Consideration for the transaction is book value at December 31, 2010, for the aforementioned businesses, currently estimated to be $283.4 million, payable in cash at closing and subject to adjustment for certain tax and other items. The transaction is expected to close in early 2011 and is subject to regulatory approvals and customary closing conditions.
The table below quantifies the impact on our reserves for claims and claim expenses, net income and shareholders’ equity as of and for the year ended December 31, 2010 of reasonably likely changes to the actuarial assumptions used to estimate our December 31, 2010 claims and claim expense reserves within our specialty reinsurance business unit. The table quantifies reasonably likely changes in our initial estimated ultimate claims and claim expense ratios and estimated loss reporting patterns. The changes to the initial estimated ultimate claims and claim expense ratios represent percentage increases or decreases to our current estimated ultimate claims and claim expense ratios. The change to the reporting patterns represent claims reporting that is both faster and slower than our current estimated claims reporting patterns. The impact on net
income and shareholders’ equity assumes no increase or decrease in reinsurance recoveries, loss related premium or redeemable noncontrolling interest - DaVinciRe.
The table below summarizes our initial assumptions and changes in those assumptions for claims and claim expense reserves within our Lloyd’s segment associated with catastrophe losses. Similar to our catastrophe unit above, the key assumption in estimating reserves for catastrophe losses in our Lloyd’s segment is our estimate of the ultimate claims and claim expenses. The table shows our initial estimates of ultimate claims and claim
The table above shows our initial estimated ultimate claims and claim expense ratios for attritional losses for each new underwriting year within our Insurance segment as of the end of each calendar year. Our initial estimated ultimate remained relatively constant between 2005 and 2008. This reflects the fact that management has not made significant changes to its estimated initial expected ultimate claims and claim expense ratio from one period to the next during that period. The principal reason for the changes from one year to the next, for example, the 2009 and 2010 underwriting years, is that the mix of business has changed. As each underwriting year has developed, our re-estimated ultimate claims and claim expense ratios have generally been reduced until recently. This reflects the impact of actual experience in our Insurance business where actual paid and reported losses to date for attritional losses are less than originally expected. For the years 2008 through 2010, our re-estimated ultimate claims and claim expense ratios increased from the initial estimate due to reported losses exceeding our initial estimate within our Insurance segment’s commercial property line of business, combined with a relatively low level of net premiums earned during those periods for our commercial property line of business. As described above, under the Bornhuetter-Ferguson actuarial method less weight is placed on initial estimates and more weight is placed on actual experience as our claims and claim expense reserves age.
We test goodwill and other intangible assets for impairment in the fourth quarter of each year, or more frequently if events or changes in circumstances indicate that the carrying amount may not be recoverable. For purposes of the annual impairment evaluation, goodwill is assigned to the applicable reporting unit of the acquired entities giving rise to the goodwill and other intangible assets and is tested based on the cash flows they produce. There are generally many assumptions and estimates underlying the fair value calculation. Principally, we identify the reporting unit or business entity that the goodwill or other intangible asset is attributed to, and review historical and forecasted operating and financial performance and other underlying factors affecting such analysis, including market conditions. Other assumptions used could produce significantly different results which may result in a change in the value of goodwill or our other intangible assets and related charge in our consolidated statements of operations. An impairment charge could be recognized in the event of a significant decline in the implied fair value of those operations where the goodwill or other intangible assets are applicable. As at December 31, 2010, excluding the amounts recorded in investments in other ventures, under equity method, as noted above, our consolidated balance sheets include $8.2 million of goodwill (2009 - $8.2 million) and $6.5 million of other intangible assets (2009 - $7.1 million). As part of the annual impairment evaluation noted above, no reporting units were identified to be at risk of failing step one of the process for recognition and measurement of an impairment loss in accordance with ASC Topic Intangibles - Goodwill and Other. Impairment charges were $nil during 2010 (2009 - $nil, 2008 - $nil).
Our Reinsurance segment premiums are prone to significant volatility due to the timing of contract inception and also due to the business being characterized by a relatively small number of relatively large transactions.
