty reinsurance to insurance companies on a worldwide basis. The following are the lines of business we write on both a treaty and facultative basis in our reinsurance segment:

·                  Catastrophe: provides protection for most catastrophic losses that are covered in the underlying insurance policies written by our ceding company clients. The exposure in the underlying policies is principally property exposure but also covers other exposures including workers compensation, personal accident and life. The principal perils in this portfolio are hurricane and windstorm, earthquake, flood, tornado, hail and fire. In some instances, terrorism may be a covered peril or the only peril. We underwrite catastrophe reinsurance principally on an excess of loss basis, meaning that our exposure only arises when our customers’ claims exceed a certain retained amount.

·                  Property: includes reinsurance written on both a pro rata and a per risk basis and covers underlying personal lines and commercial property exposures. Property pro rata treaty reinsurance covers a cedent’s aggregate losses from all events in the covered period on a proportional basis. Property per risk treaty reinsurance reinsures a portfolio of particular property risks of ceding companies on an excess of loss basis.

·                  Professional Liability: covers directors’ and officers’ liability, employment practices liability, medical malpractice and miscellaneous errors and omissions insurance risks.

·                  Credit and Bond: consists principally of reinsurance of trade credit insurance products and includes both proportional and excess-of loss structures. The underlying insurance indemnifies sellers of goods and services against a payment default by the buyer of those goods and services. Also included in this book is coverage for ceding insurers against losses arising from a broad array of surety bonds issued by bond insurers principally to satisfy regulatory demands in a variety of jurisdictions around the world, but predominantly in Europe.

·                  Motor: provides coverage to insurers for motor liability losses arising out of any one occurrence. The occurrence can involve one or many claimants where the ceding insurer aggregates the claims from the occurrence.

·                  Liability: provides coverage to insurers of standard casualty lines, including auto liability, general liability, personal and commercial umbrella and workers’ compensation.

·                  Other: includes aviation, engineering, marine, personal accident and crop reinsurance.

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

2. SEGMENT INFORMATION (Continued)

The following tables summarize the underwriting results of our operating segments for the three months ended March 31:

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Net loss and loss expenses incurred include net favorable prior period reserve development of $66.0 million, and $61.1 million during the three months ended March 31, 2007 and 2006, respectively. Prior period development arises from changes to loss estimates recognized in the current period that relate to loss reserves first reported in previous calendar years. These reserve changes were made as part of our regular quarterly reserving process and primarily arose from better than expected emergence of actual claims relative to expectations on our short tail lines of business.

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Options

During the first three months of 2007 and 2006, we incurred compensation costs $0.2 million and $0.4 million, respectively, in respect of stock options, and recorded tax benefits thereon of $0.4 million and $0.6 million, respectively. At March 31, 2007, there was $0.8 million of unrecognized compensation cost related to the grant of options which is expected to be fully recognized during 2007. The total intrinsic value of options exercised during the first three months of 2007 was $1.3 million, and we received proceeds of $1.5 million. Changes in our stock options in the three months of 2007 and 2006 were as follows:

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

At March 31, 2006, there were 1,907,750 restricted shares and options which would have resulted in the issuance of common shares that were excluded in the computation of diluted earnings per share because the effect would be anti-dilutive. There were no such anti-dilutive restricted shares or options at March 31, 2007.

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AXIS CAPITAL HOLDINGS LIMITED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is a discussion and analysis of our financial condition and results of operations. This should be read in conjunction with the consolidated financial statements and related notes included in Item 1 of this report and also our Management’s 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, 2006. Tabular dollars are in thousands, except per share amounts.

Financial Measures

We believe the following financial indicators are important in evaluating our performance and measuring the overall growth in value generated for our common shareholders:

Annualized return on average common equity(‘ROACE’): ROACE represents the level of net income available to common shareholders generated from the average of the opening and closing common shareholders’ equity during the period. Our objective is to generate superior returns on capital that appropriately reward our shareholders for the risks we assume and to grow revenue only when we deem the returns meet or exceed our requirements.

ROACE for the first three months of 2007 and 2006 was 22.6% and 25.4%, respectively. The decrease was driven by the fact that average common shareholders’ equity increased by 31% as a result of significantly higher retained earnings largely generated during the year ended December 31, 2006.

Diluted book value per common share: This is a non-GAAP financial measure; for further information refer to “Non-GAAP Financial Measures” at the end of Item 2. We consider diluted book value per common share an appropriate measure of our returns to common shareholders, as we believe growth in our book value on a diluted basis ultimately translates into growth of our stock price. Diluted book value per share increased from $24.02 at December 31, 2006 to $25.11 at March 31, 2007. The increase was substantially due to additional earnings generated in the first three months of 2007.

