We currently lease office space in Pembroke, Bermuda, where the Company and Montpelier Re are located. We also lease office space in London, U.K. where MUAL, PUAL, MCL, MMSL and MUSL are located; in Zug, Switzerland, where MEAG is located; in Boston, MA, Chicago, IL, Hartford, CT and Overland Park, KS where MUI is located; in Scottsdale, AZ where MUSIC is located; and in Woburn, MA and Hanover, NH where MTR is located.
From December 2005 to June 2008, the period prior to Blue Ocean becoming a wholly-owned subsidiary, we fully consolidated Blue Ocean in our financial statements. Net income attributable to noncontrolling interest represents the portion of Blue Ocean’s net income attributable to all other shareholders (those other than the Company) during the periods presented.
During 2007, we repurchased 939,039 Common Shares and 7,172,375.5 warrants to acquire Common Shares from White Mountains Insurance Group, Ltd. (“White Mountains”), a former affiliate, for $65.0 million. We also repurchased 3,780,305 Common Shares for $63.7 million from shareholders other than White Mountains.
During 2006, we privately sold 6,896,552 Common Shares for $100.0 million.
We ended 2009 with a fully converted tangible book value per share of $21.08, an increase of 34.7% for the year inclusive of dividends declared. The increase in our fully converted tangible book value per share during 2009 resulted from both strong underwriting and investment results. Our comprehensive income for 2009 was $463.8 million and our GAAP combined ratio was 62.2%.
We ended 2008 with a fully converted tangible book value per share of $15.88, a decrease of 9.2% for the year inclusive of dividends declared. The decrease in our fully converted tangible book value per share during 2008 was largely the result of catastrophe losses from Hurricanes Gustav and Ike and realized and unrealized losses associated with our investment portfolio. Our comprehensive loss for 2008 was $150.9 million and our GAAP combined ratio was 91.0%.
We ended 2007 with a fully converted tangible book value per share of $17.82, an increase of 17.2% for the year inclusive of dividends declared. The increase in our fully converted tangible book value per share during 2007 resulted from both strong underwriting and investment results. Our comprehensive income for 2007 was $314.0 million and our GAAP combined ratio was 61.3%.
Our underwriting results for 2007 included $88.6 million of net catastrophe losses from windstorms Kyrill and Gonu, floods in Australia and the U.K. and wildfires in California, partially offset by $36.4 million of prior year favorable loss reserve development. Our investment results for 2007 included $26.5 million of net realized and unrealized investment gains which were comprised of $19.9 million in net gains from fixed maturities, $7.5 million in net gains from equity securities and $0.9 million in net losses from other investments.
The Share Issuance Agreement was terminated on February 27, 2009. Prior to its termination, the Share Issuance Agreement had the effect of substantially eliminating the economic dilution that would otherwise have resulted from the issuance of Common Shares. Therefore, we did not consider these Common Shares outstanding for the purposes of this computation. See Note 7 of the Notes to Consolidated Financial Statements.
Computed as the change in fully converted tangible book value per share, inclusive of dividends declared.
During 2009 we, and many of our peers, experienced strong underwriting and investment returns due to a low level of catastrophes and a widespread rebound in the financial markets. Consequently, the amount of available capital in the reinsurance market for the January 2010 renewal season expanded significantly as compared to 2009. We have also observed slightly reduced demand for reinsurance as weak economic conditions are dampening growth prospects for ceding companies who, at the same time, have a greater capacity to retain risk. In summary, we expect 2010 will prove to be a more difficult operating environment than 2009, which will place a high emphasis on risk selection and capacity management.
Syndicate 5151’s newly acquired team of experienced marine underwriters commenced underwriting a diverse portfolio of short-tail marine hull, cargo and specie business during the third quarter of 2009. This portfolio is underwritten through more than twenty brokers, does not incorporate energy business and is largely uncorrelated with Syndicate 5151’s peak exposures. Terms, rates and conditions in the marine market have improved modestly in recent months and our outlook for this line of business remains positive. During 2009, Syndicate 5151 produced $8.4 million in net premiums associated with the new marine portfolio.
As a predominantly short-tail property reinsurer, we have exposure to various natural catastrophes around the world. We manage our exposure to catastrophes using a combination of CATM (our proprietary modeling tool), third-party vendor models, underwriting judgment, and our own reinsurance purchases.
