For our U.K.-based reinsurance and insurance operations, on April 1, 2005, Aspen Re signed an agreement for Underleases (following our entry in October 2004 into a heads of terms agreement) with B.L.C.T. (29038) Limited (the landlord), Tamagon Limited and Cleartest Limited in connection with leasing office space in London of approximately a total of 49,500 square feet covering three floors. The term of each lease for each floor commenced in November 2004 and runs for 15 years. Service charges of approximately £0.5 million per annum are payable from this date, and are subject to increase. It is expected that we will begin to pay the yearly basic rent of approximately £2.7 million per annum 36 months after the relevant date of practical completion of the landlord's works. The landlord’s works were completed in November 2004. The basic annual rent for each of the leases will each be subject to 5-yearly upwards-only rent reviews. There are no contractual provisions in any of the leases allowing us to terminate any of the leases prior to expiration of the 15-year contractual terms. We moved into our new premises in July 2005. We terminated our sublease for our prior premises with ACE Global Markets Ltd. effective July 31, 2005. We also license office space within the Lloyd's building on the basis of a renewable twelve-month lease. In addition, we lease office space
in Boston, Massachusetts, Marlton, New Jersey and Rocky Hill, Connecticut as well as other states in the United States in connection with our U.S. operations. We believe that our office space is sufficient for us to conduct our operations for the foreseeable future.
The following table sets forth our selected historical financial information for the period ended and as of the dates indicated. The summary income statement data for the period from our incorporation on May 23, 2002 to December 31, 2002 and for the twelve months ended December 31, 2003, 2004 and 2005 and the balance sheet data as of December 31, 2002, 2003, 2004 and 2005 are derived from our audited consolidated financial statements. The consolidated financial statements as of December 31, 2005, and for each of the twelve months ended December 31, 2005, 2004 and 2003, and the reports thereon of KPMG Audit Plc, an independent registered public accounting firm, are included elsewhere in this report. These historical results are not necessarily indicative of results to be expected from any future period. Due to our limited operating history, the ratios presented may not be indicative of our future performance. You should read the following selected consolidated financial information along with the information contained in this report, including Item 8, ‘‘Financial Statements and Supplementary Data’’ and Item 7, ‘‘Management's Discussion and Analysis of Financial Condition and Results of Operations’’ and the audited consolidated financial statements, condensed consolidated financial statements and related notes included elsewhere in this report.
The following is a discussion and analysis of the results of our operations for the twelve months ended December 31, 2005, 2004 and 2003 and of our financial condition at December 31, 2005. This discussion and analysis should be read in conjunction with our audited consolidated financial statements and accompanying notes included in this report. This discussion contains forward-looking statements that involve risks and uncertainties and that are not historical facts, including statements about our beliefs and expectations. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and particularly under the headings ‘‘Risk Factors,’’ ‘‘Business’’ and ‘‘Forward-Looking Statements’’ contained in Item 1, Item 1A and Part I of this report, respectively.
Each year we arrange reinsurance in respect of certain of our exposures, and the amounts paid and payable under these arrangements are shown as reinsurance ceded and deducted in calculating net written premiums. As a result of the hurricanes in 2005, we expect to make significant recoveries. Under the terms of our reinsurance contracts we are also obligated to make certain additional payments, usually in the form of reinstatement premiums, which are a feature of these contracts related to the reinsurers’ obligations to provide recoveries in respect of more than one loss. The amount of the additional payment obligations arising as a result of the 2005 hurricanes was $149.7 million or 7.2% of the gross written premiums for the year, whereas in 2004, we had reinstatement premiums of $22.9 million or 1.4% of gross premiums written. We had no significant reinstatement premiums in 2003.
We monitor the ratio of losses and loss adjustment expenses to net earned premium (the ‘‘loss ratio’’) as a measure of relative underwriting performance where a lower ratio represents a better result than a higher ratio. The loss ratios for our four business segments for the twelve months ended December 31, 2005, 2004 and 2003 were as follows:
The most significant impact of the 2005 hurricanes was on the loss ratio for the property reinsurance segment.
We monitor the ratio of expenses to net earned premium (the ‘‘expense ratio’’) as a measure of the cost effectiveness of our business acquisition, operating and administrative processes. The table below presents the contribution of the policy acquisition expenses and operating and administrative expenses to the expense ratio and the total expense ratios for each of the years ended December 31, 2005, 2004 and 2003:
In 2005, we generated net investment income of $121.3 million, which significantly increased from $68.3 million in 2004 and $29.6 million in 2003. The increase in our net investment income is attributable to a combination of increasing cash and investment balances and rising book yields on cash and fixed income securities.
