In any specific financial period, the original estimated premium for a specific contract may vary from actual premium reported through the life of the contract by up to 10% to 15% due to the reporting patterns of the ceding companies and, in some cases, movements in foreign exchange rates over the period. However, historically, the final reported premium compared to the original estimated premium has deviated by smaller amounts.
Our estimate of ultimate loss is determined based on a review of the results of several commonly accepted actuarial projection methodologies incorporating the quantitative and qualitative information described above. The specific methodologies we utilize in our loss reserve review process include, but may not be limited to (i) incurred and paid loss development methods, (ii) incurred and paid Bornhuetter Ferguson (“BF”) methods and (iii) loss ratio methods. Generally, we rely on BF and loss ratio methods for estimating ultimate loss liabilities for more recent treaty years. These methodologies, at least in part, apply a loss ratio, determined from aggregated analyses of pricing trends across reserve cells, to premium earned on that business. Adjustments to premium estimates generate appropriate adjustments to ultimate loss estimates in the quarter in which they occur using the BF and loss ratio methods. To estimate losses for more mature treaty years, we generally rely on the incurred loss development methodology, which does not rely on premium estimates. In addition, we may use other methods to estimate liabilities for specific types of claims. For property catastrophe losses, we may utilize vendor catastrophe models to estimate ultimate loss soon after a loss occurs, where loss information is not yet reported to us from cedants. The provision for asbestos loss liabilities is established based on an annual review of internal and external trends in reported loss and claim payments.
Due to the uncertainty involving estimates of ultimate loss exposures, we do not attempt to produce a range around our point estimate of loss. Actual results exceeded our estimates of losses and LAE in 2005, 2004 and 2003 by 5.4%, 8.0% and 6.9%, respectively. Any future impact to income of changes in losses and LAE estimates may vary considerably from historical experience. Our estimates of ultimate loss exposures are based upon the best information we have available at any given point in time and our assumptions based upon that information. Every 1% point difference in actual results compared to our reserves as of December 31, 2005 will impact pre-tax income by $39.1 million.
The total amount of reinsurance recoverables on paid and unpaid losses as of December 31, 2005 and 2004 was $1,347.7 million and $1,142.6 million, respectively. We have established a reserve for potentially uncollectible reinsurance recoverables based upon an evaluation of each retrocessionaire and our assessment as to the collectibility of individual balances. The reserve for uncollectible recoverables as of December 31, 2005 and 2004 was $30.9 million and $33.0 million, respectively, and has been netted against reinsurance recoverables on loss payments. We have also established a reserve for potentially uncollectible assumed reinsurance balances of $6.3 million and $5.9 million as of December 31, 2005 and 2004, respectively, which has been netted against premiums receivable.
The maximum coverage available under the Whole Account Excess of Loss Agreements is based on a proportion of net premiums earned during each of the coverage periods, subject to a predetermined aggregate limit. The maximum coverage available will increase or decrease as premium adjustments applicable to a particular coverage period, if any, are recognized. The attachment point represents the aggregate amount of losses, and in certain cases, acquisition costs, expressed as a proportion of net premiums earned, that will be retained by us. Losses attributable to business written during a particular period in excess of the attachment point, subject to a maximum limit, are ceded to the reinsurer. The following table provides a summary of the significant
As indicated by the table above, for the years ended December 31, 2005 and 2004, we ceded $18.7 million and $5.6 million, respectively, of losses and LAE, primarily to the 2001 aggregate excess of loss treaty. The increase in losses ceded to our Whole Account and Facultative Excess of Loss Agreements, for the years ended December 31, 2005 and 2004, were primarily attributable to adverse loss development on casualty business written in 2001. For the year ended December 31, 2003, we ceded total losses and LAE of $104.7 million relating to prior period losses, which included (i) $65.9 million ceded to the 2001 aggregate excess of loss treaty, principally due to the 2001 World Trade Center disaster, (ii) $39.0 million ceded to the 2000 aggregate excess of loss treaty, principally due to adverse loss development on U.S. casualty business written in 2000, (iii) a reduction in ceded losses of $4.5 million related to business written in prior years that was previously ceded, and (iv) $4.3 million ceded related to facultative casualty business. The higher level of losses ceded to our aggregate excess of loss treaties during 2003 as compared to 2005 and 2004 resulted in a benefit to net income in 2003 as compared to a net loss in 2005 and 2004. Losses ceded to our Whole Account and Facultative Excess of Loss Agreements in 2005 represented 11.5% of our pre-tax loss and 1.9% and 28.0% of our pre-tax income in 2004 and 2003, respectively.
