1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q (Mark one) /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period. . . . . . . . June 30, 1999 or / / Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the Transition Period from ____ to ____. Commission File Number 0-7849 W. R. BERKLEY CORPORATION (Exact name of registrant as specified in its charter) Delaware 22-1867895 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 165 Mason Street, Greenwich, Connecticut 06836-2518 (Address of principal executive offices) (Zip Code) (203) 629-3000 (Registrant's telephone number, including area code) None Former name, former address and former fiscal year, if changed since last report. Indicate by check mark whether the registrant (1) 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 and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Number of shares of common stock, $.20 par value, outstanding as of August 3, 1999: 25,785,503.
2 Part I - FINANCIAL INFORMATION ITEM 1. Financial Statements W. R. Berkley Corporation and Subsidiaries Consolidated Balance Sheets (Dollars in thousands) <TABLE> <CAPTION> June 30, December 31, 1999 1998 ---- ---- Assets (Unaudited) <S> <C> <C> Investments: Invested cash $ 230,102 $ 370,155 Fixed maturity securities: Held to maturity, at cost (fair value $168,585 and $183,469) 162,160 170,150 Available for sale at fair value (cost $2,254,392 and $2,224,244) 2,240,087 2,306,619 Equity securities, at fair value: Available for sale (cost $61,506 and $59,890) 67,151 65,869 Trading account (cost $327,518 and $373,164) 332,736 389,310 Cash 21,919 16,123 Premiums and fees receivable 419,107 377,501 Due from reinsurers 533,103 513,297 Accrued investment income 38,523 37,842 Prepaid reinsurance premiums 87,531 79,530 Deferred policy acquisition costs 184,289 168,894 Real estate, furniture & equipment at cost, less accumulated depreciation 130,775 136,884 Excess of cost over net assets acquired 78,419 76,645 Trading account receivable from broker and clearing organizations 191,252 229,520 Deferred Federal income taxes 43,000 -- Other assets 38,449 45,092 ----------- ----------- $ 4,798,603 $ 4,983,431 =========== =========== Liabilities, Reserves, Debt and Stockholders' Equity Liabilities and reserves: Reserves for losses and loss expenses $ 2,174,680 $ 2,126,566 Unearned premiums 709,781 664,297 Due to reinsurers 156,254 131,081 Deferred Federal income taxes -- 6,877 Short-term debt 75,000 55,500 Trading securities sold but not yet purchased at market value (proceeds $179,017 and $283,310) 181,182 298,165 Other liabilities 187,080 213,453 ----------- ----------- 3,483,977 3,495,939 ----------- ----------- Long-term debt 394,618 394,444 ----------- ----------- Company-obligated manditorily redeemable capital securities of a subsidiary trust holding solely 8.197% junior subordinated debentures of the Corporation due December 15, 2045 208,010 207,988 Minority interest 31,823 23,779 ----------- ----------- Stockholders' equity: Preferred stock, par value $.10 per share: Authorized 5,000,000 shares: 7 3/8% Series A Cumulative Redeemable Preferred Stock 653,952 shares issued and outstanding -- 65 Common stock, par value $.20 per share: Authorized 80,000,000 shares, issued and outstanding, net of treasury shares, 25,785,503 and 26,504,404 shares 7,281 7,281 Additional paid-in capital 331,631 429,611 Retained earnings 599,470 601,908 Accumulated other comprehensive income (8,067) 54,672 Treasury stock, at cost, 10,618,564 and 9,899,663 shares (250,140) (232,256) ----------- ----------- 680,175 861,281 ----------- ----------- $ 4,798,603 $ 4,983,431 =========== =========== </TABLE> See accompanying notes to consolidated financial statements. 1
3 W. R. Berkley Corporation and Subsidiaries Consolidated Statements of Operations (Unaudited) (Amounts in thousands except per share data) <TABLE> <CAPTION> For the Three Months For the Six Months Ended June 30, Ended June 30, ------------------------ ------------------------ Revenues: 1999 1998 1999 1998 --------- --------- --------- --------- <S> <C> <C> <C> <C> Net premiums written $ 345,187 $ 339,826 $ 725,771 $ 673,658 Change in net unearned premiums 1,195 (20,838) (37,417) (52,037) --------- --------- --------- --------- Premiums earned 346,382 318,988 688,354 621,621 Net investment income 51,181 52,384 97,175 108,778 Management fees and commission income 17,852 17,775 36,248 36,363 Realized gains on investments 285 7,090 1,013 10,507 Other income 550 673 1,173 2,916 --------- --------- --------- --------- Total revenues 416,250 396,910 823,963 780,185 Operating costs and expenses: Losses and loss expenses (249,258) (217,578) (492,097) (422,780) Other operating costs and expenses (152,133) (139,043) (296,358) (272,223) Interest expense (13,017) (12,158) (25,822) (24,331) Restructuring Charge -- -- (11,505) -- --------- --------- --------- --------- Income