Review

Adjusting the debt capital deployed

The second stage to effective balance sheet management is to consider the mix of equity and debt employed to meet medium and long term needs. Our approach to financial leverage is well established. When underwriting margins are strong, debt capital will form a significant proportion of our overall capital deployed. When margins weaken, the proportionate level of debt capital employed will fall back.

The approach is driven by the amount of underwriting risk to which we believe the balance sheet is exposed. Our underwriting strategy has cycle management at its core. If margins increase we will want to expand our business, particularly in attritional classes. In such circumstances, whilst the level of underwriting risk increases, the expected underwriting margin grows too and the income statement is better placed to absorb volatility from catastrophic events. The risk of financial loss is therefore lower, and we would use debt to fund the business expansion.

Over recent years our debt to total capital ratios have fluctuated in line with this philosophy. For example, in 2005 debt increased in order to allow us to open Amlin Bermuda and increase our catastrophe underwriting risk. Margins were very strong and we believed that funding growth through debt was appropriate. During 2006 and 2007 the debt ratio has fallen as profits have been reported. At the end of 2007 the debt to total capital ratio stands at 20.9% (2006: 22.9%). We believe that this is an appropriate reduction as margins fall in the underlying portfolio. Net of free cash, the ratio drops to zero (2006: 4.6%).

Following the move to a stricter FSA solvency capital regime in 2005 Amlin issued long term subordinated debt in 2004, 2005 and 2006. The subordinated debt, which now totals £278 million, is regulatory compliant, longer term, unsecured and contains no financial covenants that could lead to early forced repayment. Additionally, the debt is recognised as capital by a number of the ratings agencies if structured correctly. We also have £250 million of unutilised banking facilities which, together with the long term debt, provides significant future flexibility.

© Copyright Amlin 2007