The Company leases office space in Hamilton, Bermuda where the Company’s principal executive office is located. Additionally, the Company and its subsidiaries lease office space in the United States, Ireland, the United Kingdom and other jurisdictions sufficient for the operation of its insurance and reinsurance operations. We renew and enter into new leases in the ordinary course of business. For further discussion of our leasing commitments at December 31, 2009, see Note 20 of our audited consolidated financial statements.
The following is a discussion and analysis of our results of operations for the year ended December 31, 2009 compared to the year ended December 31, 2008 and for the year ended December 31, 2008 compared to the year ended December 31, 2007, and also a discussion of our financial condition as of December 31, 2009. This discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes that are included in this Annual Report on Form 10-K.
Our results for the year ended December 31, 2009 reflect profitable underwriting results from all of our segments, a significant rebound in investment results and the continuation of our targeted diversification and expansion strategy.
Net income of $246.2 million, compared to a net loss of $175.3 million in 2008;
Net favorable prior year loss reserve development, excluding the effect of premium adjustments, on property and casualty business of $78.3 million, compared to $90.8 million in 2008.
Net investment income for the year ended December 31, 2009 decreased $11.9 million to $169.7 million compared to the 2008 year, principally due to the lower interest rate environment and our significant holdings in lower-yielding cash and cash equivalents. Net realized and unrealized gains on investments included within net income increased from a net loss of $235.0 million in 2008 to a net gain of $81.8 million in 2009. In addition, unrealized investment gains within shareholders’ equity increased by $50.5 million during the year ended December 31, 2009. The rebound in fair values of our fixed maturities and hedge fund investments in 2009 compared to the declines experienced in 2008 have significantly contributed to the improvement in net income and shareholders’ equity for the year ended December 31, 2009. The total return on our invested assets was 6.68% for the year ended December 31, 2009, compared to negative 0.09% for the 2008 year.
The credit quality of our fixed maturities investment portfolio remained high. At December 31, 2009, 62.8% of our fixed maturities portfolio is AAA-rated or better, and 3.4% of our portfolio is rated BB+ or less. At December 31, 2009 the allocation of our invested assets is 13.4% in cash and cash equivalents, 80.6% in fixed maturities, and 6.0% in other investments (principally hedge funds).
We follow Accounting Standards Codification, ASC, 944 - Financial Services - Insurance in determining the accounting for our reinsurance and insurance products.
Assessing whether or not the contracts we write meet the conditions for risk transfer requires judgment. The determination of risk transfer is based, in part, on the use of actuarial and pricing models and assumptions.
Our reinsurance premiums are recorded at the inception of each contract, based upon contract terms and information received from ceding clients and their brokers. For excess of loss contracts, the amount of minimum and/or deposit premium is usually contractually documented at inception, and variances between this premium and final premium are generally small. An adjustment is posted to amend the minimum and/or deposit premium, when notified, if there are changes in underlying exposures insured. For quota share or proportional reinsurance contracts, gross premiums written are normally estimated at inception based on information provided by cedants and/or brokers. We generally account for such premiums using the client’s initial estimates, and then adjust them as more current information becomes available, with such adjustments recorded as premiums written in the period they are determined. We believe that the ceding clients’ estimate of the volume of business they expect to cede to us represents the best estimate of gross premium written at the beginning of the contract. As the contract progresses, we monitor actual premium received in conjunction with correspondence from the ceding client in order to refine our estimate. Variances from original premium estimates are normally greater for quota share contracts than excess of loss contracts. Premiums are earned on a pro rata basis over the coverage period. The net adjustments to gross premiums written as a result of changes in premium estimates for the years ended December 31, 2009, 2008 and 2007 were $10.9 million, $46.0 million and $9.3 million, respectively. Such adjustments are generally the result of changing market conditions experienced by our clients.
For each of the years ended December 31, 2009, 2008 and 2007, additional premiums relate to contracts where the coverage period had expired. Therefore, these additional premiums, representing revisions to our initial estimate of ultimate premiums as a result of changes in the estimate of loss reserves, were fully earned since the exposure period has ended.
