This Annual Report on Form 10-K and other publicly available documents may include, and Transatlantic Holdings, Inc. and its subsidiaries (collectively, "TRH"), through their officers and representatives, may from time to time make, statements which may constitute "forward-looking statements" within the meaning of the U.S. federal securities laws. These forward-looking statements are identified, including without limitation, by their use of such terms and phrases as:
It is possible that TRH's actual results, financial condition and expected outcomes may differ, possibly materially, from those anticipated in these forward-looking statements. Important factors that could cause TRH's actual results to differ, possibly materially, from those discussed in the specific forward-looking statements may include, but are not limited to, uncertainties relating to economic conditions, financial and credit market conditions, cyclical industry conditions, credit quality, government, regulatory and accounting policies, volatile and unpredictable developments (including natural and man-made catastrophes), the legal environment, legal and regulatory proceedings, failures of pricing models to accurately assess risks, the reserving process, the competitive environment in which TRH operates, interest rate and foreign currency exchange rate fluctuations and the uncertainties inherent in international operations.
These factors are further discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations and in Part I, Item 1A. Risk Factors of this Form 10-K. TRH is not under any obligation to (and expressly disclaims any such obligation to) update or alter any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future events or otherwise.
Throughout this Annual Report on Form 10-K, Transatlantic Holdings, Inc. (the "Company", and collectively with its subsidiaries, "TRH") presents its operations in the way it believes will be most meaningful. In certain instances, TRH's unpaid losses and loss adjustment expenses ("LAE") are presented net of related reinsurance recoverable ("net loss reserves") in accordance with principles prescribed or permitted by insurance regulatory authorities, as these are standard measures in the insurance and reinsurance industries.
The operations of the Company are conducted principally by its three major operating subsidiaries-Transatlantic Reinsurance Company® ("TRC"), Trans Re Zurich Reinsurance Company Ltd. ("TRZ") and Putnam Reinsurance Company ("Putnam")-and are managed based on its geographic segments. Through its operations on six continents, TRH offers reinsurance capacity on both a treaty and facultative basis-structuring programs for a full range of property and casualty products, with an emphasis on specialty lines, which may exhibit greater volatility of results over time than most other lines. Such capacity is offered through reinsurance brokers and, to a lesser extent, directly to domestic and foreign insurance and reinsurance entities.
TRH's operating strategy emphasizes product and geographic diversification as key elements in managing its level of risk concentration. TRH seeks to focus on more complex risks within the casualty and property lines and adjusts its mix of business to take advantage of market opportunities. Over time, TRH has most often capitalized on market opportunities when they arise by strategically expanding operations in an existing location or opening a branch or representative office in new locations. TRH's operations serving international markets leverage TRH's product knowledge, worldwide resources and financial strength, typically utilizing indigenous management and staff with a thorough knowledge of local markets and product characteristics.
TRH's major sources of revenues are net premiums earned for reinsurance risks undertaken and income from investments. The great majority of TRH's investments are in held to maturity and available for sale fixed maturities. In general, premiums are received significantly in advance of related claims payments.
Revenues increased in 2009 compared to 2008 due primarily to a decrease in realized net capital losses. The decrease in realized net capital losses was due principally to a decrease in OTTI and an increase in realized net capital gains (losses) on sales and redemptions of securities in 2009 as financial and credit markets stabilized and partially recovered from the turmoil at the end of 2008.
Results for 2010 included pre-tax net catastrophe costs of $202 million principally relating to the earthquake in Chile, the earthquake in New Zealand, storms and floods in Australia and the Deepwater Horizon explosion. While there were no significant catastrophe losses for events occurring in 2009, the year 2009 included a reduction of pre-tax net catastrophe costs incurred of ($6) million relating to events occurring in prior years. Results for 2008 included pre-tax net catastrophe costs of $170 million principally arising from Hurricane Ike. Catastrophe costs include losses incurred and related reinstatement premiums, the details of which can be found in Note 10 of Notes to Consolidated Financial Statements ("Note 10"). Reinstatement premiums may arise on both assumed and ceded business as a result of contractual provisions found in certain catastrophe excess-of-loss reinsurance contracts that require additional premium to be paid in the event of a loss to reinstate coverage for the remaining portion of the contract period. Net assumed (ceded) reinstatement premiums serve to increase (decrease) net premiums written and earned.
Underwriting profit (loss) is defined as net premiums earned less net losses and LAE incurred, net of commissions and other underwriting expenses, plus (minus) any increase (decrease) in deferred policy acquisition costs. (See Operational Review for further discussion.)
that affect the overall capacity of the industry to provide coverage. For the years under discussion, the reinsurance market has been characterized by significant competition worldwide in most lines of business. Additionally, TRH is exposed to the operating cycles of primary insurers as the rates charged by, and the policy terms associated with, primary insurance agreements may affect the rates charged by, and the policy terms associated with, reinsurance agreements, particularly for pro rata reinsurance business.
Following improvements in the U.S. property marketplace after significant catastrophe losses in 2004 and 2005, additional capacity entered the reinsurance market in the form of new companies in Bermuda as well as the entrance of capacity from the capital markets via sidecars, catastrophe bonds and other derivative products. The entrance of the new capacity slowly eroded property insurance and reinsurance rates through the first half of 2008, although the marketplace remained generally favorable.
During the second half of 2008, however, the global credit and financial crisis began to significantly impact the insurance and reinsurance markets. First, many alternative reinsurance solutions (such as sidecars) were terminated or not renewed. Second, the impairment of insurance company balance sheets meant historical risk levels in many cases represented a higher than desired percentage of surplus. Third, Hurricane Ike produced one of the highest insured losses from a natural peril event despite being only a category 2 storm. These changes produced an increase in demand for traditional reinsurance from insurance companies as they could not raise capital by issuing debt, did not want to issue equity at depressed stock prices and lost the ability to access the capital markets for alternative reinsurance solutions. In addition, many reinsurers, affected by similar issues, could not maintain the levels of capacity that they had in recent years to take on risk.
In the casualty lines, rates were uneven in 2009. Certain lines, like directors' and officers' liability ("D&O") of financial institutions have shown rate increases, while others have been flat or shown decreases. Results in many casualty lines had benefited from favorable accident year loss severity and frequency trends in 2009. During the January 1, 2010 renewal period, casualty insurance rates generally remained under pressure, with some modest improvements in certain lines.
Market conditions were generally challenging in 2010 as a result of several trends: there was downward pressure on reinsurance rates in many lines; ceding companies increased their retentions; there was excess capital in the reinsurance marketplace; and primary insurance brokers pushed for higher ceding commissions.
Starting in mid-2007, the U.S. residential mortgage market and the global credit and financial markets experienced serious disruptions, although some improvement was evident in the latter part of 2009 and in 2010. TRH's operating results and financial condition have been adversely affected and may continue to be adversely affected by this disruption. (See Disruption in Global Credit and Financial Markets.) However, the current global credit and financial markets may present attractive opportunities for strategic acquisitions and investments, particularly given TRH's strong capital position, financial resources and reputation, which TRH may, from time to time, evaluate and pursue.
TRH believes its most critical accounting estimates are those with respect to loss reserves, fair value measurements of certain financial assets, OTTI of investments and premium revenues, as they require management's most significant exercise of judgment on both a quantitative and qualitative basis in the
Estimates of loss reserves take into account TRH's assumptions with respect to many factors that will affect ultimate loss costs but are not yet known. The ultimate process by which actual carried reserves are determined considers not only actuarial estimates but a myriad of other factors. Such factors, both internal and external, which contribute to the variability and unpredictability of loss costs, include trends relating to jury awards, social inflation, medical inflation, worldwide economic conditions, tort reforms, court interpretations of coverages, the regulatory environment, underlying policy pricing, terms and conditions and claims handling, among others. In addition, information gathered through underwriting and claims audits is also considered. To the extent that these assumptions underlying the loss reserve estimates are significantly incorrect, ultimate losses may be materially different from the estimates included in the financial statements and may materially and adversely affect results of operations and financial condition. The impact of those differences is reflected in the period they become known.
While this process is difficult and subjective for ceding companies, the inherent uncertainties of estimating loss reserves are even greater for reinsurers, due primarily to the longer-term nature of much reinsurance business, the diversity of development patterns among different types of reinsurance treaties or facultative contracts, the necessary reliance on the ceding companies for information regarding reported claims and differing reserving practices among ceding companies, which can be subject to change without notice. Nevertheless, data received from cedants is subjected to audits periodically by TRH claims and underwriting personnel, to help ensure that reported data is supported by proper documentation and conforms to contract terms, and is analyzed, as appropriate, by TRH underwriting and actuarial personnel. Such analysis often includes a detailed review of reported data to assess the underwriting results of reinsurance assumed and to explain any significant departures from expected performance. Over time, reported loss information is ultimately corroborated when such information eventually attains paid status.
that of general inflation) and trends in court interpretations of coverage are among the factors which must be considered.
