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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q (Mark one)
or
Commission File Number 1-15202 W. R. BERKLEY CORPORATION (Exact name of registrant as specified in its charter)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or 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 þ No o Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ Number of shares of common stock, $.20 par value, outstanding as of April 30, 2012: 138,325,721 TABLE OF CONTENTS
Part I — FINANCIAL INFORMATION
W. R. BERKLEY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) (Dollars in thousands)
See accompanying notes to interim consolidated financial statements. 1 W. R. BERKLEY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (Dollars in thousands, except per share data)
See accompanying notes to interim consolidated financial statements. 2 W. R. BERKLEY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) (Dollars in thousands)
See accompanying notes to interim consolidated financial statements. 3 W. R. BERKLEY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED) (Dollars in thousands)
See accompanying notes to interim consolidated financial statements. 4 W. R. BERKLEY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (Dollars in thousands)
See accompanying notes to interim consolidated financial statements. 5 W. R. Berkley Corporation and Subsidiaries NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (1) General The accompanying unaudited consolidated financial statements of W. R. Berkley Corporation and its subsidiaries (the “Company”) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information. Accordingly, they do not include all the information and notes required by GAAP for annual financial statements. The unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring items, which are necessary to present fairly the Company’s financial position and results of operations on a basis consistent with the prior audited consolidated financial statements. Operating results for interim periods are not necessarily indicative of the results that may be expected for the year. All significant intercompany accounts and transactions have been eliminated. The preparation of financial statements requires the use of management estimates. For further information related to a description of areas of judgment and estimates and other information necessary to understand the Company’s financial position and results of operations, refer to the audited consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. Reclassifications have been made in the 2011 financial statements as originally reported to conform to the presentation of the 2012 financial statements. The income tax provision has been computed based on the Company’s estimated annual effective tax rate. The effective tax rate for the quarter differs from the federal income tax rate of 35% principally because of tax-exempt investment income. (2) Per Share Data The Company presents both basic and diluted net income per share (“EPS”) amounts. Basic EPS is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted EPS is based upon the weighted average number of common and common equivalent shares outstanding during the period and is calculated using the treasury stock method for stock incentive plans. Common equivalent shares are excluded from the computation in periods in which they have an anti-dilutive effect. Stock options for which the exercise price exceeds the average market price over the period have an anti-dilutive effect on EPS and, accordingly, are excluded from the calculation. The weighted average number of common shares used in the computation of basic and diluted earnings per share was as follows (amounts in thousands):
(3) Recent Accounting Pronouncements In October 2010, the Financial Accounting Standards Board (" FASB") issued guidance regarding the treatment of costs associated with acquiring or renewing insurance contracts. This guidance modified the definition of the types of costs that can be capitalized and specifies that the costs must be directly related to the successful acquisition of a new or renewed insurance contract. The Company adopted this guidance effective January 1, 2012 and retrospectively adjusted its previously issued financial statements. 6 A summary of the impact of the adoption of this new guidance is shown below (dollars in thousands except per share amounts):
The impact of applying this guidance retrospectively was a reduction in stockholders' equity of $51 million as of December 31, 2010. In May 2011, the FASB issued guidance related to measuring and disclosing fair values. The Company's adoption of the updated guidance effective January 1, 2012 resulted in a change in the presentation of the Company's consolidated financial statements but did not have any impact on the Company's results of operations, financial position or liquidity. In June 2011, the FASB issued guidance relating to the presentation of the components of net income and other comprehensive income. The Company's adoption of the updated guidance effective January 1, 2012 resulted in a change in the presentation of the Company's consolidated financial statements but did not have any impact on the Company's results of operations, financial position or liquidity. All recently issued but not yet effective accounting and reporting guidance is either not applicable to the Company or is not expected to have a material impact on the Company. (4) Statements of Cash Flow Interest payments were $45,358,000 and $44,927,000 and income taxes paid were $3,249,000 and $7,330,000 in the three months ended March 31, 2012 and 2011, respectively. 7 (5) Investments in Fixed Maturity Securities At March 31, 2012 and December 31, 2011, investments in fixed maturity securities were as follows:
8 The amortized cost and fair value of fixed maturity securities at March 31, 2012, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because certain issuers may have the right to call or prepay obligations.
