The Company generates its Non-life reinsurance revenue from premiums. Premium rates and terms and conditions vary by line of business depending on market conditions. Pricing cycles are driven by supply of capital in the industry and demand for reinsurance and other risk transfer products. The reinsurance business is also influenced by several other factors, including variations in interest rates and financial markets, changes in legal, regulatory and judicial environments, loss trends, inflation and general economic conditions.
of business, length of tail, and distribution channel. Further, Management believes that this diversification, in addition to the financial strength of the Company and its strong global franchise, will help to mitigate cyclical declines in underwriting profitability and achieve a more stable return over the reinsurance cycle.
During the January 2013 renewals, the Company experienced an increase of approximately 12% in renewable Non-life treaty business, on a constant foreign exchange basis. The increase in expected premium volume was driven by new business and growth opportunities in all Non-life sub-segments, with the exception of the Catastrophe sub-segment, where the Company experienced a modest decline in the premium volume as a result of slightly declining pricing in some markets that were not loss affected. The renewal of the 2013 U.S. agriculture book remains in process and is expected to be completed in the first quarter of 2013, however, Management expects a significant increase in premium in this line compared to the January 1, 2012 renewals due to new business.
Within the Company’s Life segment, the reinsurance market is differentiated between mortality (including disability) and longevity products, with mortality being the larger market. In addition, in December 2012 the Company acquired Presidio, a U.S. specialty accident and health insurance and reinsurance writer. The acquisition of Presidio provides additional specialty risks not previously written by the Company. Management believes the existing life business and Presidio’s business provides the Company with diversification benefits and balance to its portfolio as they are generally non-correlated to the Company’s Non-life business.
For the years ended December 31, 2012, 2011 and 2010, the Company did not write any new life business in the U.S., however, following the acquisition of Presidio on December 31, 2012, the Company expects to write accident and health business in the U.S. in future periods.
The Company’s capital markets and investment operations, including public and private market investments, have experienced volatile market conditions since the middle of 2007. While the market conditions remained volatile in 2012, there were some improvements in the worldwide equity markets. During 2012, the Company shortened the duration of its fixed maturity portfolio given historically low interest rates and to limit the impact of a potential rise in interest rates.
Net income (loss), preferred dividends, net income (loss) available to common shareholders and diluted net income (loss) per share for the years ended December 31, 2012, 2011 and 2010 were as follows (in millions of U.S. dollars, except per share data):
The year over year comparison of the Company’s net income (loss) and diluted net income (loss) per share is primarily affected by the level of losses related to large catastrophic and large loss events and continued volatility in the capital and credit markets during the years ended December 31, 2012, 2011 and 2010.
an increase of $1,429 million in the Non-life underwriting result, which was primarily driven by a decrease of $1,417 million in large catastrophic losses and large losses, from $1,733 million related to the 2011 catastrophic events in 2011 to $316 million related to Superstorm Sandy and the U.S. drought which impacted the agriculture line of business in the North America sub-segment in 2012; and
a decrease of $58 million in net investment income, primarily driven by lower reinvestment rates.
The increase in net income available to common shareholders and diluted net income per share in 2012 compared to 2011 was primarily due to the above factors, partially offset by an increase in preferred dividends following the issuance of preferred shares in June 2011. For diluted net income per share specifically, the increase was also due to a decrease in the diluted number of common shares outstanding as a result of share repurchases during 2012.
The decrease in net income of $1,373 million in 2011 compared to 2010 resulted primarily from:
a decrease in the Non-life underwriting result of $1,177 million, which was almost entirely driven by an increase of $1,174 million in large catastrophic losses and large losses, from $559 million in 2010 to $1,733 million related to the 2011 catastrophic events in 2011; and
a decrease in pre-tax net realized and unrealized investment gains of $335 million; partially offset by
These factors affecting the year over year comparison of the Company’s results are discussed below in Review of Net Income (Loss), Results by Segment and Financial Condition, Liquidity and Capital Resources, and may continue to affect our results of operations and financial condition in the future.
In 2012, credit spreads narrowed, equity markets improved and U.S. and European risk-free interest rates decreased, while the U.S. dollar ending exchange rate at December 31, 2012 weakened against most major currencies compared to December 31, 2011. As a result of these movements, the value of the Company’s investment portfolio and cash and cash equivalents at December 31, 2012 increased compared to December 31, 2011, positively affected by the impact of narrowing credit spreads, improvements in worldwide equity markets, impact of foreign exchange fluctuations and modest decreases in risk-free interest rates.