•Excess Casualty: The vast majority of this class consists of domestic treaties, including pro rata and excess-of-loss contracts of general liability business. Excess casualty is dominated by umbrella business, some of which have very high attachment points. This business is generally very long-tailed and characterized by relatively low frequency and high severity type losses. Therefore, expected loss ratio methods, such as the incurred B-F method, are heavily relied upon for most years due to the lack of mature reported experience in the most recent years and
•Shorter-tailed lines: These would include the property lines of business (such as fire and homeowners multiple peril), A&H and certain marine and energy classes. These lines are written by several of TRH's worldwide offices and the reserves are reviewed separately for each operating branch. Where sufficiently credible experience exists, these lines are reviewed after segregating pro rata contracts from excess-of-loss contracts. For a reinsurer, these lines do not develop to ultimate loss as quickly as when written on a primary basis; however, they are significantly shorter-tailed than the casualty classes discussed earlier. For these classes, a combination of loss development methods and B-F methods are used. Generally, selections for all but the most recent few years are based on loss development methods with the most recent years based on weightings of loss development and expected loss ratio indications.
groupings vary by branch and are reviewed annually to ensure a proper balance between homogeneity and credibility of data. In the loss development methods, paid and incurred losses by underwriting year are projected to an ultimate basis by applying appropriate age to ultimate development factors to the inception to date paid and incurred losses. The development factors are selected based on curves fitted to the historical average which best represent the data. In the B-F methods, estimates of unpaid and unreported losses are arrived at by multiplying underwriting year earned premium by an ELR and an estimated percentage of unpaid or unreported losses. These percentages of unpaid or unreported losses are derived from the loss development factors described above. These methods yield an indication of the ultimate losses for each underwriting year. The indicated incurred but not reported ("IBNR") reserve need is then determined (by year, by line of business) by subtracting the reported losses (which are equal to the sum of inception to date paid losses and the case reserves as of the balance sheet date) from the indicated ultimate losses.
An analysis of the sensitivity of the loss reserve indications to these key assumptions can be performed by measuring the effect of various changes to the assumptions utilized in the reviews. The assumptions made regarding factors considered in the sensitivity analysis, such as loss trends, ELRs and loss development factors, are generally consistent with TRH's historical experience. Loss development factors, for example, which are used to project reported paid and incurred losses to an ultimate incurred loss, are selected based on the curves fitted to the historical averages which best represent the data. ELRs are based on the ultimate loss ratios for the more mature years adjusted for changes in the rate levels and other quantifiable factors to enable the ELRs to remain consistent with historical experience. In general, it is believed that the vast majority of potential volatility in the loss reserves results from the longer-tailed lines of business. For the purpose of these sensitivity analyses, only the IBNR portion of loss reserves from these longer-tailed lines, which represent approximately 85% of the total IBNR portion of loss reserves at December 31, 2010, were included in the calculations. Additionally, only those underwriting years where it is believed reasonable for deviations from the original assumptions to occur were utilized. Generally, the last 15 years were included in the analysis. The results derived from the sensitivity analyses are roughly the same whether utilizing unpaid losses and loss adjustment expenses ("gross loss reserves") or net loss reserves.
While noting that there exists the potential for greater variations, TRH believes utilizing 5% and 10% changes to the assumptions made for both loss development factors and ELRs provide reasonable benchmarks for a sensitivity analysis of the loss reserve estimates at December 31, 2010. For example, changing the ELRs by 5 percentage points has an impact of about $230 million (either positively or negatively) on the loss reserve estimate. While less likely for many classes of business, TRH notes that changing the ELRs by 10 percentage points has an effect of about $470 million. As previously described, another key assumption is the selection of loss development patterns. The effect of increasing the tail on the selected loss development patterns by 5% is about $380 million. Similarly, a 10% deviation would impact the reserve estimate by about $745 million. Because a downward adjustment to the loss development patterns can result in implied negative future development on reported losses for certain years, this scenario is not believed to be as likely as that of an upward deviation of this amount.
Due to the assumptions and methodologies utilized by TRH in its reviews of longer-tailed classes of business, changes to the ELRs generally have a much greater impact on the assessment of loss reserves for the most recent few underwriting years while deviations from the loss development factors utilized in the reviews generally are more critical to the loss reserve indications for older underwriting years (i.e., 2002 and prior). Management believes that it is reasonable to simultaneously vary both of the assumptions previously discussed by 5% and 10%. The effect of varying these assumptions together by 5% is about $625 million. Increasing these assumptions by 10% simultaneously adds approximately $1.29 billion to the reserve estimates, although management considers this scenario to be significantly less likely than the 5% scenario previously discussed. TRH also notes that the classes of business for which these assumptions are most critical are medical malpractice, D&O, E&O and excess casualty.
See discussion of net development on losses occurring in prior years (which includes a discussion of the causative factors of such net development) under Results of Operations and further information about gross loss reserves under Financial Condition and Liquidity.
TRH measures at fair value on a recurring basis financial instruments included principally in its available for sale securities portfolios and certain short-term investments. The fair value of a financial instrument is the amount that would be received to sell an asset in an orderly transaction between willing, able and knowledgeable market participants at the measurement date.
The degree of judgment used in measuring the fair value of financial instruments generally correlates with the level of pricing observability. Financial instruments with quoted prices in active markets generally have more pricing observability and less judgment is used in measuring fair value. Conversely, financial instruments traded in other-than-active markets or that do not have quoted prices have less observability and are measured at fair value using valuation models or other pricing techniques that require more judgment. An active market is one in which transactions for the asset being valued occurs with sufficient frequency and volume to provide pricing information on an ongoing basis. An other-than-active market is one in which there are few transactions, the prices are not current, price quotations vary substantially either over time or among market makers, or in which little information is released publicly for the asset being valued. Pricing observability is affected by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established, the characteristics specific to the transaction and general market conditions. (See Note 3 of Notes to Consolidated Financial Statements ("Note 3") for the valuation techniques and inputs TRH uses to determine the fair value.)
Through June 30, 2009, the AIG Group managed the investments and performed investment recordkeeping and the valuation services discussed in Note 3 for TRH. Effective July 1, 2009, TRH employs third parties not affiliated with AIG to provide these services.
In making the assessment, TRH considers factors specific to the asset. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety.
See Note 4(g) of Notes to Consolidated Financial Statements ("Note 4(g)") for the criteria TRH uses to evaluate if an investment is a candidate for OTTI.
The determination that a security has incurred OTTI in value requires the judgment of management and consideration of the fundamental condition of the issuer, its near-term prospects and all the relevant facts and circumstances.
There can, however, be no assurance that TRH has accurately assessed the level of OTTI reflected in its financial statements. Furthermore, additional OTTI may need to be taken in the future. Historical trends may not be indicative of future OTTI.
At December 31, 2010, TRH had gross unrealized losses on all fixed maturities (including fixed maturities classified as held to maturity) and equities totaling $150 million which did not meet the criteria for OTTI charged to earnings. If TRH's determination of OTTI is materially incorrect, it could have a material adverse effect on TRH's results of operations.
TRH derives its revenue from two principal sources: premiums from reinsurance assumed net of reinsurance ceded (i.e., net premiums earned) and income from investments. The following table shows net premiums written, net premiums earned, net investment income, realized net capital gains (losses), (loss) gain on early extinguishment of debt and total revenue of TRH for the periods indicated:
International net premiums written in 2010 totaled $1.93 billion and remained level with 2009. Significant decreases in net premiums written occurred in the Miami ($36.5 million) and Paris ($35.7 million) branches, largely offset by significant increases in TRZ ($24.5 million) and the Hong Kong ($17.3 million) and Tokyo ($13.3 million) branches. Significant decreases in International net premiums written were recorded in the ocean marine ($26.9 million) and credit ($24.9 million) lines. These decreases
were largely offset by significant increases in the A&H ($35.1 million) and auto liability ($22.2 million) lines. Changes in foreign currency exchange rates decreased 2010 International net premiums written by $4.6 million compared to 2009. Excluding the impact of changes in foreign currency exchange rates, International net premiums written would have increased 0.1% in 2010 compared to 2009.