Other revenues and expenses in 2005 included an unrealized gain of $19.4 million on our catastrophe risk transfer swap, realized losses on investments and foreign currency of $22.6 million and interest payable of $16.2 million. For more information on the catastrophe risk transfer swap, see below "-Critical Accounting Policies-Risk Transfer Swap."
(2) 8,333,333 ordinary shares in our public offering in December 2005; and
• an increase in unrealized gains in foreign currency translation and derivatives accounted for as Other Comprehensive Income of $15.1 million; and
• an increase in unrealized losses on investments of $30.3 million.
The amounts outstanding under our senior notes were the only material debt that we had outstanding as of December 31, 2005. Management monitors the ratio of debt to total capital, with total capital being defined as shareholders' equity plus outstanding debt. At December 31, 2005, this ratio was 10.9%, compared to 14.4% as of December 31, 2004 and 3.0% as of December 31, 2003. Management considers this to be well under the level at which it would expect rating agencies or customers to be concerned about excessive financial leverage.
Overall, at January 1, 2006, we increased prices in three out of four of our business segments in line with our expectations. Property reinsurance is the exception where we expect the best pricing to become prevalent ahead of the mid- year renewals or even into 2007. Overall we estimate that we achieved an 11% rate increase across the part of our portfolio that renewed at January 1 on a premium weighted basis.
There is little renewal activity during the first two months of the year with respect to the aviation insurance class of business. The airports and non-critical products business we did write at January 1 increased by between 5% and 10%.
Casualty Reinsurance. A significant proportion of this business incepts at January 1 and overall we achieved an average rate increase of 3%. Our casualty reinsurance segment is expected to
represent approximately 25% of our gross earned premium in 2006. Rates have held up well on the international account and better than expected increases in our U.S. casualty lines. Our international casualty reinsurance account experienced a modest 1% average rate increase in the Australian, Canadian and London markets. Our U.S. casualty reinsurance book has seen price increases of 5% on average with workers' compensation reinsurance programs renewing close to expiring prices and medical malpractice reinsurance programs renewing at a nearly 6% increase. U.S. casualty facultative reinsurance business has seen rates firm or slightly increase.
• the amount and type of reinsurance ceded and the reinsurance premiums payable;
Revenues also include investment income and realized investment gains offset by realized investment losses. Investment income is derived from holdings of cash and money market deposits and from fixed income investments. Realized investment gains and losses are derived from the sale of fixed income investments, all of which are held as marketable securities available for sale. These securities are carried at fair market value and any resulting unrealized gains and losses are not included as revenue in our statement of operations but are included in comprehensive income as a separate component of shareholders' equity.
The amount of these expenses is a function of the amount and type of insurance and reinsurance contracts we write and, with respect to reinsurance contracts, of the loss experience of the clients we reinsure. The amount of the expense is reduced to the extent that we can make recoveries from our reinsurers.
The amount reported under this heading in any period includes payments in that period plus the change in the value of the reserves for unpaid losses and loss adjustment expenses between the beginning and the end of the period.
Our method for setting the reserves for unpaid losses and loss adjustment expenses at the end of any period is discussed below under ‘‘-Critical Accounting Policies.’’
Policy acquisition expenses. Policy acquisition expenses consist principally of commissions and similar charges payable to brokers, other intermediaries and ceding companies, many of which represent a percentage of premiums receivable by us together with staff costs directly attributable to underwriting. The amount of expenses varies according to the amount and types of contracts written.
Income tax expense. This expense primarily represents corporation tax paid or payable by our U.K. operating company.
accounting policies we use to prepare our financial statements is included in the notes to the financial statements. If factors such as those described in Item 1A, ‘‘Risk Factors’’ cause actual events to differ from the assumptions used in applying the accounting policy and calculating financial results, there could be a material adverse effect on our results of operations, financial condition and liquidity.
Written premiums. Written premiums are comprised of the estimated premiums on contracts of insurance and reinsurance entered into in the reporting period, except in the case of proportional reinsurance contracts, where written premium relates only to our proportional share of premiums due on contracts entered into by the ceding company prior to the end of the reporting period.
We refer to premiums receivable which are not fixed at the inception of the contract as adjustment premiums. The key factors in estimating adjustment premiums receivable are past underwriting experience, broker analysis and actuarial projections (in respect of treaty business). They are most significant in relation to reinsurance contracts. Differing considerations apply to non-proportional and proportional treaties as follows.
