See Item 1A. Risk Factors for a description of the possible impact of AIG’s recent actions on TRH.
levels in many cases now represented a higher than desired percentage of surplus. Third, Hurricane Ike produced one of the highest insured losses from a natural peril event despite being only a category 2 storm. These changes produced an increase in demand for traditional reinsurance from insurance companies as they 1) could not raise capital by issuing debt; 2) did not want to issue equity at depressed stock prices; and 3) lost the ability to go to the capital markets for alternative reinsurance solutions. In addition, reinsurers, affected by many of the same issues, in many cases did not have the same capacity to take on risk as they had in recent years.
The reserving process is inherently difficult and subjective, especially in view of changes in the legal and tort environment which impact the development of loss reserves, and therefore quantitative techniques frequently have to be supplemented by subjective considerations and managerial judgment. In addition, trends that have affected development of liabilities in the past may not necessarily occur or affect development to the same degree in the future.
The determination that a security has incurred an other-than-temporary impairment in value requires the judgment of management and consideration of the fundamental condition of the issuer, its near-term prospects and all relevant facts and circumstances. The above criteria also consider circumstances of a rapid and severe market valuation decline, such as that experienced in current credit markets, in which TRH could not reasonably assert that the impairment period would be temporary (severity losses).
Other-than-temporary impairment write-downs by balance sheet category at the time of impairment and type of impairment recorded for the years indicated are presented in the table below:
At December 31, 2008, reinsurance recoverable on gross loss reserves totaled $763.4 million (a component of reinsurance recoverable on paid and unpaid losses on the Consolidated Balance Sheet, which is net of an allowance for uncollectible reinsurance recoverable of approximately $12 million), a decrease of $251.1 million, or 24.8%, from the prior year-end. The decrease in reinsurance recoverable on gross loss reserves in 2008 was due largely to a decrease in reinsurance recoverable on losses relating to business which, by prearrangement with TRH, was assumed from an affiliate and then ceded in equal amounts to other affiliates. Of the amount of reinsurance recoverable on paid and unpaid losses and LAE, which totaled $790.5 million as of December 31, 2008, $425 million represented balances that were unsecured. Of such unsecured balances, $43 million was due from affiliates and 93% of the remaining balance was due from companies rated A- or better. (See Note 16.)
Of total consolidated net operating cash inflows, $416.3 million, $476.3 million and $400.1 million were derived from international operations in 2008, 2007 and 2006, respectively. In each of such years, the London branch was the most significant source of international net operating cash inflows.
For further discussion of the following recent accounting standards and their application to TRH, see Note 2(l) of Notes to Consolidated Financial Statements.
In periods subsequent to the recognition of an other-than-temporary impairment write-down of fixed maturity securities, which are not credit or foreign exchange related, TRH generally accretes into income the discount or amortizes the reduced premium resulting from the reduction in cost basis over the remaining life of the security.
Beginning January 1, 2008, assets recorded at fair value in the consolidated balance sheet are measured and classified in a hierarchy for disclosure purposes consisting of three “levels” based on the observability of inputs available in the marketplace used to measure the fair values as discussed below:
2007 includes net catastrophe losses incurred of $64.5 million, principally relating to European Windstorm Kyrill and floods in the U.K. In addition, in 2007, TRH determined that its estimates of the ultimate amounts of net losses occurring in 2006 and prior years needed to be increased as a result of greater than expected loss activity in 2007. As a result of that determination, TRH increased net losses and LAE incurred by $88.4 million, representing significant net adverse development in 2007 of losses occurring in all prior years. This net adverse development was comprised of $368.9 million relating to losses occurring in 2002 and prior, partially offset by net favorable development of $280.5 million, principally relating to losses occurring in 2006 and, to a lesser extent, 2005 and 2004. The line of business with the most significant net adverse development recorded in 2007 was the other liability line ($221 million), arising principally from losses occurring in 1998 to 2002 for reasons similar to those discussed earlier for the other liability line development in 2008. In addition, significant net adverse development was recorded in 2007 in the medical malpractice line ($38 million), arising principally from losses occurring between 1998 and 2002. These increases to incurred losses were offset in part by net favorable development occurring most significantly in the fire line ($84 million), arising principally from losses occurring in 2006, and in the allied lines ($43 million) and homeowners multiple peril ($34 million) lines, each arising principally from losses occurring between 2004 and 2006.
2008 excludes the effect of 1.3 million anti-dilutive shares (from a total of 3.1 million potential shares). 2007 excludes the effect of 0.6 million anti-dilutive shares (from a total of 3.0 million potential shares). 2006 excludes the effect of performance-based restricted stock units whose performance period had not yet begun and 1.2 million anti-dilutive shares (from a total of 2.8 million potential shares).
Gross incurred losses and LAE and reinsured losses and LAE include $62 million, $74 million and $262 million related to premiums which, by prearrangement with TRH, were assumed from an affiliate and then ceded in an equal amount to other affiliates.
A significant portion of the assets and liabilities of TRH’s international operations relate to the countries where ceding companies and reinsurers are located. Most investments are located in the country of domicile of these operations. In addition to licensing requirements, TRH’s international operations are regulated in various jurisdictions with respect to currency, amount and type of security deposits, amount and type of reserves and amount and type of local investment. Regulations governing constitution of technical reserves and remittance balances in some countries may hinder remittance of profits and repatriation of assets. International operations and assets held abroad may be adversely affected by political and other developments in foreign countries, including possibilities of tax changes, nationalization and changes in regulatory policy, as well as by consequences of hostilities and unrest. The risks of such occurrences and their overall effect upon TRH vary from country to country and cannot easily be predicted.