The market share estimates above represent an estimate of our average market share across multiple event scenarios corresponding to industry losses of a given size. However, it is important to note that our average market share may vary considerably within a particular territory depending on the specific characteristics of the event. This is particularly true for the direct insurance and facultative reinsurance portfolio we underwrite. Other factors contributing to such variation may include our decision to be overweight or underweight in certain regions within a territory. For example, our market share for a large European wind event may differ depending on whether the majority of loss comes from the U.K. or from Continental Europe. Additionally, our net market share may be impacted by the number and order of occurrence of catastrophic events during a year which could exhaust individual policy limits or trigger additional losses from certain policies offering second-event or aggregate protection. Further, certain reinsurance we purchase may have geographic restrictions or provide coverage for only a single occurrence within the policy period. Lastly, these estimates represent snapshots at a point in time. The composition of our in-force portfolio will fluctuate due to the acceptance of new policies, the expiration of existing policies, and changes in our reinsurance program.
In addition to monitoring exposed contract limits and single event accumulation potential, we attempt to measure enterprise-wide risk using a simulated annual aggregate operating result approach. This approach estimates a net operating result over simulated annual return periods, including contributions from certain variables such as aggregate premiums, losses, expenses, and investment results. We view this approach as a supplement to our single event stress test as it allows for multiple losses from natural catastrophe and other sources and attempts to take into account certain risks from non-underwriting sources. Through our modeling we endeavor to take into account many risks that we face as an enterprise. By the very nature of the insurance and reinsurance business, and the limitations of models generally, our modeling does not cover every potential risk. Examples include emerging risks, changes in liability awards, pandemic illnesses, asteroid strikes, climate change, bioterrorism, scientific accidents, and various political and financial market catastrophes.
Our consolidated financial results for the years ended December 31, 2009, 2008 and 2007 follow:
Underwriting results for Montpelier Bermuda, our largest reportable segment, for the years ended December 31, 2009, 2008 and 2007 were as follows:
The following table summarizes Montpelier Bermuda’s gross premiums, by line of business, for the years ended December 31, 2009, 2008 and 2007:
Represents an inter-segment reinsurance cover with Montpelier Syndicate 5151. This intercompany arrangement is eliminated in consolidation.
Gross premiums written within our Montpelier Bermuda segment decreased by approximately 10%, in 2009, as compared to 2008, as a result of the following:
· Due to the low level of catastrophe loss events that occurred during 2009, as well as the favorable prior period development recognized during the year, Montpelier Bermuda’s gross premiums written during 2009 included a $0.7 million net reversal of reinstatement premiums whereas gross premiums written during 2008 included $21.2 million of reinstatement premiums, primarily related to Hurricane Ike. Excluding the effects of these reinstatements, gross premiums written within our Montpelier Bermuda segment decreased by approximately 6% from 2008.
Gross premiums written within our Montpelier Bermuda segment decreased by approximately 16% in 2008, as compared to 2007, as a result of the following:
All of Montpelier Bermuda’s reinsurance purchases to date have represented prospective cover; that is, ceded reinsurance purchased to protect it against the risk of future losses as opposed to covering losses that have already occurred but have not been paid. The majority of these contracts are excess-of-loss contracts covering one or more lines of business. To a lesser extent we have also purchased quota share reinsurance with respect to specific lines of business. Montpelier Bermuda also purchases industry loss warranty policies which provide coverage for certain losses provided they are triggered by events exceeding a specified industry loss size.
The following tables present Montpelier Bermuda’s net loss and LAE and net loss and LAE ratios for the years ended December 31, 2009, 2008 and 2007:
Estimated ultimate loss and LAE recoverable from reinsurers increased (decreased) by $(27.4) million, $35.4 million and $6.9 million during 2009, 2008 and 2007, respectively.
The nature of our business is such that losses, and the resulting loss ratios, can vary widely from period to period depending on the occurrence and severity of natural and man-made catastrophes.
Net favorable loss and LAE development occurring in 2009 that related to prior year losses was $68.6 million. The primary reasons for this decrease were the following:
· Net estimated ultimate losses and LAE associated with prior year catastrophe and individual risk events decreased by $35.2 million, which is broken down as follows:
Our loss and LAE development associated with natural catastrophes such as hurricanes, wildfires, floods and windstorms is the result of new information received from multiple cedants and, for the most recent events, information regarding the impact of such losses on the entire reinsurance market.
· Net estimated ultimate losses and LAE associated with for prior year catastrophe events decreased by $54.9 million, which is broken down as follows:
· A reassessment of loss and LAE reserves in our casualty class of business, primarily relating to medical malpractice policies, resulted in a decrease in estimated losses and LAE of $13.0 million.
· The remaining development related to smaller adjustments across several classes of business.
Acquisition costs include profit commissions, brokerage costs, commissions and excise taxes, when applicable.