Net investment income in 2010 increased compared to 2009 due largely to an increase in investment income from fixed maturities of $25.1 million, offset by decreases in investment income from equities of $3.8 million and other investment income of $12.1 million. Excluding the impact of foreign currency exchange rate changes, net investment income in 2010 would have increased by 1.5% compared to 2009. The increase in investment income from fixed maturities is due in part to the investment of net operating cash inflows in recent periods. Net investment income in 2009 increased compared to 2008 due to an increase in investment results from other invested assets of $40 million, principally related to alternative investments. Excluding the changes in foreign currency exchange rates, net investment income in 2009 would have increased 8.1% compared to 2008. Net investment income from other invested assets can display greater volatility than other classes of investments. (See Note 4(d) of Notes to Consolidated
For 2010, 2009 and 2008, the pre-tax effective yields on investments were 3.7%, 4.1% and 3.8%, respectively. The pre-tax effective yield on investments represents net investment income divided by the average balance sheet carrying value of investments and interest-bearing cash. The decrease in the pre-tax effective yield on investments for 2010 compared to 2009 is due primarily to a lower pre-tax effective yield on the fixed maturity portfolio. The increase in the pre-tax effective yield on investments for 2009 compared to 2008 is due largely to increased investment income from other invested assets and the impact of securities lending invested collateral on the yield in 2008, partially offset by the decrease in pre-tax effective yield on fixed maturities for 2009 compared to 2008. Investment returns from securities lending invested collateral served to negatively impact the yield in 2008 by 0.3%, as the net return from the invested collateral is very small in relation to the balance sheet carrying amount because investment income earned from invested collateral is reduced by interest payable to the collateral provider. (See Investment Results in Item 1. Business.)
The property and casualty insurance and reinsurance industries use the combined ratio as a measure of underwriting profitability. The combined ratio reflects only underwriting results and does not include income from investments. Generally, a combined ratio under 100% indicates an underwriting profit and a combined ratio exceeding 100% indicates an underwriting loss. Underwriting profitability is subject to significant fluctuations due to competition, natural and man-made catastrophic events, economic and social conditions, foreign currency exchange rate fluctuations, interest rates and other factors. TRH's combined ratio and its components, for all periods in this Form 10-K, are presented in accordance with the methodology commonly used by insurance industry analysts and TRH's peers. The combined ratio represents the sum of the loss ratio and the underwriting expense ratio. The loss ratio represents net losses and LAE incurred expressed as a percentage of net premiums earned. The underwriting expense ratio represents the sum of the commission ratio and the other underwriting expense ratio. The commission
The following table presents loss ratios, underwriting expense ratios and combined ratios for consolidated TRH and each of TRH's reporting segments, for the years indicated:
The higher loss ratio for consolidated TRH in 2010 compared to 2009 is due principally to increased catastrophe costs, partially offset by increased favorable net loss reserve development. The lower loss ratio for consolidated TRH in 2009 compared to 2008 is due principally to lower catastrophe costs and increased favorable net loss reserve development. In the aggregate, catastrophe costs and net loss reserve development added (decreased) 3.9%, (0.9)% and 4.4% to (from) the consolidated TRH combined ratio in 2010, 2009 and 2008, respectively.
Based on information presently available, TRH's current loss reserves represent management's best estimate of ultimate losses, but there can be no assurance that TRH's loss reserves will not develop adversely due to, for example, the inherent volatility in loss trend factors and variability of reporting practices for those classes, among other factors, and materially exceed the carried loss reserves as of December 31, 2010 and thus, have a material adverse effect on future net income, financial condition and cash flows.
For 2010 compared to 2009, the change in gross and ceded losses and LAE incurred includes the changes in gross and ceded catastrophe losses as discussed in Note 10.
In addition, in 2009, TRH decreased its estimates of the ultimate amounts of net losses occurring in 2008 and prior years by $38.9 million. This net favorable development was comprised of net favorable development of $219.1 million for losses occurring in 2002 to 2008, partially offset by net adverse development of $180.2 million relating to losses occurring in 2001 and prior. The detail of the $38.9 million net favorable development by line of business relating to all prior years is presented in the table below:
(1)Amount of reestimation represents the (increase) decrease in net losses and LAE incurred in 2009 relating to losses occurring in 2008 and prior years.
Significant net favorable development was recorded for losses occurring in the allied lines and fire lines, each arising principally from losses occurring in 2007, and in the homeowners multiple peril and auto liability lines, each arising principally from losses occurring in 2005 to 2007. The line of business with the most significant net adverse development recorded in 2008 was the other liability line, arising principally
from losses occurring between 1997 and 2002, partially offset by favorable development from losses occurring in 2004 to 2006. The other liability line includes certain specialty casualty classes, such as D&O and E&O, and general casualty classes. In addition, significant net adverse development was recorded in 2008 for losses occurring in the medical malpractice line, arising principally from losses occurring in 1995 to 2001 and in 2006. (See Note 10 for amounts included in net adverse development that relate to catastrophe losses.)
On October 3, 2008, TRH adopted the Retention Plan covering a significant number of its employees, including its senior-most management. Salary expense incurred related to the Retention Plan totaled nil in 2010, $20 million in 2009 and $8 million in 2008. (See Note 19 of Notes to Consolidated Financial Statements.)
Deferred policy acquisition costs vary as the components of net unearned premiums change and the deferral rate changes. Policy acquisition costs, consisting primarily of commissions incurred, are charged to earnings over the period in which the related premiums are earned.
In November 2009, the Company issued $350 million principal amount of the 2039 Notes, all of which remains outstanding as of December 31, 2010. $692 million and $695 million principal amount of the 2015
Notes were outstanding at December 31, 2010 and 2009, respectively. Interest expense incurred and interest paid in connection with the Senior Notes is shown below:
The increased interest expense incurred and paid in 2010 compared to 2009 is due principally to the 2039 Notes.
Income before income taxes was $472.8 million in 2010, $596.0 million in 2009 and $3.2 million in 2008. The decrease in income before income taxes in 2010 compared to 2009 principally resulted from a decrease in underwriting profit, partially offset by realized net capital gains in 2010 compared to realized net capital losses in 2009. The decrease in underwriting profit is due principally to increased catastrophe costs, partially offset by increased favorable net loss reserve development. The net impact of increased catastrophe costs and increased favorable net loss reserve development was to decrease pre-tax underwriting profit in 2010 by $185.5 million compared to 2009.
The increase in income before income taxes in 2009 compared to 2008 resulted from a decrease in realized net capital losses and an increase in underwriting profit. The increase in underwriting profit is due to a decrease in catastrophe costs and an increase in favorable net loss reserve development in 2009. The net impact of decreased catastrophe costs and increased favorable net loss reserve development was to increase pre-tax underwriting profit in 2009 by $216.2 million compared to 2008.
Federal and foreign income tax expense (benefit) of $70.6 million, $118.4 million and ($99.0) million were recorded in 2010, 2009 and 2008, respectively. The 2008 tax benefit, which exceeds income before income taxes in 2008, resulted from the tax benefit generated by the significant amount of realized net capital losses occurring during the year, including the tax benefit on $100.3 million of tax capital loss carrybacks to prior years, in addition to the customary tax benefits associated with tax-exempt interest and the dividends received deduction.
TRH recognized income tax (benefits) expenses of ($70.9) million, $2.0 million and ($59.4) million relating to catastrophe costs occurring in 2010, 2009 and 2008, respectively.
Net income and net income per common share on a diluted basis are summarized below for the years indicated:
The performance of TRH is commonly assessed by analysts and others based on performance measures which are not defined under GAAP. Those measures include net operating income ("NOI"), NOI per Common Share (diluted) and operating return on equity ("Operating ROE"). NOI is defined as GAAP net income excluding realized net capital gains (losses) and the (loss) gain on early extinguishment of debt, net of taxes. NOI Per Common Share (diluted) represents NOI divided by average common shares outstanding on a diluted basis. Operating ROE is defined as NOI divided by the average of beginning and ending stockholders' equity. In addition, GAAP return on equity ("GAAP ROE") is defined as GAAP net income divided by the average of beginning and ending stockholders' equity. TRH uses these measures in analyzing its performance as these measures focus on the core fundamentals of TRH's operations. While TRH considers realized capital gains (losses) and the (loss) gain on early extinguishment of debt as integral parts of its business and results, such items are not indicative of the core fundamentals of TRH's operations. TRH believes these measures are of interest to the investment community because they provide additional meaningful methods of evaluating certain aspects of TRH's operating performance from period to period on bases that are not otherwise apparent under GAAP. These non-GAAP measures, namely, NOI, NOI Per Common Share (diluted) and Operating ROE should not be viewed as substitutes for GAAP net income, GAAP net income per common share on a diluted basis and GAAP ROE, respectively. Reconciliations of NOI, NOI Per Common Share (diluted) and Operating ROE to GAAP net
income, GAAP net income per common share on a diluted basis and GAAP ROE, respectively, the most directly comparable GAAP measures, are included below:
The decreases in NOI, NOI per Common Share (diluted) and Operating ROE in 2010 compared to 2009 is due largely to an increase in catastrophe costs in 2010. The increase in NOI, NOI per Common Share (diluted) and Operating ROE in 2009 compared to 2008 is due largely to a decrease in catastrophe costs in 2009.