Certain of the contracts we write, particularly the property reinsurance risks, provide for reinstatements of coverage. Reinstatement premiums are the premiums for the restoration of the insurance or reinsurance limit of a contract to its full amount after a loss occurrence by the insured or reinsured and principally relate to our property catastrophe reinsurance contracts. The purpose of optional and required reinstatements is to permit the insured / reinsured to reinstate the insurance coverage at a pre-determined price level once a loss event has penetrated the insured layer. In addition, required reinstatement premiums permit the insurer / reinsurer to obtain additional premiums to cover the additional loss limits provided.
The liability for losses, including loss adjustment expenses, represents estimates of the ultimate cost of all losses incurred but not paid as of the balance sheet date. In estimating reserves, we utilize a variety of standard actuarial methods. Although these actuarial methods have been developed over time, assumptions about anticipated size of loss and loss emergence patterns are subject to fluctuations. Newly reported loss information from
clients is the principal contributor to changes in the loss reserve estimates. These estimates, which generally involve actuarial projections, are based upon an assessment of known facts and circumstances, as well as estimates of future trends in claims severity and frequency and judicial theories of liability factors, including the actions of third parties, which are beyond our control.
When determining reserves, we also consider historical data, industry loss trends, legal developments, changes in social attitudes and economic conditions, including the effects of inflation.
The table below breaks our reserves as of December 31, 2009 into these components by segment.
Our reserving methodologies, as discussed above, uses a loss reserving model that calculates a point estimate for our ultimate losses, as opposed to a methodology that develops a range of estimates. Although we believe that our assumptions and methodologies are reasonable, we cannot be certain that our ultimate payments will not vary, perhaps materially, from the estimates we have made. If we determine that adjustments to an earlier estimate are appropriate, those adjustments are reflected in our net income during the period in which we determine these adjustments. The establishment of new reserves, or the adjustment of reserves for reported claims, could result in significant upward or downward changes to our financial condition or results of operations in any particular period. We regularly review and update these estimates using the most current information available to us.
Development of our prior period incurred losses for each of the three years ended December 31, 2009 is reported in Note 7-”Property and casualty losses and loss adjustment expenses” to our consolidated financial statements. Our development of prior period loss reserves has been less than 6.0% in each of the three years ending December 31, 2009 and an average of 3.7% over the past eight years. Based on this experience, we currently believe it reasonably likely that loss reserves could change 3.5% from currently reported amounts. This change could be higher or lower depending on our client reported data and potential future commutation of reserves. As at December 31, 2009, we estimate that a 3.5% change in loss reserves would impact our net income and shareholders’ equity by $111.2 million. Depending on whether the reasonably likely adjustments to loss reserves are on contracts ceded to one of our various reinsurance arrangements, there may also be a partially offsetting change in the losses recoverable, net income and shareholders’ equity.
Our Bermuda/Dublin property insurance loss reserves, which include case reserves, IBNR reserves and loss adjustment expenses, are compiled on a portfolio basis and are computed on an undiscounted basis. These reserves are adjusted for losses reported by our clients and for our estimate of losses resulting from catastrophe events, based on a detailed, location specific analysis of our clients’ properties impacted by the events.
We establish and review our Bermuda/Dublin insurance loss reserves on a quarterly basis. The process for adjusting our Bermuda/Dublin insurance loss reserves is based upon loss reports received from clients, which are input into actuarial models. We use a variety
of actuarial techniques and methods in estimating our ultimate liability for property and casualty insurance losses and loss expenses, together with management judgment. As noted above, these methods include paid loss development, incurred loss development, paid and incurred Bornhuetter-Ferguson methods and frequency-severity methods. This actuarial data is analyzed by product, type of risk, coverage and accident or policy year. Industry loss experience is also used to supplement our own data in selecting long term trend and development factors and in areas where our own data or the insureds’ data is limited. The table below breaks our insurance reserves as of December 31, 2009 and 2008 into casualty and property components.
We establish and review our Bermuda/Dublin reinsurance loss reserves on a quarterly basis. The process for establishing our Bermuda/Dublin reinsurance loss reserves is based upon actuarial analysis of exposure loss data provided by clients. We use a variety of actuarial techniques and methods in estimating our ultimate liability for Bermuda/Dublin reinsurance losses and loss expenses, together with management judgment. These methods include expected loss ratio, paid loss development, incurred loss development, paid and incurred Bornhuetter-Ferguson methods and frequency-severity methods. This actuarial data is analyzed by product, type of risk, coverage and accident or policy year, as appropriate. Industry loss experience is also used to supplement our own data in selecting development factors in areas where our own data or the clients’ data is limited.
