Per share amounts have been retroactively adjusted to reflect the two-for-one stock split effective March 31, 2006.
The consolidated financial statements include amounts based on informed estimates and judgments of management for transactions that are not yet complete. Such estimates and judgments affect the reported amounts in the financial statements. Those estimates and judgments that were most critical to the preparation of the financial statements involved the determination of loss reserves and the recoverability of related reinsurance recoverables. These estimates and judgments, which are discussed within the following analysis of our results of operations, require the use of assumptions about matters that are highly uncertain and therefore are subject to change as facts and circumstances develop. If different estimates and judgments had been applied, materially different amounts might have been reported in the financial statements.
Net income was $2.5 billion in 2006 compared with $1.8 billion in 2005 and $1.5 billion in 2004. The significant increase in net income in 2006 was driven by substantially higher underwriting income in our property and casualty insurance business.
Results in 2005 included a pre-tax realized investment gain of $171 million from a transaction we completed in December 2005 involving a new reinsurance company, Harbor Point Limited. As part of the transaction, we transferred our continuing reinsurance assumed business and certain related assets, including renewal rights, to Harbor Point.
Underwriting results were exceptionally profitable in 2006 compared with highly profitable results in 2005 and 2004. Our combined loss and expense ratio was 84.2% in 2006 compared with 92.3% in both 2005 and 2004. The impact of catastrophes accounted for 1.4 percentage points of the combined ratio in 2006 compared with 5.6 percentage points in 2005 and 2.3 percentage points in 2004. The greater catastrophe impact in 2005 was due to costs of $462 million related to Hurricane Katrina, including estimated net losses of $403 million and net reinsurance reinstatement premium costs of $59 million.
Total net premiums written decreased by 3% in 2006 after increasing by 2% in 2005. Net premiums written in our insurance business increased 2% in 2006 and 4% in 2005. The relatively low growth in our insurance business in both years reflected our continued emphasis on underwriting discipline in an increasingly competitive market environment. In the reinsurance assumed business, net premiums written decreased 57% in 2006 and 21% in 2005. The decrease in 2006 was in line with our expectations following the sale of the ongoing business in December 2005.
Property and casualty investment income after tax increased by 10% in 2006 and 11% in 2005. The growth was due to an increase in invested assets over the period. For more information on this non-GAAP financial measure, see “Property and Casualty Insurance - Investment Results.”
Property and casualty income before tax in 2006 was substantially higher than in 2005 which, in turn, was higher than in 2004. Income in all three years benefited from highly profitable underwriting results. Underwriting income in 2006 was substantially higher than in 2005, due largely to significantly lower catastrophe losses and improvement in our specialty insurance business unit. Underwriting income increased modestly in 2005 compared with 2004 despite significantly higher catastrophe losses, primarily from Hurricane Katrina. Results in 2006 and 2005 also benefited from significant increases in investment income.
Net premiums written amounted to $12.0 billion in 2006, a decrease of 3% compared with 2005. A modest increase in premiums from our insurance business was more than offset by a decline in premiums from our reinsurance assumed business. Net premiums written increased 2% in 2005 over 2004, as an increase in premiums from our insurance business was partially offset by a decline in premiums from our reinsurance assumed business.
Net reinsurance assumed premiums written decreased by 57% in 2006 and 21% in 2005. Premiums in 2005 included net reinstatement premium revenue of $43 million related to Hurricane Katrina. As discussed below, we sold our ongoing assumed reinsurance business to Harbor Point Limited in December 2005.
As a result of the substantial losses incurred by reinsurers from the catastrophes in 2004 and 2005, the cost of property catastrophe reinsurance increased significantly in 2006 and there were capacity restrictions in the marketplace.