2010 compared to 2009-Revenues increased slightly in 2010 due principally to realized net capital gains in 2010 compared to realized net capital losses in 2009, largely offset by a decrease in net premiums earned. The increase in realized net capital gains (losses) is due in part to a reduction in OTTI in 2010. The decrease in net premiums earned occurred principally in the medical malpractice, auto liability, A&H and property lines, partially offset by an increase in the other liability line.
Income before income taxes increased due principally to realized net capital gains in 2010 compared to realized net capital losses in 2009, partially offset by a decrease in underwriting profit and an increase in interest expense on the Senior Notes. The decrease in underwriting profit reflects increases in the expense ratio and the loss ratio. The increase in interest expense is due to increased interest expense on the 2039 Notes in 2010. Interest expense on the 2039 Notes was minimal in 2009.
partially offset by a decrease of $456 million in short-term investments. The increase in fixed maturities available for sale and the decrease in short-term investments are due in part to the reallocation of some short-term investments to fixed maturities. The increase in fixed maturities is also due in part to the investment of net operating cash inflows. The decrease in short-term investments is also due in part to the use of some proceeds from the sales or redemptions of short-term investments to repurchase shares of the Company's common stock pursuant to the Company's share repurchase program in 2010.
2009 compared to 2008-Revenues increased in 2009 due principally to a decrease in realized net capital losses, including OTTI write-downs, and, to lesser extents, increases in net investment income and net premiums earned. The reduction in realized net capital losses resulted in part from a decrease in OTTI write-downs as financial and credit markets stabilized and partially recovered from the turmoil at the end of 2008. The increase in net investment income in 2009 is largely due to an increase in results from other invested assets, principally related to alternative investments. The increase in net premiums earned in 2009 occurred primarily in the property and A&H lines offset in part by significant decreases in the medical malpractice and other liability lines. Income (loss) before income taxes for 2009 increased due primarily to a decrease in realized net capital losses and an increase in underwriting profit (loss). The increase in underwriting profit (loss) is largely due to a decrease in net catastrophe costs.
2010 compared to 2009-Revenues decreased due to decreases in net premiums earned. Revenues decreased in the London and Paris branches, partially offset by an increase in TRZ. The decrease in net premiums earned occurred principally in the property, ocean marine, boiler and machinery and credit lines, partially offset by significant increases in the A&H and other liability lines. Income before income taxes decreased largely due to a decrease in underwriting profit (loss). The decrease in underwriting profit (loss) reflects an increase in catastrophe costs, partially offset by a lower combined ratio excluding catastrophe costs.
includes net catastrophe costs of $112.3 million, principally related to the earthquake in Chile, the earthquake in New Zealand, storms and flooding in Australia and the Deepwater Horizon explosion. Net catastrophe costs in 2009 were insignificant.
Net catastrophe costs in 2009 were insignificant. 2008 includes net catastrophe costs of $22.1 million principally relating to Hurricane Ike, offset in part by favorable development on catastrophe events occurring in 2007 and 2005.
2010 compared to 2009-Revenues decreased in 2010 due largely to a decrease in net premiums earned and an increase in realized net capital losses. Revenues decreased in the Miami and Hong Kong branches, partially offset by increases in the Toronto and Tokyo branches. The decrease in net premiums earned occurred principally in the auto liability line, partially offset by a significant increase in the property line. Income before income taxes decreased due principally to a decrease in underwriting profit. The decrease in underwriting profit reflects increased catastrophe costs and an increase in the commission ratio.
In addition, while net premiums written were level in 2010 compared to 2009, changes in foreign currency exchange rates between the U.S. dollar and the currencies in which premiums are written increased net premiums written by $29.6 million in 2010 as compared to 2009.
2009 compared to 2008-Revenues increased in 2009 due largely to an increase in net premiums written, net of the change in unearned premiums and a decrease in realized net capital losses. Changes in foreign currency exchange rates between the U.S. dollar and the currencies in which premiums are written lessened the increase in net premiums written by $19.8 million in 2009 compared to 2008. The increase in net premiums earned occurred principally in the surety line along with relatively smaller increases spread across several lines. Significant increases in revenues occurred in the Tokyo and Toronto branches. Income before income taxes increased in 2009 due to an increase in underwriting profit and a decrease in realized net capital losses. The increase in underwriting profit generally reflects a lower loss ratio and a lower commission ratio.
(1)At December 31, 2010, includes gross unrealized gains of $0.4 million and gross unrealized losses of ($22.9) million on fixed maturities rated below BBB and gross unrealized gains of $0.5 million and insignificant gross unrealized losses on fixed maturities which are not-rated. At December 31, 2009, includes no gross unrealized gains and gross unrealized losses of ($34.0) million on fixed maturities rated below BBB and gross unrealized gains of $1.0 million and gross unrealized losses of ($1.0) million on fixed maturities which are not-rated.
The components of gross loss reserves as of December 31, 2010 and 2009 by major class of business, split between the case portion and the IBNR portion is presented below:
(1)A large majority of the amounts within the other liability line relates to complex risks such as E&O and D&O, to general casualty risks and, to a much lesser extent, environmental impairment liability. Gross loss reserves represent the accumulation of estimates for losses occurring on or prior to the balance sheet date. Gross case reserves are principally based on reports and individual case estimates received from ceding companies. The IBNR portion of gross loss reserves is based on past experience and other factors. The methods used to determine such estimates and to establish the resulting reserves are continually reviewed and updated. Any adjustments are reflected in income currently.
Net loss reserves totaled $8.21 billion at December 31, 2010, an increase of $342.9 million, or 4.4%, from the prior year-end. The overall increase in net loss reserves was mitigated by the exchange rate impact of changes in certain foreign currency exchange rates against the U.S. dollar since the end of 2009 which served to decrease net loss reserves by $131.4 million. An analysis of the change in net loss reserves from year-end 2009 to year-end 2010 is included in Note 6 of Notes to Consolidated Financial Statements.
Net loss reserves include amounts for risks relating to environmental impairment and asbestos-related illnesses totaling $212 million and $163 million at December 31, 2010 and 2009, respectively, including $71 million and $30 million at the aforementioned dates, respectively, relating to such losses occurring in 1985 and prior. As TRC, the major operating subsidiary of the Company, commenced operations in 1978, the majority of TRH's environmental and asbestos-related net loss reserves arose from contracts entered into after 1985 that were underwritten specifically as environmental or asbestos-related coverages rather than as standard general liability coverages, where the environmental or asbestos-related liabilities were neither clearly defined nor specifically excluded. The reserves carried for these claims, including the IBNR portion, are based upon known facts and current law. However, significant uncertainty exists in determining the amount of ultimate liability for environmental impairment and asbestos-related losses, particularly for those occurring in 1985 and prior. This uncertainty is due to inconsistent court resolutions and judicial interpretations with respect to underlying policy intent and coverage and uncertainties as to the allocation of responsibility for resultant damages, among other things.
Because the reserving process is inherently difficult and subjective, actual losses may materially differ from reserves and related reinsurance recoverables reflected in TRH's consolidated financial statements, and, accordingly, may have a material effect on future results of operations, financial condition and cash flows. And while there is also the possibility of changes in statutes, laws, regulations and other factors that could have a material effect on these liabilities and, accordingly, the financial statement elements cited immediately above, TRH believes that its loss reserves carried at December 31, 2010 are adequate.
URA, net of tax, is subject to significant volatility resulting from changes in the fair value of fixed maturities available for sale, equities available for sale and other invested assets. Fair values may fluctuate due to changes in general economic and political conditions, market interest rates, prospects of investee companies and other factors.
In November 2009, the Company issued $350 million principal amount of the 2039 Notes, all of which remains outstanding as of December 31, 2010 and 2009. In 2010 and 2009, TRH repurchased $3 million and $30 million, respectively, principal amount of the 2015 Notes. $692 million and $695 million principal amount of the 2015 Notes were outstanding at December 31, 2010 and 2009, respectively. (See Note 7 for the (losses) gains realized on the early extinguishment of the 2015 Notes.)
(1)Includes anticipated interest payments. (2)Represents commitments to provide funding to a non-U.S. reinsurer (see Note 18 of Notes to Consolidated Financial Statements) and to invest in limited partnerships. With respect to commitments and contingent liabilities, see Note 18 of Notes to Consolidated Financial Statements.