before income taxes and minority interest 1,842 28,131 (1,819) 60,851 Federal income tax (expense) benefit 4,450 (6,503) 9,623 (13,700) --------- --------- --------- --------- Income before minority interest 6,292 21,628 7,804 47,151 Minority interest (668) 1,115 292 1,265 --------- --------- --------- --------- Net income before preferred dividends 5,624 22,743 8,096 48,416 Preferred dividends -- (1,887) (497) (3,774) --------- --------- --------- --------- Net income before change in accounting principle and extraordinary loss 5,624 20,856 7,599 44,642 Cumulative effect of change in accounting principle (net of taxes of $1,750) -- -- (3,250) -- Extraordinary loss on early extinguishment of long-term debt (net of taxes of $1,390 and $2,701) -- (2,582) -- (5,017) --------- --------- --------- --------- Net income attributable to common stockholders $ 5,624 $ 18,274 $ 4,349 $ 39,625 ========= ========= ========= ========= Earning per share: Basic: Net income before change in accounting principle and extraordinary loss $ .22 $ .73 $ .29 $ 1.54 Cumulative effect of change in accounting principle -- -- (.12) -- Extraordinary loss on early extinguishment of long-term debt -- (.09) -- (.17) --------- --------- --------- --------- Net income attributable to common stockholders $ .22 $ .64 $ .17 $ 1.37 ========= ========= ========= ========= Diluted: Net income before change in accounting principle and extraordinary loss $ .22 $ .70 $ .29 $ 1.48 Cumulative effect of change in accounting principle -- -- (.12) -- Extraordinary loss on early extinguishment of long-term debt -- (.09) -- (.17) --------- --------- --------- --------- Net income attributable to common stockholders $ .22 $ .61 $ .17 $ 1.31 ========= ========= ========= ========= Average shares outstanding: Basic 25,955 28,469 26,139 29,024 ========= ========= ========= ========= Diluted 26,095 29,734 26,304 30,271 ========= ========= ========= ========= </TABLE> See accompanying notes to consolidated financial statements. 2
4 W. R. Berkley Corporation and Subsidiaries Consolidated Statements of Cash Flows (Unaudited) (Dollars in thousands) <TABLE> <CAPTION> For the Six Months Ended June 30, ------------------------ 1999 1998 --------- --------- <S> <C> <C> Cash flows from operating activities: Net income before preferred dividends and extraordinary items $ 4,846 $ 48,416 Adjustments to reconcile net income to cash flows from operating activities: Minority interest (292) (1,264) Change in reserves for losses and loss expenses, net of due to/from reinsurers 53,481 76,269 Depreciation and amortization 11,483 12,423 Change in unearned premiums and prepaid reinsurance premiums 37,483 52,040 Change in premiums and fees receivable (41,606) (77,376) Change in Federal income taxes (11,364) (2,132) Change in deferred acquisition cost (15,395) (16,235) Realized gains on investments (1,013) (10,507) Other, net (31,707) (25,815) --------- --------- Net cash flows from operating activities before trading account sales 5,916 55,819 Trading account sales, net (1,758) (28,519) --------- --------- Net cash flows from operating activities 4,158 27,300 --------- --------- Cash flows from (used in) investing activities: Proceeds from sales, excluding trading account: Fixed maturity securities available for sale 300,540 384,936 Equity securities 433 23,538 Proceeds from maturities and prepayments of fixed maturity securities 82,814 86,456 Cost of purchases, excluding trading account: Fixed maturity securities available for sale (407,546) (418,935) Equity securities (3,841) (13,871) Change in balances due to/from security brokers (15,287) 6,128 Net additions to real estate, furniture & equipment (1,494) (15,623) Other, net 2,668 (290) --------- --------- Net cash flows from (used in) investing activities (41,713) 52,339 --------- --------- Cash flows used in financing activities: Net proceeds from issuance of short-term debt 19,500 -- Purchase of treasury shares (18,072) (66,044) Cash dividends to common stockholders (6,590) (6,803) Cash dividends to preferred stockholders (2,001) (3,658) Repurchase of preferred stock (98,092) -- Retirement of long-term debt -- (49,104) Net proceeds from issuance of long-term debt -- 39,834 Other, net 8,553 (226) --------- --------- Net cash flows used in financing activities (96,702) (86,001) --------- --------- Net decrease in cash and invested cash (134,257) (6,362) Cash and invested cash at beginning of year 386,278 280,847 --------- --------- Cash and invested cash at end of period $ 252,021 $ 274,485 ========= ========= Supplemental disclosure of cash flow information: Interest paid $ 25,661 $ 23,855 ========= ========= Federal income taxes paid, net $ -- $ 15,825 ========= ========= </TABLE> See accompanying notes to consolidated financial statements. 3
