Lloyd’s, Newline Syndicate 1218; Hudson Insurance Company and Hudson Specialty Insurance Company. On November 15, 2004, we acquired Overseas Partners US Reinsurance Company (“Opus Re”), a reinsurance company domiciled in the state of Delaware. Opus Re’s name has been changed to Clearwater Select Insurance Company. On October 1, 2004, we sold all of our shares of First Capital to Fairfax Asia Limited in exchange for Class B non-voting shares of Fairfax Asia, representing a $38.6 million, or approximately 45%, ownership interest in Fairfax Asia. Fairfax Financial Holdings Limited, a Canadian financial services holding company, owned 80.8% of our common stock as of December 31, 2004, and also owns the controlling interest in Fairfax Asia.
Through our operating subsidiaries, we are a leading United States based underwriter of reinsurance, providing a full range of property and casualty products on a worldwide basis. We offer a broad range of both treaty and facultative reinsurance to property and casualty insurers and reinsurers. Treaty reinsurance involves the reinsurance of a specific line or class of business for an insurance company pursuant to an agreement or treaty. Facultative reinsurance involves the reinsurance of a specific policy as opposed to a line or class of business. We also write specialty and non-traditional lines of reinsurance, including professional liability, marine and aerospace. We also underwrite specialty program insurance as well as physicians medical malpractice and hospital professional liability insurance.
Our reserves for unpaid losses and loss adjustment expenses reflect estimates, which are considered “critical accounting estimates,” of ultimate claim liability. We perform quarterly reviews of the adequacy of these estimates of ultimate claim liability taking into consideration current and historical claim information, industry information, pricing and loss trends and relevant qualitative information. The effect of such quarterly reviews impacts incurred losses for the current period. Our methodology for evaluating reserve adequacy involves processes that may involve assessment of individual contracts, groups of like contracts, classes of business and business units. The complexities of our operations require analysis on both quantitative and qualitative bases. In
Europe. For the year ended December 31, 2004, our Paris office had gross premiums written of $430.7 million, an increase of $130.8 million, or 43.6%, from $299.9 million for the year ended December 31, 2003. For the years ended December 31, 2004 and 2003, our Singapore office had gross premiums written of $98.0 million and $90.6 million, respectively, an increase of $7.4 million, or 8.2%.
Other Expenses (Income), Net. Other expenses (income), net, for the year ended December 31, 2003 was a net expense of $7.9 million compared to $5.0 million of net income for the year ended December 31, 2002. The other expense (income), net, for the years ended December 31, 2003 and 2002, is primarily comprised of the operating expenses of the holding company.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) 123R, “Share-Based Payment.” This Statement is a revision of SFAS 123, “Accounting for Stock-Based Compensation,” and supersedes Accounting Principles Board Opinion 25, “Accounting for Stock Issued to Employees,” and its related implementation guidance. SFAS 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The statement requires entities to recognize stock compensation expense for awards of equity instruments to employees based on the grant-date fair value of those awards (with limited exceptions). SFAS 123R is effective for the first interim or annual reporting period that begins after June 15, 2005. In addition, SFAS 123R requires that excess tax benefits related to stock compensation expense be reported as a financing cash inflow rather than as a reduction of taxes paid in cash flow from operations.
As an economic hedge against a decline in the equity markets, the Company entered into total return swap transactions on Standard & Poor’s 500 Depository Receipts (“SPDRs”) and The Financial Select SPDR Fund (“XLF”) and, as described below, purchased long Standard & Poor’s and XLF index call options on 100% of the securities underlying the swap transactions. The aggregate notional amount of the swap transactions is $451.8 million. The swap transactions terminate during the fourth quarter of 2006. As of December 31, 2004, the Company has provided $99.2 million of US Treasury bills as collateral for the swap transactions. The swap transactions are recorded at fair value, based on the remainder of the notional amount less the fair value of the underlying securities. Changes in the fair value of the swap transactions are recorded as realized gains or losses in the consolidated statement of operations. As of December 31, 2004, the net change in the fair value of the swap transactions resulted in a net realized loss of $44.9 million.
Through investment in securities denominated in foreign currencies, we are exposed to foreign (i.e., non-U.S.) currency risk. Foreign currency exchange rate risk is the potential for loss in market value owing to a decline in the U.S. dollar value of these investments resulting from a decline in the exchange rate of the foreign
For further detail on our losses and loss adjustment expenses see note 15 of our consolidated financial statements included in this Form 10-K. Our reserves for losses and loss adjustment expenses do not have contractual maturity dates. However, based on historical payment patterns, we have included an estimate of when we expect our losses and loss adjustment expenses to be paid in the table above. The exact timing of the payment of claims cannot be predicted with certainty. We maintain a portfolio of investments with varying maturities and a substantial amount of short-term investments to provide adequate cash flows for the payment of claims. The reserves for unpaid losses and loss adjustment expenses reflected in the table above have not been reduced for reinsurance recoverables on unpaid losses which are reflected in our consolidated balance sheet as an asset of $1,092.1 million as of December 31, 2004. Based on historical patterns, we estimate that we will collect the recoveries as follows: $312.1 million in less than one year; $412.2 million in 1 to 3 years; $193.6 million between three and five years and $174.2 million in more than five years.
The gross unrealized appreciation of $278.6 million and the gross unrealized depreciation of $118.0 million resulted principally from the change in value of U.S. and non-U.S. equities, the credit quality of fixed income securities and the current interest rate environment.
matter. The settlement was confirmed by the court on February 8, 2005. We anticipate final resolution of this matter early in the second quarter of 2005, and that such resolution will not be material to us.
The statutory provision for potentially uncollectible reinsurance recoverables due from unauthorized companies is reduced to the extent collateral is held by Clearwater or Hudson. Pursuant to indemnification agreements between the Company and Clearwater, and between the Company and Hudson, the Company provides letters of credit (“LOCs”) and/or cash in respect of uncollateralized balances due from unauthorized reinsurers. The use of such collateral provided by the Company is a permitted accounting practice approved by the Insurance Department of the State of Delaware, the domiciliary state of Clearwater and Hudson.
The Company’s asbestos and environmental reserve development, gross and net of reinsurance, for the years ended December 31, 2004, 2003 and 2002, respectively, is set forth in the table below (in thousands):
(1) The condensed financial information of the registrant should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included elsewhere herein. Certain prior year amounts have been reclassified to conform to the balance sheet presentation as of December 31, 2004.