In 2011, U.S. and European risk-free interest rates decreased and credit spreads widened, while the U.S. dollar ending exchange rate at December 31, 2011 strengthened against most major currencies compared to December 31, 2010. As a result of these movements, the value of the Company’s investment portfolio and cash and cash equivalents at December 31, 2011 increased compared to December 31, 2010, positively affected by the impact of decreased risk-free interest rates, which were largely offset by the impact of widening credit spreads and foreign exchange rates.
Effective January 1, 2011, Management redefined its operating earnings or loss available to common shareholders (operating earnings or loss) calculation to additionally exclude net foreign exchange gains or losses. Management believes that net foreign exchange gains or losses are not indicative of the performance of, and distort trends in, the Company’s business as they predominantly result from general economic and foreign exchange market conditions. In addition, Management redefined its Annualized operating return on beginning diluted book value per common share and common share equivalents outstanding (Operating ROE, previously referred to as operating return on beginning common shareholders’ equity) calculation to measure Operating ROE on a diluted per share basis. Management believes that the redefined Operating ROE incorporates capital
management activities whilst still being based on the concept of deploying available capital on an annual basis. Operating earnings or loss and Operating ROE for the year ended December 31, 2010 have been recast to reflect the Company’s redefined non-GAAP measures.
Diluted book value per common share and common share equivalents outstanding (Diluted Book Value per Share): Management uses compound annual growth rate in Diluted Book Value per Share as a key measure of the value the Company is generating for its common shareholders, as Management believes that growth in the Company’s Diluted Book Value per Share ultimately translates into growth in the Company’s share price. Diluted Book Value per Share is impacted by the Company’s net income or loss, capital resources management and external factors such as foreign exchange, interest rates, credit spreads and equity markets, which can drive changes in realized and unrealized gains or losses on its investment portfolio.
During 2012, the Company’s Diluted Book Value per Share increased by 19% to $100.84 at December 31, 2012 from $84.82 at December 31, 2011 primarily due to comprehensive income of $1,158 million and the accretive impact of share repurchases. The comprehensive income was mainly driven by net income of $1,135 million in 2012, which is described in Review of Net Income (Loss) below.
Operating earnings increased by $1,306 million, from a loss of $642 million in 2011 to an income of $664 million in 2012 primarily due to an increase in the Non-life underwriting result of $1,429 million, partially offset by an increase in income tax expense on the higher level of operating earnings.
Operating ROE: Management uses Operating ROE as a measure of profitability that focuses on the return to common shareholders. To support the Company’s growth objectives, most economic decisions, including capital attribution and underwriting pricing decisions, incorporate an Operating ROE impact analysis. For the purpose of that analysis, an appropriate amount of capital (equity) is attributed to each transaction for determining the transaction’s priced return on attributed capital. Subject to an adequate return for the risk level as well as other factors, such as the contribution of each risk to the overall risk level and risk diversification, capital is attributed to the transactions generating the highest priced return on deployed capital. Management’s challenge consists of (i) attributing an appropriate amount of capital to each transaction based on the risk created by the transaction, (ii) properly estimating the Company’s overall risk level and the impact of each transaction on the overall risk level, (iii) assessing the diversification benefit, if any, of each transaction, and (iv) deploying available capital. The risk for the Company lies in mis-estimating any one of these factors, which are critical in calculating a meaningful priced return on deployed capital, and entering into transactions that do not contribute to the Company’s growth objectives.
Operating ROE increased from a loss of 10.1% in 2011 to an income of 12.3% in 2012. The increase in Operating ROE was primarily due to the increase in operating earnings in 2012 compared to 2011, which was driven by the lower level of catastrophic loss activity. The factors contributing to increases or decreases in operating earnings are described further in Review of Net Income (Loss) below.
The average Operating ROE for the last five years and ten years was 8.7% and 12.2%, respectively. Both the five-year and the ten-year averages primarily reflect some years that were impacted by significant catastrophic losses and other years that were not impacted by catastrophes. Due to the volatility related to the level of catastrophic losses incurred, Management believes that it is more appropriate to measure performance based on an average Operating ROE target over the reinsurance cycle rather than focusing on the results for single periods.