5 W. R. Berkley Corporation and Subsidiaries Notes to Consolidated Financial Statements June 30, 1999 (Unaudited) The accompanying consolidated financial statements should be read in conjunction with the following notes and with the Notes to Consolidated Financial Statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 1998. 1. FEDERAL INCOME TAXES The Federal income tax provision has been computed based on the Company's estimated annual effective tax rate which differs from the Federal income tax rate of 35% principally because of tax-exempt investment income. 2. REINSURANCE CEDED The amounts of ceded reinsurance included in the statements of operations are as follows (amounts in thousands): <TABLE> <CAPTION> For the Three Months For the Six Months Ended June 30, Ended June 30, --------------------- --------------------- 1999 1998 1999 1998 -------- -------- -------- -------- <S> <C> <C> <C> <C> Ceded premiums written $ 83,422 $ 67,616 $156,905 $132,998 ======== ======== ======== ======== Ceded premiums earned $ 82,101 $ 63,965 $151,024 $125,870 ======== ======== ======== ======== Ceded losses and loss expenses $ 81,685 $ 41,620 $125,261 $ 94,825 ======== ======== ======== ======== </TABLE> Effective, January 1, 1999 the Company purchased additional aggregate reinsurance protection for the regional property casualty insurance segment. Pursuant to the contract, the reinsurer will indemnify the regional companies for losses occurring during 1999 in excess of 71% of earned premiums, up to a limit of $35.0 million. Premiums of $12.8 million and losses of $22.2 million were ceded to the reinsurer in the second quarter and first six months of 1999. 3. COMPREHENSIVE INCOME The differences between comprehensive income and net income are unrealized foreign exchange gains (losses) as well as unrealized gains (losses) on securities. The following is a reconciliation of comprehensive income (amounts in thousands): <TABLE> <CAPTION> For the Three Months For the Six Months Ended June 30, Ended June 30, ---------------------- ---------------------- 1999 1998 1999 1998 -------- -------- -------- -------- <S> <C> <C> <C> <C> Net income (loss) attributable to common stockholders $ 5,624 $ 18,274 $ 4,349 $ 39,625 -------- -------- -------- -------- Other comprehensive income: Change in unrealized foreign exchange gains (losses) 2 225 711 (766) Unrealized holding gains(losses)on investment securities arising during the period (40,708) (4,344) (64,108) (7,991) Less: Reclassification adjustment for gains included in net income, net of tax 185 4,609 658 6,830 -------- -------- -------- -------- Net change in unrealized gains during the period (40,523) 265 (63,450) (1,161) Other comprehensive income (loss) (40,521) 490 (62,739) (1,927) -------- -------- -------- -------- Comprehensive income (loss) $(34,897) $ 18,764 $(58,390) $ 37,698 ======== ======== ======== ======== </TABLE> 4
6 4. INDUSTRY SEGMENTS The Company's operations are presently conducted through five basic segments: regional property casualty insurance; reinsurance; specialty lines of insurance; alternative markets operations and international. The regional property casualty insurance segment writes standard commercial and personal lines insurance for such risks as automobiles, homes and businesses. The Company's reinsurance segment specializes in underwriting property, casualty and surety reinsurance on both a treaty and facultative basis. The specialty lines of insurance consist primarily of excess and surplus lines, commercial transportation, professional liability, directors and officers liability and surety. The Company's alternative markets segment specializes in insuring, reinsuring, and administering self-insurance programs and other alternative risk transfer mechanisms for public entities, private employers and associations. Finally, the international operations represent the Company's joint venture (65% owned by the Company) with Northwestern Mutual Life International, Inc., which writes property and casualty insurance, as well as life insurance, internationally. For the six months ended June 30, 1999 and 1998, the joint venture wrote life insurance premiums of $9.3 million and $2.7 million, respectively. The accounting policies of the segments are the same as those described in the summary of significant accounting policies; see the Company's Annual Report on Form 10-K for the year ended December 31, 1998 for a complete description. Income tax expense (benefits) were calculated in accordance with the Company's tax sharing agreements, which provide for the recognition of tax loss carry-forwards only to the extent of taxes previously paid. Summary financial information about the Company's operating segments is presented in the following table. Income before income taxes by segment consists of revenues less expenses related to the respective segment's operations. These amounts include realized gains (losses) where