the reinsurer, the Company’s liability for unpaid losses and loss expenses (loss reserves) is based largely upon estimates. The Company categorizes loss reserves into three types of reserves: reported outstanding loss reserves (case reserves), additional case reserves (ACRs) and incurred but not reported (IBNR) reserves. The Company updates its estimates for each of the aforementioned categories on a quarterly basis using information received from its cedants. Case reserves represent unpaid losses reported by the Company’s cedants and recorded by the Company. ACRs are established for particular circumstances where, on the basis of individual loss reports, the Company estimates that the particular loss or collection of losses covered by a treaty may be greater than those advised by the cedant. IBNR reserves represent a provision for claims that have been incurred but not yet reported to the Company, as well as future loss development on losses already reported, in excess of the case reserves and ACRs. Unlike case reserves and ACRs, IBNR reserves are often calculated at an aggregated level and cannot usually be directly identified as reserves for a particular loss or treaty. The Company also estimates the future unallocated loss adjustment expenses (ULAE) associated with the loss reserves and these form part of the Company’s loss adjustment expense reserves. The Company’s Non-life loss reserves for each category, line and sub-segment are reported in the tables included later in this section.
In determining the loss reserves, the Company often relies on a blend of the results from two or more methods (e.g., weighted averages). The judgment as to which of the above method(s) is most appropriate for a particular underwriting year and reserving cell could change over time as new information emerges regarding underlying loss activity and other data issues. Furthermore, as each line is typically composed of several reserving cells, it is likely that the reserves for the line will be dependent on several reserving methods. This is because reserves for a line are the result of aggregating the reserves for each constituent reserving cell and that a different method could be selected for each reserving cell. Although it is not appropriate to refer to reserves for a line as being determined by a particular method, the table below summarizes the methods that were given principal weight in selecting the best estimates of reserves in each reserving line and can therefore be viewed as key drivers of selected reserves. The table distinguishes methods for mature and immature underwriting years, as they are often different. The definition of maturity is specific to a line and is related to the reporting tail. If at the reserve evaluation date, a significant proportion of losses for the underwriting year are expected to have been reported, then the underwriting year is deemed to be mature, otherwise it is deemed to be immature. For short-tail lines, such as property or agriculture, immature years can refer to the one or two most recent underwriting years, while for longer tail lines, such as casualty, immature years can refer to the three or four most recent underwriting years. To the extent that the principal reserving methods used for major components of a reserving line are different, these are separately identified in the table below.
For a discussion of net prior year favorable reserve development by Non-life sub-segment, see Results by Segment below and Note 9 to Consolidated Financial Statements in Item 8 of Part II of this report.
Property / Specialty Property: Aggregate losses reported for North America and Global (Non-U.S.) property lines were lower than expected for most years. The Company reflected this experience by decreasing its loss ratios for the most recent underwriting years.
The point estimates related to net loss reserves recorded by the Company, and the range of actuarial estimates at December 31, 2011 and 2010, were as follows for each sub-segment of the Non-life segment (in millions of U.S. dollars):
Policy benefits for life and annuity contracts relate to the business in the Company’s Life segment, which predominately includes reinsurance of longevity, subdivided into standard and non-standard annuities, and mortality business, which includes death and disability covers (with various riders) primarily written in Continental Europe, TCI primarily written in the U.K. and Ireland, and GMDB business primarily written in Continental Europe.
The Company records all of its fixed maturities, short-term investments and equities, certain other invested assets, including derivative financial instruments, and its fixed maturities, short-term investments and certain other invested assets underlying the funds held - directly managed account at fair value in its Consolidated Balance Sheets. The changes in fair value of all of the Company’s investments, carried at fair value, are recorded in net realized and unrealized investment gains and losses in the Consolidated Statements of Operations and are included in the determination of net income or loss in the period in which they are recorded.
The Company is exposed to changes in the expected amount of future cash flows of the reference assets in its total return swap portfolio. The Company’s total return swap portfolio references many different underlying assets with a number of risk factors. At December 31, 2011, the notional value of the Level 3 total return swap portfolio was $117 million and the fair value of the assets underlying the Level 3 total return swap portfolio was $123 million. The Company estimated that each 1% increase or decrease in the amount of all expected future cash flows related to the reference assets would result in a $2 million increase or decrease, respectively, in the fair value of its total return swap portfolio at December 31, 2011.
At December 31, 2011, the Company’s insurance-linked securities that are classified as Level 3 include longevity swaps and weather derivatives, with insignificant fair values. At December 31, 2011, the notional exposure of the longevity swaps and weather derivatives classified as Level 3 was $121 million and $15 million,
These factors affecting the year over year comparison of the Company’s results are discussed below in Review of Net (Loss) Income, Results by Segment and Financial Condition, Liquidity and Capital Resources, and may continue to affect our results of operations and financial condition in the future.
a decrease in pre-tax net realized and unrealized investment gains of $189 million;
The underwriting result for the Life segment, which does not include allocated investment income, improved by $24 million, from a loss of $51 million in 2010 to a loss of $27 million in 2011. The improvement in the Life underwriting result was primarily due to a decrease in net adverse prior year loss development, from net adverse development of $12 million in 2010 to net favorable development of $1 million in 2011, and increased profitability generated from new and existing business. See Results by Segment below.
The net favorable loss development of $189 million included net favorable development for prior accident years in most lines of business, predominantly in the casualty line, while the credit/surety and motor lines experienced combined adverse loss development for prior accident years of $11 million. Loss information provided by cedants in 2011 for prior accident years was lower than the Company expected (higher for credit/surety and motor) and included no individually material losses or reductions but a series of attritional losses or reductions. Based on the Company’s assessment of this loss information, the Company decreased (increased for credit/surety and motor) its expected ultimate loss ratios for most lines of business, which had the net effect of decreasing (increasing for credit/surety and motor) prior year loss estimates.