We exercise judgment in determining the adjustment premiums, which represent a small portion of total premiums receivable. Commission is charged as a fixed percentage of premium per contract and is adjusted in line with adjustments in premium. The proportion of adjustable premiums included in the premium estimates varies between business lines with the largest adjustment premiums associated with property reinsurance business and the smallest with property and liability insurance.
The reported gross written premiums for treaty pro rata business includes estimates of premiums due to the Company but not yet reported by the cedent because of time delays between contracts being written by our cedents and the submission of treaty statements to the Company. This additional premium is normally described as pipeline premium. Treaty statements disclose information on the underlying contracts of insurance written by our cedents and are generally submitted on a monthly or quarterly basis, from 30 to 90 days in arrears. In order to report all risks incepting prior to a period end, the Company will estimate the premiums written between the last submitted treaty statement and the period end.
Premiums receivable are recorded as amounts due less any required provision for doubtful accounts. A significant portion of amounts included as premiums receivable, which represent estimated premiums written, net of commissions, is not currently due based on the terms of the underlying contracts. In determining whether or not any bad debt provision is necessary, we consider the financial security of the policyholder, past payment history and any collateral held. We have not made a provision for doubtful accounts in relation to assumed premium estimates as adjustable premiums are considered to be inseparable from minimum and deposit premiums. In addition, based on the above process, management believes that the premium estimates included in premiums receivable will be collectible and, therefore, we have not maintained a bad debt provision for doubtful accounts on the premiums at December 31, 2005.
Risk Transfer Swap. Our catastrophe risk transfer swap falls under the requirement of Statement of Financial Accounting Standards ("SFAS") No. 133 'Accounting for Derivative Instruments and Hedging Activities', as amended (‘‘SFAS 133’’) and is therefore recorded in the balance sheet at fair value with any changes in the fair value shown on the consolidated statement of operations. This contract requires us to make quarterly payments in return for which we are entitled to receive a total of up to $100 million on the occurrence of hurricanes making landfall in Florida and causing insured damage in excess of $39 billion or earthquakes in California causing insured damage in excess of $23
billion. The determination of whether or not we are entitled to a recovery depends on estimates of insured damage published by Property Claims Services ("PCS"). The amount of any recovery due increases on a linear basis from $0 to $100 million depending on the PCS estimate with the full amount of $100 million receivable at or above $47 billion for a hurricane event or $29 billion for an earthquake event. If a recovery becomes due then the future payments under the contract may be reduced. As we provided in full for these future payments when the contract commenced any actual or projected reduction in this liability is also reflected as a gain in the statement of operations. The latest estimate of the insured loss arising from Hurricane Katrina published by PCS on December 6, 2005 was $38.1 billion. Based on the record of increasing PCS estimates following previous natural catastrophe losses in the United States, we expect that future estimates by PCS of this loss will increase. We have taken this and the illiquid nature of the catastrophe risk transfer swap market into account in our valuation of this contract as at December 31, 2005. As there is no quoted market value available for this derivative, the fair value is determined by management using internal models taking into account changes in the market for catastrophe reinsurance contracts with similar economic characteristics and the potential for recoveries from events preceding the valuation date. The amount recognized could be materially different from the amount realized in actual payments to us made under the contract.
Reserves by segment. The following presents our loss reserves by business segment as at December 31, 2005 and 2004:
The gross reserves may be further analysed between outstanding or reported claims and IBNR as at December 31, 2005 and 2004, as follows:
Gross reserves for our property and casualty insurance segment were $565.0 million in 2005 compared to $371.8 million in 2004, of which 42.5% and 45.1% were IBNR for 2005 and 2004, respectively. The change in reserves was due to the insurance portfolio maturing and an increase in reserves would be expected as reserves build up over time, particularly in the longer-tail liability business lines. In addition, the property line recognized losses of $158.3 million following the 2005 hurricanes.
Full policy information is recorded at the time of underwriting and includes inception and expiry dates, attachment points and limits and our share of the risk. Claims information received typically includes the loss date, details of the claim, the recommended reserve and reports from the loss adjusters dealing with the claim. In respect of pro rata treaties we receive regular statements (bordereaux) which detail for each cedent the earned and unearned premium and summary paid and loss reserves, with large losses separately identified. Reinsurance claims are subject to a longer time lag both in their reporting and in their time to final settlement. The time lag is a factor which is included in the projections to ultimate claims within the actuarial analyses and helps to explain why in general a higher proportion of the initial reinsurance reserves are represented by IBNR than for insurance reserves for business in the same class.