applicable. Intersegment revenues consist primarily of dividends, interest on inter-company debt and fees paid by subsidiaries for portfolio management and other services to the Company. Identifiable assets by segment are those assets used in the operation of each segment. <TABLE> <CAPTION> INCOME REVENUES (LOSS) ---------------------------------------- BEFORE INCOME TAX INVESTMENT UNAFFILIATED INTER- INCOME (EXPENSE) (DOLLARS IN THOUSANDS) INCOME CUSTOMERS SEGMENT TOTAL TAXES BENEFITS - -------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> For the six months ended June 30, 1999: Regional $ 27,084 $ 345,527 $ 948 $ 346,475 $ (14,798) $ (6,850) Reinsurance 23,778 165,631 338 165,969 8,033 1,060 Specialty 26,324 155,766 (1,211) 154,555 21,374 5,010 Alternative Markets 17,993 110,046 204 110,250 15,462 2,560 International 3,341 44,034 -- 44,034 560 879 Corporate and other 721 2,959 37,754 40,713 (3,853) (10,503) Adjustments and eliminations (2,066) -- (38,033) (38,033) (28,597) (1,779) - -------------------------------------------------------------------------------------------------------------- Consolidated $ 97,175 $ 823,963 $ -- $ 823,963 $ (1,819) $ (9,623) - -------------------------------------------------------------------------------------------------------------- For the six months ended June 30, 1998: Regional $ 28,293 $ 343,830 $ 1,079 $ 344,909 $ 8,288 $ (3,132) Reinsurance 25,307 142,178 433 142,611 23,654 (6,209) Specialty 32,295 149,942 1,484 151,426 45,958 (13,286) Alternative Markets 18,658 99,983 453 100,436 19,178 (5,883) International 3,572 38,471 -- 38,471 (3,750) (5) Corporate and other 4,215 5,781 43,886 49,667 5,865 (13,695) Adjustments and eliminations (3,562) -- (47,335) (47,335) (38,342) 28,510 - -------------------------------------------------------------------------------------------------------------- Consolidated $ 108,778 $ 780,185 $ -- $ 780,185 $ 60,851 $ (13,700) - -------------------------------------------------------------------------------------------------------------- </TABLE> Interest expense for the reinsurance and alternative market segments was $1,460,000 and $1,163,000 for the six months ended June 30, 1999 and 1998, respectively. Additionally, corporate interest expense (net of intercompany amounts) was $24,362,000 and $23,168,000 for the corresponding periods. 5
7 Identifiable assets by segment are as follows: <TABLE> <CAPTION> JUNE 30, DECEMBER 31, 1999 1998 ------------------------------ <S> <C> <C> Regional $ 1,429,717 $ 1,370,849 Reinsurance 961,082 996,186 Specialty 1,450,842 1,502,366 Alternative Markets 876,995 863,578 International 163,882 151,832 Corporate and other 1,462,427 1,545,744 Elimination (1,546,342) (1,447,124) - -------------------------------------------------------------------------------- Consolidated $ 4,798,603 $ 4,983,431 ================================================================================ </TABLE> 5. RESTRUCTURING CHARGE In the first quarter of 1999, the Company implemented a plan to restructure certain of its operating units. Under the plan, the Company will consolidate ten of its regional units into four; merge two of its alternative market units; and combine two of its international units. In connection with the restructuring plan, the Company expects to reduce its workforce by approximately 386 employees. The Company reported a restructuring charge of $11,505,000 in the first quarter of 1999 to reflect the estimated costs of the plan. These charges consist mainly of severance payments, contractual lease payments related to abandoned facilities, and abandoned equipment and property owned. The activities under the plan are expected to be substantially completed in 1999. The Company has paid $2,668,000 related to the restructuring charge, and the remaining restructuring accrual is $8,837,000 at June 30, 1999. 6. CHANGE IN ACCOUNTING As previously disclosed in the Company's 1998 Annual Report and Form 10-K, in the first quarter the Company adopted AICPA Statement of Position 97-3, "Accounting By Insurance and Other Enterprises for Insurance-Related Assessments." The adoption of this statement resulted in a non-cash, after-tax charge of $3.3 million, or 12 cents per diluted share, which is reflected as a cumulative effect of a change in accounting principle. 7. OTHER MATTERS Reclassifications have been made in the 1998 financial statements as originally reported to conform them to the presentation of the 1999 financial statements. In the opinion of management, the summarized financial information reflects all adjustments which are necessary for a fair presentation of financial position and results of operations for the interim periods. Seasonal weather variations affect the severity and frequency of losses sustained by the insurance and reinsurance subsidiaries. Although the effect on the Company's business of such natural catastrophes as tornadoes, hurricanes, hailstorms and earthquakes is mitigated by reinsurance, they nevertheless can have a significant impact on the results of any one or more reporting periods. 