Although property catastrophe reinsurance rates increased in 2006, our overall ceded reinsurance premiums for our insurance business, excluding the impact of reinstatement premiums related to Hurricane Katrina, were only modestly higher than in 2005 due to modifications to certain of our reinsurance treaties. On our casualty clash treaty, our initial retention remained at $75 million. We reduced our reinsurance coverage at the top of the program by $50 million and increased our participation in the program. This treaty now provides coverage of approximately 55% of losses between $75 million and $150 million per insured event. On our commercial property per risk treaty, we increased our retention from $15 million to $25 million. This treaty now provides $425 million of coverage per risk in excess of our retention. Our property catastrophe treaty for events in the United States was modified to increase our initial retention from $250 million to $350 million and to increase our participation in the program. At the same time, we increased the reinsurance coverage in the northeastern part of the country by $400 million, enhancing our protection in the region where we have our greatest concentration of exposure. The treaty now provides coverage of approximately 75% of losses (net of recoveries from other available reinsurance) between $350 million and $1.3 billion, with additional coverage of 80% of losses between $1.3 billion and $2.05 billion in the northeastern part of the country. Our property catastrophe treaty for events outside the United States was modified to increase our initial retention from $50 million to $75 million. The treaty now provides coverage of approximately 90% of losses (net of recoveries from other available reinsurance) between $75 million and $275 million. Our property reinsurance treaties generally contain terrorism exclusions for acts perpetrated by foreign terrorists.
We do not expect the changes we made to our reinsurance program during 2005 and 2006 to have a material effect on the Corporation’s results of operations, financial condition or liquidity.
The combined loss and expense ratio, expressed as a percentage, is the key measure of underwriting profitability traditionally used in the property and casualty insurance business. Management evaluates the performance of our underwriting operations and of each of our business units using, among other measures, the combined loss and expense ratio calculated in accordance with statutory accounting principles. It is the sum of the ratio of losses and loss expenses to premiums earned (loss ratio) plus the ratio of statutory underwriting expenses to premiums written (expense ratio) after reducing both premium amounts by dividends to policyholders. When the combined ratio is under 100%, underwriting results are generally considered profitable; when the combined ratio is over 100%, underwriting results are generally considered unprofitable.
Underwriting results in 2006 were exceptionally profitable compared with highly profitable results in 2005 and 2004. The combined loss and expense ratio for our overall property and casualty business was as follows:
At the end of 2005, we estimated that our net losses from Hurricane Katrina were $403 million and our net reinsurance reinstatement premium costs related to the hurricane were $59 million. In our insurance business, estimated net losses were $335 million and reinstatement premium costs were $102 million, for an aggregate cost of $437 million. In our reinsurance assumed business, estimated net losses were $68 million and net reinstatement premium revenue was $43 million, for a net cost of $25 million. At the end of 2005, we estimated that our gross losses from Hurricane Katrina were about $1.2 billion. Almost all of the losses were from property exposure and business interruption claims. Our net losses of $403 million were significantly lower than the gross amount due to a property per risk treaty that limited our net loss per risk and our property catastrophe treaty.
Other than the reinsurance recoverable related to Hurricane Katrina, we did not have any recoveries from our catastrophe reinsurance treaties during the three year period ended December 31, 2006 because there were no other individual catastrophes for which our losses exceeded our initial retention under the treaties.
Our net catastrophe losses incurred in 2006 were $173 million, which were offset in part by the $20 million reduction in previously accrued reinsurance reinstatement premium costs related to Hurricane Katrina. The net impact of catastrophes in 2006 accounted for 1.4 percentage points of the loss ratio. In 2005, we incurred $630 million of net catastrophe losses and $59 million in related net reinsurance reinstatement premium costs, which in the aggregate accounted for 5.6 percentage points of the loss ratio. Losses from catastrophes were $270 million in 2004, which represented 2.3 percentage points of the loss ratio. The 2004 catastrophe loss amount reflected an $80 million reduction in loss reserves related to the September 11, 2001 attack, which reduced the loss ratio for the year by 0.7 of a percentage point.
Our expense ratio increased in 2006 as net premiums written decreased whereas compensation and other operating costs increased. The decrease in the expense ratio in 2005 was due primarily to lower contingent commission expenses. To a lesser extent, the 2005 decrease was due to flat overhead expenses compared with 2004 and the discontinuation of a professional liability per risk reinsurance treaty that resulted in an increase in net premiums written without a commensurate increase in expenses.
Our personal insurance business produced profitable underwriting results in each of the last three years. Overall results have shown substantial improvement in each succeeding year, driven largely by
Net premiums written from commercial insurance, which represented 43% of our premiums written in 2006, increased by 2% in both 2006 and 2005. Net premiums written for the classes of business within the commercial insurance segment were as follows:
Multiple peril results were highly profitable in each of the past three years. Results in 2005 were less profitable than in 2006 and 2004 largely due to higher catastrophe losses. The impact of catastrophes accounted for 2.9 percentage points of the combined loss and expense ratio for this class in 2006 compared with 9.1 percentage points in 2005. Catastrophe losses were negligible for this class in 2004 due to a $30 million reduction in net loss reserves related to the September 11, 2001 attack. The property component of this business benefited from low non-catastrophe losses in all three years. Results in the liability component improved in 2005 and again in 2006.