The Non-life combined ratio decreased by 37.6 points, from 125.4% in 2011 to 87.8% in 2012. The decrease in the combined ratio in 2012 compared to 2011 primarily reflected a decrease in the impact of large catastrophic losses and large losses of 36.5 points (from 45.2 points in 2011 to 8.7 points in 2012). The impact on the combined ratio by catastrophic event for each year is analyzed above.
Throughout this filing, the Company’s results of operations have been presented in the way that Management believes will be the most meaningful and useful to investors, analysts, rating agencies and others who use financial information in evaluating the performance of the Company. This presentation includes the use of operating earnings or loss and Operating ROE that are not calculated under standards or rules that comprise U.S. GAAP. These measures are referred to as non-GAAP financial measures within the meaning of Regulation G. Management believes that these non-GAAP financial measures are important to investors, analysts, rating agencies and others who use the Company’s financial information and will help provide a consistent basis for comparison between years and for comparison with the Company’s peer group, although non-GAAP measures may be defined or calculated differently by other companies. Investors should consider these non-GAAP measures in addition to, and not as a substitute for, measures of financial performance prepared in accordance with GAAP. A reconciliation of these measures to the most directly comparable U.S. GAAP financial measures, net income or loss and return on beginning common shareholders’ equity calculated with net income or loss available to common shareholders, is presented above.
The Company’s Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP). The preparation of financial statements in conformity with U.S. GAAP requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The following presents a discussion of those accounting policies and estimates that Management believes are the most critical to its operations and require the most difficult, subjective and complex judgment. If actual events differ significantly from the underlying assumptions and estimates used by Management, there could be material adjustments to prior estimates that could potentially adversely affect the Company’s results of operations, financial condition and liquidity. These critical accounting policies and estimates should be read in conjunction with the Notes to Consolidated Financial Statements, including Note 2, Significant Accounting Policies, for a full understanding of the Company’s accounting policies. The sensitivity estimates that follow are based on outcomes that the Company considers reasonably likely to occur.
Because a significant amount of time can elapse between the assumption of risk, occurrence of a loss event, the reporting of the event to an insurance company (the primary company or the cedant), the subsequent reporting to the reinsurance company (the reinsurer) and the ultimate payment of the claim on the loss event by the reinsurer, the Company’s liability for unpaid losses and loss expenses (loss reserves) is based largely upon estimates. The Company categorizes loss reserves into three types of reserves: reported outstanding loss reserves (case reserves), additional case reserves (ACRs) and incurred but not reported (IBNR) reserves. The Company updates its estimates for each of the aforementioned categories on a quarterly basis using information received from its cedants. Case reserves represent unpaid losses reported by the Company’s cedants and recorded by the Company. ACRs are established for particular circumstances where, on the basis of individual loss reports, the Company estimates that the particular loss or collection of losses covered by a treaty may be greater than those advised by the cedant. IBNR reserves represent a provision for claims that have been incurred but not yet reported to the Company, as well as future loss development on losses already reported, in excess of the case reserves and ACRs. Unlike case reserves and ACRs, IBNR reserves are often calculated at an aggregated level and cannot usually be directly identified as reserves for a particular loss or treaty. The Company also estimates the future unallocated loss adjustment expenses (ULAE) associated with the loss reserves and these form part of the Company’s loss adjustment expense reserves. The Company’s Non-life loss reserves for each category, line and sub-segment are reported in the tables included later in this section.
The Company analyzes its ultimate losses and loss expenses after consideration of the loss experience of various reserving cells. The Company assigns treaties to reserving cells and allocates losses from the treaty to the reserving cell. The reserving cells are selected in order to ensure that the underlying treaties have homogeneous loss development characteristics (e.g., reporting tail) but are large enough to make estimation of trends credible. The selection of reserving cells is reviewed annually and changes over time as the business of the Company evolves. For each reserving cell, the Company tabulates losses in reserving triangles that show the total reported or paid claims at each financial year end by underwriting year cohort. An underwriting year is the year during which the reinsurance treaty was entered into as opposed to the year in which the loss occurred (accident year), or the calendar year for which financial results are reported. For each reserving cell, the Company’s estimates of loss reserves are reached after a review of the results of several commonly accepted actuarial projection methodologies. In selecting its best estimate, the Company considers the appropriateness of each methodology to the individual circumstances of the reserving cell and underwriting year for which the projection is made. The methodologies that the Company employs include, but may not be limited to, paid and reported Chain Ladder methods, Expected Loss Ratio method, paid and reported Bornhuetter-Ferguson (B-F) methods, and paid and reported Benktander methods. In addition, the Company uses other methodologies to estimate liabilities for specific types of claims. For example, internal and vendor catastrophe models are typically used in the estimation of loss and loss expenses at the early stages of catastrophe losses before loss information is reported to the reinsurer. In the case of asbestos and environmental claims, the Company has established reserves for future losses and allocated loss expenses based on the results of periodic actuarial studies, which consider the underlying exposures of the Company’s cedants.