During the January 1, 2012 renewals, the Company observed a fairly stable environment with competitive conditions in most markets, and price increases generally in loss affected markets only. The expected premium volume from the Company’s January 1, 2012 renewal modestly decreased compared to the prior year renewal primarily as a result of the Company’s decision to cancel or reduce certain business. The agriculture business traditionally renews later and remains largely in process. Management expects a continuation of the observed trends in pricing and conditions during the remainder of 2012.
The decrease of $178 million in the technical result and corresponding increase in technical ratio in 2010 compared to 2009 was primarily due to an increase of $156 million, net of reinstatement premiums, in large catastrophic losses and a decrease of $54 million in net favorable prior year loss development, which was partially offset by a lower level of mid-sized loss activity and normal fluctuations in profitability between periods.
net favorable loss development on prior accident years of $44 million, or 6.5 points on the loss ratio;
The increase of $387 million in losses and loss expenses in 2010 compared to 2009 included:
Based on renewal information from cedants and brokers, and assuming that similar conditions experienced during the January 1, 2012 renewals continue throughout the year, Management expects a modest shift in the relative distribution of gross premiums written from non-proportional to other treaty types as a result of the Company continuing to reduce its catastrophe exposures.
The fair value of the Company’s fixed maturities increased by $1.1 billion from $12.8 billion at December 31, 2010 to $13.9 billion at December 31, 2011. The increase in the Company’s fixed maturities is predominantly in the residential mortgage-backed securities and U.S. government and government sponsored enterprises categories, which have increased by $977 million and $210 million, respectively, at December 31, 2011 compared to December 31, 2010. The increases primarily reflect the reallocation of a portion of the Company’s cash and cash equivalents to the investment portfolio. In addition, the increase in residential mortgage-backed securities, and the corresponding decrease in corporate securities, at December 31, 2011 compared to December 31, 2010, reflects a rebalancing of the portfolio and an increased allocation to residential mortgage-backed securities given they provide a higher return than U.S. treasuries, while still being backed by U.S. government agencies.
The U.S. government and government sponsored enterprises category includes U.S. treasuries and U.S. government agency securities which accounted for 98% and 2%, respectively, of this category at December 31, 2011. The U.S. treasuries are not rated, however, they are generally considered to have a credit quality equivalent to or greater than AA+ corporate issues. At December 31, 2011, 68% of U.S. government agency securities, although not specifically rated, are generally considered to have a credit quality equivalent to AA+ corporate issues. The remaining 32% of U.S. government agency securities at December 31, 2011 were rated AA.
As part of its overall strategy to manage its level of currency exposure, from time to time the Company uses forward foreign exchange derivatives to hedge or partially hedge the net investment in certain non-U.S. dollar functional currency subsidiaries and branches. These derivatives have been designated as net investment hedges, and accordingly, the changes in fair value of the derivative and the hedged item related to foreign currency are recognized in currency translation adjustment in the Consolidated Balance Sheets. The Company also uses, from time to time, interest rate derivatives to mitigate exposure to interest rate volatility.
The components of net investment income for the years ended December 31, 2011, 2010 and 2009 were as follows (in thousands of U.S. dollars):
The table below is a reconciliation of losses and loss expenses including life policy benefits for the years ended December 31, 2011, 2010 and 2009 (in thousands of U.S. dollars):
The Life segment reported net favorable loss development for prior accident years of $1 million and $15 million for the years ended December 31, 2011 and 2009, respectively, and net adverse loss development for prior accident years of $12 million for the year ended December 31, 2010.
The net adverse prior year loss development of $12 million in 2010 was primarily driven by adverse development of $23 million due to an improvement in the mortality trend related to an impaired life annuity treaty in the longevity line and adverse development on certain mortality treaties. This adverse development was partially offset by favorable prior year loss development of $17 million resulting from the GMDB business, where the payout is linked to the performance of underlying capital market assets, driven by new cedant information and updated assumptions.
During 2011, the Company repurchased, under its authorized share repurchase program, 5.4 million of its common shares at a total cost of $396.2 million, representing an average cost of $73.41 per share. At December 31, 2011, the Company had approximately 5.3 million common shares remaining under its current share repurchase authorization and approximately 19.4 million common shares were held in treasury and are available for reissuance.
The reinsurance subsidiaries are required to file annual statements with insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities (statutory basis), maintain minimum levels of solvency and liquidity and comply with risk-based capital requirements and licensing rules. At December 31, 2011, the reinsurance subsidiaries’ solvency, liquidity and risk-based capital amounts were in excess of the minimum levels required. The typical adjustments to insurance statutory basis amounts to convert to U.S. GAAP include elimination of certain statutory reserves, deferral of certain acquisition costs, recognition of goodwill, intangible assets and deferred income taxes, valuation of bonds at fair value and presentation of ceded reinsurance balances gross of assumed balances.
The following table summarizes the statutory shareholders’ equity of the Company’s reinsurance subsidiaries at December 31, 2011 and 2010 (in millions of U.S. dollars):
For the years ended December 31, 2011, 2010 and 2009, the Company’s share-based compensation expense was $24.2 million, $33.5 million and $21.7 million, respectively, with a tax benefit of $2.4 million, $3.4 million and $2.7 million, respectively. Included within these tax benefits are amounts related to the exercise of share options and the conversion of RSUs and SSARs into shares by employees of the Company’s U.S. subsidiaries of $3.1 million, $5.9 million and $1.6 million for the years ended December 31, 2011, 2010 and 2009, respectively.
The following tables provide a summary of the segment results for the years ended December 31, 2011, 2010 and 2009 (in millions of U.S. dollars, except ratios):