Results for our casualty business were less profitable in 2006 and 2005 compared with the highly profitable results in 2004. The automobile component of our casualty business was highly profitable in each of the past three years. Results in the primary liability component were less profitable in each succeeding year. Results in the excess liability component were unprofitable in 2006 and 2005 compared with profitable results in 2004. Results in 2004 for this component benefited from a $30 million reduction in net loss reserves related to the September 11, 2001 attack. In 2006 and 2005, excess liability results and, to a lesser extent, primary liability results were adversely affected by unfavorable loss development related to older accident years.
Property and marine results were highly profitable in 2006 and 2004 compared with marginally profitable results in 2005. The less profitable results in 2005 were due to substantially higher catastrophe losses, primarily from Hurricane Katrina. Results in each year benefited from relatively
Net premiums written from specialty insurance, which represented 25% of our premiums written in 2006, decreased by 3% in 2006 compared with a 6% increase in 2005. Net premiums written for the classes of business within the specialty insurance segment were as follows:
Growth in net premiums written for the professional liability classes of business was constrained in both 2006 and 2005 by the continued competitive pressure on rates that began in the latter half of 2003 and our commitment to maintain underwriting discipline in this environment. Growth in both years was also dampened by the sale of renewal rights, effective July 1, 2005, on our hospital medical malpractice and managed care errors and omissions business. The net premium growth in 2005 in the professional liability classes was due to the non-renewal of a per risk reinsurance treaty.
The growth in net premiums written for our surety business was substantial in both 2006 and 2005. About half of the growth in both years was due to the non-renewal of a high excess reinsurance treaty during 2005.
Our specialty insurance business produced highly profitable underwriting results in 2006 compared with modestly profitable results in 2005 and unprofitable results in 2004. The combined loss and expense ratios for the classes of business within specialty insurance were as follows:
errors and omissions liability and fiduciary liability components improved in 2005 and again in 2006, benefiting from the cumulative effect of price increases in prior years, lower policy limits and better terms and conditions. Results in 2006 also benefited from modest favorable loss development related to prior accident years. Conversely, results in 2005 and 2004, but more so in 2004, were adversely affected by unfavorable loss development related to accident years prior to 2003. This adverse development was predominantly from claims that have arisen due to corporate failures and allegations of management misconduct and accounting irregularities. Adverse development was particularly significant in 2004 due to an increase of about $160 million in errors and omissions liability loss reserves in the second quarter related to investment banks.
Our surety business produced highly profitable results in each of the past three years due to favorable loss experience.
We continue to have substantial commercial and construction surety exposure for current and prior customers, including exposures related to surety bonds issued on behalf of companies that have experienced deterioration in creditworthiness since we issued bonds to them. We therefore may experience an increase in filed claims and may incur high severity losses. Such losses would be recognized if and when claims are filed and determined to be valid, and could have a material adverse effect on the Corporation’s results of operations and liquidity.
Other than pursuant to certain arrangements entered into with Harbor Point, we generally no longer engage directly in the reinsurance assumed business. However, Harbor Point has the right for a transition period of up to two years to underwrite specific reinsurance business on our behalf. We retain a portion of any such business and cede the balance to Harbor Point in return for a fronting commission. We will receive additional payments based on the amount of business renewed by Harbor Point, which will be recognized when earned.
Net premiums written from our reinsurance assumed business, which represented 3% of our premiums written in 2006, decreased by 57% in 2006 and 21% in 2005. The significant decrease in premiums in 2006 was expected in light of the sale of our continuing reinsurance assumed business to Harbor Point. The decrease in premiums in 2005 was in line with our expectations as we had anticipated fewer attractive opportunities in the reinsurance market. Premiums in 2005 included net reinsurance reinstatement premium revenue of $43 million related to Hurricane Katrina.
