Trends in our catastrophe account over the last three years are distorted by reinstatement premiums. These were significantly higher in 2005 following cedants’ utilization of coverage in Hurricanes Katrina, Rita and Wilma. Excluding reinstatement premiums, we experienced growth in our catastrophe book of 3.8% between 2005 and 2006. This was driven by significant rate increases, particularly on U.S exposures impacted by the hurricane losses of 2005. Growth, however, was tempered by our decision to reduce our aggregate natural peril catastrophe exposures on this line. The decrease in gross premiums written in our property account in 2006 is driven by a reduction in our property pro rata renewal. This was partially a result of certain cedants exiting the property market and was also due to the fact that such business was considered less attractive than in 2005.
In addition to common equity, we depend upon other external sources of finance such as debt, preferred shares and credit facilities to support our operating activities. Having sufficient capital allows us to take advantage of profitable opportunities, maintain our financial strength ratings and also comply with various local statutory regulations. The following table summarizes our consolidated capitalization at December 31:
On October 3, 2005, we filed an unallocated universal shelf registration statement with the Securities and Exchange Commission that was declared effective on October 11, 2005. Under the shelf registration statement, we may issue up to $1.5 billion of equity, debt, trust preferred securities or a combination of these securities. On November 21, 2005, we completed a common share offering of 6,800,000 shares at
Our reinsurance business is predominantly short to medium tail in nature, which typically allows us to determine the ultimate loss experience within a relatively short period after a contract has expired. However, the reserving process for our reinsurance operations is more complicated than for our insurance operations. For reported losses, we generally establish case reserves based on reports received primarily from brokers and also from ceding companies. With respect to contracts written on an excess of loss basis, we typically are notified of insured losses on specific contracts and record a case reserve for the estimated amount of the ultimate expected liability arising from the claim. With respect to contracts written on a pro rata basis, we typically receive aggregated claims information and record a case reserve based on this information.
Our independent actuary applies loss and loss expense ratios to our earned premium to generate estimated baseline ultimate costs of the losses. From the estimated baseline ultimate costs of losses, we deduct paid losses and reported case reserves to generate our baseline IBNR. The estimated baseline ultimate costs of losses will almost certainly differ materially from our actual losses and loss expenses. The uncertainty surrounding our actual losses and loss expenses is greater for a company like ours that has a limited operating history and claims loss development patterns. In addition, our limited operating history and claims loss development patterns have necessitated the use of benchmarks in deriving our IBNR. These benchmarks could differ materially from our actual experience despite management’s and the independent actuaries care in selecting them.
For the majority of our insurance business, we receive a flat premium which is identified in the policy and which is recorded as unearned premium on the inception date of the contract. This premium will adjust only if the underlying insured values adjust. We actively monitor underlying insured values and record adjustment premiums in the period in which amounts are reasonably determinable.
recorded in the period during which the adjustment is determined. During 2006, 2005 and 2004, proportional premiums accounted for 15%, 15% and 10%, respectively, of total gross premiums written.
The estimated fair value was initially calculated and provided by the seller, a financial institution, using a proprietary Monte Carlo model. Prior to the consummation of the transaction as disclosed in Item 8, Note 6 (c) of the Consolidated Financial Statements, we engaged Ernst & Young, as an independent actuary, to perform due diligence on the pricing of the structured life deal which included a review of life expectancy data, the survival probability curves, and the Monte Carlo model methodology used by the above financial institution. Based on the results of this due diligence, we have established the estimated fair value of the life settlement contracts at December 31, 2006.
At December 31, 2006, we have not entered into any off-balance sheet arrangements, as defined by Item 303 (a) (4) of Regulation S-K.
Purchases and sales of investments are recorded on a trade date basis. Realized gains or losses on sales of investments are determined based on the specific identification method. Net investment income is recognized when earned and includes interest and dividend income together with amortization of market premiums and discounts using the effective yield method and is net of investment fees. For mortgage-backed securities and any other holdings for which there is a prepayment risk, prepayment assumptions are evaluated and revised as necessary. Any adjustments required due to the change in effective yields and maturities are recognized on a prospective basis through yield adjustments.
The Company evaluates the performance of its insurance and reinsurance segments based on underwriting results. The Company does not allocate its assets by segment as it evaluates the underwriting results of each segment separately from the results of the investment portfolio.
Proceeds from sales of fixed maturities classified as available for sale were $4,123.5 million, $6,306.7 million and $5,268.7 million in 2006, 2005 and 2004 respectively. The gross gains and losses on those sales are included in the table above.