The reinsurance recoverables on paid and unpaid losses related to the Whole Account and Facultative Excess of Loss Agreements are $251.9 million and $262.0 million as of December 31, 2005 and 2004, respectively. Funds held under reinsurance contracts, related to these agreements, shown as a liability on our consolidated balance sheets, reflect $150.7 million and $152.7 million as of December 31, 2005 and 2004, respectively. Other collateral related to these agreements is $124.8 million and $130.6 million as of December 31, 2005 and 2004, respectively.
a decrease of $18.6 million for the year ended December 31, 2005 over 2004 in net income due to equity accounting of Advent Capital (Holdings) PLC, a Lloyd’s syndicate which is included in common stock, at equity. This resulted in a net loss of $15.4 million for the year ended December 31, 2005 from $3.2 million in 2004, primarily reflecting catastrophe losses from Hurricanes Katrina, Rita and Wilma during 2005.
Net Premiums Earned. Net premiums earned for the year ended December 31, 2004 increased by $361.6 million, or 18.3%, to $2,333.5 million, from $1,971.9 million for the year ended December 31, 2003. Net premiums earned increased in each of our divisions. The Americas division increased by $55.7 million, or 4.7%, reflecting the growth in volume over the past two years, offset by a slight decline in net premiums written in the current year. The EuroAsia division increased by $117.4 million, or 32.2%, reflecting the continued premium growth in the current year. The London Market division increased by $85.8 million, or 25.5%, reflecting the prior period growth in premium volume, and the U.S. Insurance division increased by $102.7 million, or 107.4%, representing the growth in net premiums written in 2004.
For the London Market division, losses and LAE increased 42.9% to $293.6 million for the year ended December 31, 2004, from $205.5 million for the year ended December 31, 2003. This resulted in a loss and LAE expense ratio of 69.4% for the year ended December 31, 2004, compared to 61.0% for the year ended December 31, 2003. The increase in losses and LAE was related to the increase in net premiums earned of 25.5% and property catastrophe losses of $25.4 million related to the 2004 Florida Hurricanes. In the London Market division, losses and LAE reserves adjustments for the year ended December 31, 2004 related to 2003 and prior
Net Investment Income. Net investment income for the year ended December 31, 2004 increased by $28.2 million, or 21.0%, to $162.3 million from $134.1 million for the year ended December 31, 2003, driven by an $837.0 million or 19.8% increase in total investments and cash over the period. Net investment income is comprised of gross investment income of $192.9 million less investment expenses of $30.6 for the year ended December 31, 2004, compared to gross investment income of $170.2 million less investment expenses of $36.1 million for the year ended December 31, 2003. Higher net investment income for the year ended December 31, 2004 is primarily attributable to the following:
For further detail on our long term debt principal and interest payments, see Note 12 to our consolidated financial statements included in this Form 10-K. For further detail on our operating lease payments, see Note 15 to our consolidated financial statements included in this Form 10-K.
Net income (loss) per common share for the years ended December 31, 2005, 2004 and 2003 has been computed in the following table based upon weighted average common shares outstanding (in thousands, except share amounts):
The following table sets forth the changes in unrealized net appreciation (depreciation) of investments, and the related tax effect, reflected in accumulated other comprehensive income for the years ended December 31, 2005, 2004, and 2003 (in thousands):
Many of the Company’s hedge fund and private equity investments are subject to restrictions on redemptions or sales, which are determined by the governing documents thereof, and limit the Company’s ability to liquidate these investments in the short term. Due to a time lag in reporting by a majority of hedge fund and private equity fund managers, valuations for these investments are reported by OdysseyRe on a one month or one quarter lag. Income from hedge funds and private equity investments included in net investment income totaled $15.3 million, $15.4 million and $6.6 million for the years ended December 31, 2005, 2004 and 2003, respectively. With respect to the Company’s $24.4 million in private equity partnerships included in other invested assets as of December 31, 2005, the Company has commitments that may require additional funding of up to $25.6 million over the next four years. Interest and dividend income, and realized and unrealized gains and losses of hedge funds and private equity partnerships are generally included in net investment income. Other invested assets include $14.2 million related to the Company’s investment in O.R.E Holdings Limited, which reflects an other-than-temporary writedown of $2.4 million for the year ended December 31, 2005.
The Company has investments in warrants, which are contracts that grant the holder the right to purchase an underlying financial instrument at a given price and time or at a series of prices and times. The total cost of the warrants was $7.0 million and $7.9 million, and the fair value was $11.9 million and $12.8 million as of December 31, 2005 and 2004, respectively. The notional amount of the warrants was $219.2 million and $270.8 million as of December 31, 2005 and 2004, respectively. Warrants, which are included in other invested assets, are recorded at fair value with the related changes in fair value recognized as a realized gain or loss in the period in which they occur. As of December 31, 2005 and 2004, the net change in the fair value of the warrants resulted in a net realized gain of $6.9 million and $6.1 million, respectively.
Several additional factors have emerged in recent years regarding asbestos exposure that further compound the difficulty in estimating ultimate losses for this exposure. These factors include: (i) continued growth in the number of claims filed due to a more aggressive plaintiffs’ bar; (ii) an increase in claims involving defendants formerly regarded as peripheral; (iii) growth in the use of bankruptcy filings by companies as a result of asbestos liabilities, which companies in some cases attempt to resolve asbestos liabilities in a manner that is prejudicial to insurers; (iv) the concentration of claims in states with laws or jury pools particularly favorable to plaintiffs; and (v) the potential that states or the U.S. Congress may enact legislation on asbestos litigation reform.