Profit commissions, which are paid by assuming companies to ceding companies in the event of a favorable loss experience, change as our estimates of loss and LAE fluctuate. Relatively few of our assumed reinsurance contracts contain profit commission clauses. The terms of these profit commissions are specific to the individual contracts and vary as a percentage of the contract results. Profit commissions (reversals), which are accrued based on the estimated results of the subject contract, totaled $(3.8) million, $5.9 million and $6.8 million for 2009, 2008 and 2007, respectively. The 2009 reversal reflects profit commission adjustments on a few large contracts.
All other acquisition costs are generally driven by contract terms and are normally a set percentage of gross premiums written. Such acquisition costs consist of the net of commission expenses incurred on assumed business and commission revenue earned on purchased reinsurance covers. Commission revenue on purchased reinsurance covers is earned over the same period over which the corresponding premiums are expensed.
The following table summarizes Montpelier Bermuda’s general and administrative expenses during the years ended December 31, 2009, 2008 and 2007:
Underwriting results for Montpelier Syndicate 5151, which commenced operations on July 1, 2007, were as follows for the years ended December 31, 2009, 2008 and 2007:
To date, most of Montpelier Syndicate 5151’s outward reinsurance has been purchased by the Montpelier Bermuda segment, which in turn provides inter-segment reinsurance to Montpelier Syndicate 5151. This inter-segment reinsurance purchased by Montpelier Syndicate 5151 totaled $8.6 million, $5.3 million and zero in 2009, 2008 and 2007, respectively. Additionally, from time to time, Montpelier Syndicate 5151 purchases a limited amount of third-party reinsurance cover for its own account.
All of Montpelier Syndicate 5151’s own-account reinsurance purchases to date have represented prospective cover; that is, ceded reinsurance purchased to protect it against the risk of future losses as opposed to covering losses that have already occurred but have not been paid.
Various factors will continue to affect this segment’s appetite and capacity to write and retain risk. These include, but are not limited to the impact of changes in frequency and severity assumptions used in our models and the corresponding pricing required to meet our return targets, evolving industry-wide capital requirements and increased competition.
Our best estimate for Montpelier Syndicate 5151’s ending gross loss and LAE reserves at December 31, 2009 and 2008 was $96.0 million and $48.8 million, respectively.
We estimated Montpelier Syndicate 5151’s loss and LAE reserves using the methodology outlined in our “Summary of Critical Accounting Estimates” contained in Item 7 herein. We did not make any significant changes in the assumptions or methodology used in our reserving process during the year ended December 31, 2009.
During 2009, Montpelier Syndicate 5151 incurred $72.1 million of net loss and LAE from current year losses, $50.1 million of which represents IBNR losses across all lines of business. Similarly, the $22.0 million of reported case losses related to small claims affecting multiple classes of business written.
During 2007, Montpelier Syndicate 5151 incurred $4.2 million of net loss and LAE from current year loss, the majority of which represented IBNR losses.
· The settlement of two individual risk losses below the amounts previously reserved, which represented $5.4 million of favorable development.
During 2008, Montpelier Syndicate 5151 experienced $0.7 million in adverse development on its loss and LAE reserves relating to prior year losses.
Acquisition costs include profit commissions, brokerage costs, commissions and excise taxes, when applicable. Profit commissions and brokerage costs can vary based on the nature of business produced.
Montpelier Syndicate 5151’s fixed expenses are driven mainly by salaries and premises costs associated with its underwriting and Coverholder operations located in the U.S., U.K. and Switzerland and intercompany allocations of information technology and risk modeling expenses. Increases in these expenses for 2009, as compared to 2008, were offset by a reduction in annual Lloyd’s fees, as well as a $2.1 million credit received in respect of Lloyd’s fees relating to the 2007 and 2008 years of account. These fees had been largely tied to Montpelier Syndicate 5151’s underwriting capacity, which increased from £47 million in 2007 to £143 million in 2008. For 2009 and beyond, Lloyd’s fees are based on Montpelier Syndicate 5151’s actual premium writings.
The significant increase in Montpelier Syndicate 5151’s share-based and other incentive compensation recognized during 2009 versus 2008 is the result of an increase in accrued incentive compensation to above-target levels in response to stronger operating results achieved by the Company during 2009. The increase in incentive compensation costs from 2007 to 2008 was mainly due to increases in the number of staff within the U.S. and U.K. operations, and was partially offset by a decrease in incentive accruals made during the third quarter of 2008 resulting from the significant storm losses we incurred during that period.
