In July 2007, Duncan Hayward was appointed Chief Accounting Officer. Mr. Hayward also serves as the Chief Financial Officer of our Life Reinsurance International Segment, a position he held since August 2006. He stepped down from the Chief Accounting Officer position effective November 2007 and continues in his role as Chief Financial Officer of the Life Reinsurance International Segment.
In October 2007, Michael Baumstein assumed the role of Executive Vice President, Investments, Treasury and Capital Markets. He previously served as our Senior Vice President, Corporate Finance since March 2004.
the mix of different types of business that we reinsure, because profits on some lines of business emerge later than on other lines; and
The most important factors we monitor to evaluate our financial condition and performance include:
Volatility in Credit Markets. During the latter half of 2007 and continuing into the first half of 2008, credit markets experienced sharply reduced liquidity, higher volatility and widening credit spreads across asset classes mainly as a result of marketplace uncertainty arising from higher defaults in sub-prime and Alt-A residential mortgage loans. In connection with this uncertainty, we believe investors and lenders have retreated from many investments in asset-backed securities including those associated with sub-prime and Alt-A residential mortgage loans, as well as types of debt investments with weak lender protections or those with limited transparency and/or complex features which hindered investor understanding. At the same time, investors shifted emphasis towards safety, pushing up the demand for U.S. Treasury instruments. These credit market conditions in 2007 contributed to an unexpectedly large increase in realized investment losses in our $7.6 billion investment portfolio of fixed maturity securities reflecting widening spreads in our mortgage-backed and asset-backed securities, partially offset by the effects of a lower risk-free interest rate environment, contributing to the sharply higher level of impairments on our investment portfolio. The continued volatility during the first half of 2008 in the valuation of our investments in fixed income securities, especially our holdings of sub-prime and Alt-A residential mortgage-backed securities, has driven further impairments on our investment portfolio as credit spreads widened further. We expect to experience continued volatility in the valuation of our investments in fixed maturity securities, as well as a generally higher level of credit-related investment losses, including additional impairments on our investment portfolio. In addition, a weakening in the economic environment could lead to increased credit defaults. See “Management’s Discussion and Analysis of Financial Condition and Results of Operation-Financial Condition-Investments.”
For both ceded and assumed reinsurance, risk transfer requirements must be met in order to obtain reinsurance status for accounting purposes, principally resulting in the recognition of cash flows under the contract as premiums and losses. To meet risk transfer requirements, a reinsurance contract must include insurance risk, consisting of both underwriting and timing risk, and a reasonable possibility of a significant loss for the assuming entity. To assess risk transfer for certain contracts, we generally develop expected discounted cash flow analyses at contract inception. If risk transfer requirements are not met, a contract is accounted for using the deposit method. Deposit accounting requires that consideration received or paid be recorded in the balance sheet as opposed to premiums written or losses incurred in the statement of operations and any non-refundable fees earned based on the terms of the contract.
For our traditional life reinsurance business, we estimate assumed premiums using actuarial model projections at the treaty level. Consistent with reinsurance industry practices, these models use the most recent policy level data available from our ceding companies and our estimate of new business for treaties still open to new business. The estimated premiums from the models are then compared to historical trends in reported assumed premiums by treaty and other information and adjusted if appropriate. Actual results could differ materially from these estimates. We continue to enhance the automation of both our assumed premium accruals and retrocession premium estimates. The adjustments in a given period have generally not been significant to the overall premiums or results of operations.
Costs of acquiring new business, which vary with and are primarily related to the production of new business, have been capitalized and amortized in our financial statements as Deferred Acquisition Costs (“DAC”) to the extent that such costs are deemed recoverable from future premiums or gross profits. Such costs include commissions and allowances as well as certain costs of policy issuance and underwriting. Some of the factors that can affect the carrying value of DAC include mortality assumptions, interest spreads and policy lapse rates. We perform periodic tests to determine the recoverability of DAC and, if financial performance of the underlying
Fully diluted book value per ordinary share is a non-GAAP measure, based on total shareholders’ equity less preferred shares plus the assumed proceeds from the exercise of outstanding options, warrants, and other convertible securities, divided by the sum of shares, options and warrants outstanding, and the number of shares required upon the conversion of convertible securities. We believe that fully diluted book value per ordinary share more accurately reflects the book value that is attributable to an ordinary share.
On June 25, 2007, proceeds from the issuance of notes in a private offering by Clearwater Re of $365.9 million were used to fund the Regulation XXX excess reserve requirement for a defined block of level premium term life insurance policies issued between January 1, 2004 and December 31, 2006 reinsured by SRUS. External investors have committed to funding up to $555.0 million in order to fund the ongoing expected Regulation XXX collateral requirements on this block.
