| BERKLEY W R CORP ITEM 1A RISK FACTORS CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS Our business faces significant risks |
| If any of the events or circumstances described as risks below actually occurs, our business, results of operations or financial condition could be materially and adversely affected |
| Risks Relating to Our Industry Our results may fluctuate as a result of many factors, including cyclical changes in the insurance and reinsurance industry |
| The results of companies in the property casualty insurance industry historically have been subject to significant fluctuations and uncertainties |
| The demand for insurance is influenced primarily by general economic conditions, while the supply of insurance is directly related to available capacity |
| The adequacy of premium rates is affected mainly by the severity and frequency of claims, which are influenced by many factors, including natural disasters, regulatory measures and court decisions that define and expand the extent of coverage and the effects of economic inflation on the amount of compensation due for injuries or losses |
| In addition, investment rates of return may impact policy rates |
| These factors can have a significant impact on ultimate profitability because a property casualty insurance policy is priced before its costs are known, as premiums usually are determined long before claims are reported |
| These factors could produce results that would have a negative impact on our results of operations and financial condition |
| Our actual claims losses may exceed our reserves for claims, which may require us to establish additional reserves |
| Our gross reserves for losses and loss expenses were approximately dlra6dtta7 billion as of December 31, 2005 |
| Our loss reserves reflect our best estimates of the cost of settling all claims and related expenses with respect to insured events that have occurred |
| Reserves do not represent an exact calculation of liability |
| Rather, reserves represent an estimate of what management expects the ultimate settlement and claims administration will cost for claims that have occurred, whether known or unknown |
| The major assumptions about anticipated loss emergence patterns are subject to unanticipated fluctuation |
| These estimates, which generally involve actuarial projections, are based on management’s assessment of facts and circumstances then known, as well as estimates of future trends in claims severity and frequency, inflation, judicial theories of liability, reinsurance coverage, legislative changes and other factors, including the actions of third parties which are beyond our control |
| The inherent uncertainties of estimating reserves are greater for certain types of liabilities, where long periods of time elapse before a definitive determination of liability is made and settlement is reached |
| In periods with increased economic volatility, it becomes more difficult to accurately predict claim costs |
| Reserve estimates are continually refined in an ongoing process as experience develops and further claims are reported and settled |
| Adjustments to reserves are reflected in the results of the periods in which such estimates are changed |
| Because setting reserves is inherently uncertain, we cannot assure you that our current reserves will prove adequate in light of subsequent events |
| Should we need to increase our reserves, our pre-tax income for the period would decrease by a corresponding amount |
| 22 _________________________________________________________________ [71]Table of Contents We increased our estimates for claims occurring in prior years by dlra187 million in 2005, dlra295 million in 2004 and dlra245 million in 2003 |
| We, along with the property casualty insurance industry in general, have experienced higher than expected losses for certain types of business written from 1998 to 2001 |
| Although our reserves reflect our best estimate of the costs of settling claims, we cannot assure you that our claim estimates will not need to be increased in the future |
| We discount our reserves for excess and assumed workers’ compensation business because of the long period of time over which losses are paid |
| Discounting is intended to appropriately match losses and loss expenses to income earned on investment securities supporting liabilities |
| The expected loss and loss expense payout pattern subject to discounting is derived from our loss payout experience and is supplemented with data compiled from insurance companies writing similar business |
| Changes in the loss and loss expense payout pattern are recorded in the period they are determined |
| If the actual loss payout pattern is shorter than anticipated, the discount will be reduced and pre-tax income will decrease by a corresponding amount |
| As a property casualty insurer, we face losses from natural and man-made catastrophes |
| Property casualty insurers are subject to claims arising out of catastrophes that may have a significant effect on their results of operations, liquidity and financial condition |
| Catastrophe losses have had a significant impact on our results |
| In addition, through our recent quota share arrangements with certain Lloyd’s syndicates, we have additional exposure to catastrophic losses |
