Other Customers. We also underwrite reinsurance contracts with primary insurance companies other than Tower, insurance policies written under insurance risk-sharing agreements with insurance companies other than Tower, and premiums produced by program underwriting managers. We originated substantial third party business in 2007 (approximating 25% of managed premiums) that will be reflected in revenues in 2008, and expect to maintain or exceed 30% in 2008.
The critical accounting policies and estimates set forth below involve, among others, the reporting of premiums written and earned, reserves for losses and loss adjustment expenses (including reserves for losses that have occurred but had not been reported or paid by the financial statement date), the reporting of deferred acquisition costs and the recording of other-than-temporarily impaired investments.
In order to better understand the underlying loss characteristics and further improve our best estimates of loss reserves, our estimate of ultimate loss is determined based on a review of the results of several commonly accepted actuarial projection methodologies. Our estimate of ultimate loss also incorporates qualitative information, such as changes in the claims department, business mix, pricing and knowledge about specific large claims. The specific methodologies we utilize in our loss reserve review process may include, but are not limited to, (i) incurred and paid loss development methods; (ii) incurred and paid Bornhuetter Ferguson, or BF, methods and (iii) loss ratio methods. Due to the nature of our business, any of these methods may not be practical in particular circumstances based upon the information provided by the ceding company for each treaty. Also, various methodologies are actuarially more appropriate given the line of business, the maturity of the treaty, the limits insured or reinsured, the type of treaty, and other considerations. Generally, we rely on BF and loss ratio methods for estimating ultimate loss liabilities for more recent treaty years. These methodologies, at least in part, apply a loss ratio, determined from aggregated analyses of internally developed pricing trends, to premiums earned on that business. Adjustments to premium estimates generate related adjustments to ultimate loss estimates in the quarter in which they occur. To estimate losses for more mature treaty years, we generally rely on the incurred loss development methodology. This methodology relies on loss emergence analyses determined from cedent supplied claim information or industry patterns. For property catastrophe losses, we may utilize vendor catastrophe models to estimate ultimate loss soon after a loss occurs, where loss information is not yet reported to us from cedents. IBNR is determined by subtracting the total of paid loss and reported reserves from the estimated ultimate loss.
Underwriting expense ratio. The underwriting expense ratio is the ratio of direct and ceding commission expenses and other underwriting expenses less policy billing fees to premiums earned. The underwriting expense ratio measures our operational efficiency in producing, underwriting and administering our insurance and reinsurance business. We calculate our underwriting expense ratios on a gross basis (before the effect of ceded reinsurance) to measure our operational efficiency and on a net basis (after the effect of ceded reinsurance) to measure the effects on our consolidated income before income taxes.
Direct commission revenue. Direct commission revenue is dependent upon the premiums written during the year with respect to the program business managed by CastlePoint Management. CastlePoint Management receives a 30% commission from CastlePoint Insurance Company and Tower’s insurance companies for program business placed by CastlePoint Management with these companies, less boards, bureaus and premium taxes (which we refer to as “BB&T”) and less direct commission expenses that are incurred by Tower and CastlePoint Insurance Company. Direct commission revenue increased 219.3% to $7.5 million for the year ended December 31, 2007 compared to $2.3 million for the year ended December 31, 2006. These commission revenues were received for the specialty programs and traditional programs. We also bound three additional programs, which contributed to the increase in revenues in 2007.
The inability of our operating subsidiaries to pay dividends in an amount sufficient to enable us to meet our cash requirements at the holding company level could adversely affect us.
United States. CastlePoint Insurance Company is subject to regulation by the State of New York, its state of domicile. Under New York State insurance law, CastlePoint Insurance Company may not, during any 12-month period, declare or pay dividends in excess of the lesser of 10% of its policyholders surplus as shown on its last filed financial statement or 100% of CastlePoint Insurance Company’s adjusted net income during such period, without obtaining the New York State Insurance Department’s prior approval. All dividends paid by CastlePoint Insurance Company may only be paid out of earned surplus. CastlePoint Insurance Company did not declare a dividend in 2007.
approximately $96.9 and $15.0 million in net proceeds from Tower Group’s initial investment in the Company, less dividends paid to shareholders of $2.2 million.
The following table summarizes our investment portfolio at December 31, 2007.
In addition, CastlePoint Re entered into a trust agreement to establish a trust fund in the United States as security for U.S. policyholders and third-party claimants in connection with
As of December 31, 2007, CastlePoint Re had trust accounts for the benefit of its reinsureds totaling approximately $216.7 million, an increase of approximately $118.9 million since December 31, 2006. In addition, as of December 31, 2007, CastlePoint Re had letters of credit in the amount of $1.4 million. As of December 31, 2007, CastlePoint Insurance Company also had trust assets in the amount of $8.0 million. CastlePoint Re and CastlePoint Insurance earn and collect the interest on the trust funds. For more information, see Note 11 “Commitments and Contingencies” to our audited financial statements as of and for the year ended December 31, 2007 and the year ended December 31, 2006.