On a gross of reinsurance basis through December 31, 2009 the majority of the U.S. specialty business we have written is property business. On a net of reinsurance basis, the earned premium is approximately equally split between property and casualty. Our U.S. specialty property and casualty loss reserves, which include case reserves, amounts for IBNR reserves and loss adjustment expenses, are compiled on a portfolio basis and are computed on an undiscounted basis.
The table below breaks our Max at Lloyd’s loss reserves as of December 31, 2009 and 2008 into casualty and property components.
(3) The difference between the loss development included above and that reflected in the reconciliation of losses and loss adjustment expenses in Note 7 to the consolidated financial statements of $298 relates to amortization of deferred charges on retroactive reinsurance.
(5) Gross and net reserve for property and casualty losses includes, for the first time, Max America, which we acquired in June 2008.
(6) Gross and net reserve for property and casualty losses includes, for the first time, Max UK, which we acquired in November 2008.
Net favorable development for the Bermuda/Dublin insurance segment of $41.3 million; $21.0 million of which was recognized on professional liability and $7.1 million on general casualty lines of business, primarily on the 2005 and prior years, and $13.3 million on the short tail property and aviation lines of business from the 2008 and 2007 years.
primarily on the 2008 and prior years, including $20.3 million on property reinsurance, and $5.5 million on other short tail lines, offset by adverse development of $24.3 million on the marine and energy lines of business.
Net favorable development for our Max at Lloyd’s segment of $6.1 million, largely recognized on the professional liability line of business. This was partially offset by adverse development of $1.1 million in our U.S specialty segment.
Favorable development of $11.4 million arising from reductions in reinsurance premium estimates of $10.9 million. Changes in premium estimates occur on prior year contracts each year as we receive additional information on the underlying exposures insured and the associated loss is recorded, at the original loss ratio, concurrently with the premium adjustment. The favorable development is offset by a decrease in earned premium net of acquisition costs of $11.7 million.
Premium adjustments in our Bermuda/Dublin insurance segment resulted in adverse development of $2.1 million which was offset by an increase in earned premium during the year.
There have been no material reserve adjustments to our life and annuity reinsurance benefit reserves during the years ended December 31, 2009, 2008 and 2007.
In order to reduce the likelihood of needing to sell our available for sale investments before maturity, especially given the unpredictable and potentially significant cash flow requirements of our property catastrophe business, we maintain significant cash and cash equivalent balances and can access our credit facility, which is described in Note 20 of our audited consolidated financial statements. We believe it is more likely than not that we will not be required to sell those fixed maturity securities in an unrealized loss position until such time as they reach maturity or the fair value increases.
We utilize dynamic financial analysis to determine our overall asset and liability risk and the potential for adverse scenarios producing projected losses and potential adverse cash flow. This analysis is accomplished through a stochastic simulation of future periods with asset and liability cash flows individually modeled. This stochastic simulation utilizes the expected volatility of each of our individual asset and liability cash flows. We construct our asset portfolio based on the characteristics of our liability portfolio. Fixed maturities securities are purchased to meet cash flows along the entire maturity spectrum of the liabilities. Our liability cash flows are highly variable. Because of this risk, we maintain a significant cash balance, which has consistently exceeded $250.0 million. We have also generated at least $175.0 million of positive operating cash flow in each of the five years ended December 31, 2009.
The independent pricing services used by our investment custodians and investment managers obtain actual transaction prices for securities that have quoted prices in active markets. Each pricing service has its own proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of “matrix pricing” in which the independent pricing service uses observable market inputs including, but not limited to, reported trades, benchmark yields, broker/dealer quotes, interest rates, prepayment speeds, default rates and such other inputs as are available from market sources to determine a reasonable fair value. In addition, pricing services use valuation models, such as an Option Adjusted Spread model, to develop prepayment and interest rate scenarios. The Option Adjusted Spread model is commonly used to estimate fair value for securities such as mortgage-backed and asset-backed securities. The ability to obtain quoted market prices is reduced in periods of decreasing liquidity, which generally increases the use of matrix pricing methods and generally increases the uncertainty surrounding the fair value estimates. This could result in the reclassification of a security between levels of the hierarchy.