The following tables summarize MUSIC’s net loss and LAE for the years ended December 31, 2009, and 2008:
We estimated MUSIC’s loss and LAE reserves using the methodology outlined in our “Summary of Critical Accounting Estimates” contained in Item 7 herein. We did not make any significant changes in the assumptions or methodology used in our reserving process during the year ended December 31, 2009.
MUSIC’s acquisition costs of $3.4 million and $0.5 million for 2009 and 2008, respectively, reflected the level of its earned premium.
The following table summarizes MUSIC’s general and administrative expenses during the years ended December 31, 2009, 2008 and 2007:
The increase in fixed expenses during 2008, as compared to 2007, is primarily the result of: (i) an increase in salaries and benefits associated with the hiring of additional finance, risk management and legal personnel in support of our new insurance and reinsurance initiatives; (ii) the promotion of certain corporate officers in connection with the Company’s 2008 succession planning actions; (iii) increased inter-segment allocations from the Company’s service companies; and (iv) upgrades made to the Company’s information and accounting systems. The decrease in incentive compensation during 2008, as compared to 2007, is due primarily to 2008 hurricane losses whereas 2007 was a year with significantly stronger operating results and few significant loss events.
Management services for 2008 and 2007 represented underwriting, risk management, claims management, ceded retrocession agreement management, actuarial and accounting service fees provided to Blue Ocean, while it was in existence.
The following table summarizes our consolidated net investment income and total investment return for the years ended December 31, 2009, 2008 and 2007:
Our total investment return for 2009 was significantly higher than that of 2008 and 2007, due to sizable net realized and unrealized investment gains partially offsetting reductions in net investment income experienced from 2007 to 2009.
Our investment expenses were higher in 2009, as compared to 2008 and 2007, due mainly to higher investment portfolio balances under management and changes in investment managers made during those years. As of December 31, 2009, 2008 and 2007, our ending investment portfolio, excluding cash, totaled $2,469 million, $2,097 million and $2,359 million, respectively.
During 2008, we experienced $82.4 million of net realized and unrealized losses from our fixed maturity investments and securities lending collateral, $103.5 million in net realized and unrealized losses from our equity investments and $59.0 million in net realized and unrealized losses from our other investments. The significant fixed maturity losses we experienced during 2008 were largely the result of credit concerns for corporate and asset-backed debt securities. Our equity portfolio also experienced significant losses during 2008, suffering from losses in the U.S. equity market as a whole. The net realized investment losses recorded during 2008 principally resulted from a $17.5 million loss within our fixed maturity portfolio resulting from the bankruptcy of Lehman Brothers and $43.6 million in losses within our other investment portfolio attributable to two leveraged limited partnership funds which specialized in distressed loans.
During 2009, 2008 and 2007, we recorded unrealized gains (losses) from our investment in Symetra Financial Corporation (“Symetra”) of $(0.5) million, $0.9 million and $(1.6) million respectively. Our investment in Symetra was acquired in a private placement in 2004. In January 2010, Symetra’s common shares began trading on the New York Stock Exchange under the symbol “SYA”. As a result, beginning in the first quarter of 2010, Montpelier’s investment in Symetra will be presented as an equity security on the Company’s consolidated balance sheets and changes in its fair value will be recorded as net realized and unrealized gains (losses) on the Company’s consolidated statements of operations. Symetra provides retirement plans, employee benefits, life insurance and annuities through a national network of independent advisors and agents.
As of December 31, 2009, $202.6 million or 8.3% of our total invested assets measured at fair value were considered to be Level 3 assets. Our investments classified as Level 3 at December 31, 2009 consisted primarily of the following: (i) with respect to fixed maturity investments, certain corporate bonds, convertible debt and asset-backed securities, many of which are not publicly traded or are not actively traded; (ii) with respect to equity securities, certain preferred and non-U.S. equity securities; and (iii) with respect to other investments, certain limited partnership interests and our investment in Symetra.
The decrease in our Level 3 securities from December 31, 2008 to December 31, 2009, was the result of an increase in pricing transparency of certain of the Company’s fixed maturities historically classified as Level 3. During the first quarter of 2010, our Level 3 investments will further decrease as our investment in Symetra will be reclassified from Level 3 to Level 1.
The following table summarizes the components of our consolidated net foreign exchange gains (losses) for years ended December 31, 2009, 2008 and 2007:
In 2008, we entered into an Industry Loss Warranty (“ILW”) swap contract (the “ILW Swap”) with a third-party in order to provide protection against our U.S. hurricane exposure. In return for a fixed-rate payment of $0.7 million, we are entitled to receive a floating-rate payment triggered on the basis of losses incurred by the insurance industry as a whole through April 30, 2009. The maximum recovery to us under the ILW Swap is $5.0 million. The ILW Swap expired without value.