Cash dividends per common share: Our dividend policy is an integral part of the value we create for our shareholders. Our quarterly cash dividend was $0.165 per common share in the first three months of 2007 compared to $0.15 per common share in the first three months of 2006. In December 2006, our Board of Directors authorized a 10% increase in the quarterly dividend.

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Results of Operations: Three months ended March 31, 2007 and 2006

Overview

The following table breaks out net income for the three months ended March 31:

The 17% increase in net income available to common shareholders was driven by a 52% increase in net investment income (including net realized gains/losses). This was due to a combination of a larger investment base, higher yields and increased income from our allocation to other investments. Underwriting income in both segments was affected by changes to our estimate of prior period loss reserves recorded in each quarter - see “underwriting results by segments” below for further discussion. Overall, our combined ratio was largely unchanged.

Underwriting Results

Premiums: Gross and net premiums written and earned in insurance and reinsurance in the three months ended March 31 were as follows:

Changes in net premiums earned reflect period to period changes in net premiums written and business mix, together with normal variability in earning patterns. Net premiums written increased 15% driven by growth of our property and casualty reinsurance business in the U.S. and Europe. Approximately 5 percentage points of the increase related to the favorable impact of exchange rate movements, predominantly within our reinsurance segment.

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Loss ratio: The table below shows the components of our net loss and loss expense ratio (“loss ratio”) for the three months ended March 31:

The prior period development was the net favorable result of several underlying reserve developments from prior accident years, primarily on our short tail lines of business. While we believe that our loss reserves at March 31, 2007 are adequate, new information may lead to future developments in ultimate loss and loss expenses significantly greater or less than the reserves currently provided. In addition, conditions and trends that affected the development of liabilities in the past may not necessarily occur in the future. Accordingly, it is inappropriate to anticipate future redundancies or deficiencies based on historical experience.

Our current year ratio may fluctuate from period to period depending on a number of variables that include the level of estimated attritional losses, changes in our mix of business and changes in the benchmark assumptions used to establish our loss ratios. These benchmarks are developed by our independent actuaries primarily using broader market data that is adjusted for changes in underlying rates, terms and conditions.

General and Administrative Ratio:The increase in our general and administrative ratio reflects the cost associated with supporting the growth of our business. In particular, we incurred additional underwriting support and recruitment costs in the first three months of 2007 relating to the expansion of our U.S. operations.

Net Investment Income and Net Realized Investment Gains/Losses

Our investment portfolio is structured to preserve capital and provide us with a high level of liquidity. Additionally we invest our portfolio with a focus on total return rather than establishing yield or income targets.

The following table provides a breakdown of net investment income, net realized investment gains/losses and also the associated yields and returns for the three months ended March 31:

(1) Calculated by dividing the net investment income generated from invested assets by the average balance of the assets managed by our external investment managers.

(2) Invested assets represent assets managed by external investment managers.

Net investment income: Net investment income increased by 34% driven by a larger investment base, higher investment yields and increased income from our allocation to other investments. The average investment base of our cash and fixed maturity investments increased by $1.0 billion and was generated from positive operating cash flows. The growth in the annualized effective yield was primarily due to higher U.S. interest rates at the short end of the yield curve. The yield on our portfolio may vary significantly from period to period due primarily to the timing of cash flows, changes in interest rates and changes in asset allocation. Increased income from our other investment portfolio was a result of larger allocations to collateralized loan obligations, fund of hedge funds, and credit funds combined with better total returns from those investments. The average investment base of our other investments has increased by $0.5 billion.

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Net realized investment losses/gains: The majority of our portfolio is invested in the fixed income market and as a result the level of realized gains and losses on these investments are highly correlated to fluctuations in interest rates. The effect of increasing interest rates up to and throughout the first three months of 2006 negatively impacted the price of fixed income resulting in larger unrealized loss positions.

Total return:Our portfolio is managed to maximize total return within certain guidelines. In assessing returns under this approach, we include net investment income, net realized investment gains and losses and the change in unrealized gains and losses generated by our investment portfolio. The increase in our total return was due to a growing allocation to higher returning other investments, and more significantly, the decrease in intermediate U.S. Treasury yields that had a positive impact on the price of the fixed income portfolio. During the first three months of 2006, intermediate U.S. Treasury yields increased, which negatively impacted the price component of the total return.

Other Revenues and Expense items

The following table sets forth our other revenues and expenses for the three months ended March 31:

Corporate expenses: Our corporate expenses include holding company costs necessary to support our worldwide insurance and reinsurance operations and costs associated with operating as a publicly-traded company. As a percentage of net premiums earned, corporate expenses were 1.8% in both periods.

Foreign exchange gains: Some of our business is written in currencies other than U.S dollars. The gains in the first three months of 2007 and 2006 were principally made on the revaluation of asset balances denominated in Euro following an appreciation of the Euro against the U.S dollar during these periods of 1.2% and 2.3%, respectively.