Certain of our funds have either imposed a gate on redemptions, or have segregated a portion of the underlying assets into a side-pocket. Based on the review process applied by management, a reduction of $0.7 million was made to the net asset values reported by
Additional information about the fair values of the hedge fund portfolio can be found in Note 4 to our audited consolidated financial statements included herein.
As at December 31, 2009, the hedge fund portfolio contained 30 underlying investments in nine different strategies. We focus on risk, as opposed to return, in the selection of each of our investments within the hedge fund portfolio. This causes us to select individual hedge funds that have exhibited attractive risk/reward characteristics and low correlation to other investments in the portfolio, as opposed to individual investments that have shown the highest return, but also higher volatility of return. We then combine the selected hedge fund investments into a portfolio of hedge fund investments. By combining investments with moderate volatility and low correlations, we aim to achieve a hedge fund portfolio that has overall lower volatility relative to investing in a common stock portfolio or a typical fund of hedge funds portfolio.
recognize our proportionate share of income or loss and dividends from these investments. Future adverse changes in general market, global and economic conditions, changes to the interest and currency rate environment or poor operating results by our investments carried under the equity method of accounting could result in losses. At December 31, 2009, our total investment in reinsurance private equity was an interest in Grand Central Re of $2.8 million.
Bermuda/Dublin reinsurance-This segment offers property and casualty quota share and excess of loss capacity from our Bermuda and Dublin offices, providing coverage for a portfolio of underlying risks written by our clients.
U.S. specialty-This segment offers property and casualty coverage insurance from offices in the United States on specific risks related to individual insureds.
Max at Lloyd’s-This segment offers property and casualty quota share and excess of loss capacity from our London and Copenhagen offices. This segment comprises our proportionate share of the underwriting results of the Syndicates, and the results of our managing agent, Max at Lloyd’s.
Life and annuity reinsurance-This segment operates out of Bermuda only and offers reinsurance products focusing on existing blocks of life and annuity business, which take the form of co-insurance transactions whereby the risks are reinsured on the same basis as the original policies.
The U.S. specialty and the Max at Lloyd’s segments each have their own portfolio of fixed maturities investments; as a result the investment income earned by each of these portfolios is reported in its respective segment. The management of these portfolios, however, is handled on a consolidated basis together with the invested assets of the Bermuda/Dublin insurance, Bermuda/Dublin reinsurance and life and annuity segments.
The 2009 loss ratio decreased over the comparative 2008 period by 13.8 percentage points to 64.3%. The decrease in the loss ratio in 2009 was principally attributable to lower property catastrophe and per-risk losses compared to 2008. Significant items impacting the loss ratio were:
There were no significant catastrophe-related losses in 2009, compared to $5.4 million of hurricane losses in 2008.
The 2008 loss ratio increased 1.0 percentage point over the 2007 loss ratio. The increase in the loss ratio in 2008 was principally attributable to higher property catastrophe and per-risk losses, partly offset by a greater amount of favorable prior year loss reserve development. Significant items impacting the loss ratio were:
Excluding net favorable loss development, the 2008 loss ratio was 90.6% compared to 81.5% for the 2007 year;
There were net losses of $5.4 million related to hurricane losses in 2008, compared to no significant catastrophe losses in 2007.
Acquisition costs are net of ceding commissions associated with premiums ceded to our quota share partners. These ceding commissions are designed to compensate us for the costs of producing the portfolio of risks ceded to our reinsurers. Acquisition costs have remained relatively stable from 2007 to 2009.
expenses in 2008 compared to 2007 resulted principally from additional claims and underwriting staff added over the course of 2008 and 2007 in order to service a growing base of clients, as well as higher expense associated with the vesting of long-term stock-based compensation.
Net investment income and net realized and unrealized gains on investments are discussed within the corporate function results of operations as we manage investments for this segment on a consolidated basis with the Bermuda/Dublin reinsurance and life and annuity reinsurance segments.