Net losses and loss adjustment expenses for asbestos claims increased $41.2 million for the year ended December 31, 2005. Environmental net losses and loss adjustment expenses declined $0.8 million for the year ended December 31, 2005. Net amounts relating to losses and loss adjustment expenses are net of amounts ceded to an indemnification in the form of a stop loss reinsurance agreement from nSpire Re Limited (“nSpire Re”), a wholly owned subsidiary of Fairfax (the “1995 Stop Loss Agreement”).
In addition to the Whole Account Excess of Loss Agreements, the Company entered into a three-year aggregate excess of loss reinsurance contract protecting its United States facultative casualty business for underwriting years 1998 through 2000 (“Facultative Excess of Loss Agreement”) which indemnified the Company for losses in excess of an annual retention, subject to an annual limit of liability. The aggregate limit for underwriting years 1998, 1999 and 2000 was equal to 40% of the Company’s total facultative net premiums written, subject to a minimum annual dollar limit of $7.4 million, and a maximum annual dollar limit of $18.5 million. The aggregate limit of liability is $41.6 million across all years, which has been fully utilized. The retention in each year was equal to the greater of $9.3 million or 51.0% of the subject written premium income, together with amounts contributed to a loss payment account under the agreement. The Company maintained a loss payment account for the benefit of the reinsurer, equal to 18.5% of the subject written premium income for underwriting year 1998, and 18.9% for each of 1999 and 2000. A minimum interest credit shall be applied to the loss payment account, equal to the one year U.S. Treasury Bill yield plus 75 basis points. As of December 31, 2005, the loss payment account had a zero balance.
On September 7, 2005, the Company announced that it had been advised by Fairfax, the Company’s majority shareholder, that Fairfax had received a subpoena from the SEC requesting documents regarding any non-traditional insurance and reinsurance transactions entered into or offered by Fairfax and any of its affiliates, which included OdysseyRe. The United States Attorney’s Office for the Southern District of New York is reviewing documents provided to the SEC in response to the subpoena, and is participating in the investigation into these matters. In addition, the Company has provided information and made a presentation to the SEC and the U.S. Attorney’s office relating to the restatement of the Company’s financial results announced by it on February 9, 2006. The Company is cooperating fully in addressing its obligations under this subpoena. This inquiry is ongoing, and the Company continues to comply with requests from the SEC and the U.S. Attorney’s office. The outcome and ultimate effect of these matters, on the Company’s consolidated financial statements including questions by the SEC with respect to the Company’s accounting for these transactions, cannot be
Net periodic benefit cost included in the Company’s consolidated statements of operations is comprised of the following components (in thousands):
The weighted average fair value of each option granted is estimated on the date of grant using the Black-Scholes Price Model with the following weighted average assumptions used for the 2005 grant: expected volatility of 30.0%; risk-free interest rate of 1.9%; annual dividend yield of 0.6%; and expected lives of five years
During 2001, the Company adopted the Odyssey Re Holdings Corp. Restricted Share Plan (the “Restricted Share Plan”), which provides for the grant of restricted shares to directors and key employees of the Company. Shares granted under the Restricted Share Plan generally vest and become exercisable in equal installments over three years or five years from the grant dates. Amounts granted in 2001 vest and become exercisable in two equal installments on the fifth and tenth anniversary of the grant dates. As of December 31, 2005 and 2004, respectively, 784,314 and 506,866 restricted shares were outstanding. During the year ended December 31, 2005 and 2004, 368,468 and 184,005 restricted shares were granted, 72,891 and 72,272 restricted shares vested and 18,129 and 44,341 restricted shares were forfeited, pursuant to the Restricted Share Plan. At the time of grant, the market value of the shares awarded is recorded as unearned compensation and is presented as a separate component of shareholders’ equity and is charged to income over the vesting period. Compensation expense recorded for each of the years ended December 31, 2005, 2004 and 2003 was $2.9 million, $1.8 million and $1.1 million, respectively, and is included in other expense, net.
As of December 31, 2005, such reinsurance in force had a remaining maturity term of one (1) to 25 years. The approximate distribution of the estimated debt service (principal and interest) of bonds, by type and unearned premiums, for the years ended December 31, 2005 and 2004 is as follows (in millions):
(1) The condensed financial information of the registrant should be read in conjunction with the consolidated financial statements and Notes to consolidated financial statements included elsewhere herein. As further described in Note 2 to the consolidated financial statements, the Company has restated its consolidated financial statements as of and for the years ended December 31, 2000 through 2004, as well as its results as of and for the nine months ended September 30, 2005. The restated amounts are reflected in equity in undistributed net (income) loss of subsidiary in the condensed statements of operations.