Our reinsurance assumed business was profitable in 2006, 2005 and 2004. Results in 2006 were particularly profitable. While the volume of business was substantially lower than in the previous two years, results in 2006 benefited from significant favorable loss development related to prior accident years. Results in 2005 were similar to those in 2004 despite higher catastrophe losses.
The September 11, 2001 attack changed the way the property and casualty insurance industry views catastrophic risk. That tragic event demonstrated that numerous classes of business we write are subject to terrorism related catastrophic risks in addition to the catastrophic risks related to natural occurrences. This, together with the limited availability of terrorism reinsurance, has required us to change how we identify and evaluate risk accumulations. We have licensed a terrorism model that provides loss estimates under numerous event scenarios. Also, the above noted risk concentration management tool enables us to identify locations and geographic areas that are exposed to risk accumulations. The information provided by the model and the tracking tool has resulted in our non-renewing some accounts and has restricted us from writing others. Actual results may differ materially from those suggested by the model.
Our gross case and incurred but not reported (IBNR) loss reserves and related reinsurance recoverable by class of business were as follows:
Due to the inherent complexity of the loss reserving process and the potential variability of the assumptions used, the actual emergence of losses could vary, perhaps substantially, from the estimate of losses included in our financial statements, particularly when settlements may not occur until well into the future. Our net loss reserves at December 31, 2006 were $19.7 billion. Therefore, a relatively small percentage change in the estimate of net loss reserves would have a material effect on the Corporation’s results of operations.
Expected loss ratio methods use loss ratios for prior accident years, adjusted to reflect our evaluation of recent loss trends, the current risk environment, changes in our book of business and changes in our pricing and underwriting, to determine the appropriate expected loss ratio for a given accident year. The accident year expected loss ratio is multiplied by the calendar year earned premiums to calculate estimated ultimate losses.
Frequency/severity methods first project ultimate claim counts (using one or more of the other methods described above) and then multiply those counts by an estimated average claim cost to estimate ultimate losses. The average claims costs are often estimated by fitting historical severity data to an observed trend.
Using the various actuarial methods, our actuaries estimate the ultimate cost of all claims by accident year for each class of business. From this amount, cumulative paid losses and loss expenses and case reserves are subtracted to estimate the IBNR reserve for each class of business. The IBNR reserve includes a provision for claims that have occurred but have not yet been reported to us, some of which are not yet known to the insured, as well as a provision for future development on reported claims. A relatively large proportion of our net loss reserves, particularly for long tail liability classes, are reserves for IBNR losses. In fact, more than 65% of our aggregate net loss reserves at December 31, 2006 were for IBNR losses.
In completing their loss reserve analysis, our actuaries are required to determine the most appropriate actuarial methods to employ for each class of business. Within each class, the business is further segregated by accident year and generally by jurisdiction. Each estimation method has its own pattern, parameter and/or judgmental dependencies, with no estimation method being better than the others in all situations. The relative strengths and weaknesses of the various estimation methods can also change over time. In many cases, multiple estimation methods will be valid for the particular facts and circumstances of the relevant class of business. The manner of application and the degree of reliance on a given method will vary by class of business, by accident year and by jurisdiction based on our actuaries’ evaluation of the above dependencies and the potential volatility of the loss frequency and severity patterns. The estimation methods selected or given weight by our actuaries at a particular valuation date are those that are believed to produce the most reliable indication for the loss reserves being evaluated. These selections incorporate input from claims personnel, pricing actuaries and underwriting management on loss cost trends and other factors that could affect the reserve estimates.
For short tail classes, the emergence of paid and incurred losses is likely indicative of ultimate losses. For these classes, the loss development factor method is generally relatively straightforward to apply and usually requires only modest extrapolation. For long tail classes, applying the loss development factor method often requires more judgment in selecting development factors as well as more significant extrapolation. For those long tail classes with high frequency and relatively low per-loss severity (e.g. workers’ compensation), volatility will often be sufficiently modest for the loss development factor method to be given significant weight, except in the most recent accident years.
each class of business. In making the determination, management considers numerous factors, such as changes in actuarial indications in the period, the maturity of the accident year, trends observed over the recent past and the level of volatility within a particular class of business. Such an assessment requires considerable judgment. It is often not possible to determine whether a change in the data represents credible actionable information or an anomaly. Even if a change is determined to be permanent, it is not always possible to determine the extent of the change until sometime later. As a result, there can be a time lag between the emergence of a change and a determination that the change should be reflected in the carried loss reserves. In general, changes are made more quickly to more mature accident years and less volatile classes of business.