Risk Based Capital ("RBC") standards, promulgated by the National Association of Insurance Commissioners ("NAIC"), relate an individual company's statutory policyholders' surplus to the risk inherent in its overall operations and set thresholds at which certain company and regulatory corrective actions are mandated. At December 31, 2010 the statutory surpluses of TRC and Putnam each exceeded the level of surplus required under RBC requirements for regulatory attention.
"Florida, Wind" has the highest modeled after-tax net catastrophe costs arising out of events with a 1.0% probability of being exceeded and would represent 9.1% of TRH's stockholders' equity at December 31, 2010. "Florida, Wind" has the highest modeled after-tax net catastrophe costs arising out of events with a 0.4% probability of being exceeded and would represent 16.1% of TRH's stockholders' equity at December 31, 2010. If multiple severe catastrophic events occur in any one year, the potential economic cost to the company could be materially higher than any one of the amounts shown above.
See Note 10 for catastrophe costs incurred in 2010, 2009 and 2008.
These issues carry risk relating to certain lines of business TRH underwrites because disruption in the credit and financial markets may increase claim activity in lines such as D&O, E&O, credit, and to a limited extent mortgage guaranty business, among others. TRH also participates in the mortgage market through investments in mortgage-backed securities.
The operating results and financial condition of TRH have been and may continue to be adversely affected by factors related to the market disruptions referred to above, among others. The duration and severity of the downward cycle could extend further if there is an increase in the severity of the economic difficulties being experienced around the world, including the U.S. Continued difficulties in the economy may have an adverse effect on TRH's operating results in the future. The impact on TRH's operations with exposure to the credit and financial markets will be somewhat dependent on future market conditions.
See Note 2(k) of Notes to Consolidated Financial Statements for a discussion of recent accounting standards and their application to TRH.
Consolidated Statements of Operations For the Years Ended December 31, 2010, 2009 and 2008
Consolidated Statements of Stockholders' Equity For the Years Ended December 31, 2010, 2009 and
Consolidated Statements of Comprehensive Income (Loss) For the Years Ended December 31, 2010, 2009 and
TRH, through its primary operating subsidiaries TRC, TRZ and Putnam, offers reinsurance capacity for a full range of property and casualty products to insurers and reinsurers on a treaty and facultative basis, with an emphasis on specialty classes. Including domestic as well as international risks, TRH's principal lines of business are other liability (including directors' and officers' liability ("D&O"), errors and omissions liability ("E&O") and general casualty), medical malpractice, ocean marine and aviation, auto liability (including non-standard risks), accident and health and surety and credit in the casualty lines, and fire, allied lines, auto physical damage and homeowners multiple peril lines in the property lines (which include property catastrophe risks). Casualty lines represented 70.7%, 71.3% and 69.8% of net premiums written in 2010, 2009 and 2008, respectively. The balance represented property lines.
Subsequent events through the time of filing of this Form 10-K were evaluated for potential recognition or disclosure in the financial statements. (See Note 21.)
Correction of Amortized Cost or Cost of Certain Fixed Maturities and Equities Denominated in Functional Currencies
In the first quarter of 2010, it was determined that as of December 31, 2009 the amortized cost of fixed maturities and cost of equities available for sale that were denominated in functional currencies were incorrectly translated into the reporting currency (i.e., U.S. dollars) using historical, rather than period-end, foreign currency exchange rates. This practice, which began in the third quarter of 2009, resulted in an understatement of amortized cost or cost of such investments of $98.1 million ($80.1 million relating to fixed maturities and $18.0 million relating to equities) as of December 31, 2009. Thus, net unrealized appreciation of investments, net of tax, (a component of accumulated other comprehensive income ("AOCI") on the Balance Sheet) was overstated by $63.7 million as of December 31, 2009 with an equal and offsetting overstatement of net unrealized currency translation loss, net of tax (also a component of AOCI). The related components of other comprehensive income (loss) ("OCI") were similarly affected, with no net effect on OCI. The error discussed above had no net effect on AOCI, stockholders' equity, net income, comprehensive income or cash flows for 2009.
As of December 31, 2010, the amortized cost of fixed maturities and cost of equities available for sale that are denominated in functional currencies were properly translated into the reporting currency using period-end foreign currency exchange rates. However, as the correction of the treatment discussed earlier occurred in 2010, both net unrealized depreciation of investments, net of tax, and net unrealized currency translation gain, net of tax, in the 2010 Statement of Comprehensive Income include $63.7 million related to this correction, with no net effect on OCI. In addition, this correction had no net impact on AOCI and stockholders' equity as of December 31, 2010 nor did it have any net impact on net income, comprehensive income or cash flows for 2010.
The preparation of financial statements in conformity with GAAP requires the use of estimates and assumptions that affect the reported amounts and related disclosures. TRH relies on historical experience and on various other assumptions that it believes to be reasonable, under the circumstances, to make judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates.
TRH believes its most critical accounting estimates are those with respect to loss reserves, fair value measurements of certain financial assets, other-than-temporary impairments ("OTTI") of investments and premium revenues, as they require management's most significant exercise of judgment on both a quantitative and qualitative basis in the preparation of TRH's consolidated financial statements and footnotes. The accounting estimates that result require the use of assumptions about certain matters that are highly uncertain at the time of estimation. To the extent actual experience differs from the assumptions used, TRH's results of operations and financial condition would be affected, possibly materially.
as yield adjustments over their estimated lives, until maturity or call date, if applicable. Equities are carried at fair value. See Note 3 for TRH's methodology for determining the fair value of its investments.
Other invested assets primarily include alternative investments in which TRH holds a 5% or greater interest or where TRH has more than a minor influence over operations of the investee and TRH's 40% interest in Kuwait Reinsurance Company (K.S.C.). Such investments are accounted for on the equity method. In applying the equity method of accounting, TRH consistently uses the most recently available financial information for each of these investments for the period ended one to three months prior to the end of TRH's reporting period. The financial statements of these investees are generally audited on an annual basis. The carrying value of such investments represents TRH's share of the net asset value of these entities. The changes in such net asset values for investments carried on the equity method, other than the portion related to TRH's share of the investees' changes in AOCI, are recorded in net investment income. In each of 2010 and 2009, the fair value option was elected for one investment. These investments are carried at fair value and unrealized gains and losses on these investments are reported in earnings through net investment income.
Through 2008, TRH participated in a securities lending program (the "Securities Lending Program") managed by a subsidiary of AIG, whereby certain securities (principally fixed maturities available for sale) from its portfolio were loaned to third parties. Under such program, TRH loaned securities to counterparties and received collateral, generally cash, which was invested to earn a spread. The collateral was returned to the counterparties when the loaned securities were returned to TRH at a future date. In the fourth quarter of 2008, TRH terminated its participation in the Securities Lending Program.
In periods subsequent to the recognition of OTTI on fixed maturity securities, which are not credit related, TRH generally accretes the discount or amortizes the reduced premium resulting from the reduction in cost basis into income over the remaining life of the security.
Cash and cash equivalents, which are principally interest-bearing, generally include cash deposited in demand deposits at banks and highly liquid investments with original maturities of 90 days or less.
Transaction gains and losses on assets and liabilities denominated in foreign currencies are recorded as a component of realized net capital gains (losses) during the period in which they occur.
For all other impaired fixed maturities, this guidance requires entities to develop a best estimate of the present value of expected cash flows on a security by security basis. Entities must recognize OTTI equal to the difference between the present value of expected cash flows and the amortized cost basis of the security, if the results of the cash flow analysis indicate the entity will not recover the full amount of its amortized cost basis in the investment. This amount is the credit component of the OTTI and is recorded in earnings as a realized capital loss. The difference between the total unrealized loss position on the security and the OTTI amount recognized in earnings is non-credit related and is recorded in OCI as "net unrealized holding losses of fixed maturities on which other-than-temporary impairments were taken".
TRH adopted this guidance effective April 1, 2009. Upon adoption, this guidance required entities to assess the credit versus non-credit components of previously recognized OTTI on fixed maturities still held, and for which the entity did not intend to sell or more likely than not would not be required to sell prior to an anticipated recovery in fair value. The cumulative amount of non-credit related OTTI amounts on these securities, net of income tax effect, was recorded as an increase to retained earnings and an equal and offsetting reduction to AOCI as of April 1, 2009, with no net change to total stockholders' equity. TRH recorded a cumulative effect adjustment ("CEA") of $110.1 million, or $71.6 million, net of tax, related to its adoption of this guidance. The adoption of this guidance did not have a material effect on TRH's consolidated financial condition, results of operations, comprehensive income or cash flows.