| Catastrophes can be caused by various events, including hurricanes, windstorms, earthquakes, hailstorms, explosions, severe winter weather and fires, as well as terrorist activities |
| The incidence and severity of catastrophes are inherently unpredictable but have increased in recent years |
| The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event |
| Some catastrophes are restricted to small geographic areas; however, hurricanes and earthquakes may produce significant damage in large, heavily populated areas |
| Catastrophes can cause losses in a variety of our property casualty lines, and most of our past catastrophe-related claims have resulted from severe storms |
| Seasonal weather variations may affect the severity and frequency of our losses |
| Insurance companies are not permitted to reserve for a catastrophe until it has occurred |
| It is therefore possible that a catastrophic event or multiple catastrophic events could produce significant losses and have a material adverse effect on our results of operations and financial condition |
| We face significant competitive pressures in our businesses, which may reduce premium rates and prevent us from pricing our products at attractive rates |
| We compete with a large number of other companies in our selected lines of business |
| We compete, and will continue to compete, with major US and non-US insurers and reinsurers, other regional companies, as well as mutual companies, specialty insurance companies, underwriting agencies and diversified financial services companies |
| Competition in our businesses is based on many factors, including the perceived financial strength of the company, premium charges, other terms and conditions offered, services provided, commissions paid to producers, ratings assigned by independent rating agencies, speed of claims payment and reputation and experience in the lines to be written |
| Some of our competitors, particularly in the reinsurance business, have greater financial and marketing resources than we do |
| These competitors within the reinsurance segment include Berkshire Hathaway, Swiss Re, Transatlantic Reinsurance and Everest Reinsurance Company |
| We expect that perceived financial strength, in particular, will become more important as customers seek high quality reinsurers |
| Certain of our competitors operate from tax advantaged jurisdictions and have the ability to offer lower rates due to such tax advantages |
| New competition could cause the supply and/or demand for insurance or reinsurance to change, which could affect our ability to price our products at attractive rates |
| We, as a primary insurer, may have significant exposure for terrorist acts |
| To the extent an act of terrorism is certified by the Secretary of Treasury, we may be covered under the Terrorism Risk Insurance Act of 2002, as amended December 22, 2005 (“TRIA”), for up to 90prca in 2006 (85prca in 2007) of our losses for certain property/casualty lines of insurance |
| However, any such coverage would be subject to a mandatory deductible based on a percent of earned premium for the covered lines of commercial property and casualty insurance |
| Based on our 2005 earned premiums, our deductible under TRIA during 2006 will increase to approximately dlra548 million which is a result of an increase in premium and an increase in the applicable deductible percentage 23 _________________________________________________________________ [72]Table of Contents from 15prca in 2005 to 17dtta5prca in 2006 |
| The deductible percentage increases to 20prca in 2007 |
| In addition, the coverage provided under TRIA is scheduled to terminate on December 31, 2007 unless extended or replaced by a similar program |
| We are subject to extensive governmental regulation, which increases our costs and could restrict the conduct of our business |
| We are subject to extensive governmental regulation and supervision |
| Most insurance regulations are designed to protect the interests of policyholders rather than stockholders and other investors |
| This system of regulation, generally administered by a department of insurance in each state in which we do business, relates to, among other things: • standards of solvency, including risk-based capital measurements; • restrictions on the nature, quality and concentration of investments; • requiring certain methods of accounting; • rate and form regulation pertaining to certain of our insurance businesses; and • potential assessments for the provision of funds necessary for the settlement of covered claims under certain policies provided by impaired, insolvent or failed insurance companies |
| State insurance departments conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to the financial condition of insurance companies, holding company issues and other matters |
| Recently adopted federal financial services modernization legislation may lead to additional federal regulation of the insurance industry in the coming years |
| Also, foreign governments regulate our international operations |
| The insurance industry recently has become the subject of increasing scrutiny with respect to insurance broker and agent compensation arrangements and sales practices |