For reported claims, reserves are established on a case by case basis within the parameters of coverage provided in the insurance policy or reinsurance agreement. In estimating the cost of these claims, we consider circumstances related to the claims as reported, any information available from
The actuarial range is not intended to include the minimum or maximum amount that the claims may ultimately settle at, but is designed to provide management with a range from which it is reasonable to select a single best estimate for inclusion in our financial statements taking into account the impact that all the factors affecting the reserves may have.
The following table sets out the actuarial range of gross reserves for each of our segments and compares it to management's selected best estimate for the twelve months ended December 31, 2005 and 2004.
The range for 2005 has been set on a different basis than in 2004 when it was bounded at the lower end by the minimum value of potential best estimates based on standard actuarial methods and the upper end was set at the level which reflected specific reasonably likely causes of more adverse outcomes.
Lines of business where claims are typically reported relatively quickly after the claim event tend to display lower levels of volatility between initial estimates and final outcomes. For reinsurance lines of business, a higher proportion of initial reserves is statistically based IBNR due to longer reporting delays between the original loss and the time when reinsurers are aware of the extent of the losses. For insurance business, notifications are received earlier and closer to the date of original loss notification. This delay in reinsurance lines explains why there is a higher degree of uncertainty in reinsurance than direct loss reserves. Delays in receiving information from cedents are an expected part of normal business operations and are included within the statistical estimate of IBNR to the extent that current levels of backlog are consistent with historical data. Currently, there are no processing backlogs which would materially affect our financial statements.
The higher degree of uncertainty associated with reserves for reinsurance business is associated with the assumptions used in deriving the IBNR. Where it is based on an analysis of past loss experience, then the principal assumption is that past patterns of development will be repeated on current business. The process of extrapolation is by necessity one involving subjective judgment because the actuary has to take into account the impact of the changing business mix as well as changes in legislative conditions, changes in judicial interpretation of legal liability policy coverages and inflation. These factors are incorporated in the recommended reserve range from which management selects its best point estimate. As at December 31, 2005, a 5% change in the net reserve for IBNR losses would equate to a change of approximately $44.5 million in loss reserves which would represent 27.7% of net income before income tax for the twelve months ended December 31, 2005. As at December 31, 2004, a 5% change in the net reserve for IBNR losses would equate to a change of approximately $30.6 million in loss reserves which would represent 11.6% of net income before income tax for the twelve months ended December 31, 2004.
Casualty Reinsurance: As at December 31, 2004 the casualty reinsurance segment held net claims reserves of $ 373.2 million. Favorable trends in claims development in the non-U.S. casualty and U.S. casualty lines have seen claims develop at a slower than expected rate, and led to a release of prior year net reserves of $10.9 million. Most of the release in respect of the U.S. casualty lines relates to workers' compensation catastrophe excess of loss contracts which have a short reporting period.
Specialty Insurance and Reinsurance: As at December 31, 2004 the specialty segment held net claims reserves of $157.9 million, partly derived through the Wellington quota share arrangements. These have developed better than anticipated resulting in a release of $7.2 million. A better than expected development from the 2004 windstorms saw a favorable development of $1.3 million, while a significantly lower than anticipated development of IBNR claims, particularly in the specialty reinsurance lines led to a favorable development of $18.9 million.
Property Reinsurance: The net reserves of the property reinsurance segment as at December 31, 2003 were $95.3 million, which included specific case reserves in relation to brush fires in the United States, Hurricanes Fabian and Isabel and a Phillips factory loss in Normandy, France. Further claims information received during the twelve months ended December 31, 2004 highlighted a lower severity of these reported claims than was originally anticipated and gave rise to a $17.1 million reduction in reserves in the period.
Specialty Insurance and Reinsurance: The net reserves of the specialty segment as at December 31, 2003 were $94.0 million, largely derived through the Wellington quota share arrangements. Premium and claims information received from the cedent during the twelve months ended December 31, 2004 enabled the Company to refine its accident year assessment. Further information received concerning the development of reserves acquired on the acquisition of City Fire (now renamed Aspen Re) has also contributed to the overall release in reserves of $18.1 million.