In January 2010, the FASB issued new accounting guidance on disclosures about fair value measurements. This guidance requires the amounts and reasons for significant transfers in and out of Levels 1 and 2 to be discussed. In addition, a greater level of disaggregation of asset and liability classes is required in fair value measurement disclosures. For fair value measurements that fall in either Level 2 or Level 3, a reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. TRH adopted this portion of the guidance in the first quarter of 2010. The adoption of this guidance had no effect on TRH's consolidated financial condition, results of operations or cash flows.
In addition, for activity within Level 3, this guidance requires that purchases, sales, issuances and settlements be presented separately rather than as one net amount, as currently permitted. For TRH, these disclosures are effective for interim and annual periods beginning after December 15, 2010. The adoption of this guidance is expected to have no effect on TRH's results of operations, financial condition or cash flows.
(4)Adoption of new accounting guidance on the consolidation of variable interest entities ("VIE") (ASU 2009-17)
In June 2009, the FASB issued new accounting guidance on the consolidation of VIE. This guidance makes significant changes to an enterprise's analysis to determine whether the enterprise's variable interest or interests give it a controlling financial interest in a VIE. This guidance replaces the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a VIE with an approach focused on identifying which enterprise has the power to direct the activities of a VIE that most significantly impacts the entity's economic performance and the obligation to absorb losses of the entity or the right to receive benefits from the entity. Additionally, this guidance adds an additional reconsideration event for determining whether an entity is a VIE, requires ongoing assessments of whether an enterprise is the primary beneficiary of a VIE and requires additional disclosures about an enterprise's involvement in the VIE. TRH adopted this guidance in the first quarter of 2010 with its provisions applied prospectively. The adoption of this guidance did not have a material effect on TRH's consolidated financial condition, results of operations or cash flows.
(6)Adoption of new accounting standard on disclosures about the credit quality of financing receivables and the allowance for credit losses (ASU 2010-20)
In July 2010, the FASB issued new accounting guidance on disclosures about the credit quality of financing receivables and the allowance for credit losses. This guidance requires additional disclosures to facilitate the evaluation of the nature of an entity's credit risk and the determination of and changes in the entity's allowance for credit losses. TRH adopted this guidance in the fourth quarter of 2010. The adoption of this guidance had no effect on TRH's consolidated financial condition, results of operations or cash flows.
Fair values for fixed maturity securities based on observable market prices for identical or similar instruments implicitly include the incorporation of counterparty credit risk. Fair values for fixed maturity securities based on internal models would incorporate counterparty credit risk by using
(2)Certain Short-Term Investments Short-term investments are carried at cost or amortized cost, which approximates fair value, and principally include money market instruments, treasury bills and commercial paper. These instruments are typically not traded in active markets; however, their fair values are based on market observable inputs.
•Level 1: Fair value measurements that are quoted prices (unadjusted) in active markets that TRH has the ability to access for identical assets. Market price data generally is obtained from exchange or dealer markets. Assets measured at fair value on a recurring basis and classified as Level 1 principally include actively traded listed common stocks and mutual funds (which are included on the balance sheet in equities available for sale).
•Level 2: Fair value measurements based on inputs other than quoted prices included in Level 1 that are observable for the asset, either directly or indirectly. Level 2 inputs include quoted prices for similar assets in active markets and inputs other than quoted prices that are observable for the asset, such as interest rates and yield curves that are observable at commonly quoted intervals. Assets measured at fair value on a recurring basis and classified as Level 2 generally include most government and government agency securities, state, municipal and political subdivision obligations, most investment-grade and high-yield corporate bonds, most residential mortgage-backed securities ("RMBS"), most commercial mortgage-backed securities ("CMBS"), certain other asset-backed securities and most short-term investments.
recurring basis and classified as Level 3 principally include certain RMBS, CMBS, other-asset backed securities and other invested assets.
In 2010, there were no transfers in or out of Level 1, $64.2 million of transfers into Level 2 from Level 3 and $10.8 million of transfers out of Level 2 into Level 3. In 2009, there were no transfers in or out of Level 1, $14.2 million of transfers into Level 2 from Level 3 and $39.5 million of transfers out of Level 2 into Level 3. The transfers into Level 2 from Level 3 in 2010 were due to an increase in observable inputs related to the valuation of such securities. No other transfers in 2010 and 2009 were significant.
Both observable and unobservable inputs may be used to determine the fair values of positions classified in Level 3. As a result, the unrealized gains and losses on instruments held at December 31, 2010 and 2009 may include changes in fair value that were attributable to both observable inputs (e.g., changes in market interest rates) and unobservable inputs (e.g., changes in unobservable long-dated volatilities).
Net unrealized depreciation related to Level 3 investments approximated $6.7 million and $23.9 million at December 31, 2010 and 2009, respectively.
None of TRH's assets were written down to fair value on a non-recurring basis during 2010 and 2009.
Investments with carrying values of $574 million and $606 million at December 31, 2010 and 2009, respectively, were deposited with governmental authorities as required by law. The substantial majority of these deposits are fixed maturities and common stocks available for sale.
(1)Represents the non-credit portion of OTTI, not adjusted for subsequent changes in unrealized gains or losses, taken on securities still held as of year-end (including the pre-tax CEA, see Note 2(k)), pursuant to accounting guidance adopted on April 1, 2009. See Note 2(k) for additional information.
At December 31, 2010 and 2009, net unrealized appreciation (depreciation) of equities available for sale included gross gains of $92.5 million and $67.8 million, respectively, and gross losses of ($4.5) million and ($2.1) million, respectively. (See Note 2(a) of Notes to Consolidated Financial Statements.)
(1)Asset-backed fixed maturities by their nature do not generally have single maturity dates.
Equity securities sold at a loss in 2010, 2009 and 2008 were in a continuous unrealized loss position for 12 months or less and did not meet the conditions of TRH's accounting policy to be considered OTTI at any quarter-end prior to the time of sale. (See Note 4(g) for the criteria TRH uses to evaluate if an equity investment is considered OTTI.) TRH's equity security investment strategy includes the intent to optimize total investment return through active management, which can lead to selling securities at a gain or loss due to changing market conditions and as market opportunities arise.
As of December 31, 2010 and 2009, the aging of the gross unrealized losses with respect to all fixed maturities, including both held to maturity and available for sale, and equities available for sale, grouped by months in a continuous unrealized loss position, was as follows:
•Securities with gross unrealized losses were valued, in the aggregate, at approximately 95.7% of their current cost or amortized cost. •Approximately 98.5% of these securities had unrealized losses of less than or equal to 20% of their current cost or amortized cost. •Approximately 0.9% of the fixed maturity securities had issuer credit ratings which were below investment grade or not rated.
At December 31, 2010, TRH held 387 and 66 individual fixed maturity and equity investments, respectively, that were in an unrealized loss position, of which, 92 individual fixed maturity investments were in a continuous unrealized loss position for 12 months or more.
As of December 31, 2010 and 2009, no single issuer accounted for more than 11% and 10%, respectively, of the aggregate gross unrealized losses.
•Trading at a significant (25% or more) discount to par, amortized cost (if lower) or cost for an extended period of time (nine consecutive months or longer);
OTTI on all investments other than fixed maturities are recognized through earnings as a realized capital loss. OTTI on fixed maturities prior to the second quarter of 2009 were recognized through earnings as a realized capital loss. Effective in the second quarter of 2009, at each balance sheet date, TRH recognizes an OTTI on a fixed maturity in an unrealized loss position if (a) TRH intends to sell the security; (b) it is more likely than not TRH will be required to sell the security prior to an anticipated recovery in fair value, in order to meet a liquidity, regulatory or other business need; or (c) TRH determines it will not recover the entire amortized cost basis of the security.
If TRH intends to sell an impaired fixed maturity security, or if it is more likely than not it will have to be sold, the total amount of the unrealized loss position is recognized in earnings as a realized capital loss. On a quarterly basis, TRH develops for fixed maturities, a best estimate of the present value of expected cash flows on a security by security basis. If the results of the cash flow analysis indicate TRH will not recover the full amount of its amortized cost basis in the investment, TRH recognizes OTTI equal to the difference between the present value of expected cash flows and the amortized cost basis of the security. This amount is the credit component of the OTTI and is recorded in earnings as a realized capital loss. The difference between the total unrealized loss position on the security and the OTTI amount recognized in earnings is non-credit related and is recorded in OCI as "net unrealized holding losses of fixed maturities on which other-than-temporary impairments were taken".
If a loss is recognized from a sale subsequent to a balance sheet date pursuant to changes in circumstances, the loss is recognized in the period in which the intent to hold the security to recovery no longer existed.