| The New York State Attorney General and other state and federal regulators have commenced investigations and other proceedings relating to compensation and bidding arrangements between producers and issuers of insurance products, and alleged unsuitable sales practices by producers on behalf of either the issuer or the purchaser |
| The practices currently under investigation include, among other things, allegations that contingent commission arrangements may conflict with a broker’s duties to its customers and that certain brokers and insurers may have engaged in anti-competitive practices in connection with insurance premium quotes |
| The New York State Attorney General has entered into settlement agreements with certain parties against whom civil complaints had been filed |
| These investigations and proceedings are expected to continue, and new investigative proceedings may be commenced, in the future |
| These investigations and proceedings could result in legal precedents and new industry-wide practices or legislation, rules or regulations that could significantly affect the insurance industry |
| For example, following the public disclosure of the New York State Attorney General’s investigation, the Company commenced an internal review with the assistance of outside counsel that focused on the Company’s relationships with its distribution channels |
| As a result of its investigation, the Company uncovered at a single insurance operating unit certain limited instances of conduct that could be characterized as involving inappropriate solicitation practices |
| That operating unit has reached an agreement with its domiciliary insurance regulator resolving all issues pertaining to its inquiry without penalty |
| We may be unable to maintain all required licenses and approvals and our business may not fully comply with the wide variety of applicable laws and regulations or the relevant authority’s interpretation of the laws and regulations |
| Also, some regulatory authorities have relatively broad discretion to grant, renew or revoke licenses and approvals |
| If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, the insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or monetarily penalize us |
| Also, changes in the level of regulation of the insurance industry, whether federal, state or foreign, or changes in laws or regulations themselves or interpretations by regulatory authorities, restrict the conduct of our business |
| In certain of our insurance businesses, the rates we charge our policyholders are subject to regulatory approval |
| Certain lines of business are subject to a greater degree of regulatory scrutiny then others |
| For example, the workers’ compensation business is highly regulated |
| During 2005, approximately 12prca of our net premiums written represented primary workers’ compensation business |
| Of our net premiums written, approximately 4prca represented primary workers’ compensation business written in the State of California, which is undergoing workers’ compensation reform that may adversely affect our ability to adjust rates |
| 24 _________________________________________________________________ [73]Table of Contents Risks Relating to Our Business We cannot guarantee that our reinsurers will pay in a timely fashion, if at all, and, as a result, we could experience losses |
| We purchase reinsurance by transferring part of the risk that we have assumed, known as ceding, to a reinsurance company in exchange for part of the premium we receive in connection with the risk |
| Although reinsurance makes the reinsurer liable to us to the extent the risk is transferred or ceded to the reinsurer, it does not relieve us, the reinsured, of our liability to our policyholders |
| Our reinsurers may not pay the reinsurance recoverables that they owe to us or they may not pay such recoverables on a timely basis |
| Accordingly, we bear credit risk with respect to our reinsurers, and if our reinsurers fail to pay us, our financial results would be adversely affected |
| Underwriting results and investment returns of some of our reinsurers may affect their future ability to pay claims |
| As of December 31, 2005, the amount due from our reinsurers was dlra954 million, including amounts due from state funds and industry pools |
| Certain of these amounts due from reinsurers are secured by letters of credit or held in trust on our behalf |
| We are rated by AM Best, Standard & Poor’s, and Moody’s, and a decline in these ratings could affect our standing in the insurance industry and cause our sales and earnings to decrease |
| Ratings have become an increasingly important factor in establishing the competitive position of insurance companies |
| Certain of our insurance company subsidiaries are rated by AM Best, Standard & Poor’s and Moody’s Investors Services |
| While AM Best, Standard & Poor’s and Moody’s ratings reflect their opinions as to a company’s financial strength, operating performance, strategic position and ability to meet its obligations to policyholders, they are not evaluations directed to investors and are not recommendations to buy, sell or hold our securities |
| Our ratings are subject to periodic review, and we cannot assure you that we will be able to retain those ratings |