As part of our loss reserving analysis, we take into consideration the various factors that contribute to the uncertainty in the loss reserving process. Those factors that could materially affect our loss reserve estimates include loss development patterns and loss cost trends, rate and exposure level changes, the effects of changes in coverage and policy limits, re-underwriting efforts and business mix shifts, the effects of regulatory and legislative developments, the effects of changes in judicial interpretations, the effects of emerging claims and coverage issues, and the effects of changes in claim handling practices. In making estimates of reserves, however, we do not necessarily make an explicit assumption for each of these factors. Moreover, all estimation methods do not utilize the same assumptions and typically no single method is determinative in the reserve analysis for a class of business. Consequently, changes in our loss reserve estimates generally are not the result of changes in any one assumption. Instead, the variability will be affected by the interplay of changes in multiple assumptions, many of which are implicit to the approaches used.
Reserves for commercial excess liability (excluding asbestos and toxic waste claims) were $2.7 billion, net of reinsurance, at December 31, 2006. These reserves are included within commercial casualty. Based on a review of our loss experience, if the loss development factor for each accident year changed such that the cumulative loss development factor for the most recent accident year changed by 15%, we estimate that the net reserves for commercial excess liability would change by approximately $250 million, in either direction. This degree of change in the reported loss development pattern is within the historical variation around the averages in our data.
interpretations and legislative actions that in some cases have tended to broaden coverage beyond the original intent of such policies and in others have expanded theories of liability. The insurance industry as a whole is engaged in extensive litigation over coverage and liability issues and is thus confronted with a continuing uncertainty in its efforts to quantify these exposures.
Asbestos Reserves. Asbestos remains the most significant and difficult mass tort for the insurance industry in terms of claims volume and dollar exposure. Asbestos claims relate primarily to bodily injuries asserted by those who came in contact with asbestos or products containing asbestos. Until recently, judicial interpretations and legislative actions attempted to maximize insurance availability from both a coverage and liability standpoint. Early court cases established the “continuous trigger” theory with respect to insurance coverage. Under this theory, insurance coverage is deemed to be triggered from the time a claimant is first exposed to asbestos until the manifestation of any disease. This interpretation of a policy trigger can involve insurance companies over many years and increases their exposure to liability.
In establishing our asbestos reserves, we evaluate the exposure presented by each insured. As part of this evaluation, we consider a variety of factors including: the available insurance coverage; limits and deductibles; the jurisdictions involved; past settlement values of similar claims; the potential role of other insurance, particularly underlying coverage below our excess liability policies; potential bankruptcy impact; and applicable coverage defenses, including asbestos exclusions. We have assumed a continuing unfavorable legal environment with no benefit from any federal asbestos reform legislation. Proposed legislation that would have created a $140 billion asbestos trust fund but would have provided neither certainty nor finality was not adopted and the future of federal legislation remains uncertain.
The following table presents the number of policyholders for whom we have open asbestos case reserves and the related net loss reserves at December 31, 2006 as well as the net losses paid during 2006 by component.
the number of insureds seeking bankruptcy protection as a result of asbestos-related liabilities;
These significant uncertainties are not likely to be resolved in the near future. While there have been some positive legislative and judicial developments in the asbestos arena over the past three years, it is too early to call it a trend.
The federal Comprehensive Environmental Response Compensation and Liability Act of 1980 (Superfund) has been interpreted to impose strict, retroactive and joint and several liability on potentially responsible parties (PRPs) for the cost of remediating hazardous waste sites. Most sites have multiple PRPs.
Most PRPs named to date are parties who have been generators, transporters, past or present landowners or past or present site operators. These PRPs had proper government authorization in many instances. However, relative fault has not been a factor in establishing liability. Insurance policies issued to PRPs were not intended to cover the clean-up costs of pollution and, in many cases, did not intend to cover the pollution itself. In more recent years, however, policies specifically excluded such exposures.
As the costs of environmental clean-up became substantial, PRPs and others increasingly filed claims with their insurance carriers. Litigation against insurers extends to issues of liability, coverage and other policy provisions.