Net favorable development of $32.0 million, excluding the development associated with changes in reinsurance premium estimates described below. We recorded net favorable development on long tail lines of business, including $10.5 million from general casualty primarily on 2005 and prior years, $8.6 million on professional liability primarily on 2006 and prior years, $7.9 million on medical malpractice primarily on 2007 and prior years, and $3.3 million on other long tail lines of business. We recorded net favorable development on short tail lines of business primarily on the 2008 and prior years, including $20.3 million on property reinsurance, and $5.5 million on other short tail lines, offset by adverse development of $24.3 million on the marine and energy lines of business. The net favorable development in 2008 was principally related to the professional liability ($25.8 million), property ($22.1 million), whole account ($15.1 million), and general casualty ($9.5 million), lines of business. This development was partially offset by adverse development of $13.5 million in the marine and energy line of business.
Changes in reinsurance premium estimates resulted in a decrease in loss reserves of $11.4 million in 2009 compared to a decrease of $17.0 million in 2008. In both years, this favorable development was more than offset by decreases in net earned premiums net of acquisition costs of $11.7 million and $24.2 million, in 2009 and 2008, respectively;
There were $47.0 million of catastrophe-related losses in 2008, compared to no significant property catastrophe losses in 2007.
The ratio of reinsurance premiums ceded to gross premiums written for the year ended December 31, 2009 was 16.4%, a decrease of 5.6 percentage points from 22.0% in 2008. The decrease was due to a significant quota share contract incepting in the third quarter of 2008 which renewed in 2009 at a significantly lower amount. In addition, reinstatement premiums ceded triggered by property catastrophe losses during 2008 were $1.7 million compared to no significant reinstatement premiums ceded in 2009. These items also explain the increase from 2007 to 2008 in the ratio of premiums ceded to premiums written.
The ratio of acquisition costs to net premiums earned increased 3.3 percentage points (to 18.3% from 15.0%) for the year ended December 31, 2009 compared to 2008. This is principally as a result of changes in the mix of business written, in particular the significant growth in professional liability and workers compensation business, which raised the average ceding commission. The decrease in the ratio of acquisition costs to net premiums earned of 4.4 percentage points to 15.0% in 2008 from 19.4% in 2007 was principally attributable to changes in our business mix, with the lower acquisition costs in our agriculture product line having the largest impact.
Our U.S. specialty segment, which comprises the underwriting operations of our U.S.-based business, commenced underwriting activities in April 2007. The rate of growth from 2007 to 2009 may not necessarily be representative of future trends.
The loss ratio for the year ended December 31, 2009 improved 7.9 percentage points compared to 2008, after improving 12.6 percentage points over 2007. As gross premiums written volume increased, creating a broader client base, we expected to see this improvement in our net loss ratio. Our planned increase in the mix of general casualty business and our planned addition of professional liability business may temper the reduction in the loss ratio in future periods as those lines tend to have higher average loss ratios than property lines. Net losses and loss expenses in this segment typically comprise a larger volume of smaller dollar value losses compared to our Bermuda/Dublin insurance and reinsurance segments. The years ended December 31, 2008 and 2007 included $5.0 million and $nil losses, respectively, related to hurricane events, net of reinsurance recoveries. There were no equivalent catastrophic losses in 2009. For the year ended December 31, 2009, net adverse development on prior year reserves was $1.1 million. This was principally in the marine line of business ($2.2 million) and general casualty ($0.6 million), partially offset by favorable development of prior year property reserves ($1.7 million). There was no significant development on prior year reserves in 2008 or 2007.
Net investment income, which excludes realized and unrealized gains and losses, is comprised principally of interest on cash and fixed maturities investments held by Max Specialty and Max America. The average annualized investment yield on cash and fixed maturities for the year ended December 31, 2009 was 3.86%, compared to 4.59% for the year ended December 31, 2008 and 5.08% for the year ended December 31, 2007.
The combined ratio was 86.3% for the year ended December 31, 2009. The combined ratio for the period from acquisition to December 31, 2008 of 138.5% is not a meaningful comparative figure due to the short time period involved.
Gross premiums written of $129.0 million were in line with our plan for 2009 for existing lines of business. Gross premiums written in 2009 increased 7.3% in comparison to full year 2008 gross premiums written of $120.2 million ($111.4 million of which were written prior to our acquisition of Max at Lloyd’s, and therefore are not included in the consolidated results for the year ended December 31, 2008, and $8.8 million was written following the acquisition and is reflected in the table above). This growth was predominantly in the property and accident and health business lines. Also, in the fourth
General and administrative expenses principally comprise personnel and infrastructure costs. The ratio of general and administration expenses to net premiums earned was 21.0% for the year ended December 31, 2009 compared to 58.5% for the period ended December 31, 2008. The 2008 ratio is not a meaningful comparative figure due to the short period involved, which included significant initial integration and infrastructure costs.