During 2009 and 2008, our investment managers executed various exchange-traded investment options and futures (the “Investment Options and Futures”) as part of their investing strategy. As of December 31, 2009 and 2008, our investment managers held open long options with a fair value of $1.8 million and $0.1 million, respectively.
We recorded net revenues associated with our Investment Options and Futures of $8.1 million and $1.8 million during 2009 and 2008, respectively.
In 2006, we entered into a catastrophe bond facility (the “CAT Bond Facility”) under which we were entitled to receive contract payments from a third-party in return for assuming mark-to-market risk on a portfolio of securitized catastrophe risks. The difference between the notional capital amounts of the catastrophe bonds and their market value were marked to market over the terms of the bonds; the difference was settled on a monthly basis.
In March 2009 we repurchased and retired $21.0 million in face value of our senior unsecured debt (“Senior Notes”) due in 2013 and recognized a gain of $5.9 million representing the difference between the $15.1 million in consideration paid and the carrying value of the Senior Notes repurchased.
Our other revenue is comprised of interest on funds advanced to ceding companies to cover losses in accordance with contract terms and fees we earn from the Pioneer Diversified High Income Trust (the “Pioneer Fund”). The following table summarizes our consolidated other revenue for the years ended December 31, 2009, 2008 and 2007:
In 2007, we began serving as a sub-advisor to the Pioneer Fund, a publicly traded closed-end fund offering investors exposure to event-linked bonds known as catastrophe bonds, as well as other fixed income instruments. During 2008, we terminated our sub-advisory relationship and now serve as a consultant to the Pioneer Fund. We are not an investor in the Pioneer Fund.
Our interest and other financing expenses decreased significantly during 2008, as compared to 2007, due primarily to the repayment of the Blue Ocean Debt and the cancellation of Blue Ocean Re’s credit facility, each of which occurred in January 2008.
In the normal course of business, the Company, Montpelier Re and MCL maintain letter of credit facilities and Montpelier Re and MCL provide letters of credit to third parties. In addition, Blue Ocean Re established trust funds for the benefit of ceding companies. See “Liquidity and Capital Resources” contained in Item 7.
We are domiciled in Bermuda and have subsidiaries that are domiciled in several other countries, including the U.S., the U.K. and Switzerland.
The Company and its Bermuda-domiciled subsidiaries have received an assurance from the Bermuda Minister of Finance exempting them from all Bermuda-imposed income, withholding and capital gains taxes until March 2016. At the present time, no such taxes are levied in Bermuda.
The Company has no operations of its own and relies on dividends and distributions from its subsidiaries to pay its operating expenses, interest on debt, dividends to common shareholders and to fund any Common Share repurchase activities. There are restrictions on the payment of dividends to the Company from its regulated operating companies as described under “Regulation” herein. We currently have in place a regular dividend of $0.09 per Common Share per quarter. Any future determination to pay dividends or distributions to our shareholders will be at the discretion of our Board of Directors and will be dependent upon many factors, including our results of operations, cash flows, financial position, capital requirements, general business opportunities, legal, tax, regulatory and contractual restrictions.
During the years ended December 31, 2009, 2008 and 2007, we were able to meet all of our cash obligations. We anticipate that our current cash and cash equivalent balances, sales and maturities of investments and our projected future cash flows from operations should be sufficient to cover our cash obligations under most loss scenarios through the foreseeable future.
The following table summarizes our capital structure as of December 31, 2009 and 2008:
Our Senior Notes are scheduled to mature on August 15, 2013. Our Junior Notes mature on March 30, 2036, but are redeemable at our option at par beginning March 30, 2011. Neither the Senior Notes nor the Junior Notes contain any covenants regarding financial ratios or specified levels of net worth or liquidity to which the Company or any of its subsidiaries must adhere.
In the normal course of business, we maintain letter of credit facilities and provide letters of credit to third parties. These letter of credit facilities were secured by collateral accounts containing cash and investments totaling $835.8 million and $724.5 million at December 31, 2009 and 2008, respectively. The following table outlines these facilities as of December 31, 2009:
Montpelier Re entered into its five-year syndicated secured facility (II) in June 2007 which was subsequently reduced from $250.0 million to $215.0 million. This facility is subject to an annual commitment fee of 0.275% on drawn balances and 0.08% on undrawn balances.