Uncertainty remains as to our ultimate liability relating to toxic waste claims. However, toxic waste losses appear to be developing as expected due to relatively stable claim trends. In many cases, claims are being settled for less than initially anticipated due to more efficient site remediation efforts.
In other cases, we have been successful at buying back our policies, thus removing the threat of additional losses in the future.
Of the net toxic waste loss reserves at December 31, 2006, $82 million was for IBNR losses.
Reinsurance recoverable on unpaid losses and loss expenses represents an estimate of the portion of our gross loss reserves that will be recovered from reinsurers. Such reinsurance recoverable is estimated as part of our loss reserving process using assumptions that are consistent with the assumptions used in estimating the gross loss reserves. Consequently, the estimation of reinsurance recoverable is subject to similar judgments and uncertainties as the estimation of gross loss reserves.
During 2006, we experienced overall favorable prior year development of $296 million, which represented 1.6% of the net loss reserves as of December 31, 2005. This compares with unfavorable prior year development of $163 million during 2005, which represented 1.0% of the net loss reserves at December 31, 2004, and $327 million during 2004, which represented 2.3% of the net loss reserves at December 31, 2003. Such development was reflected in operating results in these respective years.
We experienced favorable development of about $70 million in the fidelity classes due to lower than expected reported loss emergence, mainly related to more recent accident years. Loss reserve estimates in these classes include an expectation of more large late reported losses than actually occurred in 2006. However, since we would still expect such losses to occur in a typical year, the favorable development in 2006 was given only modest weight in our determination of carried fidelity loss reserves at December 31, 2006.
We experienced favorable development of about $25 million in the personal automobile class. Case development during 2006 on previously reported claims was better than expected, reflecting improved case management. Also, the number of late reported claims was less than expected, reflecting a continuation of recent generally favorable frequency trends. Both of these factors were reflected in the determination of the carried loss reserves for this class at December 31, 2006.
We experienced adverse development of about $415 million in the professional liability classes other than fidelity. The adverse development resulted from significant reported loss activity in
accident years 1998 through 2002 due in large part to claims related to corporate failures and allegations of management misconduct and accounting irregularities, especially those involving investment banks and other financial institutions. As a result, we increased the expected loss ratios for these accident years.
We experienced favorable development of about $270 million related to the 2003 accident year, due in large part to an unusually low amount of late reported homeowners and commercial property losses.
In Item 1 of this report, we present an analysis of our consolidated loss reserve development on a calendar year basis for each of the ten years prior to 2006. The variability in reserve development over the ten year period illustrates the uncertainty of the loss reserving process.
Property and casualty investment income before taxes increased by 11% in both 2006 and 2005 compared with the respective prior years. Growth in both years was due to an increase in invested assets, which reflected substantial cash flow from operations over the period. The after-tax annualized yield on the investment portfolio that supports our property and casualty insurance business was 3.48% in 2006 compared with 3.45% in 2005 and 3.55% in 2004.
Corporate and other produced a loss before taxes of $89 million in 2006 compared with losses of $172 million and $176 million in 2005 and 2004, respectively. The lower loss in 2006 compared with 2005 was primarily due to a significantly smaller loss in our real estate operations and higher investment income. Corporate and other results were similar in 2005 and 2004 as an increase in investment income in 2005 was substantially offset by a larger loss in our real estate operations. The growth in investment income in 2006 and 2005 was due to an increase in corporate invested assets over the period, resulting from the issuance of Chubb’s common stock upon the settlement of equity unit warrants and purchase contracts and under stock-based employee compensation plans.
At December 31, 2006, we owned approximately $145 million of land and $30 million of commercial properties and land parcels under lease. Management believes that it has made adequate provisions for impairment of real estate assets.
structure of these portfolio credit default swaps generally would require CFS to make payment to counterparties to the extent cumulative losses, related to credit events of the referenced entities within a portfolio, exceed a specified threshold.
Portfolio credit default swaps are derivatives and are carried in the financial statements at estimated fair value, which represents management’s best estimate of the cost to exit our positions. Credit default swaps tend to be unique transactions and there is no market for trading such exposures. To estimate the fair value of the obligation in each credit default swap, we use internal valuation models that are similar to external valuation models. Changes in fair value are included in income in the period of the change.