TRH evaluated the significant categories of fixed maturity investments in an unrealized loss position for OTTI. For state, municipality and political subdivision securities, TRH takes into account the taxing power of the issuer, source of revenue, credit risk and credit enhancements and pre-refunding. For asset-backed securities, TRH discounted its best estimate of future cash flows at an effective rate equal to the original effective yield of the security. Those models included TRH's assumptions about prepayment speeds, default and delinquency rates, and underlying collateral (if any), as well as credit ratings, credit enhancements and other observable market data. For corporate fixed maturities, TRH reviewed business prospects, credit ratings and available information from asset managers and rating agencies for individual securities.
At December 31, 2010, the large majority of fixed maturities in an unrealized loss position consist of highly-rated state, municipality or political subdivision, corporate and asset-backed fixed maturities. TRH did not consider the unrealized losses on these impaired fixed maturities to be credit related. In making these determinations, TRH has considered factors specific to the securities that have unrealized losses coupled with TRH's history of consistently strong operating cash flows, levels of cash, cash equivalents and liquid investment classes, as well as its short and medium-term cash needs. TRH does not intend to sell these securities, and will not likely be required to sell these securities before an anticipated recovery in fair value. Other considerations included the length of time and extent to which the security has been in an unrealized loss position, observable adverse conditions specifically related to the issuer or industry sector of the security, conditions in the country of issuance or primary market for the security, historical and implied volatility of the security's fair value, defaults on principal or interest payments, and recoveries or further declines in fair value subsequent to the balance sheet date.
included in net investment income. As a result of conditions affecting the financial and credit markets, in the fourth quarter of 2008, counterparties were successful in negotiating significantly reduced collateral levels (i.e., collateral received as a percentage of the fair value of the security loaned). Due to the lower collateral levels, during the fourth quarter of 2008, many of such loaned securities were accounted for as sales at the time of transfer and as purchases when the securities were subsequently returned. The sale and return of such securities resulted in realized net capital losses of $16 million in 2008.
In 2008, TRH repaid certain securities lending payables using cash from sources other than the sale of securities lending invested collateral. In that regard, fixed maturities were transferred from the securities lending invested collateral portfolio to the fixed maturities available for sale portfolio. Such transferred securities included CMBS, RMBS and other asset-backed securities.
The Company files a U.S. consolidated federal income tax return with its domestic subsidiaries, which includes foreign operations. TRC will include as part of its taxable income those items of income of the non-U.S. subsidiary, TRZ, which are subject to U.S. income tax currently, pursuant to Subpart F income rules of the Internal Revenue Code, and included, as appropriate, in the consolidated federal income tax return.
The U.S. federal income tax rate was 35% for 2010, 2009 and 2008. Actual tax expense (benefit) on income before income taxes differs from the "expected" amount computed by applying the U.S. federal income tax rate because of the following:
Income (loss) before income taxes from Domestic operations was $354.1 million, $327.1 million and ($263.9) million in 2010, 2009 and 2008, respectively. Income before income taxes from foreign operations was $118.7 million, $269.0 million and $267.1 million in 2010, 2009 and 2008, respectively.
tax benefit on $100.3 million of tax capital loss carrybacks to prior years. The actual capital loss included in the 2008 U.S. consolidated tax return was $114.0 million. The 2009 tax expense includes an adjustment to align the amounts reflected in the 2008 tax expense with the amounts included in the 2008 income tax return. In addition, the 2008 deferred tax benefit includes the reversal of a previously recorded minimum tax credit carryforward in the amount of $15.0 million.
The components of the net deferred income tax asset at December 31, 2010 and 2009 were as follows:
Interest and penalties relating to unrecognized tax expenses (benefits) are recognized in income tax expense, when applicable. There was no liability for interest or penalties accrued as of December 31, 2010. In 2010, $9.6 million of interest, net of tax, was received on tax refunds. As of December 31, 2009, there was $10.2 million of interest, net of tax, receivable on income taxes. In 2010, current income tax expense was increased by approximately $0.5 million to align the interest, net of tax, receivable at December 31, 2009 with the amount actually received in 2010. Current income tax expense was reduced by $1.1 million and $3.7 million of interest on net tax refunds in 2009 and 2008, respectively.
The total income taxes recovered in 2010 of $131.1 million consist of a $109.0 million refund of federal income taxes related to amended tax returns for prior tax years and $22.1 million of refund claims related to capital loss carrybacks to certain other prior tax years. Income taxes recovered (paid), net, in 2010, 2009 and 2008 consisted of:
2010 includes net catastrophe losses incurred of $203.7 million, principally relating to the earthquake in Chile, the earthquake in New Zealand, storms and flooding in Australia and the Deepwater Horizon explosion. In addition, in 2010, TRH decreased its estimates of the ultimate amounts of net losses occurring in 2009 and prior years by $57.0 million. This net favorable development was comprised of net favorable development of $216.9 million for losses occurring in 2002 to 2009, offset by net adverse development of $159.9 million relating to losses occurring in 2001 and prior.
Net favorable development was recorded for losses occurring in the fire ($70.1 million), surety and credit ($54.8 million) and ocean marine ($45.8 million) lines, each arising principally from losses occurring in 2005 to 2009. Significant net adverse development was recorded in 2010 in the other liability line ($116.7 million), arising principally from losses occurring in 2002 and prior, partially offset by favorable development from losses occurring between 2003 and 2006. The other liability line includes certain specialty casualty classes, such as D&O and E&O, and general casualty classes. In addition, net adverse development was recorded in 2010 for losses occurring in the fidelity ($32.1 million) line, arising principally from losses occurring in 2006 to 2009.
The favorable development in 2005 through 2009 results generally from favorable loss trends. The net adverse development arising from losses occurring in 2001 and prior, generally relates to various excess casualty lines such as general liability and excess umbrella liability which were impacted by late reported excess claims.
casualty lines such as general liability and excess umbrella liability which were impacted by late reported high layer excess claims. Ceding companies and their reinsurers continue to experience increased loss costs relative to expectations as loss emergence patterns continue to lengthen as regards the soft market years of 1997 through 2001.
Significant net favorable development was recorded for losses occurring in the allied lines ($43.6 million) and fire ($11.6 million) lines, each arising principally from losses occurring in 2007, and in the homeowners multiple peril ($17.0 million) and auto liability ($13.2 million) lines, each arising principally from losses occurring in 2005 to 2007. The line of business with the most significant net adverse development recorded in 2008 was the other liability line ($79.6 million), arising principally from losses occurring between 1997 and 2002, partially offset by favorable development from losses occurring in 2004 to 2006. The other liability line includes certain specialty casualty classes, such as D&O and E&O, and general casualty classes. In addition, significant net adverse development was recorded in 2008 for losses occurring in the medical malpractice ($35.4 million) line, arising principally from losses occurring in 1995 to 2001 and in 2006.
Net catastrophe costs in 2010 principally relate to the earthquake in Chile, the earthquake in New Zealand, storms and flooding in Australia and the Deepwater Horizon explosion. There were no significant net catastrophe costs for events occurring during 2009. Net catastrophe costs in 2008 principally related to Hurricane Ike. Net catastrophe costs also include estimated changes in net catastrophe costs incurred relating to events occurring in prior years.
Through 2009, TRH's employees participated in certain benefit plans sponsored by the AIG Group, including noncontributory defined benefit ("DB") pension plans, defined contribution ("DC") pension plans and other postretirement benefit plans. A substantial majority of TRH's employees were eligible to participate in these plans. Certain of the pension plans were multiemployer plans in that they do not separately identify plan benefits and plan assets attributable to participating companies. For such plans, only contributions paid or accrued were charged to expense.
In 2009, the Board of Directors (the "Board") adopted, and the stockholders approved, the Transatlantic Holdings, Inc. 2009 Long Term Equity Incentive Plan (the "2009 Plan"). The 2009 Plan permits the granting of stock options, stock appreciation rights ("SARs"), restricted stock, restricted stock units, performance awards and share awards. The maximum number of shares available for grant under the 2009 Plan is 2,600,000 shares, of which no more than 1,000,000 may be issued in the form of incentive stock options. In addition, the maximum number of options, SARs, performance-based restricted stock units
("Performance RSUs") and performance share units granted to an individual in any three year calendar period may not exceed 1,000,000 and the maximum dollar amount of cash or the fair market value of shares that any individual may receive in any calendar year in respect to performance units may not exceed $5 million. As of December 31, 2010, there were 1,019,370 shares of common stock available for issuance (no more than 1,000,000 of which may be incentive stock options) in connection with future grants of awards under the 2009 Plan. Shares available for future issuance assume participants will earn the maximum number of Performance RSUs until the actual amounts are determined, at which time, such shares available amount will be adjusted accordingly.