At March 31, 2012, there were no investments, other than investments in United States government and government agency securities, which exceeded 10% of common stockholders’ equity. (6) Investments in Equity Securities Available for Sale At March 31, 2012 and December 31, 2011, investments in equity securities available for sale were as follows:
(7) Arbitrage Trading Account At March 31, 2012 and December 31, 2011, the fair value and carrying value of the arbitrage trading account were $345 million and $397 million, respectively. The primary focus of the trading account is merger arbitrage. Merger arbitrage is the business of investing in the securities of publicly held companies which are the targets in announced tender offers and mergers. Arbitrage investing differs from other types of investing in its focus on transactions and events believed likely to bring about a change in value over a relatively short time period (usually four months or less). The Company believes that this makes arbitrage investments less vulnerable to changes in general financial market conditions. 9 (8) Net Investment Income Net investment income consists of the following:
(9) Investment Funds Investment funds consist of the following:
(10) Real Estate Real estate is directly owned property held for investment. At March 31, 2012, real estate consists of two office buildings in London, including one in operation and one under development, and a long-term ground lease in Washington D.C. Future minimum rental income expected on operating leases relating to real estate held for investment is $1,421,000 in 2012, $1,464,000 in 2013, $1,508,000 in 2014, $1,553,000 in 2015, $1,600,000 in 2016 and $331,476,000 thereafter. 10 (11) Loans Receivable Loans receivable are as follows (dollars in thousands):
Loans receivable in non-accrual status were $13 million and $30 million at March 31, 2012 and December 31, 2011, respectively. If these loans had been current, additional interest income of $0.2 million and $0.1 million would have been recognized in accordance with their original terms for the three months ended March 31, 2012 and 2011, respectively. The Company monitors the performance of its loans receivable and assesses the ability of the borrower to pay principal and interest based upon loan structure, underlying property values, cash flow and related financial and operating performance of the property and market conditions. Loans receivable with a potential for default are further assessed using discounted cash flow analysis and comparable cost and sales methodologies, if appropriate. The Company's seven largest loans receivable, which have an aggregate amortized cost of $225 million and an aggregate fair value of $208 million at March 31, 2012, are secured by commercial real estate located primarily in New York City, California, Hawaii and Boston. These loans earn interest at floating LIBOR-based interest rates and have maturities (inclusive of extension options) through March 2016. As part of the evaluation process, the Company reviews certain credit quality indicators for these loans. The Company utilizes an internal risk rating system to assign a risk to each of its commercial loans. The loan rating system takes into consideration credit quality indicators including loan to value ratios, which compare the outstanding loan amount to the estimated value of the property, the borrower's financial condition and performance with respect to loan terms, the Company's position in the capital structure, and the overall leverage in the capital structure. Based on this rating system, two loans with an aggregate cost basis of $41 million were considered to be impaired at March 31, 2012. For each of these loans, a determination was made as to the amount of loss in the event of a default and whether the loss is probable. The results of the determination were considered in connection with the valuation allowance noted above. An additional credit quality indicator is the debt service coverage ratio, which compares a property's net operating income to the borrower's principal and interest payments. At March 31, 2012, each of the seven largest loans referred to above had a debt service coverage ratio greater than 3.0, except one that is lower due to a recent and temporary rate abatement. 11 (12) Realized and Unrealized Investment Gains (Losses) Realized and unrealized investment gains (losses) are as follows:
____________ (1) Represents reduction of valuation allowance of $7 million, net of other-than-temporary-impairment of $3 million. 12 (13) Securities in an Unrealized Loss Position The following table summarizes all securities in an unrealized loss position at March 31, 2012 and December 31, 2011 by the length of time those securities have been continuously in an unrealized loss position:
Fixed Maturity Securities – A summary of the Company’s non-investment grade fixed maturity securities that were in an unrealized loss position at March 31, 2012 is presented in the table below.