The agreements governing these facilities contain covenants that limit our ability, among other things, to grant liens on our assets, sell our assets, merge or consolidate with others, incur debt and enter into certain burdensome agreements. In addition, the syndicated secured facilities and the Lloyd’s Standby Facility each require the Company to maintain debt leverage of no greater than 30% and Montpelier Re to maintain an A.M. Best financial strength rating of no less than B++. If we were to fail to comply with these covenants or fail to meet these financial ratios, the lenders could revoke these facilities and exercise remedies against the collateral. As of December 31, 2009 and 2008, we were in compliance with all covenants.
We currently believe that we will be able to renew our operational letter of credit facilities as they expire, if needed, although current pricing indications are less favorable than those of our existing facilities. As such, our interest and financing expenses associated with such facilities may increase in the future, perhaps significantly. We are currently exploring the use of collateralized trust arrangements as an alternative means of providing collateral to our cedants and to Lloyd’s.
Our debt and interest and other financing obligations presented assume that we do not exercise our option to redeem the Junior Notes at par in March 2011 and that, for periods thereafter through March 2036, interest on the debt accrues at the applicable floating rate of 3-month LIBOR plus 380 basis points. Our letter of credit facilities, each of which is cancellable within one year, are assumed to be fully cancelled at December 31, 2010.
Vested and earned incentive compensation represents amounts due to employees at December 31, 2009 under our annual bonus and performance share plans for the applicable performance cycles ending as of that date. This amount excludes RSU awards which are paid in Common Shares.
· we spent $393.6 million on net purchases of fixed maturities,
· we received $244.8 million from net sales of equity securities and other investments,
· we spent $15.1 million to repurchase and retire a portion of our Senior Notes,
· we spent $254.8 million on net purchases of equity securities and other investments,
· we spent $1.0 million in connection with the termination of our securities lending program,
· we spent $75.0 million to retire Blue Ocean’s debt, paid $38.1 million in distributions and redemptions to Blue Ocean’s noncontrolling common shareholders and paid $21.0 million in dividends and redemptions to Blue Ocean’s noncontrolling preferred shareholders,
· we paid $30.5 million to acquire all the remaining outstanding common shares of Blue Ocean, and
We also experienced a $0.9 million increase in cash and cash equivalents due to foreign exchange rate fluctuations.
· we spent $135.2 million in distributions and redemptions to Blue Ocean’s noncontrolling common shareholders and paid $46.4 million in dividends and redemptions to Blue Ocean’s noncontrolling preferred shareholders, and
Our reserving methodology does not lend itself well to a statistical calculation of a range of estimates surrounding the best point estimate of our loss and loss adjustment expense reserves. Due to the low frequency and high severity nature of our business, our reserving methodology principally involves arriving at a specific point estimate for the ultimate expected loss on a contract by contract basis, and our aggregate loss reserves are the sum of the individual reserves established. Our internal actuaries review our reserving assumptions and our methodologies on a quarterly basis. Our third quarter and year-end loss estimates are subject to a corroborative review by independent actuaries using generally accepted actuarial principles. The Audit Committee of our Board of Directors receives our quarterly and annual reserve analyses.
While the approach we use in reserving for large events is generally applied consistently, at any point in time the specific reserving assumptions may vary among contracts. The assumptions for a specific contract may depend upon the class of business, historical reporting patterns of the cedant, whether or not the cedant provides an IBNR estimate, how much of the loss has been paid, the number of underlying claims still open and other factors. For example, the expected loss development for a contract with 1% of claims still outstanding would likely be less than for a contract with 50% of claims still open.
For non-catastrophe losses, we often apply trend-based actuarial methodologies in setting reserves, including paid and incurred loss development, Bornheutter-Ferguson and frequency and severity techniques. We also utilize industry loss ratio and development pattern information in conjunction with our own experience. The weight given to a particular method will depend on many factors, including the homogeneity within the class of business, the volume of losses, the maturity of the accident year and the length of the expected development tail. For example, development methods rely on reported losses, while expected loss ratio methods are primarily based on expectations in place prior to a notification of loss. Therefore, as an accident year matures, we may shift weight from an expected loss ratio method to an incurred development method.