Our underwriting results over the last three years have been, and may well continue to be, impacted by prior year reserve development. Our prior year reserves experienced $286.0 million, $249.5 million and $188.1 million of net favorable development in 2010, 2009 and 2008, respectively. The favorable development on prior year reserves in 2010 included $157.5 million related to our catastrophe reinsurance unit and $128.6 million related to our specialty reinsurance unit. The favorable development within the catastrophe reinsurance unit was due to reductions of $33.6 million to the estimated ultimate losses of mature, large, mainly international catastrophe events, combined with reductions in net ultimate losses associated with the 2005 Buncefield Oil Depot loss of $27.4 million, the 2005 hurricanes of $25.5 million, the 2008 hurricanes of $10.9 million, European windstorm Klaus of $8.0 million and the 2004 hurricanes of $8.1 million, with the remainder due to a reduction in ultimate losses on a large number of relatively small catastrophes. The favorable development within the specialty unit includes $31.4 million associated with actuarial assumption changes made in the first quarter of 2010, principally in the casualty clash and surety lines of business, and partially offset by an increase in reserves within the workers compensation per risk line of business, principally as a result of revised initial expected loss ratios and loss development factors due to actual experience coming in better than expected; $25.9 million due to a decrease in case reserves and additional case reserves, which are reserves established at the contract level for specific losses or large events; and reported losses developing more favorably than expected in 2010 on prior accident years events.
Operating expenses consist primarily of salaries and other general and administrative expenses. For 2010, operating expenses decreased $9.3 million, or 6.7%, to $130.0 million, compared to $139.3 million in 2009, primarily due to a change in our internal allocation of certain expenses. For 2009, our operating expenses increased $57.5 million, or 70.3%, to $139.3 million, compared to $81.8 million in 2008, primarily as a result of an increase in our employee base and our strong financial results in 2009 which increased performance-related compensation costs, as well as the impact of the larger employee base on technology, occupancy, consulting and related general and administrative expenses. Our operating expense ratio may increase over time, as a result of factors including the absolute and comparative growth of our operating expenses, further refinements to internal expense allocations, and market trends and dynamics.
Catastrophe Reinsurance Underwriting Results - Our catastrophe unit generated $399.7 million of underwriting income in 2010, compared to $649.4 million in 2009, a decrease of $249.7 million. The decrease in underwriting income was due primarily to a $255.4 million increase in net claims and claim expenses as a result of $252.4 million of net claims and claim expenses related to the 2010 earthquakes and a $10.2 million increase in underwriting expenses, and partially offset by a $15.8 million increase in net premiums earned. Net premiums earned in 2010 included $28.0 million of reinstatement premiums earned as a result of the 2010 earthquakes.
In 2009, we established Syndicate 1458, a Lloyd’s syndicate, to start writing certain lines of insurance and reinsurance business. The syndicate was established to enhance our underwriting platform by providing access to Lloyd’s extensive distribution network and worldwide licenses. Our Lloyd’s segment reflects results principally from our subsidiary, Syndicate 1458, our corporate capital vehicle, RenaissanceRe CCL, prior to its inter-company cession of Syndicate 1458 business to Renaissance Reinsurance, and our managing agency, RSML. The results of our Lloyd’s unit were not significant in 2009; however, we expect its absolute and relative contributions to our consolidated results of operations to grow over time.
Income from discontinued operations includes the financial results of substantially all of our U.S.-based insurance operations being sold to QBE pursuant to the Stock Purchase Agreement. Included in income from discontinued operations in 2010 is underwriting income of $57.0 million, compared to $1.9 million in 2009. The $55.1 million increase in underwriting income is primarily attributable to strong underwriting results for the 2010 crop year.