CFS’s aggregate exposure, or retained risk, from each of its remaining in-force portfolio credit default swaps is referred to as notional amount. Notional amounts are used to express the extent of involvement in swap transactions. These amounts are used to calculate the exchange of contractual cash flows and are not necessarily representative of the potential for gain or loss. The notional amounts are not recorded on the balance sheet.
The notional amount and fair value of our future obligations under derivative contracts were as follows:
In 2005, we transferred our ongoing reinsurance business and certain related assets to Harbor Point Limited. In exchange, we received from Harbor Point $200 million of 6% convertible notes and warrants to purchase common stock of Harbor Point. The notes and warrants represent in the aggregate on a fully diluted basis approximately 16% of the new company. The transaction resulted in a pre-tax gain of $204 million, of which $171 million was recognized as a realized investment gain in 2005. The remaining gain of $33 million was deferred and will be recognized based on the timing of the ultimate disposition of our economic interest in Harbor Point.
Decisions to sell equity securities and fixed maturities are governed principally by considerations of investment opportunities and tax consequences. As a result, realized gains and losses on the sale of these investments may vary significantly from period to period. However, such gains and losses generally have little, if any, impact on shareholders’ equity as almost all of these investments are carried at fair value, with the unrealized appreciation or depreciation reflected in comprehensive income.
A primary reason for the sale of fixed maturities in each of the last three years has been to improve our after-tax portfolio return without sacrificing quality where market opportunities have existed to do so. In addition, in the fourth quarter of 2005, to reduce our income tax liability, we engaged in a program to sell taxable and tax-exempt fixed maturities to generate realized losses to offset a portion of the gain related to the Harbor Point transaction.
In connection with the sale of a subsidiary a number of years ago, we agreed to indemnify the buyer for certain pre-closing tax liabilities. During the first quarter of 2005, we settled this obligation with the purchaser. Accordingly, we reduced our income tax liability, which resulted in the recognition of a benefit of $22 million.
The Board of Directors approved a two-for-one stock split in the form of a stock dividend payable to shareholders of record on March 31, 2006. Share and per share amounts have been adjusted to reflect the stock split.
In 2003, Chubb issued $460 million of unsecured 2.25% senior notes due in 2008 and 18.4 million purchase contracts to purchase its common stock. The notes and purchase contracts were issued together in the form of 7% equity units, each of which initially represented $25 principal amount of notes and one purchase contract. In May 2006, the notes were successfully remarketed as required by their terms. The interest rate on the notes was reset to 5.472% from 2.25%, effective May 16, 2006. The remarketed notes mature on August 16, 2008. Each purchase contract obligated the holder to purchase, on or before August 16, 2006, for a settlement price of $25, a variable number of shares of Chubb’s common stock. The number of shares purchased was determined based on a formula that considered the market price of Chubb’s common stock immediately prior to the time of settlement in relation to the $29.75 per share sale price of the common stock at the time the equity units were offered. Upon settlement of the purchase contracts, Chubb issued 12,883,527 shares of common stock and received proceeds of $460 million.
Chubb also has outstanding $225 million of unsecured 3.95% notes due in 2008, $400 million of unsecured 6% notes due in 2011, $275 million of unsecured 5.2% notes due in 2013, $100 million of unsecured 6.6% debentures due in 2018 and $200 million of unsecured 6.8% debentures due in 2031. Chubb Executive Risk Inc., a wholly owned subsidiary, has outstanding $75 million of unsecured 7 1/8% notes due in 2007, which are guaranteed by Chubb.
At December 31, 2006, Executive Risk Capital Trust, wholly owned by Chubb Executive Risk, had outstanding $125 million of 8.675% capital securities. The sole assets of the Trust were debentures issued by Chubb Executive Risk. The capital securities were subject to mandatory redemption in 2027 upon repayment of the debentures. The capital securities were also subject to mandatory redemption in certain other specified circumstances beginning in 2007. On February 1, 2007, the debentures were repaid and the Trust redeemed the capital securities at a price that included a make-whole premium of $5 million in the aggregate.
In June 2003, a shelf registration statement that Chubb filed in March 2003 was declared effective by the Securities and Exchange Commission. Under the registration statement, up to $2.5 billion of various types of securities could be issued. At December 31, 2006, approximately $650 million remained under the shelf registration statement.
In December 2005, the Board of Directors authorized the repurchase of up to 28,000,000 shares of Chubb’s common stock. In December 2006, the Board of Directors authorized the repurchase of up to an additional 20,000,000 shares of common stock.