8. SAFE HARBOR STATEMENT This Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Generally, forward-looking statements are statements other than historical information or statements of current condition. Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected or otherwise reflected in forward-looking statements, including pricing competition and other initiatives by competitors, product demand, catastrophe and storm losses, legislative and regulatory developments, interest rate levels, investment results and other conditions in the financial and securities markets, unforeseen technological or other issues associated with Year 2000 compliance efforts and the extent to which vendors, public utilities, financial institutions, governmental entities and other third parties that interface with the Company may fail to achieve Year 2000 compliance and other risks referred to from time to time in the Company's reports filed with the Securities and Exchange 6
8 Commission. The inclusion of forward-looking statements in this report shall not be considered a representation by the Company that the objectives or plans of the Company, or other matters addressed by forward-looking statements, will be achieved. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Net income attributable to common stockholders ("net income") was $5.6 million ($.22 diluted per share) for the second quarter of 1999, in comparison with net income of $18.3 million ($.61 diluted per share) for the 1998 period. Net income was $4.3 million ($.17 diluted per share) for the first six months of 1999, in comparison with $39.6 million ($1.31 diluted per share) for the 1998 period. Operating income, which is defined as net income before realized investment gains, the change in accounting principle, and the extraordinary loss on early extinguishment of long-term debt, was $5.4 million ($.21 diluted per share) for the second quarter of 1999 in comparison with $16.2 million ($.55 diluted per share) earned in the corresponding 1998 quarter. Operating income was $6.9 million ($.26 diluted per share) for the first six months of 1999, in comparison with $37.8 million ($1.25 diluted per share) for the corresponding 1998 period. Adjusting for the restructuring charge, operating income was $14.2 million ($.54 diluted per share) for the first six months of 1999. The decline in earnings was primarily due to the effects of competition on rate adequacy, higher catastrophe losses and lower investment earnings. The year-to-date 1999 results include an after-tax restructuring charge of $7.3 million, or $.28 per diluted share, primarily related to the Company's previously announced restructuring. The restructuring, which should be substantially completed by the end of 1999, is expected to result in annual after-tax savings of approximately $12.4 million. Under generally accepted accounting principles, the restructuring charge does not include additional costs related to systems changes, financial incentives and other activities, although they are directly related to the restructuring plan. The Company incurred such additional costs of approximately $1.6 million, on an after-tax basis, in the first six months of 1999 and estimates that such additional costs of approximately $2.4 million, on an after-tax basis, will be incurred over the next 18 months. As previously disclosed in the Company's 1998 Annual Report and Form 10-K, during the six months, the Company adopted AICPA Statement of Position 97-3, "Accounting By Insurance and Other Enterprises for Insurance-Related Assessments." The adoption of this statement resulted in a non-cash, after-tax charge of $3.3 million, or $.12 per diluted share, which is reflected as a cumulative effect of a change in accounting principle. Second quarter net income included capital gains, net of taxes, of $200,000, or $.01 per share diluted, compared with $4.6 million, or $.15 per share diluted, for the same period last year. For the first six months of 1999 capital gains were $700,000, or $.02 per diluted share, compared with $6.8 million, or $.23 per diluted share, recorded during the corresponding 1998 period. The Company also reported an extraordinary loss of $2.6 million and $5.0 million for the second quarter and first six months of 1998, respectively, related to the repurchase and retirement of $34.7 million (face amount) of long-term debt. There were no comparable extraordinary items in 1999. Operating Results for the First Six Months of 1999 as Compared to the First Six Months of 1998 Net premiums written during the six months of 1999 increased by 8% to $725.8 million from $673.7 million written in the comparable 1998 period. Net premiums written by the regional segment increased by $4.6 million, or 1%, as the effects of geographic expansion and increased rates were partially offset by the purchase of additional reinsurance protection (see Note 2 of the Notes to Consolidated Financial Statements included herein). Specialty net premiums written 7
9 increased by $8.8 million, or 7%, as business relating to new products was partially offset by the non-renewal of certain business based on underwriting and pricing criteria. Net premiums written by the reinsurance operations increased by $27.4 million, or 22%, primarily due to an increase in pro-rata treaty volume. Alternative markets net premiums written increased $9.3 million, or 17%, due to an increase in business written by Key Risk Insurance Company, which commenced operations in January 1998, to underwrite business previously managed on behalf of a self-insurance association. International net premiums written increased $2.1 million, or 6%, primarily due to growth in the Philippines. Pre-tax investment income decreased by 11% to $97.2 million. Investment income declined for several reasons, including a lower yield earned on the Company's merger arbitrage investments (from 14.9% annualized to 10.8% annualized); an increase in the portion of the portfolio invested in municipal securities (from 38% at June 30, 1998 to 43% at June 30, 1999); and the repurchase of common and preferred shares in 1998 and 1999. (See "Liquidity and Capital Resources.") Management fees and commission income ("Management fees") consist primarily of revenues earned by the alternative markets segment. Management fees decreased $0.2 million from the comparable 1998 amount, principally due to a decline in fees earned by Key Risk Service Company (see the discussion above regarding increased net premiums written by Key Risk Insurance Company). Realized gains decreased to $1.0 million from $10.5 million earned in the comparable 1998 period. Realized gains on fixed income securities result primarily from the Company's strategy of maintaining an appropriate balance between the duration of its fixed income portfolio and the duration of its liabilities; realized gains on equity securities arise primarily as a result of a variety of factors which influence the Company's valuation criteria. The majority of the 1999 and 1998 realized gains resulted from the sale of fixed income securities. The combined ratio (on a statutory basis) of the Company's insurance operations increased to 106.8% from 102.5% in the comparable 1998 period due to an increases in the consolidated loss and expense ratios. The consolidated loss ratio (losses and loss expenses incurred expressed as a percentage of premiums earned) increased to 71.2% in 1999 from 67.8% in 1998 due to an increase in current year loss ratios at the regional, reinsurance and specialty units. The increase in the regional loss ratio is primarily due to the continued severity of competitive pressures. The increase in the reinsurance loss ratio is primarily due the effects of competition on rate adequacy and to losses incurred as a result of the earthquake in Columbia in January 1999. The increase in the specialty loss ratio is due to an increase in loss activity at the transportation unit. Catastrophe losses, were $35.8 million for the first six months of 1999, compared with $31.4 million for the same period last year. The increase in incurred losses in the first six months was partially offset by recoveries under the aggregate reinsurance cover (see Note 2 of the Notes to Consolidated Financial Statements included herein). Other operating costs and expenses, which consist of the expenses of the Company's insurance and alternative markets operations as well as the Company's corporate and investment expenses, increased by 9% to $296.4 million. The increase in other operating costs and expenses is primarily due to growth in premium volume which in turn results in an increase in underwriting expenses. The consolidated expense ratio (underwriting expenses expressed as a percentage of premiums written) increased to 35.2% from 34.3%, mainly due to higher commissions and the effects of ceding additional reinsurance premiums. The Federal income tax benefit in 1999 was $9.6 million as compared to a $13.7 million expense for the comparable 1998 period. The benefit in 1999 is due primarily to an increase in the percentage of pre-tax income that is tax-exempt. In addition, the 1999 Federal income tax benefit was adjusted to reflect the closing with the Internal Revenue Service of tax years 1992 through 1994. (See "Liquidity and Capital Resources.") 8
10 Operating Results for the Second Quarter of 1999 as Compared to the Second Quarter of 1998 For the second quarter of 1999 as compared to the corresponding 1998 period, net premiums written increased 2%; net investment income decreased 2%, generally all for the reasons discussed above. The combined ratio (on a statutory basis) of the Company's insurance operations increased to 108.6% from 102.6% for the comparable 1998 period due to an increase in the consolidated loss ratio and an increase in the consolidated expense ratio. The consolidated loss ratio (losses and loss expense incurred expressed as a percentage of premiums earned) increased to 71.5% in 1999 from 67.8% in 1998 for the reasons discussed above. Other operating costs and expenses increased 9% to $152.1 million and the consolidated expense ratio of the Company's insurance operations (underwriting expenses expressed as a percentage of premiums written) increased to 36.7% for the 1999 period from 34.3% for the comparable 1998, for the reasons discussed above. Liquidity and Capital Resources Cash flow from operating activities before trading account activities was $5.9 million in the six months of 1999 compared with $55.8 million for the same period in 1998. The decrease in cash flow was primarily due to a higher level of claim activity and to the decrease in investment income discussed above. The investment portfolio, excluding trading account securities, on a cost basis, decreased by $116.2 million to $2,708.2 million at June 30, 1999 from $2,824.4 million at December 31, 1998. This decrease was primarily due to the repurchase of the remaining shares of Series A preferred stock in January 1999. The Company's investments are currently comprised of fixed income securities and trading securities. At June 30, 1999, as compared to December 31, 1998, the portfolio mix of the fixed income securities was as follows: tax-exempt securities were 43% (42% in 1998); U.S. Government securities and cash equivalents were 24% (23% in 1998); mortgage-backed securities were 15% (18% in 1998); corporate fixed maturity securities were 16% (15% in 1998); and the balance of 2% was invested in other fixed income securities. The Company had net trading assets (trading account equity securities plus trading account receivables from brokers and clearing organizations less trading account securities sold but not yet purchased) of $342.8 million as of June 30, 1999, as compared to $320.7 million as of December 31, 1998. The net trading account represented approximately 11% and 10% of the Company's net invested assets as of June 30, 1999 and December 31, 1998, respectively. On January 25, 1999, the Company repurchased all outstanding Series A preferred shares for $98.1 million using funds previously escrowed for this purpose. During the first six months of 1999 the Company also purchased 730,000 shares of its common stock for $18.1 million. For the six months of 1999, stockholders' equity decreased by approximately $181.1 million primarily due to the repurchase of the Company's preferred and common stock and to the change in unrealized holding gains and losses on investment securities. Accordingly, the Company's total capitalization decreased to $1,283.0 million at June 30, 1999 and the percentage of the Company's capital attributable to long-term debt increased to 31% from 27% at December 31, 1998. For background information concerning discussion of the Company's Liquidity and Capital Resources, see the Company's Annual Report on Form 10-K for the year ended December 31, 1998. Year 2000 The Company continues to address system requirements with regard to Year 2000 compliance issues and believes that all of the critical, primary operating software has been modified or replaced as necessary for compliance. This includes both operational and financial systems upon 9
11 which the Company is dependent. Testing has been completed for those systems, and changes are expected to be finalized by the end of August 1999. Testing for secondary systems, such as telephone, building systems and small computer items, is expected to be completed by the end of the third quarter. The Company continues to communicate with third parties with which it has a material operating relationship, e.g. independent insurance agents and financial institutions, to identify Year 2000 system issues with respect to those third parties. Due to these communications, the Company has no reason to believe that those third parties will not be in general compliance with Year 2000 readiness; however, the Company is unable to determine whether all such third parties will achieve Year 2000 readiness in such manner as not to result in any material adverse effect on the Company. It is the Company's practice in the normal course of business to upgrade technology, including hardware and software, as appropriate. As a result of this practice, much of its Year 2000 readiness has been accomplished in the ordinary course. Through June 30, 1999, the Company has incurred approximately $6.7 million of costs which have been expensed as incurred, and estimates an additional $0.6 million