(1) This investment is a residential mortgage-backed security that was evaluated based on the performance of the underlying collateral under various economic and default scenarios. The security has met its contractual obligations and the Company expects that it will continue to meet those contractual payment obligations as they become due. Based on this evaluation, the Company does not consider the investment to be OTTI. 13 For OTTI of fixed maturity securities that management does not intend to sell or, more likely than not, would not be required to sell, the portion of the decline in value considered to be due to credit factors is recognized in earnings and the portion of the decline in value considered to be due to non-credit factors is recognized in other comprehensive income. For the three months ended March 31, 2012 and 2011, there were no changes in the portion of impairments recognized in earnings for those securities that have been impaired due to both credit factors and non-credit factors. The Company has evaluated its fixed maturity securities in an unrealized loss position and believes the unrealized losses are due primarily to temporary market and sector-related factors rather than to issuer-specific factors. None of these securities are delinquent or in default under financial covenants. Based on its assessment of these issuers, the Company expects them to continue to meet their contractual payment obligations as they become due and does not consider any of these securities to be OTTI. (14) Fair Value Measurements The Company’s fixed maturity and equity securities available for sale and its trading account securities are carried at fair value. Fair value is defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” The Company utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for similar assets in active markets. Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs may only be used to measure fair value to the extent that observable inputs are not available. Because many fixed maturity securities do not trade on a daily basis, the Company utilizes pricing models and processes which may include benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. Market inputs used to evaluate securities include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. Quoted prices are often unavailable for recently issued securities, securities that are infrequently traded or securities that are only traded in private transactions. For publicly traded securities for which quoted prices are unavailable, the Company determines fair value based on independent broker quotations and other observable market data. For securities traded only in private negotiations, the Company determines fair value based primarily on the cost of such securities, which is adjusted to reflect prices of recent placements of securities of the same issuer, financial projections, credit quality and business developments of the issuer and other relevant information. Preferred Stocks – At March 31, 2012, there were five preferred stocks in an unrealized loss position, with an aggregate fair value of $66 million and a gross unrealized loss of $7 million. Two of those preferred stocks with an aggregate fair value of $17 million and a gross unrealized loss of $4 million were rated non-investment grade. Based upon management’s view of the underlying value of these securities, the Company does not consider these preferred stocks to be OTTI. Common Stocks – At March 31, 2012, the Company owned five common stocks in an unrealized loss position with an aggregate fair value of $47 million and an aggregate unrealized loss of $0.7 million. The Company does not consider these common stocks to be OTTI. 14 The following tables present the assets and liabilities measured at fair value, on a recurring basis, as of March 31, 2012 and December 31, 2011 by Level:
There were no significant transfers between Levels 1 and 2 during the three months ended March 31, 2012 or during the year ended December 31, 2011. 15 The following tables summarize changes in Level 3 assets and liabilities for the three months ended March 31, 2012 and for the year ended December 31, 2011:
There were no significant transfers in or out of Level 3 during the three months ended March 31, 2012 or during the year ended December 31, 2011. 16 (15) Reinsurance The following is a summary of reinsurance financial information:
The Company reinsures a portion of its exposures principally to reduce its net liability on individual risks and to protect against catastrophic losses. Estimated amounts due from reinsurers are reported net of reserves for uncollectible reinsurance of $3 million as of March 31, 2012 and December 31, 2011. (16) Fair Value of Financial Instruments The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments:
The estimated fair values of the Company’s fixed maturity securities, equity securities available for sale and arbitrage trading account securities are based on various valuation techniques, as described in note 14 above. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for similar assets in active markets. Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs may only be used to measure fair value to the extent that observable inputs are not available. The fair value of loans receivable are estimated by using current institutional purchaser yield requirements for loans with similar credit characteristics, which is considered a Level 2 input. The fair value of the senior notes and other debt and the junior subordinated debentures is based on spreads for similar securities, which is considered a Level 2 input. 17 (17) Restricted Stock Units Pursuant to its stock incentive plan, the Company may issue restricted stock units (RSUs) to officers of the Company and its subsidiaries. The RSUs generally vest five years from the award date and are subject to other vesting and forfeiture provisions contained in the award agreement. Grants of RSUs are made periodically, generally twice within a five-year period. A summary of RSUs issued in the three months ended March 31, 2012 and 2011 follows (dollars in thousands):
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