Since we rely on estimates of paid losses, case reserves, and IBNR reserves provided by ceding companies in order to assist us in estimating our own loss and LAE reserves, we maintain certain procedures designed to mitigate the risk that such information is incomplete or inaccurate. These procedures include, for example, the comparison of expected premiums to reported premiums to help us identify delinquent client periodic reports, ceding company audits to facilitate loss reporting and identify inaccurate or incomplete claim reporting, and underwriting reviews to ascertain that the losses ceded are covered as provided under the contract terms. We also use catastrophe model output and industry market share information to evaluate the reasonableness of reported losses, which are also compared to loss reports received from other cedants. In addition, each subsequent year of loss experience with a given cedant provides additional insight into the accuracy and timeliness of previously reported information. These procedures are incorporated in our internal controls process on an ongoing basis, and are regularly evaluated and amended as market conditions, risk factors, and unanticipated areas of exposure develop. Since our follow up actions form part of our normal due diligence process in claims handling matters, we do not capture data which records the extent to which ceding company claims are subsequently adjusted as a result of these activities alone, nor is it possible to determine the extent to which our actions influence the accuracy of subsequent cedant reporting. However, unreliable reporting is a factor which influences our underwriters’ willingness to offer terms to potential cedants. We believe that our diligence in these matters promotes better reporting by brokers and cedants over the long term. In our relatively short history, disputes with ceding companies have been rare and those which have not been resolved in negotiation have been resolved through arbitration in accordance with contractual provisions.
The development of our prior-year losses is monitored during the course of subsequent calendar years by comparing the actual reported losses against expected losses. The analysis of this loss development is an important factor in our ongoing refinement of the assumptions underlying our reserving process. Our internal analysis of changes in prior year reserve estimates is focused on changes in the estimated ultimate loss and therefore management believes that it is not meaningful to split the movement of prior year reserve estimates between case reserves and IBNR. With regards to our short-tail property book of business, we do not feel that we can estimate the expected breakdown of losses in the first year with a high level of accuracy. The percentage split between paid losses, case reserves, and IBNR would vary greatly depending on the number, nature and timing of losses throughout the year. However, we would expect that by the end of the year subsequent to the year in which the loss occurred, the majority of these short-tail property losses would be reported to us, and by the end of the following year the majority would be paid.
The uncertainties inherent in the reserving process, together with the potential for unforeseen developments, including changes in laws and the prevailing interpretation of policy terms, may result in loss and LAE significantly greater or less than the reserves initially established. Changes to our prior year loss reserves will impact our current underwriting results by improving our results if the prior year reserves prove to be redundant or impairing our results if the prior year reserves prove to be insufficient. We expect volatility in our results in periods that significant loss events occur because U.S. GAAP does not permit insurers or reinsurers to reserve for loss events until they have occurred and are expected to give rise to a claim. As a result, we do not record contingency reserves to account for expected future losses. We anticipate that claims arising from future events will require the establishment of substantial reserves from time to time.
The following tables provide the details of our gross case reserves and IBNR, by line of business, at December 31, 2009 and 2008:
Our reserving methodology does not lend itself well to a statistical calculation of a range of estimates surrounding the best point estimate of our loss and loss adjustment expense reserves. Due to the low frequency and high severity nature of our business, our reserving methodology principally involves arriving at a point estimate for the ultimate expected loss on a contract by contract basis, and our aggregate loss reserves are the sum of the individual reserves established.
Reinsurance contracts can be written on a risks-attaching or losses-occurring basis. Under risks-attaching reinsurance contracts, all claims from cedants’ underlying policies incepting during the contract period are covered, even if they occur after the expiration date of the reinsurance contract. In contrast, losses-occurring reinsurance contracts cover all claims occurring during the period of the contract, regardless of the inception dates of the underlying policies. Any claims occurring after the expiration of the losses-occurring contract are not covered.
Premiums written are recognized as revenues, net of any applicable underlying reinsurance coverage, and are earned over the term of the related policy or contract. For direct insurance, and facultative and losses-occurring contracts, the earnings period is the same as the reinsurance contract. For risks-attaching contracts, the earnings period is based on the terms of the underlying insurance policies.
Insurance and facultative reinsurance contracts are written based on agreed upon terms and conditions which include a stated premium for coverages provided. The stated premium is then recorded as written premium at the effective date of the policy. In general, if the terms and conditions change during the policy period, either through policyholder request or underwriting audit, the policy would be endorsed to reflect the change in coverage. This endorsement usually generates a change to the policy premium which is then recorded as an adjustment to written premium.
We routinely review the creditworthiness of our cedants on the basis of our market knowledge, the cedant’s current financial strength ratings, the timeliness of cedants’ past payments and the status of current balances owing. In addition, we may also review the financial condition of ceding companies. Based on our reviews, we established allowances of $2.3 million and $0.8 million for uncollectible premiums receivable as of December 31, 2009 and 2008, respectively.
The cost of quota share reinsurance is initially based on our estimated gross premium written related to the specific lines of business covered by the reinsurance contract. As gross premiums are written during the period of coverage, reinsurance premiums ceded are adjusted in accordance with the terms of the quota share agreement.