Property and Casualty Insurance: The net reserves of the commercial property line of business as at December 31, 2003 were $40.5 million. Better than expected development in incurred claims during 2004 and the short-tail nature of this class of business has enabled us to refine our accident year assessment. This has given rise to a release in net reserves of $13.8 million. The net reserves of the commercial liability line of business as at December 31, 2003, were $126.8 million. During 2004, development of incurred claims has been slower than previously expected resulting in a reduction in the projected loss ratio suggested by the actuarial projection at December 31, 2004. This has resulted in a release in net reserves of $13.6 million in the period.
arrangements. Premiums and claims information received from Lloyd's Syndicates 3030 ("Syndicate 3030") and Syndicate 2020 (together, the "Syndicates") and other cedents during the twelve months ended December 31, 2003, has indicated both a reduction in the 2002 underwriting year loss ratio and also an improvement in the accident year loss ratio for 2002. This resulted from a lower development of the severity of reported claims than is often observed in this segment and gave rise to a $3.8 million reduction in reserves.
Casualty Reinsurance: The net reserves of the casualty reinsurance segment as at December 31, 2002 were $10 million. Although we do not receive notice of most of the claims in this segment until a considerable time has passed, some claims have a shorter notification period due to some of the more catastrophic elements of the business. The development of incurred losses in the twelve months subsequent to December 31, 2002 has enabled a small reduction in the projected loss ratio for this business from that suggested by the actuarial projection at December 31, 2002, giving rise to the reduction in reserves of $0.4 million.
Our financial statements are prepared in accordance with U.S. GAAP. The discussions that follow include tables and discussions relating to, our consolidated income statement and our segmental operating results for the twelve months ended December 31, 2005, 2004 and 2003.
reinsurance contracts we are also obligated to make certain additional payments usually in the form of reinstatement premiums which are a feature of these contracts related to the reinsurers’ obligations to provide recoveries in respect of more than one loss. The amount of the additional payment obligations arising as a result of the 2005 hurricanes was $149.7 million or 7.2% of the gross premiums written for the year, whereas in 2004, we had reinstatement premiums of $22.9 million or 1.4% of gross premiums written.
Policy acquisition expenses. Policy acquisition expenses increased by 33.6% in 2005 compared to 2004, and represented 14.7% of gross premiums earned, whereas in 2004, policy acquisition expenses increased by 39.2% compared to 2003, and represented 14.4% of gross premiums earned for the twelve months ended December 31, 2004. The increase in expenses in 2005 was due to the growth in premiums written and earned.
During 2005, we continued our strategy of gradually extending portfolio duration as interest rates and bond yields rose during the year. As a result, our aggregate portfolio book yield increased from 3.30% as of December 31, 2004 to 4.08% as of December 31, 2005. The aggregate portfolio duration increased from 1.76 years at December 31, 2004 to 2.20 years at December 31, 2005. Our fixed income portfolio duration increased from 2.20 years as of December 31, 2004 to 2.90 years as of December 31, 2005. The increase in duration resulted in greater exposure to interest rate risk as discussed below.
Unrealized gains on derivatives. This arose from an increase in the estimated fair value of a catastrophe risk transfer swap contract entered into for a three-year period in August 2004. This contract requires us to make quarterly payments in return for which we are entitled to receive a total of up to $100 million on the occurrence of hurricanes making landfall in Florida and causing damage in excess of $39 billion or an earthquakes in California causing insured damage in excess of $23 billion. The determination of whether or not we are entitled to a recovery under the contract depends on estimates of insured damage published by PCS. The latest estimate of the insured loss arising from Hurricane Katrina published by PCS on December 6, 2005 was $38.1 billion. Based on the record of increasing PCS estimates following previous natural catastrophe losses in the United States, we expect that future estimates by PCS of this loss will increase. We have taken this and the illiquid nature of the catastrophe risk transfer swap market into account in our valuation of this contract as at December 31, 2005. See above ‘‘-Critical Accounting Policies-Risk Transfer Swap.’’
Income/(loss) before tax. In 2005, we incurred losses before tax of $160.4 million. The principal source of loss in 2005 was underwriting losses of $358.2 million in our property reinsurance segment resulting from the 2005 hurricanes. Our underwriting losses were offset by $121.3 million in respect of net investment income and a $19.4 million net unrealized gain on derivatives. We also incurred losses of $18.2 million from the sale or revaluation of foreign currencies and $4.4 million from the sale of investments. Income before tax in 2004 was $263.2 million (2003-$206.6 million), which included underwriting income of $204.2 million (2003-$178.3 million) and net investment income of $68.3 million (2003-$29.6 million).
Net income/(loss). In 2005, we had a net loss of $177.8 million, equivalent to a loss of $2.40 per share based on the weighted average number of shares in issue during the period. Because of the losses in the year the diluted loss per share is the same as the basic loss per share. This compares to a net income of $195.1 million in 2004, equivalent to $2.82 earnings per basic share and $2.74 fully
diluted earnings per share, and net income of $152.1 million in 2003, equivalent to $2.63 earnings per basic share and $2.56 fully diluted earnings per share on the basis of the weighted average number of shares in issue during the period.