We write life and annuity reinsurance transactions when attractive opportunities arise. The nature of life and annuity reinsurance transactions that we consider results in a limited number of transactions actually bound with potentially large variations in quarterly and annual premium volume. Consequently, components of our underwriting results, such as premiums written, premiums earned and benefits can be volatile and, accordingly, period-to-period comparisons are not necessarily representative of future trends. Our life and annuity benefit reserves are recorded on a discounted present value basis. This discount is amortized through net income as a claims and policy benefits expense, over the term of the underlying policies. As a result, income before taxes is driven by the spread between the actual rate of return on our investments and the interest discount on our reserves, together with differences between estimated and actual claims, premiums, expenses and persistency of the underlying policies.
We wrote one life and annuity contract during the year ended December 31, 2009 with gross premiums written totaling $41.6 million, covering a closed block of traditional life insurance for a new client. For the year ended December 31, 2008, we wrote three contracts totaling gross premiums written of $239.6 million, each covering closed blocks of pension annuities for existing clients. For the year ended December 31, 2007 we wrote six contracts totaling gross premiums written of $299.3 million, each covering closed blocks of pension annuities; $207.9 million was from new clients and $91.4 million was from existing clients.
Net investment income and net realized and unrealized gains on investments are discussed within the corporate function results of operations as we manage investments for this segment on a consolidated basis with the Bermuda/Dublin insurance and Bermuda/Dublin reinsurance segments.
The results of operations for the corporate function discussed below include the net investment income, net realized and unrealized gains/losses on investments, net impairment losses recognized in income and net realized gain on retirement of senior notes for all of our segments, including amounts which are allocated to the segments and included in the segment discussions above. These investment results are presented below on a consolidated basis for purposes of ease of discussion.
The increase in the ratio of cash to invested assets since 2007 is principally attributable to significant cash redemptions received from our hedge fund portfolio, growth in gross premiums written, and a desire to maintain high levels of liquidity, partially offset by the repayment of debt during the period. We anticipate this ratio to decrease as we seek to deploy cash in higher-yielding investments.
Change in fair value of other investments. Net gains on the hedge fund portfolio were $76.5 million, or a 12.35% rate of return, for the year ended December 31, 2009, compared to net losses of $233.0 million, or a negative 19.27% rate of return, for the year ended December 31, 2008. Net gains on the hedge fund portfolio were $186.7 million, or 16.97% for the year ended December 31, 2007. During 2009 there has been a significant improvement in major equity markets in comparison to the declines seen in 2008. The comparable returns of the HFRI Fund of Funds Composite Index, the Merrill Lynch Master Bond Index and the S&P 500 for the years ended December 31, 2009, 2008 and 2007 were as follows:
Eight out of the nine hedge fund strategies we employed had positive returns during the year ended December 31, 2009. The largest contributors by investment strategy to the net gain for the current year were the distressed securities and the event-driven arbitrage strategies. As of December 31, 2009, 20.0% and 13.3% of our hedge fund portfolio was allocated to the distressed securities and the event-driven arbitrage strategies, respectively.
Each hedge fund portfolio strategy we employed was profitable during the year ended December 31, 2007. The hedge fund strategies which principally contributed to the gains in 2007 were the event-driven arbitrage and long/short equity strategies. Contributing to the returns were meaningful gains from a variety of long and short sub-prime mortgage positions taken by several of the underlying funds in our hedge fund portfolio. As at December 31, 2007, 16.1% and 25.4% of our hedge fund portfolio was allocated to the event-driven arbitrage and long/short equity strategies, respectively.
Included in change in fair value of other investments for the year ended December 31, 2008 was a $3.8 million realized loss on a futures transaction that was initiated and fully settled in September 2008. This transaction was initiated as an economic hedge on a portion of our holdings of U.S. government securities.