The impact on the financial statements of the Stock Purchase Plan and the Sharesave Plan was not material to TRH in 2010, 2009 and 2008. A discussion of the more significant stock-based compensation awards follows.
Options to purchase the Company's common stock ("TRH shares") were granted to certain key employees and non-employee directors at prices not less than the New York Stock Exchange ("NYSE") closing price on the date of grant under the 2000 Plan. In general, 25% of the options become exercisable on the anniversary date of the grant in each of the four years following the grant and expire 10 years from the date of grant.
No options were granted in 2010 or 2009. 197,500 options were granted in 2008. The fair value of each option grant is estimated on the date of grant using a binomial option pricing model. The weighted average grant date fair value and the weighted average assumptions which were used in the calculation for options granted in 2008 were as follows:
The expected volatility was based on the historical volatility of TRH shares. The risk-free interest rate was based on the U.S. treasury yield curve in effect at the time of grant. The dividend yield was based on the dividend yield over the twelve month period prior to the grant date. The expected term was calculated based on historical data on employee exercise behavior.
A summary of the status of options granted as of December 31, 2010 and the changes since January 1, 2010 is presented below:
The number of Service RSUs granted and vested in 2010, 2009 and 2008 were as follows:
As of December 31, 2010, there was $25.8 million of total unrecognized compensation costs relating to Performance RSUs granted but not yet vested. Compensation expense for Performance RSUs is recognized on a straight-line basis. These costs are expected to be recognized over a weighted average period of 2.0 years.
Prior to June 10, 2009 and as of December 31, 2008, AIG beneficially owned approximately 59% of the Company's outstanding shares. On June 10, 2009, AIG and AHAC, a wholly owned subsidiary of AIG, consummated the June 2009 Offering of 29.9 million issued and outstanding shares of the common stock of the Company owned by AIG and AHAC. According to the Form 13F filed on February 18, 2010 by AIG, as of December 31, 2009, the AIG Group had sole voting authority over 9.2 million shares of the Company's common stock, representing approximately 13.8% of the Company's outstanding shares as of December 31, 2009.
On March 15, 2010, AHAC consummated the March 2010 Offering of 8.5 million issued and outstanding shares of the Company's common stock owned by AHAC. The Company repurchased two million shares of its common stock from AHAC in the March 2010 Offering pursuant to a stock offering agreement for an aggregate purchase price of approximately $105 million. TRH did not receive any proceeds from the Secondary Offerings. Immediately following the March 2010 Offering, the AIG Group, including AHAC, beneficially owned 0.7 million shares of the Company's common stock (excluding shares held by certain mutual funds that are advised or managed by subsidiaries of AIG), representing approximately 1.1% of the Company's then outstanding shares. As a result of its reduced ownership percentage, the AIG Group was no longer considered a related party after March 15, 2010.
Gross premiums written originated by the AIG Group and ceded to TRH from contracts that were entered into while the AIG Group was a related party totaled approximately $196 million (4.8%), $263 million (6.3%) and $310 million (7.0%) in 2010, 2009 and 2008, respectively. These amounts exclude (a) premiums assumed that initially were insured by AIG subsidiaries as a result of TRH's marketing efforts and then ceded to TRH by prearrangement; (b) amounts assumed from an AIG subsidiary and ceded in an equal amount to other AIG subsidiaries; and (c) all premiums from contracts that were effective after March 15, 2010. The amount of premiums assumed that initially were insured by AIG subsidiaries as a result of TRH's marketing efforts and then ceded to TRH by prearrangement are not material. (See Note 16 for the amount of premiums assumed from an AIG subsidiary and ceded in an equal amount to other AIG subsidiaries.)
In 2009 and 2008, TRH's employees participated in certain benefit plans administered by the AIG Group. (See Note 12.)
In the normal course of business, TRH generally purchases reinsurance from its retrocessionnaires to reduce the effect of individual or aggregate losses, to reduce volatility in specific lines, to improve risk adjusted portfolio returns and to increase gross premium writings and risk capacity without requiring additional capital.
(1)Premiums written and earned that were ceded to related parties represent amounts from contracts with the AIG Group with effective dates of March 15, 2010 or earlier. Such ceded premiums principally represent amounts which, by prearrangement with TRH, were assumed from an AIG subsidiary and then ceded in an equal amount to other AIG subsidiaries. (See Note 14.) (2)See Note 10 for gross and ceded catastrophe losses. (3)Gross incurred losses and LAE and reinsured losses and LAE ceded include $41 million, $40 million and $62 million in 2010, 2009 and 2008, respectively, related to premiums which, by prearrangement with TRH, were assumed from an AIG subsidiary and then ceded in an equal amount to other AIG subsidiaries. Amounts recoverable from retrocessionnaires are recognized in a manner consistent with the claims liabilities associated with the retrocession and are presented on the balance sheet as reinsurance recoverable on paid and unpaid losses and LAE. Such balances at December 31, 2010 and 2009 are comprised as follows:
written off. At December 31, 2010, $8.2 million of the total reinsurance recoverable balance was overdue by more than 90 days, $2.2 million of which was collateralized.
With respect to reinsurance recoverable on paid and unpaid losses and LAE, TRH is the beneficiary of substantial amounts of funds held, trust agreements and letters of credit collateralizing reinsurance recoverables with respect to certain reinsurers. At December 31, 2010, such funds held, trust agreements and letters of credit secured $352.1 million of TRH's reinsurance recoverable on paid and unpaid losses. No uncollateralized amounts recoverable from a single retrocessionnaire are considered material to the financial position of TRH.
Financial data from the London and Paris branches and from TRZ are reported in the aggregate as International-Europe and considered as one segment due to operational and regional similarities. Data from the Miami (which serves Latin America and the Caribbean), Toronto, Hong Kong and Tokyo branches are grouped as International-Other and represents the aggregation of segments that are generally not material. In each segment, property and casualty reinsurance is provided to insurers and reinsurers on a treaty and facultative basis, through brokers or directly to ceding companies.
A significant portion of the assets and liabilities of TRH's international operations relate to the countries where ceding companies and reinsurers are located. Most investments are located in the country of domicile of these operations. In addition to licensing requirements, TRH's international operations are regulated in various jurisdictions with respect to currency, amount and type of security deposits, amount and type of reserves and amount and type of local investment. Regulations governing constitution of
technical reserves and remittance balances in some countries may hinder remittance of profits and repatriation of assets. International operations and assets held abroad may be adversely affected by political and other developments in foreign countries, including possibilities of tax changes, nationalization and changes in regulatory policy, as well as by consequences of hostilities and unrest. The risks of such occurrences and their overall effect upon TRH vary from country to country and cannot easily be predicted.
On September 30, 2009, TRC initiated arbitration proceedings, with the AIDA Reinsurance and Insurance Arbitration Society, against United Guaranty Residential Insurance Company, United Guaranty Mortgage Indemnity Company, United Guaranty Credit Insurance Company and United Guaranty Residential Insurance Company of North Carolina (collectively, "UGC"), each a subsidiary of the AIG Group. The arbitration proceedings involve certain contracts related to subprime mortgages and credit default insurance pursuant to which UGC purchased reinsurance from TRC (the "Disputed Contracts"). TRC seeks in the proceedings, among other things, to rescind the Disputed Contracts. While the final outcome cannot be predicted with certainty, TRH believes these arbitration proceedings, when resolved, will not have a material adverse effect on TRH's consolidated results of operations, financial position or cash flows.
As of December 31, 2010, the future minimum lease payments (principally for leased office space) under various long-term operating leases were as follows:
In 2010, TRH entered into a funding agreement with a non-U.S. reinsurer to provide funding by May 2011 to serve as collateral against losses on property catastrophe business the reinsurer will underwrite and then cede to TRH. As of December 31, 2010, TRH had funding commitments of approximately $16 million outstanding relating to this agreement.
In October 2008, TRH adopted a retention program (the "Retention Plan") covering a significant number of its employees, including its senior-most management. Salary expenses incurred related to the Retention Plan totaled nil in 2010 and approximately $20 million and $8 million in 2009 and 2008, respectively.
During 2011, portions of Australia experienced severe damage from several events, including the Brisbane area floods and Cyclone Yasi. Based on an analysis of preliminary data, TRH expects to incur pre-tax net catastrophe costs (net of reinstatement premiums) of between $50 million and $100 million in the first quarter of 2011. This range reflects estimated total insured losses from these events of $3 billion to $5 billion. Due to the preliminary nature of the information used to prepare this estimate, among other factors, the ultimate costs that TRH will incur related to these events may differ materially from this estimate.