The following tables summarize gross and net premiums written and earned, underwriting results, and combined ratios and reserves for each of our four business segments for the twelve months ended December 31, 2005, 2004 and 2003.
In 2005, we wrote property reinsurance on both a treaty and facultative basis. The property treaty reinsurance we write includes catastrophe, including a small retrocession account, risk excess and pro rata. For a more detailed description of this segment, see Part I, Item 1, ‘‘Business-Business Segments-Property Reinsurance.’’
Reinsurance ceded. In 2005, we paid or provided for $116.5 million of additional ceded premiums to reinstate reinsurance protections following the 2005 hurricanes (2004-$104.4 million; 2003-$9.0 million).
Losses and loss adjustment expenses. Losses and loss adjustment expenses increased by 167.0% in 2005 compared to 2004. The losses of $700.8 million in 2005 (2004-$262.5 million; 2003-$106.7 million) include the following losses:
Our casualty reinsurance segment is written mainly on a treaty basis with a small proportion of facultative risks. The casualty treaty reinsurance is primarily written on an excess of loss basis and includes coverage for claims arising from automobile accidents, employers' liability, professional indemnity and other third party liabilities. It is written in respect of cedents located mainly in the United States, the United Kingdom, Europe and Australia. The casualty facultative business covers United States umbrella, workers' compensation and general liability business. For a more detailed description of this segment, see Part I, Item 1, ‘‘Business-Business Segments-Casualty Reinsurance.’’
The increase in U.S. treaty includes $55.4 million in respect of three contracts written by our structured risk team. In 2004, the gross premiums written increased by 52.8% compared to 2003. We saw an increase of $154.4 million in 2004 largely due to increases in U.S. casualty, although U.S. auto liability business written through WU Inc. in 2003 was discontinued in 2004 and we are no longer writing automobile reinsurance of this type.
The loss ratio for 2005 benefited from a prior year reserve release of $13.9 million as discussed above under ‘‘-Critical Accounting Policies-Prior year loss reserves.’’
Our specialty insurance segment includes marine and energy and aviation insurance written by Aspen Re. Our specialty reinsurance lines of business include aviation, marine and other specialty reinsurance. For a more detailed description of this segment, see Part I, Item 1, ‘‘Business-Business Segments-Specialty Insurance and Reinsurance.’’
Losses and loss adjustment expenses. Losses and loss adjustment expenses increased by $103.0 million in 2005 compared to 2004. The increase in loss expenses was attributable to the growth of the specialty insurance lines in this segment. In addition, we also incurred the following large losses in 2005. We did not incur any significant large losses in 2003 and 2004.
For 2004, the loss expenses had decreased significantly by 43.5% compared to 2003 due to an $18.1 million reserve release being recognized in that year.
Policy acquisition, operating and administration expenses. Total expenses increased by $38.3 million or 171.7% in 2005, mostly attributed to the first full year of underwriting by our specialty insurance lines. The higher expense ratio for specialty insurance business is due to the higher acquisition costs associated with this business. Total expenses did not change significantly between 2003 and 2004.
The following table summarizes gross and net written premiums and earned, underwriting results and combined ratios for each of the lines of business within our insurance segment for the twelve months ended December 31, 2005, 2004 and 2003:
Gross premiums written. Gross premiums written in this segment increased by 5.3% in 2005 compared to 2004, whereas in 2004, the gross premiums written increased by 19.7% compared to 2003. The table below shows our gross premiums written for each line of business for each of 2005, 2004 and 2003, and the percentage increase in gross premiums written for each line:
In 2005, we increased our U.S. surplus lines in both property (2005-$67.0 million; 2004-$40.4 million) and casualty (2005-$74.8 million; 2004-$30.3 million). We wrote less U.K. liability business than in 2004 as rates have dropped. The increase in 2004 was primarily due to the first full year of premiums from Aspen Specialty, which wrote both property and casualty insurance in the United States.
Policy acquisition, operating and administrative expenses. Total expenses in 2005 increased by 16.4% compared to 2004, largely as a result of increases in gross premiums earned in this segment. Total expenses increased by 74.0% in 2004 compared to 2003, which was due to the set up costs associated with the establishment of our U.S. insurance operations, and the relatively low contribution to earned premiums from these operations during this early stage of development. Additionally, the worldwide property team's costs were recorded in 2004. Neither of these had costs in 2003. The expense ratio increased slightly in 2005 by 2.9%. The rate of increase in expenses was consistent with the rate of increase in gross premiums earned which was 15.8% in 2005. The expense ratio increased by 5.3% in 2004 compared to 2003 due to a greater proportion of commercial property business, which attracts higher brokerage rates, being written in 2004 when compared with 2003.