In 2005, we repurchased 2,787,800 shares of Chubb’s common stock in open market transactions at a cost of $135 million. In January 2006, we repurchased 5,100,000 shares under an accelerated stock buyback program at an initial price of $48.91 per share, for a total cost of $249 million. The program was completed in March, at which time, under the terms of the agreement, we received a price adjustment based on the volume weighted average price of Chubb’s common stock during the program period. The price adjustment could be settled, at our election, in Chubb’s common stock or cash. We elected to have the counterparty deliver 125,562 additional shares in settlement of the price adjustment. During the remainder of 2006, we repurchased 20,140,700 shares in the open market. In the aggregate, in 2006, we repurchased 25,366,262 shares of Chubb’s common stock at a cost of $1,257 million. As of December 31, 2006, 19,845,938 shares remained under the 2006 share repurchase authorization, which has no expiration date. Based on our outlook for 2007, we expect to repurchase all of the shares remaining under the 2006 authorization by the end of 2007.
Credit ratings assess a company’s ability to make timely payments of interest and principal on its debt. The following table summarizes the Corporation’s credit ratings from the major independent rating organizations as of February 26, 2007.
Financial strength ratings assess an insurer’s ability to meet its financial obligations to policyholders. The following table summarizes our property and casualty subsidiaries’ financial strength ratings from the major independent rating organizations as of February 26, 2007.
Our property and casualty operations provide liquidity in that premiums are generally received months or even years before losses are paid under the policies purchased by such premiums. Historically, cash receipts from operations, consisting of insurance premiums and investment income, have provided more than sufficient funds to pay losses, operating expenses and dividends to Chubb. After satisfying our cash requirements, excess cash flows are used to build the investment portfolio and thereby increase future investment income.
As a holding company, Chubb’s ability to continue to pay dividends to shareholders and to satisfy its debt obligations relies on the availability of liquid assets, which is dependent in large part on the dividend paying ability of its property and casualty subsidiaries. Our property and casualty subsidiaries are subject to laws and regulations in the jurisdictions in which they operate that restrict the amount of dividends they may pay without the prior approval of regulatory authorities. The restrictions are generally based on net income and on certain levels of policyholders’ surplus as determined in accordance with statutory accounting practices. Dividends in excess of such thresholds are considered “extraordinary” and require prior regulatory approval. During 2006, these subsidiaries paid to Chubb dividends totaling $650 million. The maximum dividend distribution that may be made by the property and casualty subsidiaries to Chubb during 2007 without prior approval is approximately $1.6 billion.
The following table provides our future payments due by period under contractual obligations as of December 31, 2006, aggregated by type of obligation.
Our gross liability for unpaid losses and loss expenses was $22.3 billion at December 31, 2006. Of this $22.3 billion liability, we estimate that approximately $5.1 billion will be paid in 2007, an aggregate $7.1 billion will be paid in 2008 and 2009, and an aggregate $3.8 billion will be paid in 2010 and 2011. The estimate is based on our historical loss payment patterns. The ultimate amount and timing of loss payments will likely differ from our estimate and the differences could be material. We expect that these loss payments will be funded, in large part, by future cash receipts from operations.
Fixed maturity securities that we have the ability and intent to hold to maturity are classified as held-to-maturity. All our other fixed maturities, which may be sold prior to maturity to support our investment strategies, such as in response to changes in interest rates and the yield curve or to maximize after-tax returns, are classified as available-for-sale. Fixed maturities classified as held-to-maturity are carried at amortized cost while fixed maturities classified as available-for-sale are carried at market value. About 1% of the fixed maturity portfolio was classified as held-to-maturity at December 31, 2006, 2005 and 2004.
The unrealized appreciation before tax of investments carried at market value, which includes fixed maturities classified as available-for-sale and equity securities, was $603 million, $478 million and $961 million at December 31, 2006, 2005 and 2004, respectively. Such unrealized appreciation is reflected in comprehensive income, net of applicable deferred income tax.
Consolidated financial statements of the Corporation at December 31, 2006 and 2005 and for each of the three years in the period ended December 31, 2006 and the report thereon of our independent registered public accounting firm, and the Corporation’s unaudited quarterly financial data for the two-year period ended December 31, 2006 are listed in Item 15(a) of this report.