| Two of our insurance subsidiaries, Admiral Insurance Company and Clermont Insurance Company, have AM Best ratings of “A+ (Superior)” which is AM Best’s second highest rating |
| All of other domestic insurance subsidiaries and W R Berkley Insurance (Europe), Limited have AM Best ratings of “A (Excellent)” which is the third highest rating out of 15 possible ratings by A M Best |
| The Standard & Poor’s financial strength rating for our domestic insurance subsidiaries is A+ (the seventh highest rating out of twenty-seven possible ratings) |
| Our Moody’s rating is A2 for Berkley Insurance Company (the sixth highest rating out of twenty-one possible ratings) |
| If our ratings are reduced from their current levels by AM Best, Standard & Poor’s or Moody’s, our competitive position in the insurance industry could suffer and it would be more difficult for us to market our products |
| A significant downgrade could result in a substantial loss of business as policyholders move to other companies with higher claims-paying and financial strength ratings |
| If market conditions cause reinsurance to be more costly or unavailable, we may be required to bear increased risks or reduce the level of our underwriting commitments |
| As part of our overall risk and capacity management strategy, we purchase reinsurance for certain amounts of risk underwritten by our insurance company subsidiaries, especially catastrophe risks |
| Market conditions beyond our control determine the availability and cost of the reinsurance protection we purchase, which may affect the level of our business and profitability |
| Our reinsurance facilities are generally subject to annual renewal |
| We may be unable to maintain our current reinsurance facilities or to obtain other reinsurance facilities in adequate amounts and at favorable rates |
| If we are unable to renew our expiring facilities or to obtain new reinsurance facilities, either our net exposures would increase or, if we are unwilling to bear an increase in net exposures, we would have to reduce the level of our underwriting commitments, especially catastrophe exposed risks |
| Our international operations expose us to investment, political and economic risks |
| Our international operations expose us to investment, political and economic risks, including foreign currency and credit risk |
| Changes in the value of the US dollar relative to other currencies could have an adverse effect on our results of operations and financial condition |
| 25 _________________________________________________________________ [74]Table of Contents We may not find suitable acquisition candidates or new insurance ventures and even if we do, we may not successfully integrate any such acquired companies or successfully invest in such ventures |
| As part of our present strategy, we continue to evaluate possible acquisition transactions and the start-up of complementary businesses on an ongoing basis, and at any given time, we may be engaged in discussions with respect to possible acquisitions and new ventures |
| We cannot assure that we will be able to identify suitable acquisition transactions or insurance ventures, that such transactions will be financed and completed on acceptable terms or that our future acquisitions or ventures will be successful |
| The process of integrating any companies we do acquire or investing in new ventures may have a material adverse effect on our results of operations and financial condition |
| We may be unable to attract and retain qualified employees |
| We depend on our ability to attract and retain experienced underwriting talent and other skilled employees who are knowledgeable about our business |
| If the quality of our underwriting team and other personnel decreases, we may be unable to maintain our current competitive position in the specialized markets in which we operate, and be unable to expand our operations into new markets |
| Risks Relating to Our Investments A significant amount of our assets is invested in fixed income securities and is subject to market fluctuations |
| Our investment portfolio consists substantially of fixed income securities |
| As of December 31, 2005, our investment in fixed income securities was approximately dlra8dtta5 billion, or 82prca of our total investment portfolio |
| The fair market value of these assets and the investment income from these assets fluctuate depending on general economic and market conditions |
| The fair market value of fixed income securities generally decreases as interest rates rise |
| Conversely, if interest rates decline, investment income earned from future investments in fixed income securities will be lower |
| In addition, some fixed income securities, such as mortgage-backed and other asset-backed securities, carry prepayment risk as a result of interest rate fluctuations |
| Based upon the composition and duration of our investment portfolio at December 31, 2005, a 100 basis point increase in interest rates would result in a decrease in the fair value of our investments of approximately dlra352 million |
| The value of investments in fixed income securities, and particularly our investments in high-yield securities, is subject to impairment as a result of deterioration in the credit worthiness of the issuer |