The ability of our Insurance Subsidiaries to pay us dividends or other distributions are subject to the laws and regulations applicable to each jurisdiction, as well as the Insurance Subsidiaries’ need to maintain capital requirements adequate to maintain their insurance and reinsurance operations and their financial strength ratings issued by independent rating agencies. For a discussion of the various restrictions on our ability and our Insurance Subsidiaries' ability to pay dividends, see ‘‘Business-Regulatory Matters’’ in Part I, Item 1 in this report. As of December 31, 2005, Aspen Bermuda has an accumulated deficit and therefore could not pay a dividend or make a distribution based upon the Bermuda Insurance Act and the Bermuda Companies Act regulations. As of December 31, 2005, Aspen Re could pay a dividend totaling approximately $139.8 million without prior regulatory approval based upon the FSA and the Companies Act regulations. Aspen Specialty could pay a dividend without regulatory approval of approximately $11.3 million.
Management monitors the liquidity of Aspen Holdings and of each of its Insurance Subsidiaries. In relation to Aspen Holdings, we monitor its ability to service debt, to finance dividend payments to shareholders and holders of our Perpetual PIERS and to provide financial support to the Insurance Subsidiaries. In 2004, our board of directors authorized a quarterly dividend payment of $0.03 per ordinary share per fiscal quarter. In 2005, we increased our quarterly dividend payments to $0.15 per share.
With respect to our Insurance Subsidiaries, one of our responsibilities is to ensure that we have funds readily available to settle claims. As of December 31, 2005, the Insurance Subsidiaries held approximately $1,181.0 million in cash and short-term investments that are readily realizable securities. In addition, we maintain credit facilities. Management monitors the value, currency and duration of cash and investments held by its Insurance Subsidiaries to ensure that they are able to meet their insurance and other liabilities as they become due and was satisfied that there was a comfortable margin of liquidity as at December 31, 2005 and for the foreseeable future.
Cash flows for the twelve months ended December 31, 2005. Our total net cash flow from operating activities in 2005 was $789.1 million, a reduction of 17.9% from 2004. This decrease was mainly due to claims paid of $551.9 million (an increase of 235% over 2004) in the period which were mostly in relation to the 2004 and 2005 hurricanes. In 2005, we paid dividends on our ordinary shares totaling $45.5 million and raised approximately $790 million after expenses from our issuance of 25,884,891 ordinary shares and 4,000,000 Perpetual PIERS. As at December 31, 2005, we had a consolidated cash balance of $748.3 million, which we consider to be sufficient to meet our current operating requirements.
Cash flows for the twelve months ended December 31, 2003. In 2003, we generated net cash from operating activities of $636.6 million, primarily relating to premiums and investment income received offset by reinsurance premiums payable. We paid claims of $53.9 million in the period. We made net investments in the amount of $696.4 million in market securities during the period. Cash and cash equivalents increased from $9.6 million at the beginning of the period to $230.8 million at the end of the period.
Liquidity. Liquidity is a measure of a company’s ability to generate cash flows sufficient to meet short-term and long-term cash requirements of its business operations. Our liquidity depends on operating, investing and financing cash flows, described as follows. On an ongoing basis, our Insurance Subsidiaries' sources of funds primarily consist of premiums written, investment income and proceeds from sales and redemptions of investments.
Aspen Bermuda is subject to and at December 31, 2005 met the solvency requirements of the Insurance Act (as defined in Part I, Item 1, ‘‘Business-Regulatory Matters-Bermuda Regulation’’). See Part I, Item 1, ‘‘Business-Regulatory Matters-Bermuda Regulation’’ elsewhere in this report. Aspen Bermuda's statutory capital and surplus was $957.1 million at December 31, 2005 and $632.7 million at December 31, 2004. Its capital and surplus as measured under U.S. GAAP was $1,026.0 million at December 31, 2005 (2004-$658.8 million).
Aspen Re has established a Canadian trust fund with a Canadian bank to secure a Canadian insurance license. The initial minimum trust fund amount was Can$25 million and the balance at December 31, 2005 was Can$100.5 million. In addition, Aspen Specialty has a total of $7.0 million ($7.4 million December 31, 2004) on deposit with certain U.S. states in order to satisfy state regulations for writing business there.
