We have identified the policies and estimates described below as critical to our business operations and the understanding of the results of our operations. Our preparation of the Consolidated Financial Statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our Consolidated Financial Statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates. Those estimates that were most critical to the preparation of the consolidated financial statements involved the following: (i) reserves for losses and loss expenses; (ii) deferred policy acquisition costs; (iii) premium audit; (iv) pension and post-retirement benefit plan actuarial assumptions; (v) OTTI; and (vi) reinsurance.
At December 31, 2011, no other individual line of business had recorded reserves of more than $90 million, net of reinsurance. We have not identified any recent trends that would create additional significant reserve uncertainty for these other lines of business.
In 2009, we experienced favorable loss development of approximately $67 million in accident years 2004 through 2007, partially offset by unfavorable loss development in the 2008 accident year, as well as accident years prior to 2003, of approximately $38 million, netting to favorable prior year development of $29 million. For further discussion on the prior year development in loss and loss expense reserves, see the discussion on “Net Loss and Loss Expense Reserves” in Item 1. “Business” and Item 8. “Financial Statements and Supplementary Data,” Note 9 of this Form 10-K.
For CMBS, we also consider the net operating income (“NOI”) generated by the underlying properties. Our assumptions of the properties’ ultimate cash flows takes into consideration both an immediate reduction to the reported NOIs and decreases to projected NOIs.
As a result of the unprecedented catastrophe losses, the industry has begun experiencing a modest level of commercial lines renewal price increases, particularly in the fourth quarter of 2011, according to the Commercial Lines Insurance Pricing Survey. As reflected by A.M. Best’s February 2012 affirmation to maintain its negative outlook for the commercial lines industry, we believe these modest increases in rate are not sufficient, and a widespread hardening needs to materialize given: (i) the instability of the U.S. economy and the current low interest rate environment that has continued to put pressure on investment yields; (ii) an industry statutory combined ratio for 2011 of 107.5% as reported by A.M. Best; (iii) higher anticipated reinsurance costs (see the “Reinsurance” section below for more detail); and (iv) declining industry profitability as a result of elevated levels of catastrophe-related losses.
o $14.5 million in additional audit and endorsement premium, a $62.4 million improvement in 2011.
o Net renewals were down 5%, or $15.2 million, to $302.9 million despite our ability to achieve pure price as indicated above;
The Property Catastrophe treaty, which covers both our standard market and E&S business, renewed effective January 1, 2012 at an increase in premium of 19% for the same coverage, which reflected increased exposure change and recent market trends due to increased global catastrophe losses. The current treaty structure provides coverage of $435 million in excess of $40 million and the annual aggregate limit net of our co-participation continues to be approximately $790 million for 2012.
Although we model various catastrophic perils, due to our geographic spread, the risk of hurricane continues to be the most significant natural catastrophe peril to which our portfolio is exposed. Below is a summary of the largest four actual hurricane losses that we experienced in the past 22 years:
· Short-term investments are carried at cost, which approximates fair value. Given the liquid nature of our short-term investments, we generally validate their fair value by way of active trades within approximately a week of the financial statement close. These securities are classified as Level 1 in the fair value hierarchy.
· Our investments in other miscellaneous securities are generally accounted for under the equity method or at fair value based on net asset value and included in Level 2 in the fair value hierarchy. Investments in tax credits are carried under the effective yield method of accounting.
The improvement in the restated per share amounts reflect the decrease in the statutory expense ratio over the last several years.
Cash paid or received during the year for interest and federal income taxes was as follows for the years ended December 31, 2011, 2010, and 2009:
While net investment income remained relatively flat in 2011 compared to 2010, its components reflect increased dividend income from the high dividend yield equities strategy that we implemented during the year partially offset by lower yields on our fixed maturity securities. In 2011, bonds that matured or were sold, valued at $481.9 million, had yields that averaged 3.8%, pre-tax, while new purchases of $490.8 million had an average yield of 2.7%.
· $6.4 million of CMBS credit OTTI charges. These charges were due to reductions in the related cash flows of the underlying collateral of these securities. These charges were primarily associated with securities that had been previously impaired but, over time, had shown little, if any, improvement in valuations, poor net operating income performance of the underlying properties, and, in some cases, an increase in over 60-day delinquency rates. These securities had, on average, unrealized/unrecognized loss positions of more than 60% of their amortized cost. Based on our DCF analysis, we did not believe it was probable that we would receive all contractual cash flows for these securities.
In addition, on a net basis, losses and loss expenses incurred also reflect increased catastrophic losses that we have retained. These losses increased by $62.3 million, to $118.8 million in 2011, from 2010. Hurricane Irene represented the majority of the 2011 losses, with the remainder of losses in 2011 resulting from more than 20 additional events. The total impact of Hurricane Irene was $40.2 million ($47.1 million on a gross basis), including the reinstatement premium.
1 Consists of leaking underground storage tanks and other latent environmental exposures.
The weighted-average fair value of options and stock per share, including restricted stock and RSUs granted for the Parent's stock plans, during 2011, 2010, and 2009 is as follows:
(b) We have various operating leases for office space and equipment. Such lease agreements, which expire at various times, are generally renewed or replaced by similar leases. Rental expense under these leases amounted to $11.6 million in 2011, $11.4 million in 2010, and $11.5 million in 2009. See Note 2(q) for information on our accounting policy regarding leases.
In the ordinary course of conducting business, we are named as defendants in various legal proceedings. Most of these proceedings are claims litigation involving our Insurance Subsidiaries as either: (a) liability insurers defending or providing indemnity for third-party claims brought against insureds; or (b) insurers defending first-party coverage claims brought against them. We account for such activity through the establishment of unpaid loss and loss adjustment expense reserves. We expect that the ultimate liability, if any, with respect to such ordinary course claims litigation, after consideration of provisions made for potential losses and costs of defense, will not be material to our consolidated financial condition, results of operations, or cash flows.