Derivative Contracts. We have underwritten certain contracts that have been determined to meet the definition of a derivative under FAS 133, and are therefore recorded at their fair value. We generally determine fair value using a cash flow model developed by us that is dependent upon several factors, including estimated future default rates, credit spreads, changes in credit quality and future recovery rates. Installment premiums are also considered in the determination of discounted net cash flows. The change resulting from a movement in the fair value of such contracts is included in the statement of operations in other insurance related income. During the year ended December 31, 2005, all contracts that had been determined to meet the definition of a derivative expired.
In late August 2005, Hurricane Katrina caused widespread damage to homes and businesses in the six U.S. states of Louisiana, Mississippi, Alabama, Florida, Tennessee and Georgia. The following month Hurricane Rita struck Texas and Louisiana causing significant destruction in those areas. Both storms also passed through the oil and gas producing sector of the Gulf of Mexico causing extensive damage to fixed and mobile structures as well as significant disruption throughout the Gulf coast region. In late October 2005, Hurricane Wilma made several landfalls, with the most destructive effects felt in the Yucatán Peninsula of Mexico and the U.S. state of Florida.
including our clients, brokers and loss adjustors. We focus on key accounts that we expect to be exposed to significant insured losses and then promptly follow with a review of all remaining accounts. During this period, we perform a detailed cross check of the modeled loss estimate with external loss information, and, where appropriate, also review these estimates against market share analyses of industry loss predictions. After losses are appraised by loss adjustors, we receive more robust and reliable reserve estimates. Eventually, the industry model estimates and non-modeled loss information are fully replaced by our own reported claims information. All loss advices, loss adjuster reports and any letter of credit requests are reviewed by our claims management team for accuracy and adequacy. Over a period of time, our loss and loss expense reserves are then converted into paid settlements.
increase in our professional lines and other specialty book was due to an increase of $48.3 million in directors’ and officers liability premium following our entry into this line of business in the second half of 2003. The increase in our political risk gross written premiums was due to an increase in the level of direct foreign investment and a strategic initiative targeting this business. We experienced an increase in our terrorism and war risk line primarily due to an increase in our aviation war account following an increase in our renewal premium participation and also new business written.
The increase in gross premium written in U.S. insurance was primarily driven by our property and liability books of business following an increase in the level of underwriting staff and increased marketing efforts.
The net loss and loss expense ratio for the year ended December 31, 2004 was 63.4% compared to 47.1% for the year ended December 31, 2003. The increase was due to losses from Hurricanes Charley, Frances, Ivan and Jeanne from which we incurred net losses and loss expenses of $169.2 million, or 19.2 percentage points. Our hurricane losses benefited from reinsurance recoveries of $72.5 million. Our estimates for the losses incurred from these hurricanes were derived from formal loss advices, the output of industry models, a review of in-force contracts and preliminary indications from clients. Consequently, actual losses from these hurricanes may vary materially from estimated losses. Our gross losses were reduced by reinsurance recoveries that were triggered by the occurrence of a series of large industry loss events. Recoveries under our reinsurance are dependent on industry losses, which are calculated by independent third parties, exceeding predetermined trigger points. During the year ended December 31, 2003, our loss experience benefited from the lack of major catastrophes. Our reinsurance segment has loss experience categorized as low frequency but high severity in nature and, therefore, our loss experience can be volatile.
Investments that are considered to be “available for sale” under the definition included in FAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” are reported at fair market value. The fair market value of investments is based upon quoted market values. The net unrealized gain or loss on investments, net of tax, is included as accumulated other comprehensive income (loss) in shareholders’ equity.
The Company participates in a securities lending program whereby the Company’s securities, which are included in investments, are loaned to third parties, primarily major brokerage firms for short periods of time through a lending agent. The Company maintains control over the securities it lends, retains the earnings and cash flows associated with the loaned securities and receives a fee from the borrower for the temporary use of the securities. Collateral in the form of cash, government securities and letters of credit is required at a rate of 102% of the market value of the loaned securities and is monitored and maintained by the lending agent. The Company had $974.9 million (2004: $848.0 million) in securities on loan at December 31, 2005.
December 31, 2004. The notional value of these contracts was $315.0 million as at December 31, 2004.
AXIS Specialty entered into an agreement in November 2001 with The Putnam Advisory Company, L.L.C. (“Putnam”) under which Putnam was appointed as an investment manager of part of the Company’s investment portfolio. This agreement was entered into on an arms length basis on terms generally available in the market. During the year ended December 31, 2005, AXIS Specialty incurred $1,118 (2004: $716; 2003: $704) of fees pursuant to this agreement of which $288 (2004: $248; 2003: $176) was included in accounts payable and accrued expenses.