Interest expense: The increase was primarily due to interest costs incurred on the $400.0 million repurchase agreement we entered into in December 2006. We renewed the agreement for a further three months in March 2007 at an interest rate of 3-month LIBOR plus 0.75% per annum.

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Underwriting Results by Segment: Three months ended March 31, 2007 and 2006

Insurance Segment

Results of our insurance segment for the three months ended March 31 were as follows:

The 11.3 percentage point change in our combined ratio was largely due to less favorable prior period reserve development in 2007 (9.1 percentage points) than in 2006 (20.4 percentage points).

Gross premiums written: The following table provides gross premiums written by line of business for the three months ended March 31:

Gross premiums written were consistent quarter on quarter although there was some variation between individual lines of business. Our insurance segment is strongly diversified by product and geography which gives us the flexibility to allocate capacity where we see the best-rated opportunities. Consequently, our mix of business changes based on market conditions. The growth in our property book is primarily due to rate increases on wind peril catastrophe exposed business in the U.S relative to the first three months of 2006 when we declined business that was inadequately priced. The non-catastrophe and international components of our property account remain highly competitive but we continue to identify good business that meets our pricing criteria.

Our aviation and terrorism lines continue to suffer from aggressive competition and we have reduced our participation. We also experienced increased competition and deterioration in rates for casualty business and consequently our premiums on this line reduced. Gross premiums written on our political risk book can vary considerably between periods depending on the timing of major transactions. However, additional underwriting resources on this line allowed us to increase our volume of business in the first three months of 2007 compared to 2006.

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Net premiums earned: The following table provides net premiums earned by line of business for the three months ended March 31:

Changes in net premiums earned reflect period to period changes in net premiums written and business mix, together with normal variability in earning patterns. The overall 2% decrease was largely attributable to our aviation line where, due to continued deteriorating market conditions, we have decreased net premiums written by 43% in the respective rolling twelve months to March 31. Over the same period we significantly increased our political risk premium. Because this line typically provides multi-year coverage, the earning of this premium is spread over a greater number of periods.

Loss ratio: The table below shows the components of our loss ratio for the three months ended March 31:

The prior period reserve development in each quarter was the net favorable result of several underlying reserve developments, primarily on our short tail lines of business. The first three months of 2006 included 9.3 percentage points of favorable development on losses relating to Hurricanes Katrina, Rita and Wilma from 2005.

Outlook

Generally, we are satisfied that the broad property and casualty insurance marketplace, provides us ample opportunity to target attractively priced risks. Current rate levels for some lines of business, like catastrophe-exposed property and energy business, continue to produce returns above historic levels. In areas where the competition has been much more aggressive, such as terrorism and aviation, we have been reducing our participation. Other lines, such as primary casualty, umbrella, and professional lines, still contain good profit potential, but bear closer scrutiny as they come under increasing pressure. Smaller accounts are experiencing less pricing pressure and we continue to develop our capabilities for efficiently accessing and underwriting these accounts.

During the quarter, we announced the acquisition of the assets and operations of Media/Pro. Media/Pro is a full-service managing general underwriter with operations in the U.S., Canada and the U.K. Professional liability lines written by Media/Pro include media liability insurance, cyber-technology insurance and miscellaneous professional liability insurance. We have been the exclusive carrier for several of its E&O liability programs for the prior two years. Our premium volume generated from the Media/Pro relationship in 2006 was approximately $55 million and we now have renewal rights to the broader portfolio, which could represent $70 million of additional annual premium to us.

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Reinsurance Segment

Results in our reinsurance segment for the three months ended March 31 were as follows:

The 8.5 percentage point change in our combined ratio was largely due to the impact of prior period loss reserve development. We experienced 10.1 percentage points of net favorable development in the first three months of 2007 compared to net adverse development of 1.6 percentage points in the same period of 2006.

Gross Premiums Written: The following table provides gross premiums written by line of business for the three months ended March 31:

The 19% increase in gross premiums written was partially due to foreign exchange rate movements between January 1, 2006 and January 1, 2007, most significantly the weakening of the U.S dollar against the Euro and Sterling. The impact on our various lines of business is highlighted above.

Overall, the reinsurance market remained stable and at attractive levels in the first three months of 2007 with no significant changes in either terms or conditions. The increase in gross premiums written mostly reflects increased participation of the U.S and European reinsurance markets. Since early 2006 we have recruited additional underwriting resources and also increased our marketing efforts in the U.S. These measures drove additional business in the first three months of 2007, most notably in property and liability lines. We also broadened our portfolio in Europe by writing new catastrophe and property pro rata business in Eastern Europe, increasing our market share of the French motor market and writing new engineering business. The reduction in professional lines premium was primarily related to the timing of renewals.

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Net premiums earned: The following table provides net premiums earned by line of business for the three months ended March 31: