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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PERSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
[ ] TRANSITION REPORT PERSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________
Commission file no. 000-50990
Tower Group, Inc.
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(Exact name of registrant as specified in its charter)
Delaware 13-3894120
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
120 Broadway, 14th Floor
New York, NY 10271
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(Address of principal executive offices) (Zip Code)
(212) 655-2000
(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 and Exchange Act of 1934
during the preceding 12 months (or for 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 [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act)
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 19,752,916 shares of common
stock, par value $0.01 per share, as of May 9, 2005.
INDEX
PAGE
PART I FINANCIAL INFORMATION
Item 1. Financial statements
Consolidated Balance Sheets - March 31, 2005 (unaudited)
and December 31, 2004 1
Consolidated Statements of Income and Comprehensive Net Income
- Three months ended March 31, 2005 and 2004 (unaudited) 2
Consolidated Statements of Cash Flows
- Three months ended March 31, 2005 and 2004 (unaudited) 3
Notes to Consolidated Financial Statements (unaudited) 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk 17
Item 4. Controls and Procedures 18
PART II OTHER INFORMATION
Item 6. Exhibits 18
SIGNATURES 19
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Tower Group, Inc.
Consolidated Balance Sheets
(Unaudited)
March 31, December 31,
2005 2004
------------- -------------
($ in thousands, except par
value and share amounts)
ASSETS
Fixed-maturity securities, available-for-sale, at
fair value (amortized cost $255,034 in 2005 and
$223,562 in 2004) $ 251,929 $ 224,523
Equity securities, at fair value (cost $29,681 in
2005 and $1,827 in 2004) 29,710 2,485
Common trust securities - statutory business trusts,
equity method 1,426 1,426
------------- -------------
Total investments 283,065 228,434
Cash and cash equivalents 24,130 55,201
Investment income receivable 2,449 1,975
Agents' balances receivable 34,126 33,473
Assumed premiums receivable 1,144 1,197
Ceding commission receivable 8,727 8,329
Reinsurance recoverable 100,454 101,173
Receivable - claims paid by agency 2,251 1,622
Prepaid reinsurance premiums 31,847 28,391
Deferred acquisition costs net of deferred ceding
commission revenue 22,223 18,740
Federal income taxes and state taxes recoverable - 1,975
Deferred income taxes 480 -
Intangible assets 6,039 4,978
Fixed assets, net of accumulated depreciation 5,620 5,420
Other assets 3,860 3,239
------------- -------------
Total Assets $ 526,415 $ 494,147
============= =============
LIABILITIES
Loss and loss adjustment expenses $ 140,518 $ 128,722
Unearned premium 114,306 95,505
Reinsurance balances payable 8,867 2,735
Payable to issuing carriers 15,473 18,652
Funds held as agent 782 785
Funds held under reinsurance agreements 53,559 54,152
Accounts payable and accrued expenses 11,240 12,410
Checks outstanding 2,694 2,726
Payable for securities 1,272 -
Federal and state income taxes payable 459 -
Deferred income taxes - 1,587
Subordinated debentures 47,426 47,426
------------- -------------
Total Liabilities 396,596 364,700
------------- -------------
STOCKHOLDERS' EQUITY
Common stock ($0.01 par value per share; 40,000,000
shares authorized; 19,835,635 and 19,826,135 shares
issued in 2005 and 2004) 198 198
Paid-in-capital 112,478 112,375
Accumulated other comprehensive net income (1,999) 1,052
Retained earnings 21,453 18,224
Unearned compensation - restricted stock (1,817) (1,908)
Treasury stock (88,967 shares in 2005 and 2004) (494) (494)
------------- -------------
Total Stockholders' Equity 129,819 129,447
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Total Liabilities and Stockholders' Equity $ 526,415 $ 494,147
============= =============
See accompanying notes to the consolidated financial statements.
1
Tower Group, Inc.
Consolidated Statements of Income and
Comprehensive Net Income
(Unaudited)
Three Months Ended
March 31,
2005 2004
------------- -------------
($ in thousands, except
share and per share amounts)
Revenues
Net premiums earned $ 30,018 $ 7,930
Ceding commission revenue 5,846 10,301
Insurance services revenue 3,781 2,524
Net investment income 2,615 764
Net realized gains on investments 209 11
Policy billing fees 201 174
------------- -------------
Total revenues 42,670 21,704
------------- -------------
Expenses
Loss and loss adjustment expenses 18,062 5,017
Direct commission expense 8,792 7,086
Other operating expenses 8,917 6,777
Interest expense 1,165 651
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Total expenses 36,936 19,531
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Income before income taxes 5,734 2,173
Income tax expense 2,017 851
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Net income $ 3,717 $ 1,322
============= =============
Comprehensive Net Income
Net income $ 3,717 $ 1,322
Other comprehensive income:
Gross unrealized investment holding (losses)
gains arising during period (4,486) 947
Less: reclassification adjustment for gains
included in net income (209) (11)
------------- -------------
(4,695) 936
Income tax benefit (expense) related to items
of other comprehensive income 1,644 (318)
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Total other comprehensive net (loss) income (3,051) 618
------------- -------------
Comprehensive Net Income $ 666 $ 1,940
============= =============
Earnings Per Share
Basic earnings per common share $ 0.19 $ 0.30
============= =============
Diluted earnings per common share $ 0.19 $ 0.23
============= =============
Weighted Average Common Shares Outstanding:
Basic 19,521,111 4,407,434
Diluted 20,076,884 5,726,083
See accompanying notes to the consolidated financial statements.
2
Tower Group, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
Three Months Ended
March 31,
2005 2004
------------- -------------
($ in thousands)
Cash flows from operating activities:
Net income $ 3,717 $ 1,322
Adjustments to reconcile net income to net cash
provided by (used in) operations:
Gain on sale of investments (209) (11)
Depreciation 563 431
Amortization of intangible assets 111 -
Amortization of bond premium or discount 288 46
Amortization of debt issuance costs 9 13
Amortization of restricted stock 172 -
Deferred income taxes (424) 149
(Increase) decrease in assets:
Investment income receivable (474) (108)
Agents' balances receivable (653) 2,896
Assumed premiums receivable 53 235
Receivable for cancelled reinsurance - 15,748
Ceding commissions receivable (398) -
Reinsurance recoverable 90 (7,801)
Prepaid reinsurance premiums (3,456) 4,189
Deferred acquisition costs, net (3,483) (2,052)
Intangible assets (1,172) -
Other assets (629) (747)
Increase (decrease) in liabilities:
Loss and loss adjustment expenses 11,796 8,154
Unearned premium 18,801 2,670
Checks outstanding (32) 949
Reinsurance balances payable 6,132 (4,864)
Payable to issuing carriers (3,182) (3,300)
Accounts payable and accrued expenses (1,169) (2,057)
Federal and state income taxes payable 2,434 123
Funds held under reinsurance agreements (593) 11,256
Deferred compensation liability - 23
------------- -------------
Net cash flows provided by operations 28,292 27,264
------------- -------------
Cash flows from investing activities:
Purchase of fixed assets (763) (1,147)
Purchases of investments:
Fixed-maturity securities (42,627) (18,320)
Equity securities (29,568) -
Sale of investments:
Fixed-maturity securities 12,089 3,122
Equity securities 1,972 -
------------- -------------
Net cash flows used in investing activities (58,897) (16,345)
------------- -------------
Cash flows from financing activities:
Repayment of redeemable preferred stock - (1,500)
Repayment of long-term debt -- CIT - (188)
Increase in notes receivable from related parties - (11)
Dividends paid (488) (160)
Exercise of stock options 22 -
------------- -------------
Net cash flows used in financing activities (466) (1,859)
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Increase (decrease) in cash and cash equivalents (31,071) 9,060
Cash and cash equivalents, beginning of period 55,201 30,339
------------- -------------
Cash and cash equivalents, end of period $ 24,130 $ 39,399
============= =============
Supplemental disclosures of cash flow information:
Cash paid for income taxes $ 201 $ 511
Cash paid for interest $ 804 $ 394
See accompanying notes to the consolidated financial statements.
3
Tower Group, Inc.
Notes to Consolidated Financial Statements (Unaudited)
Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with instructions for Form 10-Q and, accordingly, do not
include the information and disclosures required by generally accepted
accounting principles ("GAAP") in the Unites States of America. These statements
should be read in conjunction with the consolidated financial statements as of
and for the year ended December 31, 2004 and notes thereto included in the
Company's Annual Report on Form 10-K filed on March 22, 2005. The accompanying
consolidated financial statements have not been audited by an independent
registered public accounting firm in accordance with standards of the Public
Company Accounting Oversight Board (United States), but in the opinion of
management such financial statements include all adjustments, consisting only of
normal recurring adjustments, necessary for a fair statement of the Company's
financial position and results of operations. The results of operations for the
three months ended March 31, 2005 may not be indicative of the results that may
be expected for the year ending December 31, 2005. The consolidated financial
statements include the accounts of the Company, its wholly owned subsidiaries
and other entities required by GAAP. All significant inter-company balances have
been eliminated. Business segment results are presented net of all material
inter-segment transactions.
Purchase of Shell Company and Intangible Assets
On March 25, 2005, Tower Group, Inc. closed on its purchase of the
outstanding common stock of a shell insurance company, North American Lumber
Insurance Company ("NALIC"), that was renamed Tower National Insurance Company.
The purchase price was for $1,050,000 and included nine active state licenses
and two inactive state licenses. The nine active states are New Jersey,
Connecticut, Massachusetts, Rhode Island, Vermont, Maryland, Delaware, South
Carolina and Wisconsin. The two inactive states are Pennsylvania and Maine. The
inactive state licenses have an additional contingent purchase price of $75,000
per state upon license reactivation within one year of the closing. Prior to the
closing, all liabilities and assets of Tower National Insurance Company were
transferred to a liquidating trust. Tower Group, Inc. has capitalized this
purchase as an intangible asset with an indefinite life subject to annual
impairment testing. The amount capitalized was $1,172,000 and included the cost
of the licenses, legal fees and a broker's fee. The new company will enable the
Company to expand its licensing and to proceed with its territorial expansion
plans.
Investments
Segregated assets in trust accounts associated with reinsurance agreements
amounted to $53.6 million as of March 31, 2005 and are included in invested
assets. Additionally, securities with a fair value of $0.5 million were on
deposit with state regulatory authorities as required by law as of March 31,
2005.
Intangible Assets
From the Commercial Renewal Rights Agreement entered into with OneBeacon
Insurance Group LLC ("OneBeacon") during 2004, the Company has recorded two
intangible assets: renewal rights and new agent contractual relationships, both
of which were determined to be intangible assets with a finite useful life.
As described above, an intangible asset related to state licenses was
recorded in connection with the acquisition of NALIC in 2005.
4
The components of intangible assets are summarized as follows:
Accumulated
Initial Balance Amortization Net
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($ in thousands)
March 31, 2005:
Renewal rights $ 1,250 $ (75) $ 1,175
Agency force 3,750 (58) 3,692
Insurance licenses 1,172 - 1,172
------------------- ------------------- -------------------
$ 6,172 $ (133) $ 6,039
=================== =================== ===================
Dividends Declared
Dividends declared by the Company on common stock for the three months
ended March 31, 2005 were $488,000 or $0.025 per share.
For the three months ended March 31, 2004, the dividends declared on Class
A common stock were $75,000 or $0.0379 per share and the dividends declared on
Class B common stock were $92,000 or $0.0384 per share.
Earnings Per Share
The following table shows the computation of the Company's earnings per
share:
Income Shares Per Share
(Numerator) (Denominator) Amount
------------------- ------------------- -------------------
($ in thousands, except share and per share amounts)
Three Months Ended
March 31, 2005
Net Income $ 3,717
------------------- -------------------
Basic earnings per share 3,717 19,521,111 $ 0.19
------------------- ------------------- -------------------
Effect of dilutive securities:
Stock options - 284,873
Unvested restricted stock - 216,673
Warrants - 54,227
------------------- -------------------
Diluted earnings per share $ 3,717 20,076,884 $ 0.19
=================== =================== ===================
Three Months Ended
March 31, 2004
Net Income $ 1,322
------------------- -------------------
Basic earnings per share 1,322 4,407,434 $ 0.30
------------------- ------------------- -------------------
Effect of dilutive securities:
Stock options - 268,650
Warrants 21 1,049,999
------------------- -------------------
Diluted earnings per share $ 1,343 5,726,083 $ 0.23
=================== =================== ===================
Employee Stock Option Plan
The Company has elected to follow APB 25, "Accounting for Stock Issued to
Employees" and related interpretations in accounting for its employee stock
option grants. The Company generally grants employee stock options at an
exercise price equal to the market price at the date of grant and, therefore,
under APB 25, no compensation expense is recorded. The Company follows the
disclosure provisions of SFAS 123, "Accounting for Stock-Based Compensation".
In December 2004, the Financial Accounting Standards Board issued the
revised statement SFAS No. 123-R, an amendment to SFAS No. 123, which suspends
APB 25 and requires that the cost of share-based payment transactions be
recognized in the financial statements after the fiscal quarter beginning after
June 15, 2005. The intended adoption by the Company of SFAS 123-R has been
postponed to January 2006 per the Securities and Exchange Commission's rule
amendment promulgated April 14, 2005, that allows calendar year-end companies to
elect implementing SFAS No. 123-R at the beginning of their next fiscal year
after June 15, 2005. The implementation of SFAS 123-R is not expected to have a
material impact on the Company's financial position or results of operations.
5
As of December 31, 2002, all prior stock option grants have been expensed
per the pro-forma provisions of SFAS 123 and the September 2004 stock option
grants pro-forma expense impact started in the fourth quarter of 2004. The
following table illustrates the effect on net income and earnings per share if
the Company had applied the fair value recognition provisions of SFAS 123 to
stock-based employee compensation.
Three Months Ended
March 31,
2005 2004
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($ in thousands, except
share and per share amounts)
Net income $ 3,717 $ 1,322
Deduct total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (15) -
------------- -------------
Net income, pro-forma $ 3,702 $ 1,322
Earnings Per Share
Basic - as reported $ 0.19 $ 0.30
============= =============
Basic - pro-forma $ 0.19 $ 0.30
============= =============
Diluted - as reported $ 0.19 $ 0.23
============= =============
Diluted - pro-forma $ 0.18 $ 0.23
============= =============
Weighted-Average Common Shares Outstanding
Basic 19,521,111 4,407,434
Diluted 20,076,884 5,726,083
Changes In Estimates
TICNY has recorded $20,000 of adverse development in its net losses from
prior accident years in the first quarter of 2005 compared to $48,000 in the
first quarter of 2004. TICNY's changes in estimated sliding scale commission
income resulted in $50,000 of additional commission income in the first quarter
of 2005 compared to none in the first quarter of 2004. TRM's changes in
estimated sliding scale commission income was $491,000 of additional commission
income in the first quarter of 2005 compared to none in the first quarter of
2004.
Segment Information
The Company manages its operations through three business segments:
insurance (commercial and personal lines underwriting), reinsurance and
insurance services (managing general agency, claims administration and
reinsurance intermediary operations).
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies as described in the Company's
most recently filed Form 10-K. The Company evaluates segment performance based
on segment profit, which excludes investment income, realized gains and losses,
interest expense, income taxes and incidental corporate expenses. The Company
does not allocate assets to segments because assets, which consist primarily of
investments, are considered in total by management for decision-making purposes.
6
Business Segments results are as follows:
Three Months Ended
March 31,
2005 2004
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($ in thousands)
Insurance Segment Information
Revenues
Net premiums earned $ 29,633 $ 7,698
Ceding commission revenue 5,846 10,301
Policy billing fees 196 174
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Total revenues 35,675 18,173
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Expenses
Net loss and loss adjustment expenses 17,780 4,808
Underwriting expenses 14,494 11,762
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Total expenses 32,274 16,570
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Underwriting profit $ 3,401 $ 1,603
============= =============
Reinsurance Segment
Revenues
Net premiums earned $ 385 $ 232
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Total revenues 385 232
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Expenses
Net loss and loss adjustment expenses 282 209
Underwriting expenses 47 21
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Total expenses 329 230
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Underwriting Profit $ 56 $ 2
============= =============
Insurance Services Segment
Revenues
Direct commission revenue from managing general $ 2,525 $ 1,457
agency
Claims administration revenue 1,053 869
Reinsurance intermediary fees 203 198
Policy billing fees 5 -
------------- -------------
Total revenues 3,786 2,524
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Expenses
Direct commissions expense paid to producers 1,211 950
Other insurance services expenses 485 300
Claims expense reimbursement to TICNY 1,050 802
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Total expenses 2,746 2,052
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Insurance Services Pre-tax Income $ 1,040 $ 472
============= =============
Underwriting expenses in the insurance segment are net of expense
reimbursements that are made by the insurance services segment pursuant to an
expense sharing agreement between TRM and TICNY. In accordance with terms of
this agreement, TRM reimburses TICNY for a portion of TICNY's underwriting and
other expenses resulting from TRM's use of TICNY's personnel, facilities and
equipment in underwriting insurance on behalf of TRM's issuing companies. The
reimbursement for underwriting and other expenses is calculated as a minimum
reimbursement of 5% of the premiums produced by TRM and is adjustable according
to the terms of the agreement based on the number of policies in force and
additional expenses that may be incurred by TRM. The amount of this
reimbursement was $485,000 and $300,000 for the three months ended March 31,
2005 and March 31, 2004, respectively. TRM also reimburses TICNY, at cost, for
claims administration expenses pursuant to the terms of this expense sharing
agreement. Claims expenses reimbursed by TRM were $1,050,000 and $802,000 for
the three months ended March 31, 2005 and March 31, 2004, respectively.
7
The following table reconciles revenue by segment to consolidated revenue:
Three Months Ended
March 31,
2005 2004
------------- -------------
($ in thousands)
Reconciliation
Revenues
Insurance segment $ 35,675 $ 18,173
Reinsurance segment 385 232
Insurance services segment 3,786 2,524
------------- -------------
Total segment revenue 39,846 20,929
Investment income 2,615 764
Realized capital gains 209 11
------------- -------------
Consolidated revenues $ 42,670 $ 21,704
============= =============
The following table reconciles the results of the Company's individual
segments to consolidated income before taxes:
Three Months Ended
March 31,
2005 2004
------------- -------------
($ in thousands)
Insurance segment underwriting profit $ 3,401 $ 1,603
Reinsurance segment underwriting profit 56 2
------------- -------------
Total underwriting profit 3,457 1,605
Insurance services segment pre-tax income 1,040 472
Net investment income 2,615 764
Net realized investment gains 209 11
Corporate expenses (422) (28)
Interest expense (1,165) (651)
------------- -------------
Income before income taxes $ 5,734 $ 2,173
============= =============
Employee Benefit Plans
On March 31, 2005, the Company's Compensation Committee authorized the
issuance of 6,000 shares of restricted common stock to Francis M. Colalucci,
Senior Vice President, Chief Financial Officer and Treasurer. The Board of
Directors subsequently ratified the award. The shares vest in installments over
a three-year period from the date of grant contingent upon Mr. Colalucci's
continuous employment with the Company from the date of grant through the
vesting date. During the vesting period, Mr. Colalucci has voting rights and
will receive dividends; however, the shares may not be sold, assigned,
transferred, exchanged, pledged or otherwise encumbered. The fair value of the
restricted shares was $80,000 on the grant date, which will be amortized as
compensation expense ratably over the vesting period.
Subsequent Events
On April 1, 2005, the Company's Board of Directors authorized the issuance
of 1,312 restricted common stock to each of its four non-employee Directors, or
5,248 shares in total. The fair value of these restricted shares is $69,000.
These shares will amortize ratably from grant date until the end of their
vesting period on April 1, 2006.
Like many other insurance companies, the Company has received an inquiry
relating to risk transfer under its reinsurance arrangements. The inquiry made
to the Company has been made by the New York Insurance Department, and the
Company has been providing information in response to these inquiries. The
Company believes that its reinsurance agreements demonstrate an appropriate
transfer of risk and proper accounting. The independent registered public
accounting firm for the Company has confirmed its agreement with the Company's
view as part of their audit of the Company's 2004 financial statements.
8
On April 28, 2005, the Company's Board of Directors approved a quarterly
dividend of $0.025 per share payable June 27, 2005 to stockholders of record as
of June 15, 2005.
The Company received a request dated April 25, 2005 from Friedman,
Billings, Ramsey Group, Inc. to file a registration statement under the
Securities Act of 1933 to register the resale of the 500,000 shares purchased by
it in the private place that was effected concurrently with the initial public
offering. The Company is required to file a registration statement within 60
days after its receipt of the request.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Note on Forward-Looking Statements
Some of the statements under "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and elsewhere in this Form 10-Q
may include forward-looking statements that reflect our current views with
respect to future events and financial performance. These statements include
forward-looking statements both with respect to us specifically and the
insurance sector in general. Statements that include the words "expect,"
"intend," "plan," "believe," "project," "estimate," "may," "should,"
"anticipate," "will" and similar statements of a future or forward-looking
nature identify forward-looking statements for purposes of the Federal
securities laws or otherwise.
All forward-looking statements address matters that involve risks and
uncertainties. Accordingly, there are or will be important factors that could
cause our actual results to differ materially from those indicated in these
statements. We believe that these factors include, but are not limited to, the
following:
o ineffectiveness or obsolescence of our business strategy due to
changes in current or future market conditions;
o developments that may delay or limit our ability to enter new markets
as quickly as we anticipate;
o increased competition on the basis of pricing, capacity, coverage
terms or other factors;
o greater frequency or severity of claims and loss activity, including
as a result of natural or man-made catastrophic events, than our
underwriting, reserving or investment practices anticipate based on
historical experience or industry data;
o the effects of acts of terrorism or war;
o developments in the world's financial and capital markets that
adversely affect the performance of our investments;
o changes in regulations or laws applicable to us, our subsidiaries,
brokers or customers;
o acceptance of our products and services, including new products and
services;
o changes in the availability, cost or quality of reinsurance and
failure of our reinsurers to pay claims timely or at all;
o changes in the percentage of our premiums written that we ceded to
reinsurers;
o decreased demand for our insurance or reinsurance products;
o loss of the services of any of our executive officers or other key
personnel;
o the effects of mergers, acquisitions and divestitures;
o changes in rating agency policies or practices;
o changes in legal theories of liability under our insurance policies;
o changes in accounting policies or practices; and
o changes in general economic conditions, including inflation, interest
rates and other factors.
The foregoing review of important factors should not be construed as exhaustive
and should be read in conjunction with the other cautionary statements that are
included in this Form 10-Q. We undertake no obligation to publicly update or
review any forward-looking statement, whether as a result of new information,
future developments or otherwise.
9
Consolidated Results of Operations
Three Months Ended
March 31,
2005 2004
------------- -------------
($ in thousands)
Revenues
Earned premiums
Gross premiums earned $ 45,868 $ 37,342
Less: ceded premiums earned (15,850) (29,412)
------------- -------------
Net premiums earned 30,018 7,930
------------- -------------
Total commission and fee income 9,828 12,999
Net investment income 2,615 764
Net realized investment gains 209 11
------------- -------------
Total revenues 42,670 21,704
------------- -------------
Expenses
Net loss and loss adjustment expenses 18,062 5,017
Operating expenses 17,709 13,863
Interest expenses 1,165 651
------------- -------------
Total expenses 36,936 19,531
------------- -------------
Income before taxes 5,734 2,173
Federal and state income taxes 2,017 851
------------- -------------
Net Income $ 3,717 $ 1,322
============= =============
Key Measures
Return on average equity 11.5% 37.9%
Consolidated Results of Operations Three Months Ended March 31, 2005 and 2004
Total revenues. Total revenues increased by 96.6 % to $42.7 million for the
three months ended March 31, 2005 compared to $21.7 million for the same period
in 2004. The increase is primarily due to the increase in net premiums earned,
net investment income and net realized investment gains. Net earned premiums
represented 70.3% of total revenues for the three months ended March 31, 2005
compared to 36.5% for the same period in 2004. Net investment income, excluding
realized capital gains, represented 6.1% and 3.5% of total revenues for the
three months ended March 31, 2005 and March 31, 2004, respectively. These
increases were partially offset by lower total commission and fee income for the
three months ended March 31, 2005 of $9.8 million, or 23.0% of total revenue,
compared to $13.0 million, or 59.9% of total revenue, for the same period in
2004.
Premiums earned. Net premiums earned increased by 278.5% to $30.0 million
for the three months ended March 31, 2005 compared to $7.9 million for the same
period in 2004. The increase in net premiums earned was due to the overall
increase in gross premiums written through March 31, 2005 and our decision to
reduce the ceding percentage under our quota share reinsurance agreement to 25%
in the first quarter of 2005 from 60% in the first quarter of 2004 due to the
increased capitalization of our insurance company. In addition, the net premiums
earned in the first quarter of 2005 included $5.5 million from the $13.1 million
of unearned premiums as of December 31, 2004 that would have been ceded to
Converium Reinsurance (North America) Inc. absent the 2004 novation. See
"Insurance Segment Results of Operations" and "Reinsurance Segment Results of
Operations" for further discussion of premiums.
Commission and fee income. Total commission and fee income decreased by
24.4% to $9.8 million in the first quarter of 2005 compared to $13.0 million in
the first quarter of 2004. This was due principally to a 43.2% decrease in
ceding commission revenue in the first quarter of 2005 as a result of our
decision to reduce the ceding percentage under our quota share reinsurance
agreement to 25% in the first quarter of 2005 compared to 60% in the first
quarter of 2004.
10
Net investment income and realized gains. Net investment income increased
by 242.3% to $2.6 million for the three months ended March 31, 2005 compared to
$0.8 million for the same period in 2004. This resulted from an increase in
average invested assets to $255.8 million in the first quarter of 2005 compared
to $66.4 million in the same period in 2004. The growth in invested assets in
the first quarter of 2005 resulted from net cash flows provided by operations,
the issuance of $26.8 million of subordinated debentures underlying trust
preferred securities in December 2004 and net proceeds of $107.8 million from
our initial public offering ("IPO") and concurrent private placement in October
2004. This was offset in part by a slight decrease in the yield in fixed
maturity investments held at March 31, 2005 compared to March 31, 2004. The
pre-tax yield for our fixed income investments as of March 31, 2005 was 4.6% and
includes the yield on bond funds that are recorded as equity securities on our
March 31, 2005 balance sheet. The pre-tax yield for our fixed income investments
as of March 31, 2004 was 4.8%. On a tax equivalent basis, the yield was 5.1% as
of March 31, 2005 and March 31, 2004.
Net realized capital gains were $209,000 in the three months ended March
31, 2005 compared to net realized capital gains of $11,000 for the same period
in 2004. The increase in net realized capital gains was the result of the sale
of common stocks from which the proceeds were reinvested into higher dividend
yielding securities.
There was no impact on net realized gains attributable to adjustments for
other than temporary impairment of securities held during the three months
ending March 31, 2005 and during the same period in 2004.
Losses and loss adjustment expenses. Gross loss and loss adjustment
expenses and the gross loss ratio for the insurance and reinsurance segments
combined for the three months ended March 31, 2005 were $26.1 million and 56.9%,
respectively, compared to $21.5 million and 57.6%, respectively, for the same
period in 2004. The net loss ratio for the combined segments was 60.2% for the
three months ended March 31, 2005 and 63.3% for the same period in 2004. The
improvement in the net loss ratios in the first quarter of 2005 compared to the
same period in 2004 was due primarily to the improvement in the net loss ratio
in the insurance segment due to an increase in net premiums earned that reduced
the effect of catastrophe reinsurance premiums on the net loss ratio. See
"Insurance Segment Results of Operations" and "Reinsurance Segment Results of
Operations" for further discussion.
Operating expenses. Operating expenses increased by 27.7% to $17.7 million
for the three months ended March 31, 2005 from $13.9 million for the same period
in 2004. The increase was due primarily to the increase in underwriting expenses
resulting from the growth in premiums earned in TICNY and premiums produced by
TRM, costs related to the OneBeacon transaction, including establishing two new
offices in Long Island and Western New York, additional staffing and other
expenses incurred as a public company.
Interest expense. Our interest expense increased for the three months ended
March 31, 2005 to $1.2 million compared to $0.7 million for the same period in
2004. The increase resulted from an increase in interest expense of $0.5 million
on subordinated debentures underlying our trust preferred securities issued in
December 2004 for $26.8 million and $0.2 million as a result of crediting
reinsurers on funds withheld in segregated trusts as collateral for reinsurance
recoverables effective January 1, 2004 with an annual effective yield of 2.5%.
These increases were offset by reductions of $0.2 million of interest expense on
other borrowings and preferred stock repaid in the fourth quarter of 2004.
Income tax expense. Our income tax expense was $2.0 million for the three
months ended March 31, 2005 compared to $0.9 million for the same period in
2004. The increased income tax expense was due primarily to the increase in
income before income taxes. The effective income tax rate was 35.2% for the
three months ending March 31, 2005 compared to 39.2% for the same period in
2004. The effective tax rate in 2005 was lower due to the benefit of tax-exempt
interest income for the first quarter of 2005 of $0.7 million compared to $0.1
million in the same period for 2004.
Net income and return on average equity. Our net income and annualized
return on average equity was $3.7 million and 11.5%, respectively, for the three
months ended March 31, 2005 compared to $1.3 million and 37.9%, respectively,
for the same period in 2004. Although net income increased 181.2% in the first
quarter of 2005 compared to the first quarter of 2004, the lower return on
average equity resulted from the significant increase in average stockholders'
equity as our IPO was completed in the fourth quarter of 2004. For the first
quarter of 2005, the return was calculated by dividing annualized net income of
$14.9 million by an average stockholders' equity of $129.6 million.
11
Insurance Segment Results of Operations
Three Months Ended
March 31,
2005 2004
------------- -------------
($ in thousands)
Revenues
Earned premiums
Gross premiums earned $ 45,449 $ 37,072
Less: ceded premiums earned (15,816) (29,374)
------------- -------------
Net premiums earned 29,633 7,698
Ceding commission revenue 5,846 10,301
Policy billing fees 196 174
------------- -------------
Total 35,675 18,173
Expenses
Loss and loss adjustment expenses
Gross loss and loss adjustment expenses 26,291 21,285
Less: ceded loss and loss adjustment
expenses (8,511) (16,477)
------------- -------------
Net loss and loss adjustment expenses 17,780 4,808
Underwriting expenses
Direct commission expense 7,573 6,134
Other underwriting expenses 6,921 5,628
------------- -------------
Total underwriting expenses 14,494 11,762
------------- -------------
Underwriting Profit $ 3,401 $ 1,603
============= =============
Key Measures
Premiums written
Gross premiums written $ 64,302 $ 39,878
Less: ceded premiums written (19,274) (25,208)
------------- -------------
Net premiums written $ 45,028 $ 14,670
============= =============
Loss Ratios
Gross 57.8% 57.4%
Net 60.0% 62.5%
Accident Year Loss Ratio
Gross 57.9% 56.1%
Net 60.0% 61.7%
Underwriting Expense Ratios
Gross 31.5% 31.3%
Net 28.5% 16.7%
Combined Ratios
Direct 89.3% 88.7%
Net 88.5% 79.2%
Insurance Segment Results of Operations Three Months Ended March 31, 2005 and
2004
Gross premiums. Gross premiums written increased by 61.2% to $64.3 million
for the three months ended March 31, 2005 compared to $39.9 million for the same
period in 2004. Gross premiums earned increased by 22.6% to $45.4 million for
the three months ended March 31, 2005 compared to $37.1 million for the same
period in 2004. Policies in force increased 17.5% for the three months ended
March 31, 2005 compared to the same period in 2004. Additionally, during the
quarter of 2005, premium increases on renewed business averaged 11% in personal
lines and 6% in commercial lines. The retention rate was 87% for personal lines
and 70% for commercial lines. Premiums written on business subject to the
OneBeacon renewal rights agreement, entered into in September 2004, amounted to
$8.8 million during the first quarter of 2005. New business written during the
first quarter of 2005 through former OneBeacon producers that we appointed in
consequence of the renewal rights transaction amounted to $4.9 million.
Ceded premiums. Ceded premiums written decreased by 23.5% to $19.3 million
for the three months ended March 31, 2005 compared to $25.2 million for the same
period in 2004. The lower ceded premiums written are the result of our decision
to lower the ceding percentage under the quota share reinsurance agreement to
25% beginning October 1, 2004 from 60% for the first nine months of 2004 in
consideration of the increased capitalization of our insurance company from the
IPO.
12
Net premiums. Net premiums written increased by 206.9% to $45.0 million for
the three months ended March 31, 2005 compared to $14.7 million for the same
period in 2004. This increase was greater than the increase in gross premiums
written due to the decrease in the ceding percentage mentioned above from 60% in
the three months ended March 31, 2004 to 25% in the three months ended March 31,
2005. Net premiums earned increased by 284.9% to $29.6 million in the three
months ended March 31, 2005 compared to $7.7 million in the same period in 2004.
In addition, the net premiums earned in the first quarter of 2005 included $5.5
million from the $13.1 million of retained unearned premiums as of December 31,
2004 that would have been ceded to Converium Reinsurance (North America) Inc.
absent the 2004 novation.
Ceding commission revenue. Ceding commission revenue decreased by 43.2% to
$5.8 million for the three months ended March 31, 2005 compared to $10.3 million
for the same period in 2004 due to the reduction in the quota share ceding
percentage. The reduction was offset in part by an improvement in the ceded loss
ratios on prior years' quota share treaties, which increased ceding commission
revenue by $50,000.
Loss and loss adjustment expenses and loss ratio. Gross and net losses and
loss adjustment expenses were $26.3 million and $17.8 million, respectively, for
the three months ended March 31, 2005 compared with $21.3 million and $4.8
million, respectively, for the same period in 2004. Our gross and net loss
ratios were 57.8% and 60.0%, respectively for the three months ended March 31,
2005 as compared with 57.4% and 62.5% for the same period in 2004. The decrease
in the net loss ratio in the first quarter of 2005 compared to the same period
in 2004 resulted from the increase in net premiums earned which reduced the
proportional effect of catastrophe reinsurance premiums on the net loss ratio.
We ceded catastrophe reinsurance premiums equal to 3.1% of net premiums earned
during the three months ended March 31, 2005 compared to 10.9% during the same
period in 2004. There was no significant adverse development from prior years'
loss reserves on a net basis. Also, our claims reported in the first quarter of
2005 were favorable for our property lines of business in comparison to prior
years even though the 2005 winter was very harsh in New York. Loss and loss
adjustment expenses are net of reimbursements for loss and loss adjustment
expenses made by TRM pursuant to the expense sharing agreement between TICNY and
TRM. See "Insurance Services Segment Results of Operations" for the amounts of
loss and loss adjustment expense reimbursements.
Underwriting expenses and underwriting expense ratio. Underwriting
expenses, which include direct commission expenses and other underwriting
expenses, were $14.5 million for the three months ended March 31, 2005 as
compared with $11.8 million for the same period in 2004. Our gross expense ratio
was 31.5% for the three months ended March 31, 2005 as compared with 31.3% for
the same period in 2004.
The commission portion of the gross expense ratio, which expresses direct
commission expense paid to our producers as a percentage of gross premiums
earned, was 16.7% for the three months ended March 31, 2005, which was in line
with 16.5% for the same period in 2004.
The underwriting expense portion of the gross expense ratio was 14.8% for
the three months ended March 31, 2005 as compared to 14.7% for the same period
in 2004. Underwriting expenses increased due to the increase in premium volume,
the establishment of two new branch offices and additional expenses incurred as
a public company. Nonetheless, the 23.0% increase in underwriting expenses was
only slightly higher than the 22.6% increase in gross earned premiums.
The net underwriting expense ratio was 28.5% for the three months ended
March 31, 2005 as compared to 16.7% for the same period in 2004. This was due
primarily to the reduced effects of ceding commission revenue on lowering the
gross expense ratio as a result of the reduction in the quota share ceding
percentage from 60% in the first quarter of 2004 to 25% in the first quarter of
2005.
Underwriting profit and combined ratio. The underwriting profit, which
reflects our underwriting results on a net basis after the effects of
reinsurance, was $3.4 million in the first quarter of 2005 and $1.6 million in
the same period in 2004. The gross combined ratio was 89.3% for the three months
ended March 31, 2005 as compared with 88.7% for the same period in 2004. The
increase in the gross combined ratio in the first quarter of 2005 resulted
primarily from an increase in the gross underwriting expense ratio. The net
combined ratio was 88.5% for the three months ended March 31, 2005 as compared
to 79.2% for the same period in 2004. The increase in the net combined ratio
resulted from an increase in the net expense ratio primarily due to the effects
of reduced ceding commission revenue. Notwithstanding the increase in net
combined ratio for the first quarter, underwriting profits increased due to the
overall increase in premiums earned.
13
Reinsurance Segment Results of Operations
Three Months Ended
March 31,
2005 2004
------------- -------------
($ in thousands)
REVENUES
Premiums earned
Gross premiums earned $ 419 $ 270
Less: ceded premiums earned (34) (38)
------------- -------------
Net premiums earned 385 232
------------- -------------
Total 385 232
EXPENSES
Loss and loss adjustment expenses
Gross loss and loss adjustment expenses (214) 220
Less: ceded loss and loss adjustment
expenses 496 (11)
------------- -------------
Net loss and loss adjustment expenses 282 209
Underwriting expenses
Direct commission expense 8 2
Other underwriting expenses 39 19
------------- -------------
Total underwriting expenses 47 21
------------- -------------
Underwriting Profit $ 56 $ 2
============= =============
Key Measures
Premiums written
Gross premiums written $ 366 $ 135
Less: ceded premiums written (33) (15)
------------- -------------
Net premiums written $ 333 $ 120
============= =============
Loss Ratios
Gross -51.1% 81.5%
Net 73.2% 90.1%
Accident Year Loss Ratio
Gross 59.9% 87.1%
Net 65.2% 96.3%
Underwriting Expense Ratios
Gross 11.3% 7.8%
Net 12.3% 9.1%
Combined Ratios
Direct -39.8% 89.3%
Net 85.6% 99.2%
Reinsurance Segment Results of Operations Three Months Ended March 31, 2005 and
2004
Gross premiums. Gross premiums written increased by 171.1% to $366,000 for
the three months ended March 31, 2005 as compared to $135,000 for the same
period in 2004. The increase was due to an increase in the premiums produced by
TRM's issuing companies resulting primarily from higher rates charged on the
reinsurance assumed from these issuing companies.
Net premiums. Net premiums written increased 177.5% to $333,000 for the
three months ended March 31, 2005 as compared to $120,000 for the same period in
2004 which was in line with the increase in gross premiums written. Net premiums
earned increased by 65.9% to $385,000 for the three months ended March 31, 2005
as compared to $232,000 for the same period in 2004 as a result of lower
reinsurance costs.
Loss and loss adjustment expenses and loss ratio. Gross loss and loss
adjustment expenses were a benefit of $214,000 for the three months ended March
31, 2005 as compared to a $220,000 expense for the same period in 2004. Net
losses were $282,000 for the three months ended March 31, 2005 as compared to
$209,000 for the same period in 2004. The gross loss ratio was a negative 51.1%
in the first quarter of 2005 compared to a positive 81.5% in the same period in
2004 due to an overall release of reserves from prior years. During the first
quarter of 2005, we had favorable development for accident years 2001 and 2002
of approximately $600,000 on a gross basis, which was partially offset by an
increase in reserves of $131,000 for other prior years. The favorable
development did not affect the results on a net basis as significantly, because
we had lower net retentions for the accident years sharing the favorable
developments. For the current accident year the net loss ratio was 65.2%, which
favorably compares to 96.3% for the same time period in the 2004 accident year,
reflecting higher rates for the treaty coverage. Similarly, the net calendar
year loss ratio also decreased for the three months ended March 31, 2005 to
73.2% as compared to 90.1% for the same period in 2004.
14
Underwriting expenses and underwriting expense ratio. Underwriting expenses
for the reinsurance segment are comprised of ceding commission expense paid to
TRM's issuing companies and other third-party reinsurers to acquire the ceded
premium and this segment's allocated share of our other underwriting expenses.
Gross underwriting expenses increased for the three months ended March 31, 2005
to $47,000 as compared to $21,000 for the same period in 2004. Our net
underwriting expense ratio increased to 12.3% for the three months ended March
31, 2005 from 9.1% for the same period in 2004. This was due to higher other
underwriting expenses in the first quarter of 2005 compared to the same period
in 2004.
Underwriting profit and combined ratio. The underwriting profit from
assumed reinsurance for the first quarter of 2005 was $56,000 compared to $2,000
for the first quarter of 2004. The net combined ratio was 85.6% for the first
quarter of 2005 compared to 99.2% for the first quarter of 2004. The lower net
combined ratio for the first quarter of 2005 was the result of a lower net loss
ratio as explained above.
The gross combined ratio decreased to a negative 39.8% for the first
quarter of 2005 compared to 89.3% for the first quarter of 2004 due to a
reduction in the gross loss ratio to negative 51.1% for the first quarter of
2005 compared to 81.5% for the first quarter of 2004. This was offset by an
increase in the gross underwriting expense ratio to 11.3% for the first quarter
of 2005 compared to 7.8% for the first quarter of 2004 due to increased gross
premiums written which is the basis for the allocation of underwriting expenses
to this segment.
Insurance Services Segment Results of Operations
Three Months Ended
March 31,
2005 2004
------------- -------------
($ in thousands)
REVENUES
Direct commission revenue from managing general
agency $ 2,525 $ 1,457
Claims administration revenue 1,053 869
Reinsurance intermediary fees(1) 203 198
Policy billing fees 5 -
------------- -------------
Total Revenues 3,786 2,524
------------- -------------
EXPENSES
Direct commissions expense paid to producers 1,211 950
Other insurance services expenses(2) 485 300
Claims expense reimbursement to TICNY 1,050 802
------------- -------------
Total Expenses 2,746 2,052
------------- -------------
Insurance Services Pre-tax Income $ 1,040 $ 472
============= =============
Premium produced by TRM on behalf of issuing
companies $ 8,444 $ 6,487
============= =============
(1) The reinsurance intermediary fees include commissions earned for
placement of reinsurance on behalf of TICNY.
(2) Consists of underwriting expenses reimbursed to TICNY pursuant to an
expense sharing agreement.
Insurance Services Segment Results of Operations Three Months Ended March 31,
2005 and 2004
Total revenues. Total revenues for the insurance services segment were $3.8
million for the three months ended March 31, 2005 as compared with $2.5 million
for the same period in 2004. The principal components of total revenues for our
insurance services segment are direct commission revenue, claims administration
revenue and reinsurance intermediary fees. The increase in total revenues was
primarily due to direct commission revenue that increased by 73.3% to $2.5
million for the first quarter of 2005 compared to $1.5 million for the first
quarter of 2004. Claims administration revenue increased by 21.2% to $1.1
million for the first quarter of 2005 as compared to $0.9 million for the first
quarter of 2004. Premiums produced during the first quarter of 2005 on business
subject to the renewal rights agreement with OneBeacon amounted to $2.2 million.
New business produced through former OneBeacon producers that we appointed in
consequence of the renewal rights transaction amounted to $0.6 million during
the first quarter of 2005.
15
Direct commission revenue is dependent upon the premiums and losses on
business produced by TRM on behalf of its issuing companies. For the first
quarter of 2005 direct commission revenues increased by 73.3% to $2.5 million
compared to $1.5 million for the first quarter of 2004 as a result in the
increases in premiums produced by TRM and additional commission revenue of
$491,000 resulting from favorable loss development on the premiums produced in
prior periods. Premiums produced by TRM increased by 30.2% to $8.4 million in
the first quarter of 2005 as compared to $6.5 million in the first quarter of
2004 resulting primarily from increases in premiums produced in the middle
market and small business overflow programs. The composite commission revenue
rate increased to 29.9% for the first quarter of 2005 compared to 22.5% for the
first quarter of 2004 due to growth in the middle market program and the
additional $491,000 of commission revenue resulting from favorable loss
development discussed above.
Direct commission expense. TRM's direct commission expense rate was 14.3%
for the first quarter of 2005 compared to 14.6% for the first quarter of 2004.
This was due to the mix of premiums produced for the middle market program and
the small business overflow program. The middle market program increased 67% and
the small business overflow program increased 59%. The middle market program has
a lower commission rate than the small business overflow program.
Other insurance services expenses. The amount of reimbursement for
underwriting expenses by TRM to TICNY in the first quarter of 2005 was $0.5
million as compared to $0.3 million in the first quarter of 2004. The increase
resulted from the increase in premiums produced.
Claims expense reimbursement. The amount of reimbursement by TRM for claims
administration pursuant to the terms of the expense sharing agreement with TICNY
in the first quarter of 2005 was $1.1 million as compared to $0.8 million in the
first quarter of 2004 due to an increase in the number of claims handled.
Pre-tax income. Pre-tax income in the first quarter of 2005 increased by
120.3% to $1.0 million as compared to $0.5 million in the first quarter of 2004.
The increase was due to a 73.3% increase in direct commission revenue as a
result of an increase in premiums placed with issuing carriers and additional
commission revenue of $491,000 resulting from favorable loss development on the
premiums produced. This increase was partially offset by a 33.8% increase in
expenses for the first quarter of 2005 compared to the same period in 2004.
Liquidity and Capital Resources
Cash flows. For the three months ended March 31, 2005 net cash provided by
operating activities was $28.3 million compared to $27.3 million for the same
period in 2004. The increase in net cash provided by operations for the three
months ended March 31, 2005 resulted from an increase in collected premiums as a
result of the growth in gross premiums and the reduction in the quota share
reinsurance ceding percentage to 25.0% in 2005 from 60.0% in 2004. The $27.3
million increase in net cash provided by operations in the first quarter of 2004
was significantly impacted by an increase in funds withheld as collateral for
reinsurance recoverables of $11.3 million and the collection of $15.7 million of
cash for cancelled reinsurance.
Cash flow needs at the holding company level are primarily for dividends to
our stockholders and interest payments on our $47.4 million of subordinated
debentures. The holding company receives cash from dividends from subsidiaries,
long-term borrowings and issuance of equity securities.
The operating subsidiaries' primary sources of cash are net premiums
received, commission and fee income, net investment income and proceeds from the
sale and redemption of both equity and fixed-maturity investments. Cash is used
to pay claims, commissions and operating expenses, to purchase investments and
to pay dividends to the holding company. TICNY is subject to significant
regulatory restrictions limiting its ability to declare and pay dividends. As of
March 31, 2005, the maximum amount of distributions that TICNY could pay to its
parent without approval of the New York Insurance Department was $2.7 million.
Investments
The investment portfolio provides a high degree of liquidity since it is
comprised of readily marketable equity, fixed income and short-term securities.
We classify investments in fixed maturity securities as available for sale and
report these securities at estimated fair values based on quoted market prices
or a recognized pricing service. Changes in unrealized gains and losses on these
securities are reported as a separate component of comprehensive net income and
accumulated unrealized gains and losses are reported as a component of
accumulated other comprehensive net income in stockholders' equity, net of
deferred taxes. Realized gains and losses are charged or credited to income in
the period in which they are realized.
16
The aggregate fair market value of our invested assets as of March 31, 2005
was $283.1 million. Our fixed maturity securities as of this date had a fair
market value of $251.9 million and an amortized cost of $255.0 million. The
equity securities had a fair value and cost of $29.7 million.
During the three months ended March 31, 2005, we reallocated a portion of
the taxable fixed income portfolio to higher yielding securities. Accordingly,
purchases in this quarter included approximately $9.0 million in "BB" rated
mortgage backed securities, $10.0 million of mortgage REIT funds, of which $5.0
million were a private mortgage REIT and $5.0 million were in publicly traded
funds, and $18.0 million of a short duration floating-rate asset backed fund. As
a result of the investment activity during this quarter, the taxable equivalent
book yield increased to 5.1% from 4.4% at December 31, 2004. We also reallocated
approximately $2.0 million of common stock to a higher dividend yielding stock
fund. The mortgage REIT funds and the floating rate asset backed fund are
classified as equity investments resulting in an increase in equity securities
to $29.7 million from $2.5 million at December 31, 2004.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk relates to changes in the value of financial instruments that
arise from adverse movements in factors such as interest rates and equity
prices. We are exposed mainly to changes in interest rates that affect the fair
value of our investment in securities.
Sensitivity Analysis
Sensitivity analysis is a measurement of potential loss in future earnings,
fair values or cash flows of market sensitive instruments resulting from one or
more selected hypothetical changes in interest rates and other market rates or
prices over a selected time. In our sensitivity analysis model, we select a
hypothetical change in market rates that reflects what we believe are reasonably
possible near-term changes in those rates. The term "near-term" means a period
of time going forward up to one year from the date of the consolidated financial
statements. Actual results may differ from the hypothetical change in market
rates assumed in this disclosure, especially since this sensitivity analysis
does not reflect the results of any action that we may take to mitigate such
hypothetical losses in fair value.
In this sensitivity analysis model, we use fair values to measure our
potential loss. The sensitivity analysis model includes fixed maturities and
short-term investments.
For invested assets, we use modified duration modeling to calculate changes
in fair values. Durations on invested assets are adjusted for call, put and
interest rate reset features. Durations on tax-exempt securities are adjusted
for the fact that the yield on such securities is less sensitive to changes in
interest rates compared to Treasury securities. Invested asset portfolio
durations are calculated on a market value weighted basis, including accrued
investment income, using holdings as of March 31, 2005.
The following table summarizes the estimated change in fair value on our
fixed maturity portfolio including short-term investments based on specific
changes in interest rates as of March 31, 2005:
Estimated Increase Estimated Percentage
(Decrease) in Fair Value Increase (Decrease)
Change in Interest Rate ($ in thousands) in Fair Value
--------------------------- ------------------------ --------------------
300 basis point rise (34,538) (13.7%)
200 basis rise (23,537) (9.3%)
100 basis rise (11,961) (4.7%)
As of March 31, 2005 -- 0.0%
50 basis point decline 5,926 2.4%
100 basis point decline 11,665 4.6%
17
The sensitivity analysis model used by us produces a predicted pre-tax loss
in fair value of market-sensitive instruments of $12.0 million or 4.7% based on
a 100 basis point increase in interest rates as of March 31, 2005. This loss
amount only reflects the impact of an interest rate increase on the fair value
of our fixed maturities, which constituted approximately 89.0% of our total
invested assets as of March 31, 2005.
Item 4. Controls and Procedures
Our management, with the participation of the Chief Executive Officer and
Chief Financial Officer, has evaluated the effectiveness of the design and
operation of our disclosure controls and procedures (as defined in Securities
Exchange Act Rule 13a-15(e)) as of the end of the period covered by this report.
Based on that evaluation, the Chief Executive Officer and Chief Financial
Officer have concluded that our disclosure controls and procedures are effective
to provide reasonable assurance that material information relating to us and our
consolidated subsidiaries required to be disclosed in our reports filed with or
submitted to the Securities and Exchange Commission under the Securities
Exchange Act is made known to such officers by others within these entities,
particularly during the period this quarterly report was prepared, in order to
allow timely decisions regarding required disclosure.
There have not been any changes in our internal control over financial
reporting during the three months ended March 31, 2005 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
Part II - OTHER INFORMATION
Item 6. Exhibits
31.1 Chief Executive Officer - Certification pursuant to Sarbanes-Oxley
Act of 2002 Section 302
31.2 Chief Financial Officer - Certification pursuant to Sarbanes-Oxley
Act of 2002 Section 302
32 Chief Executive Officer and Chief Financial Officer - Certification
pursuant to Sarbanes-Oxley Act of 2002 Section 906
18
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registration has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Tower Group, Inc.
----------------------------
Registrant
Date: May 9, 2005 /s/ Michael H. Lee
-------------------- -------------------------------------
Michael H. Lee
Chairman of the Board,
President and Chief Executive Officer
Date: May 9, 2005 /s/ Francis M. Colalucci
-------------------- -------------------------------------
Francis M. Colalucci
Senior Vice President,
Chief Financial Officer and Treasurer
19