| Although we attempt to manage this risk by diversifying our portfolio and emphasizing preservation of principal, our investments are subject to losses as a result of a general decrease in commercial and economic activity for an industry sector in which we invest, as well as risks inherent in particular securities |
| For example, although there were no provisions for other than temporary impairments in 2005 or 2004, we reported a provision for other than temporary impairments in the value of our fixed income investments of dlra430cmam000 in 2003 |
| We invest some of our assets in equity securities, including merger arbitrage investments and real estate securities, which may decline in value |
| We invest a portion of our investment portfolio in equity securities, including merger arbitrage investments and investments in affiliates |
| At December 31, 2005, our investments in equity securities were approximately dlra1dtta3 billion, or 13prca of our investment portfolio |
| Although we did not report any provisions for other than temporary impairments in the value of our equity securities in 2003, we reported such provisions in the amounts of dlra1dtta6 million in 2005 and dlra2dtta8 million in 2004 |
| Merger and convertible arbitrage trading securities represented 43prca of our equity securities at December 31, 2005 |
| Merger arbitrage is the business of investing in the securities of publicly held companies that are the targets in announced tender offers and mergers |
| Merger arbitrage differs from other types of investments 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 |
| Our merger arbitrage positions are exposed to the risk associated with the completion of announced deals, which are subject to regulatory as well as political and other risks |
| As a result of the reduced activity in the merger and acquisitions area, we may not be able achieve the returns that we have enjoyed in the past |
| Included in our equity security portfolio are investments in publicly traded real estate investment trusts (“REITs”) and private real estate investment funds, real estate limited partnerships and venture capital investments |
| At December 31, 2005, our investments in these 26 _________________________________________________________________ [75]Table of Contents securities were approximately dlra367 million, or 28prca of our equity portfolio |
| The values of our real estate investments are subject to fluctuations based on changes in the economy in general and real estate valuations in particular |
| In addition, the real estate investment funds, limited partnerships, and venture capital investments in which we invest are less liquid than our other investments |
| As an insurance holding company, our principal assets are the shares of capital stock of our insurance company subsidiaries |
| We have to rely on dividends from our insurance company subsidiaries to meet our obligations for paying principal and interest on outstanding debt obligations and for paying dividends to stockholders and corporate expenses |
| The payment of dividends by our insurance company subsidiaries is subject to regulatory restrictions and will depend on the surplus and future earnings of these subsidiaries, as well as the regulatory restrictions |
| During 2006, the maximum amount of dividends that can be paid without regulatory approval is approximately dlra311 million |
| As a result, in the future we may not be able to receive dividends from these subsidiaries at times and in amounts necessary to meet our obligations or pay dividends |
| We are subject to certain provisions that may have the effect of hindering, delaying or preventing third party takeovers, which may prevent our shareholders from receiving premium prices for their shares in an unsolicited takeover and make it more difficult for third parties to replace our current management |
| Provisions of our certificate of incorporation and by-laws, as well as our rights agreement and state insurance statutes, may hinder, delay or prevent unsolicited acquisitions or changes of our control |
| These provisions may also have the effect of making it more difficult for third parties to cause the replacement of our current management without the concurrence of our board of directors |
| These provisions include: • our classified board of directors and the ability of our board to increase its size and to appoint directors to fill newly created directorships; • the requirement that 80prca of our stockholders must approve mergers and other transactions between us and the holder of 5prca or more of our shares, unless the transaction was approved by our board of directors prior to such holder’s acquisition of 5prca of our shares; • the need for advance notice in order to raise business or make nominations at stockholders’ meetings; • our rights agreement which subject persons (other than William R Berkley) who acquire beneficial ownership of 15prca or more of our common stock without board approval to substantial dilution; and • state insurance statutes that restrict the acquisition of control (generally defined as 5 — 10prca of the outstanding shares) of an insurance company without regulatory approval |