Consolidated losses and loss adjustment expenses for the year ended December 31, 2006 was $477.6 million, compared to $427.2 million and $409.7 million for the same periods in 2005 and 2004, respectively. Improvement in the consolidated loss ratio in 2006 as compared to 2005 was primarily attributable to favorable development on prior accident year ultimate losses, partially offset by reserve strengthening for the 2006 accident year in certain lines. Total favorable development on prior accident year losses recognized in 2006 totaled $44.9 million across all lines and segments. Partially offsetting this favorable development was reserve strengthening for the 2006 accident year of $29.1 million due to higher than anticipated emergence of claims in the property, transportation and other liability occurrence lines. Improvement in the loss ratio in 2005 as compared to 2004 was primarily attributable to favorable development on prior year ultimate losses related to business written in 2004 and prior of approximately $20.3 million which includes $3.0 million of favorable development related to the 2004 hurricanes. Partially offsetting the favorable development recognized during 2005 was an increase to loss and loss adjustment expenses of $10.0 million associated with the commutation of a reinsurance contract in the second half of 2005. Included in losses and loss adjustment expense for the years ended December 31, 2005 and 2004 were losses from hurricane activity of $12.1 million and $17.7 million, respectively.
As of December 31, 2006, the Company’s operations include four business segments: Excess and Surplus Lines, Select Markets, Public Entity and Risk Management. Additionally, the Company has one Run-off Lines segment for policies written and assumed through the mid-1980’s. In evaluating the operating performance of its segments, the Company focuses on core
Gross written renewal premiums for the year ended December 31, 2006 were $313.5 million, compared to $243.5 million for 2005 and $203.2 million for 2004. A larger base of expiring premiums contributed to the increased renewal premiums, including $43.0 million in renewal premiums written by Argonaut Specialty for the year ended December 31, 2006.
Losses and loss adjustment expenses for the year ended December 31, 2006 resulted in a loss ratio of 51.4% compared to 55.8% in 2005 and 64.7% for 2004. The decrease in the loss ratio in 2006 is primarily attributable to $6.7 million of favorable development in both casualty and property business written in 2005 and prior. Partially offsetting the favorable development was an increase to the current accident year of $2.4 million due to September storm activity and higher than expected losses in the automobile liability line of business. The decrease in the loss ratio in 2005 is primarily attributable to $3.8 million of favorable development in both casualty and property business written in 2004 and prior. This prior year favorable development is net of $2.0 million of unfavorable development recorded in 2005 related to 2004 hurricane losses. Loss reserves for the Public Entity segment were $68.8 million, $73.6 million and $60.0 million as of December 31, 2006, 2005 and 2004, respectively.
Underwriting expenses in 2006 decreased by $21.6 million compared to 2005 as a result of the sale of the renewal rights. The expense ratio for the year ended 2005 was 64.0% compared to 50.0% in 2004. The increase in the expense ratio in 2005 was primarily caused by earned premium decreasing at a faster rate than costs to service the run off of this book of business.
The following table represents the components of gross loss reserves for the Run-off Lines for each of the years in the three-year period ended December 31, 2006:
The following table represents gross payments on asbestos and environmental claims for each of the years in the three-year period ended December 31, 2006:
The insurance subsidiaries must maintain certain levels of policyholders’ surplus to support premium writings. Guidelines of the National Association of Insurance Commissioners suggest that a property and casualty insurer’s ratio of annual statutory net premium written to policyholders’ surplus should not exceed 3-to-1. The ratio of combined annual statutory net premium written by the insurance subsidiaries to their combined policyholders’ surplus was 1.1-to-1 as of December 31, 2006. Current levels of policyholders’ surplus are adequate to support current premium writings, based on this standard. The Company monitors premium and statutory surplus levels of the insurance subsidiaries to ensure that the subsidiaries maintain adequate premiums to surplus ratios. Failure of any insurance subsidiary to maintain adequate levels of policyholders’ surplus could negatively impact the ability to write additional premiums.
When the Company initially establishes IBNR reserves at the beginning of an accident year for each line of business, it uses the expected loss ratio method. This method is initially based upon the Company’s annual analyses of historical loss ratios but may be adjusted based on pricing input from the underwriters, anticipated loss ratio trend, changes in reinsurance structure, and any other factors that may impact loss ratio expectations. At the end of each quarter, the Company will review the loss ratio selections, but will generally not deviate from the loss ratio method until the end of the accident year, at which time the Company will begin to assign weight to the paid and incurred Bornhuetter-Ferguson (BF) methods depending on the line of business being evaluated. The BF methods compute IBNR through a blend of the expected loss ratio method and traditional loss development methods. The output of the BF methods computes IBNR for an accident year as the product of expected losses (earned premium multiplied by an expected loss ratio) plus an expected percentage of unreported losses. The expected percentage of unreported losses is derived from age-to-ultimate loss development factors that result from the Company’s analyses of loss development triangles. Finally, once losses mature to the point at which the loss experience is more credible, the Company assigns most weight to the paid and incurred loss development methods.
General liability is considered a long tail line, as it takes a relatively long period of time to finalize and resolve all claims from a given accident year. The speed at which claims are received and then resolved is a function of the specific coverage provided, the jurisdiction in which the claim is located, and specific policy provisions. There are numerous components underlying the general liability product line. Some of these have relatively moderate payout patterns with most of the claims
The Company uses several loss reserving methods to capture the development characteristics of this line of business. Paid and incurred loss development, paid and incurred Bornhuetter-Ferguson methods, and a loss frequency/severity method are utilized in deriving management’s best estimate of loss reserves. In addition to these approaches, which are used across all commercial automobile liability categories of business, the Company considers additional analytic measures based upon the Claims and Book of Business risk factors noted above in deriving its loss reserve estimate.
Similar to general liability, commercial multiple peril reserves are affected by reported loss development pattern assumptions. Recorded gross reserves for commercial multiple peril business were $183.0 million as of December 31, 2006. If the development patterns underlying the Company’s net reserves for this line of business changes by 10 points, the estimated net reserve could change by $15 million, in either direction.
Recorded gross reserves for workers compensation are $704.3 million. The two most important assumptions for workers compensation reserves are loss development factors and loss cost trends, particularly medical cost inflation. Loss development patterns are dependent on medical cost inflation. Approximately half of the workers compensation net reserves are related to future medical costs. A review of National Council on Compensation Insurance data suggests that the annual growth in industry medical claim costs has varied from -2% to +12% since 1991. Across the entire reserve base, a 1 point change in calendar year medical inflation could change the estimated net reserve by $40 million, in either direction.