Prior Year Development. Our insurance operating units continually evaluate the potential for changes, both positive and negative, in their estimates of the loss and LAE liabilities and use the results of these evaluations to adjust both recorded liabilities and underwriting criteria. With respect to liabilities for unpaid losses and LAE established in prior years, these liabilities are periodically analyzed and their expected ultimate cost adjusted, where necessary, to reflect positive or negative development in loss experience and new information, including, for certain catastrophic events, revised industry estimates of the magnitude of a catastrophe. Adjustments to previously recorded liabilities for unpaid losses and LAE, both positive and negative, are reflected in our financial results in the periods in which these adjustments are made and are referred to as prior year reserve development. Each of RSUI, CATA, and EDC adjusted its prior year loss and LAE reserve estimate during 2008 based on current information that differed from previous assumptions made at the time such loss and LAE reserves were previously estimated.
During 2008, CATA had a net release of $11.8 million of prior year reserves, primarily in its liability and commercial surety lines of business. The reduction reflects favorable loss emergence compared with loss emergence patterns assumed in earlier periods for such lines of business. Such reduction did not impact the assumptions used in estimating CATA’s loss and LAE liabilities for business earned in 2008. During 2007, CATA had a net release of $14.4 million of prior year reserves, primarily in its liability and commercial surety lines of business. The reduction reflects favorable loss emergence compared with loss emergence patterns assumed in earlier periods for such lines of business.
The decrease in net earned premium, partially offset by lower loss and LAE described above, was the primary cause for the decrease in CATA’s underwriting profit in 2008 from 2007. Underwriting profit in 2007 was only modestly higher than 2006, whereby the increase in net earned premium was offset by higher loss and LAE described above, as well as higher underwriting expenses.
The loss and LAE described above were the primary cause of EDC’s underwriting loss in 2008, and underwriting profit for 2007.
77.0 percent of such securities was rated AAA by Standard & Poor’s.
At the parent level, we have adequate internally generated funds, cash resources and unused credit facilities to provide for the currently foreseeable needs of our business, and we have no material commitments for capital expenditures.
Credit Agreement. In addition to our liquid assets, we are party to a three-year unsecured credit agreement, or the “Credit Agreement,” with a bank syndicate, providing commitments for revolving credit loans in an aggregate principal amount of up to $200.0 million. Borrowings under the Credit Agreement will be available for working capital and general corporate purposes. At our option, borrowings under the Credit Agreement will bear interest at either (x) the higher of (i) the administrative agent’s prime commercial lending rate or (ii) the federal funds rate plus 0.50 percent, or (y) the London Interbank Overnight Rate plus a margin (currently 65 basis points) based on our Standard & Poor’s and/or Moody’s rating. The Credit Agreement requires that all loans shall be repaid in full no later than October 23, 2009, or the “Maturity Date,” although we may request up to two one-year extensions of the Maturity Date subject to meeting certain conditions and upon agreement of the Lenders. The Credit Agreement charges us a commitment fee of fifteen basis points (0.15%) per annum of the unused commitment.
Material Off-Balance Sheet Arrangements. We did not have any off-balance sheet arrangements outstanding at December 31, 2008, 2007 or 2006, nor did we enter into any off-balance sheet arrangements during 2008, 2007 or 2006.
Reinsurance contracts that do not result in a reasonable possibility that the reinsurer may realize a significant loss from the insurance risk assumed and that do not provide for the transfer of significant insurance risk generally do not meet the conditions for reinsurance accounting and are accounted for as deposits. Alleghany currently does not have any reinsurance contracts that qualify for deposit accounting.
The reserves for losses and loss adjustment expenses represent management’s best estimate of the ultimate cost of all reported and unreported losses incurred through the balance sheet date and include, but are not limited to: (i) the accumulation of individual estimates for claims reported on direct business prior to the close of an accounting period; (ii) estimates received from reinsurers with respect to reported claims which have been reinsured; (iii) estimates for claims incurred but not reported (“IBNR”) based on past experience modified for current trends and industry data; and (iv) estimates of expenses for investigating and settling claims based on past experience. The reserves recorded are based on estimates resulting from the review process, and differences between estimates and ultimate payments are reflected as an expense in the statement of earnings in the period in which the estimates are revised.
Reinsurance recoverables at December 31, 2008 and 2007 consist of the following (in millions):
EDC uses reinsurance to protect against catastrophe losses. Effective December 31, 2008, EDC retained the first $1.0 million of loss per occurrence and purchased reinsurance with various reinsurers for $74.0 million above that level. Any loss above $75.0 million would be the sole responsibility of EDC. EDC uses various catastrophe models to assist it in determining the amount of reinsurance to purchase. All of EDC’s 2008 reinsurance includes foreign and domestic terrorism coverage, although nuclear, chemical, biological and radiological (“NCBR”) events are
Discount rates were predicated primarily on Moody’s Investor Service Aa long-term corporate bond index, rounded to the nearest 25 basis points. Alleghany’s investment policy with respect to its defined benefit plans is to provide long-term growth combined with a steady income stream. The target allocation is 100 percent in debt securities. The overall long-term, rate-of-return-on-assets assumptions are based on historical investment returns.
“Level 2” - Management’s valuations are based on quoted market prices where such markets are not deemed to be sufficiently “active.” In such circumstances, additional valuation metrics will be used which involve direct or indirect observable market inputs. For Alleghany, assets utilizing Level 2 inputs generally include debt securities
Represents net premiums earned less loss and loss adjustment expenses and underwriting expenses, all as determined in accordance with GAAP, and does not include net investment income and other income or net realized capital gains. Underwriting expenses represent commission and brokerage expenses and that portion of salaries, administration and other operating expenses attributable to underwriting activities, whereas the remainder constitutes “other expenses.”
Selected quarterly financial data for 2008 and 2007 are presented below (in millions, except per share amounts):
We have audited the accompanying consolidated balance sheets of Alleghany Corporation and subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of earnings and comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2008. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.