As a result of our review of securities in an unrealized loss position, which is performed every quarter, we recorded other-than-temporary impairment losses through earnings for the years ended December 31, 2009, 2008 and 2007 of $3.1 million, $16.9 million and $1.1 million, respectively. These impairment losses are presented separately from all other net realized gains and losses on fixed maturities. A discussion of our process for estimating other-than-temporary impairments is included in Note 3 of our audited consolidated financial statements included herein.
Merger and acquisition expenses. Merger and acquisition expenses in 2009 are principally comprised of the professional fees related to the proposed amalgamation with IPC Holdings, Ltd, or IPC, and IPC Limited, which was terminated in June 2009. A $50.0 million termination fee received from IPC is included within merger and acquisition expenses for the year ended December 31, 2009. Merger and acquisition expenses in 2008 comprise the professional and legal fees related to the acquisition of Max UK and the creation of our Max at Lloyd’s segment.
Foreign exchange gains and losses. Foreign exchange losses for the year ended December 31, 2008 of $10.6 million arose in connection with the purchase of Max UK.
We purchased British pounds in advance of the acquisition of Max UK and before the transaction closed the value of the British pound dropped significantly relative to the U.S. dollar. Foreign exchange gains and losses for the years 2009 and 2007 were not significant to our operating results.
The increase in general and administrative expense for the year ended December 31, 2008 compared to 2007 was principally related to an increase in personnel and information technology related costs.
We record the available for sale and trading investment portfolios at fair value on our balance sheet. On our available for sale portfolio, the unrealized gain or loss (absent credit losses) associated with the difference between the fair value and the amortized cost of the investments is recorded in other comprehensive income in the shareholders’ equity section of our consolidated balance sheet. On our trading portfolio, the unrealized gain or loss associated with the difference between the fair value and the amortized cost of the investments is recorded in net income as a net realized gain or loss.
In order to reduce the likelihood of needing to sell investments before maturity, especially given the unpredictable and potentially significant cash flow requirements of our
We performed a review of these securities, at December 31, 2009, for other-than-temporary impairments, which includes the consideration of relevant factors, including prepayment rates, subordination levels, default rates, credit ratings, weighted average life and cash flow testing. Together with our investment managers, we continue to monitor our potential exposure to mortgage-backed and asset-backed securities, and we will make adjustments to the investment portfolio, if and when it is deemed necessary. As a result of this process, we recognized an other than temporary impairment charge through net income of $3.1 million during the year ended December 31, 2009.
As described in Note 4 of our audited consolidated financial statements, our available for sale and trading fixed maturities investments and our hedge fund investment portfolio are carried at fair value.
Investments in hedge funds comprise a portfolio of limited partnerships and stock investments in trading entities, or funds, which invest in a wide range of financial products. The units of account that we value are our interests in the funds and not the underlying holdings of such funds. Thus, the inputs we use to value our investments in each of the funds may differ from the inputs used to value the underlying holdings of such funds. These funds are stated at fair value which ordinarily will be the most recently reported net asset value as advised by the fund manager or administrator, where the fund’s underlying holdings can be in various quoted and unquoted investments. We believe the reported net asset value represents the fair value market participants would apply to an interest in the fund. The fund managers value their underlying investments at fair value in accordance with policies established by each fund, as described in each of their financial statements and offering memoranda.
We are able to redeem the hedge fund portfolio held through Max Diversified on the same terms that the underlying funds can be liquidated. In general, the funds in which we are invested require at least 30 days notice of redemption, and may be redeemed on a monthly, quarterly, semi-annual, annual, or longer basis, depending on the fund.
Although we believe that our significant cash balances, fixed maturities investments, and credit facilities provide sufficient liquidity to satisfy the claims of insureds and ceding clients, in the event that we were required to access assets invested in the hedge fund investment portfolio, our ability to do so may be impaired by these liquidity constraints. See “Risk Factors-Unexpected volatility or illiquidity associated with our hedge fund investment portfolio could significantly and negatively affect our ability to conduct business.”
reserves on prior period contracts. During the year ended December 31, 2009, we paid $513.6 million in property and casualty losses and recorded gross favorable development on prior period reserves of $104.9 million.
Liquidity. We generated $193.2 million of cash from operations during the year ended December 31, 2009 compared to $482.0 million for the year ended December 31, 2008. The two principal factors that impact our operating cash flow are premium collections and timing of loss and benefit payments. The decrease in cash flow from operations is principally due to the timing of the payment of property and casualty losses, the payment of reinsurance premiums ceded and the decrease in life and annuity gross premiums written.