The Company participates in a securities lending program whereby the Company’s securities, which are included in investments, are loaned to third parties, primarily major brokerage firms for short periods of time through a lending agent. The Company maintains control over the securities it lends, retains the earnings and cash flows associated with the loaned securities and receives a fee from the borrower for the temporary use of the securities. Collateral in the form of cash, government securities and letters of credit is required at a rate of 102.0% of the market value of the loaned securities and is monitored and maintained by the lending agent. The Company had $774.4 million (2005: $974.9 million) in
Interest expense includes interest payable, amortization of the offering discount and amortization of debt offering expenses. The offering discount and debt offering expenses are amortized over the period of time during which the Senior Notes are outstanding. During 2006, the Company incurred interest expense for the Senior Notes of $28.7 million (2005: $28.7 million).
On November 23, 2005, the Company issued $250.0 million of 7.50% series B preferred shares with a liquidation preference of $100.00 per share. The Company may redeem the shares on or after December 1, 2015 at a redemption price of $100.00 per share. Dividends on the series B preferred shares if, as and when declared by our board of directors will be payable initially at a fixed rate per annum equal to 7.50% of the liquidation preference on the first day of March, June, September and December of each year, commencing on March 1, 2006, up to but not including December 1, 2015. Commencing on March 1, 2016, the dividend rate on the series B preferred shares will be payable at a floating rate. During a floating rate period, the floating rate per annum will be reset quarterly at a rate equal to 3.4525% plus the 3-month LIBOR Rate. Dividends on the series B preferred shares are non-cumulative. Consequently, if the board of directors does not declare a dividend for any dividend period, holders of the series B preferred shares will not be entitled to receive a dividend for such period, and such undeclared dividend will not accumulate and will not be payable.
The Company has several defined contribution plans that are self directed. Generally, mutual funds are made available pursuant to which employees and the Company contribute a percentage of the employee’s gross salary into the plan each month. During 2006, the Company’s contribution expenses totaled $7.6 million (2005: $6.7 million; 2004: $6.0 million).
Effective January 1, 2004, the Company implemented SERPs for two executives. The SERP for Mr. Charman, Chief Executive Officer and President, requires the Company to make annual payments to Mr. Charman upon his retirement for a period of 20 years. The benefits vest over a period of two years commencing in 2006. Commencing at age 56, Mr. Charman is entitled to an annual payment of $0.8 million compounded by 3% annually for each year commencing from inception. The SERP for Mr. Butt, Chairman, requires the Company to make annual payments to Mr. Butt upon his retirement for a period of 10 years. The benefits vest over a period of two years commencing in 2006. Commencing at age 66, Mr. Butt is entitled to an annual payment of $0.3 million compounded by 3% annually for each year commencing from inception. If either Mr. Charman or Mr. Butt dies, is permanently disabled or a change of control of the Company occurs, the remaining benefits under his plan are payable by the Company in a lump sum. The benefits received under the SERPs will be reduced by the benefits received by the executives under the Company’s Bermuda retirement plan. Effective May 12, 2006, the SERP for Mr. Butt was amended to delay by one year the timing of retirement benefits to be paid and to increase the amount of retirement benefits by $0.1 million for the first five years of retirement. The measurement date of the plan was December 31, 2006. The plan assets are invested in money market funds.
The following is a summary of stock options granted under the DLTECP and related activity:
The valuation allowance relates to net unrealized losses on the Company’s fixed maturity investments and U.S. capital loss carry forwards of $8.0 million ($3.8 million expire in 2010 and $4.2 million expire in 2011). The Company believes it is necessary to establish a valuation allowance of $6.6 million against the deferred tax assets arising from capital loss carry forwards of $1.1 million and net unrealized losses of $5.5 million due to insufficient positive evidence regarding the reversal of these losses. The establishment of the valuation allowance relating to net unrealized losses of $5.5 million has been recorded as a component of other comprehensive income consistent with the treatment of the net unrealized losses. Although realization is not assured, management believes it is more likely than not that the tax benefit of the remaining net deferred tax assets will be realized.
The Company’s insurance and reinsurance operations are subject to insurance and/or reinsurance laws and regulations in the jurisdictions in which they operate, including Bermuda, Ireland and the United States. These regulations include certain restrictions on the amount of dividends or other distributions, such as loans or cash advances, available to shareholders without prior approval of the insurance regulatory authorities. At December 31, 2006 the maximum amount of distributions our subsidiaries could pay to AXIS Capital was approximately $1.4 billion.
On January 17, 2007, the Company announced a strategic reorganization to further strengthen the global operations of AXIS Insurance. As a result, AXIS Insurance will have the following four divisions managed across all geographic locations: Specialty Lines, Professional Lines, Capital Risk Solutions and AXIS Select Markets.