The Credit Agreement provides for a revolving commitment to RenaissanceRe of $150.0 million, including the issuance of letters of credit for the account of RenaissanceRe and RenaissanceRe’s insurance subsidiaries of up to $150.0 million and the issuance of letters of credit for the account of RenaissanceRe’s non-insurance subsidiaries of up to $50.0 million. RenaissanceRe has the right, subject to satisfying certain conditions, to increase the size of the facility to $250.0 million. The scheduled commitment maturity date of the Credit Agreement is April 22, 2013.
DaVinciRe shareholders are party to a shareholders agreement (the “Shareholders Agreement”) which provides DaVinciRe shareholders, excluding us, with certain redemption rights, that enable each shareholder to notify DaVinciRe of such shareholder’s desire for DaVinciRe to repurchase up to half of such shareholder’s aggregate number of shares held, subject to certain limitations, such as limiting the aggregate of all share repurchase requests to 25% of DaVinciRe’s capital in any given year and satisfying all applicable regulatory requirements. If total shareholder requests exceed 25% of DaVinciRe’s capital, the number of shares repurchased will be reduced among the requesting shareholders pro-rata, based on the amounts desired to be repurchased. Shareholders desiring to have DaVinciRe repurchase their shares must notify DaVinciRe before March 1 of each year. The repurchase price will be based on GAAP book value as of the end of the year in which the shareholder notice is given, and the repurchase will be effective as of such date. Payment will be made by April 1 of the following year, following delivery of the audited financial statements for the year in which the repurchase was effective. The repurchase price is subject to a true-up for development on outstanding loss reserves after settlement of all claims relating to the applicable years.
At December 31, 2010, we have not entered into any off-balance sheet arrangements, as defined by Item 303(a)(4) of Regulation S-K.
(3) The private equity and investment commitments do not have a defined contractual commitment date and we have therefore included them in the less than one year category.
While economic conditions in the U.S. and certain of our other key markets improved somewhat in the second half of 2010, meaningful uncertainty remains regarding the strength, duration and comprehensiveness of any economic recovery. While we believe the U.S. federal monetary and tax actions taken towards the end of the year may support continued economic strengthening, we nonetheless also believe meaningful risk remains for continued uncertainty or disruptions in general economic conditions, including dislocations in the financial markets. Moreover, if economic growth continues, such growth may be only at a comparably suppressed rate for a relatively extended period of time. While many governments, including the U.S. federal government, took substantial steps in 2009 and 2010 to stabilize economic conditions, these stabilizing efforts have been coming to an end or are currently scheduled to cease in coming periods. Their cessation, or the roll-back of stabilizing initiatives currently in place, could give rise to increased uncertainty, to a slowing of growth or even deterioration of economic conditions. If the current economic conditions persist at their current levels or decline, demand for the products sold by us or our customers or our overall ability to write business at risk-adequate rates could weaken. In addition, persistent low levels of economic activity could adversely impact other areas of our financial performance, such as by contributing to unforeseen premium adjustments, mid-term policy cancellations or commutations, or asset devaluation. Any of the foregoing or other outcomes of a prolonged period of economic weakness could adversely impact our financial position or results of operations. In addition, during a period of extended economic weakness like the current one, we believe our consolidated credit risk, reflecting our counterparty dealings with customers, agents, brokers, retrocessionaires, capital providers and parties associated with our investment portfolio, among others, is likely to be increased. Various of these risks could materialize, and our financial results could be negatively impacted, even after the end of the economic downturn.
Due to the preliminary nature of the available information as to the February 2011 New Zealand earthquake and the other factors described above, it is difficult at this time to provide an estimate of the financial impact of this event on the Company. At this time, we have not received meaningful loss or claims reports from brokers or clients. Based upon the current publicly available industry preliminary insured loss estimates, market share analysis, the application of our modeling techniques and a review of our in-force contracts, our current preliminary assessment is that the impact of the February 2011 New Zealand earthquake on our financial results (net of reinstatement premiums, retrocessional recoveries and noncontrolling interest) will be significant, and will likely be material. Losses from this event will be recorded in our first quarter 2011 results. Moreover, at this time it is too early to forecast what impacts, if any, the February 2011 New Zealand earthquake may have on future market conditions.