As of December 31, 2009 and 2008, we recorded $44.5 million and $36.4 million in reinsurance recoverable on paid losses, respectively, and $69.6 million and $122.9 million in reinsurance recoverable on unpaid losses, respectively. Based on a review of the financial condition of the reinsurers and other factors, we have determined that a reserve for uncollectible reinsurance recoverable on paid and unpaid loss and LAE was not considered necessary as of December 31, 2009 and 2008.
Since performance shares are contingently payable, we initially accrue the projected performance share expense based on: (i) the number of performance shares granted; (ii) the closing price of Common Shares on the date of grant; and (iii) an assumed 100% harvest ratio. Beginning at the mid-point of the performance cycle, and every subsequent quarter thereafter, we re-assess the projected results for each outstanding performance share cycle and adjust our performance share accrual as necessary based on: (i) the number of performance shares granted; (ii) the current price of Common Shares as of the balance sheet date; and (iii) our current estimate of the ultimate harvest ratio. As a result, during the latter half of any performance share period, our performance share expense may fluctuate significantly as the harvest ratio and the market price of Common Shares is adjusted.
The primary performance target for all participants with respect to performance shares granted for the 2005-2007, 2006-2008 and 2007-2009 performance periods was the achievement of an underwriting return on an internally generated risk-based capital measure of 16% over the period. Additionally, at the sole discretion of the CN Committee, the performance of certain members of senior management may be further measured by reference to the ratio of the actual return on equity to the return on risk-based capital and may result in an adjustment to the harvest of + / - 25%.
With respect to the 2005-2007 performance cycle, 400,000 performance shares were originally granted to employees. Due to the impact of severe hurricane losses on our 2005 results, the estimated harvest ratio for this performance cycle was reduced to zero during 2005 and such performance shares were formally cancelled without payment in 2007. As a result, the Company recognized no performance share expense for grants made under this performance cycle during the periods presented herein.
With respect to the 2006-2008 performance cycle, 164,000 performance shares were originally granted to employees of which 153,000 remained outstanding at December 31, 2008. In accordance with our accounting policy, the expected ultimate harvest ratio for this performance cycle was subsequently adjusted from 100% to 116% (95% in the case of certain members of senior management) and the reference price of Common Shares was reduced from $19.23 (the closing price on the date of grant) to $16.23 (the average of the last five trading days in 2008). The Company recognized performance share expense (income) for grants made under this cycle of $(1.3) million during 2008 and $2.6 million during 2007.
For the Variable RSU award cycle from 2008 to 2011, the targeted performance metric was based on a 2008 ROE of 11.22%. At a target achieved ROE of 11.22% we expected to grant approximately 600,000 Variable RSUs to participants, at a threshold ROE of 5.22% we expected to grant no Variable RSUs to participants and at a maximum ROE of 21.22% we expected to grant approximately 1,200,000 Variable RSUs to participants. Throughout the Initial RSU Period, our quarterly Variable RSU accrual for this cycle varied in response to actual year-to-date results achieved and ranged from 594,539 RSUs at June 30, 2008 to 169,848 RSUs at September 30, 2008. Based on the actual ROE achieved for 2008 of 8.11%, the final number of Variable RSUs granted for the 2008-2011 award cycle was determined to be 296,374 by the CN Committee and these awards have been converted to Fixed RSUs.
For the Variable RSU award cycle from 2009 to 2012, the targeted performance metric was based on a 2009 ROE of 9.77%. At a target achieved ROE of 9.77% we expected to grant approximately 650,000 Variable RSUs to participants, at a threshold ROE of 3.77% we expected to grant no Variable RSUs to participants and at a maximum ROE of 19.77% we expected to grant approximately 1,300,000 Variable RSUs to participants. Throughout the Initial RSU Period, our quarterly Variable RSU accrual for this cycle varied in response to actual year-to-date results achieved and ranged from 1,260,327 RSUs at December 31, 2009 to 685,717 RSUs at March 31, 2009. Based on the estimated ROE achieved for 2009 of 19.11%, the final number of Variable RSUs to be granted for the 2009-2012 award cycle is currently estimated to be approximately 1,260,327. The final ROE and number of Variable RSUs to be converted to Fixed RSUs will be determined by the CN Committee in March 2010.
The unamortized grant date fair value of the 508,442 Fixed RSUs outstanding as of December 31, 2009 was $3.7 million and the unamortized grant date fair value of the 1,260,327 Variable RSUs outstanding as of December 31, 2009 was $9.6 million.