The investments made by MassMutual Capital and Cerberus on May 7, 2007 qualify as a change in ownership under Section 382 of the Code. Section 382 operates to limit the future deduction of net operating losses that were in existence as of the change in ownership. As a result of this limitation, we have written off $142.6 million of net operating losses that we will be unable to utilize prior to expiration with respect to its U.S. entities. Because we had previously established a valuation allowance against these net operating losses, there is not a significant tax expense associated with Section 382 limitations.
Claims and other policy benefits decreased $16.4 million to $84.7 million in fiscal 2007. With our change in premium mix, there was an associated $33.7 million increase to our U.K. protection reserves business, and separately a $13.6 million increased reserving requirement on our Loss of License business; however, this was more than offset by reductions on other blocks of business and reserve movements. Specifically, retroceded Middle East and other exited business decreased claims expense by $44.0 million, while revised estimates decreased claims expense as a result of receiving updated client data.
As part of our fourth quarter impairment process, we marked down sub-prime bonds with an amortized cost of $1,840.2 million, realizing losses of $558.3 million bringing the unrealized loss position at December 31, 2007 to zero. As a result of estimated fair value reductions from December 31, 2007 to March 31, 2008, we estimate that we incurred further other-than-temporary of approximately $297.2 million or 23.2% of amortized cost of our sub-prime holdings and is 3.9% of our investment portfolio.
The closing of the 2007 New Capital Transaction in May 2007 provided liquidity of $555.9 million. See Note 10 “Mezzanine Equity” in the Notes to Consolidated Financial Statements. The capital provided in the 2007 New Capital Transaction allowed us to repay the $275.0 million previously drawn on the Stingray financing facility and pay the closing costs of the 2007 New Capital Transaction. The remaining proceeds from the 2007 New Capital Transaction were made available to us and SALIC to fund, as needed, the uses of liquidity described above.
On March 11, 2008, the $50.0 million previously drawn from Stingray to provide collateral for SRUS was no longer needed for that purpose and was returned to Stingray. As a result, on March 11, 2008, $325.0 million of Stingray was un-utilized, representing a $50.0 million increase to available liquidity. On March 12, 2008, a $275.0 million funding agreement was put to the facility. On April 14, 2008, an additional funding agreement of $50.0 million was put to the facility thus fully utilizing this facility.
On December 22, 2005, we entered into the Reinsurance Facility with a third-party Bermuda-domiciled reinsurer that provides up to $1.0 billion of collateral support for a portion of the business acquired from ING and subject to Regulation XXX reserve requirements. The Bermuda reinsurer provides reserve credit in the form of letters of credit or assets in trust equal to the
The Assignment also will involve amendments to certain of the agreements underlying the Ballantyne Re securitization transaction, including matters relating to services provided to Ballantyne Re and the delivery of financial and other information. We also have agreed that if SLD recapture business from Ballantyne Re following the Assignment in order to continue to receive full credit for reinsurance, SLDI is entitled to cede the recaptured business to us, in which case we will bear the costs of the LOCs obtained to support that business as described above. In addition, we also have agreed to obtain SLD’s consent before appointing any future director to the board of directors of Ballantyne Re and to not appoint as a director any person currently or formerly affiliated with Scottish Re.
Net cash provided by financing activities was $237.2 million in 2007 and $1,539.6 million in 2006. The decrease in net cash provided by financing activities principally relates to prior year financings of $1,771.8 million mainly raised in the Ballantyne Re collateral finance facility, $265.0 million related to drawdown of funds on the Stingray facility, and $153.7 million from proceeds from a prepaid variable share forward contract. The current year financings include $365.9 million raised in the Clearwater Re securitization, $555.9 million in net proceeds from the issuance of Convertible Cumulative Participating Preferred Shares offset by $265.0 million net repayment of funds drawn down from the Stingray facility.
When SALIC, SRD or Scottish Re Limited enter into a reinsurance treaty with a U.S. customer, they must contribute assets into a qualifying reserve credit trust and/or provide a letter of credit to enable the U.S. ceding company to obtain a reserve credit for the reinsurance transaction since these companies are not licensed or accredited U.S. reinsurers.
At December 31, 2007 and March 31, 2008, we had $4.0 billion of collateral finance facility obligations relating to the HSBC II, Orkney I, Orkney Re II, Ballantyne Re and Clearwater Re transactions. In connection with these transactions, we have assets with a fair value of approximately $5.3 billion that represent assets supporting the economic reserves, excess reserves, additional funding amounts and surplus in the transactions. These assets are managed in accordance with predefined investment guidelines as to permitted investments, portfolio quality, diversification and duration.
additional funding agreement of $50.0 million was put to the facility thus fully utilizing the facility. Currently, there is no availability in the Stingray facility to provide collateral to SRUS.
Amounts due under funding agreements are reported in interest sensitive contract liabilities in the consolidated balance sheets. These are agreements in which we earn a spread over LIBOR. The contractual repayment terms are detailed in the table above.