to be incurred in 1999 to complete Year 2000 compliance. The total cost associated with Year 2000 compliance is not expected to be material to the Company's financial position. Notwithstanding the above, a failure by the Company or a third party to correct a material Year 2000 problem could result in an interruption in, or a failure of, certain normal business activities or operations. Such failures could materially and adversely affect the Company's results of operations, liquidity and financial condition. Due to the general uncertainty inherent in the Year 2000 problem, including the uncertainty of the Year 2000 system readiness of third parties with whom the Company deals, the Company is unable to determine at this time whether the consequences of Year 2000 failures will have a material impact on the Company's results of operations, liquidity or financial condition. Subsidiaries of the Company are in the process of developing contingency plans to address incidents that are outside their direct control, such as a failure by an unrelated third-party. The contingency plans, which are expected to be completed by the end of the third quarter, are intended to allow the companies to mitigate such risks whenever feasible to do so at a reasonable expense, but there can be no assurance that contingency plans will be effective to deal with all such issues that may arise. The Year 2000 issue is also a concern for the Company from an underwriting standpoint to the extent of possible liability for coverage under general liability, property, directors and officers liability and other policies. Through June 30, 1999, no significant losses have arisen or come to light with respect to Year 2000 claims exposure for the Company's insurance and reinsurance subsidiaries. Additionally, certain of the Company's insurance subsidiaries may either include or exclude insurance coverage for Year 2000 exposures. However, due in part to the potential for judicial decisions which reformulate policies to expand their coverage for previously unforeseen theories of liability which may produce unanticipated claims, proposed legislative reform and because there is no prior history of such claims, the amount of any potential Year 2000 coverage liabilities is not determinable. The discussion herein with regard to Year 2000 compliance contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in such forward-looking statements. These risks could include unforeseen technological or other issues associated with Year 2000 compliance efforts and the extent to which vendors, public utilities, insurance agents, financial institutions, governmental entities and other third parties that interface with the Company may fail to achieve Year 2000 compliance. The inclusion of such forward-looking statements herein shall not be considered a representation by the Company that the objectives or plans of the Company, or other matters addressed by the forward-looking statements, will be achieved. 10
12 Item 3. Quantitative and Qualitative Disclosure About Market Risk The Company's market risk generally represents the risk of gain or loss that may result from the potential change in the fair value of the Company's investment portfolio as a result of fluctuations in prices, interest rates and currency exchange rates. The Company attempts to manage its interest rate risk by maintaining an appropriate relationship between the average duration of the investment portfolio and the approximate duration of its liabilities, i.e., policy claims and debt obligations. The Company has maintained approximately the same duration of its investment portfolio to its liabilities from December 31, 1998 to June 30, 1999. In addition, the Company has maintained approximately the same investment mix during this period. Therefore, while the Company's change in other comprehensive income may be significant, the overall market risk of the Company has remained similar to the market risk at December 31, 1998. PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Number (3.1) Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Stock. (10.1) Letter agreement between the Company and its Senior Vice President-General Counsel. (10.2) 1997 Directors Stock Plan, as Amended and Restated as of May 11, 1999. (b) Reports on Form 8-K On May 11, 1999 the Company filed a Current Report on Form 8-K with respect to amendments to the by-laws of the Company and the adoption of a shareholder rights plan (under Item 5 of Form 8-K). 11
13 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. W. R. BERKLEY CORPORATION Date: August 10, 1999 /s/ WILLIAM R. BERKLEY ------------------------------ William R. Berkley Chairman of the Board and Chief Executive Officer Date: August 10, 1999 /s/ EUGENE G. BALLARD ------------------------------ Eugene G. Ballard Senior Vice President, Chief Financial Officer and Treasurer 12