The amount which Max Capital provides as Funds at Lloyd’s is not available for distribution for the payment of dividends. Our corporate members may also be required to maintain funds under the control of Lloyd’s in excess of their capital requirements and such funds also may not be available for distribution of the payment of dividends.
Capital resources. At December 31, 2009, our capital structure consisted of common equity. Total capitalization amounted to $1,564.6 million as compared to $1,280.3 million at December 31, 2008, an increase of 22.2%. On August 20, 2007, we filed an automatic shelf registration statement on Form S-3 with the SEC indicating that we may periodically issue up to $500.0 million in debt securities, common shares, preferred shares, depository shares, warrants, share-purchase contracts and share purchase units. The shelf registration statement also covers debt securities of Max USA and trust preferred securities of Max
Capital Trust I. No securities have been issued under the shelf registration statement. We believe that we have sufficient capital to meet our financial obligations.
In April 2007, Max USA privately issued $100.0 million aggregate principal amount of 7.20% senior notes due April 14, 2017, of which $90.6 million remained outstanding at December 31, 2009. The senior notes are guaranteed by Max Capital. As of December 31, 2009, the senior notes were assigned a senior unsecured debt rating by S&P, A.M. Best, Fitch, and Moody’s (see table below). The ratings assigned by rating agencies to reinsurance and insurance companies are based upon factors and criteria established independently by each rating agency. They are not an evaluation directed to investors in our senior notes, and are not a recommendation to buy, sell or hold our senior notes. These ratings are subject to periodic review by the rating agencies or may be revised downward or revoked at the sole discretion of the rating agencies.
Ratings are an important factor in establishing the competitive position of reinsurance and insurance companies and are important to our ability to market our products. We have a financial strength rating for our non-Lloyd’s reinsurance and insurance subsidiaries from each of A.M. Best, Fitch, Moody’s and S&P (see table below). These ratings reflect each rating agency’s opinion of our financial strength, operating performance and ability to meet obligations. They are not evaluations directed toward the protection of investors in securities issued by Max Capital. The Syndicates share the Lloyd’s market ratings (see table below).
(1) Applicable to Max Bermuda, Max Specialty, Max America, Max Re Europe and Max Insurance Europe.
Continuation of cash dividends in the future will be at the discretion of the board of directors and will be dependent upon our results of operations and cash flows, and our financial position and capital requirements, general business conditions, legal, tax, regulatory and any contractual restrictions on the payment of dividends and other factors the board of directors deems relevant.
The amounts in this table represent our gross estimates of known liabilities as of December 31, 2009 and do not include any allowance for claims for future events within the time period specified. Accordingly, it is highly likely that the total amounts paid out in the time periods shown will be greater than that indicated in the table.
ASU 2010-06 requires additional disclosure, and clarifies existing disclosure requirements, about fair value measurements. The additional requirements include disclosure regarding the amounts and reasons for significant transfers in and out of Level 1 and 2 of the fair value hierarchy and also separate presentation of purchases, sales, issuances and settlements of items measured using significant unobservable inputs (i.e. Level 3). The guidance clarifies existing disclosure requirements regarding the inputs and
valuation techniques used to measure fair value for measurements that fall in either Level 2 or Level 3 of the hierarchy. The requirements are effective for interim and annual reporting periods beginning after December 15, 2009 except for the disclosures about purchases, sales, issuances and settlements which is effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The guidance is not expected to have a material impact on our consolidated financial statements.
ASU 2009-12, Fair Value Measurements and Disclosures (820)-Investments in Certain Entities That Calculate Net Asset Value per Share (or its Equivalent)
ASU 2009-12 expands the circumstances in which a practical expedient may be used to estimate fair value to include investments in foreign and other entities that have attributes of investment companies and report net asset value or its equivalent to their investors. The practical expedient cannot be used for investments that have a readily determinable fair value. The ASU sets forth disclosure requirements for investments within its scope. The amendments in ASU 2009-12 are effective for interim and annual periods ending after December 15, 2009 with early adoption permitted. We adopted this accounting standards update for the year ended December 31, 2009. It did not have a material impact on our consolidated financial statements.