Credit Facility. On August 2, 2005, we entered into a five-year $400 million revolving credit facility pursuant to a credit agreement dated as of August 2, 2005 (the ‘‘credit facilities’’) by and among the Company, certain of our direct and indirect subsidiaries (collectively, the ‘‘Borrowers’’) the lenders party thereto, Barclays Bank plc, as administrative agent and letter of credit issuer, Bank of America, N.A. and Calyon, New York Branch, as co-syndication agents, Credit Suisse, Cayman Islands Branch and Deutsche Bank AG, New York Branch, as co-documentation agents and The Bank of New York, as collateral agent. The credit facilities replace our $150 million three-year credit agreement dated August 26, 2003, which would have expired on August 29, 2006, and our $50 million 364-day credit agreement, dated as of August 26, 2003, both of which were terminated as of August 2, 2005.
Under the credit facilities, we must maintain at all times a consolidated tangible net worth of not less than approximately $1.1 billion plus 50% of consolidated net income and 50% of aggregate net cash proceeds from the issuance by the Company of its capital stock, each as accrued from January 1, 2005. We must also not permit our consolidated leverage ratio of total consolidated debt to consolidated tangible net worth to exceed 35%. In addition, credit facilities contain other customary affirmative and negative covenants as well as certain customary events of default, including with respect to a change in control. The various affirmative and negative covenants, include, among others, covenants that, subject to important exceptions, restrict the ability of the Company and its subsidiaries to: create or permit liens on assets; engage in mergers or consolidations; dispose of assets; pay dividends or other distributions, purchase or redeem the Company's equity securities or those of its subsidiaries and make other restricted payments; permit the rating of any insurance subsidiary to fall below A.M. Best financial strength rating of B++ or S&P financial strength rating of A−; make certain investments; agree with others to limit the ability of the Company's subsidiaries to pay dividends or other restricted payments or to make loans or transfer assets to the Company or another of its subsidiaries. The credit facilities also include covenants that restrict the ability of our subsidiaries to incur indebtedness and guarantee obligations.
Capital Resources. On February 4, 2005, we filed a universal shelf registration statement on Form with the SEC for the issuance and sale of up to $500 million of debt and/or equity securities from time to time. The registration statement was declared effective on March 3, 2005 and is expected to allow us access to the public capital markets to the extent the need arises. Also included in the registration statement were 52,998,036 ordinary shares which may be offered for sale by our shareholders. We will not receive any proceeds from sales by our shareholders but may have to pay related expenses.
On October 24, 2005, we filed a shelf registration statement on Form F−3 with the SEC for the issuance and sale of up to $903,685,834 amount of our securities. Also included in the registration statement were an additional 40,230 ordinary shares which may be offered for sale by our shareholders. Under the Securities Act, the prospectus included in that registration statement was a combined prospectus and also related to $96,314,166 aggregate amount of securities registered and remaining unsold by us and 39,204,755 ordinary shares registered and remaining unsold by the selling shareholders under our registration statement described above.
In 2005 and January 2006, we issued and sold the following securities in public offerings under our registration statements described above:
• on October 11, 2005, we issued 17,551,558 ordinary shares which generated $400 million in net proceeds;
The proceeds from these offerings were used for general corporate purposes, to support the operations of our Insurance Subsidiaries and to strengthen our balance sheet capital position.
Our business operations are in part dependent on our financial strength and the market’s perception thereof, as measured by shareholders' equity, which was $2,039.8 million and
On April 1, 2005, Aspen Re signed an agreement for underleases for office space in London of approximately a total of 49,500 square feet covering three floors. The term of each lease for each floor commenced in November 2004 and runs for 15 years. Service charges of approximately £0.5 million per annum are payable from this date, and are subject to increase. It is expected that we will begin to pay the yearly basic rent of approximately £2.7 million per annum 36 months after the relevant date of practical completion of the landlord's works. The basic annual rent for each of the leases will each be subject to 5-yearly upwards-only rent reviews. There are no contractual provisions in any of the leases allowing us to terminate any of the leases prior to expiration of the 15-year contractual terms. We also license office space within the Lloyd's building on the basis of a renewable twelve-month lease. In addition, we lease office space in Boston, Massachusetts, Marlton, New Jersey and Rocky Hill, Connecticut as well as other states in the United States in connection with our U.S. operations.
For a discussion of derivative instruments we have entered into, please see note 5 to our audited financial statements for the twelve months ended December 31, 2005 included elsewhere in this report.