These methods use the underlying assumption that losses reported (paid) for each underwriting year at a particular development stage follow a stable pattern. For example, the CL development method assumes that on average, every underwriting year will display the same percentage of ultimate liabilities reported by the Company’s cedants (say x%) at 24 months after the inception of the underwriting year. The percentages reported (paid) are established for each development stage (e.g., at 12 months, 24 months, etc.) after examining historical
averages from the loss development data. These are sometimes supplemented by external benchmark information. Ultimate liabilities are estimated by multiplying the actual reported (paid) losses by the reciprocal of the assumed reported (paid) percentage (e.g., 1/x%). Reserves are then calculated by subtracting paid claims from the estimated ultimate liabilities.
This method estimates ultimate losses for an underwriting year by applying an estimated loss ratio to the earned premium for that underwriting year. Although the method is insensitive to actual reported or paid losses, it can often be useful at the early stages of development when very few losses have been reported or paid, and the principal sources of information available to the Company consist of information obtained during pricing and qualitative information supplied by the cedant. However, the lack of sensitivity to reported or paid losses means that the method is usually inappropriate at later stages of development.
These methods aim to address the concerns of the Chain Ladder Development methods, which are the variability at early stages of development and the failure to incorporate external information such as pricing. However, the B-F methods are more sensitive to reported and paid losses than the Expected Loss Ratio method, and can be seen as a blend of the Expected Loss Ratio and Chain Ladder development methods. Unreported (unpaid) claims are calculated using an expected reporting (payment) pattern and an externally determined estimate of ultimate liabilities (usually determined by multiplying an a priori loss ratio with estimates of premium volume). The accuracy of the a priori loss ratio is a critical assumption in this method. Usually a priori loss ratios are initially determined on the basis of pricing information, but may also be adjusted to reflect other information that subsequently emerges about underlying loss experience. Although the method tends to provide less volatile indications at early stages of development and reflects changes in the external environment, this method can be slow to react to emerging loss development (payment). In particular, to the extent that the a priori loss ratios prove to be inaccurate (and are not revised), the B-F methods will produce loss estimates that take longer to converge with the final settlement value of loss liabilities.
In determining the loss reserves, the Company often relies on a blend of the results from two or more methods (e.g., weighted averages). The judgment as to which of the above method(s) is most appropriate for a particular underwriting year and reserving cell could change over time as new information emerges regarding underlying loss activity and other data issues. Furthermore, as each line is typically composed of several reserving cells, it is likely that the reserves for the line will be dependent on several reserving methods. This is because reserves for a line are the result of aggregating the reserves for each constituent reserving cell and that a different method could be selected for each reserving cell. Although it is not appropriate to refer to reserves for a line as being determined by a particular method, the table below summarizes the methods that were given principal weight in selecting the best estimates of reserves in each reserving line and can therefore be viewed as key drivers of selected reserves. The table distinguishes methods for mature and immature underwriting years, as they are often different. The definition of maturity is specific to a line and is related to the reporting tail. If at the reserve evaluation date, a significant proportion of losses for the underwriting year are expected to have been reported, then the underwriting year is deemed to be mature, otherwise it is deemed to be immature. For short-tail lines, such as property or agriculture, immature years can refer to the one or two most recent underwriting years, while for longer tail lines, such as casualty, immature years can refer to the three or four most recent underwriting years. To the extent that the principal reserving methods used for major components of a reserving line are different, these are separately identified in the table below. The table below identifies reserving lines for the Company’s Non-life sub-segments, which are defined in Results by Segment below.
In addition to examining the data, the selection of the parameter assumptions is dependent on several underlying factors. The Company’s actuaries review these underlying factors and determine the extent to which these are likely to be stable over the time frame during which losses are projected, and the extent to which these factors are consistent with the Company’s data. If these factors are determined to be stable and consistent with the data, the estimation of the reserving parameter assumptions are mainly carried out using actuarial and statistical techniques applied to the Company’s data. To the extent that the actuaries determine that they cannot continue to rely on the stability of these factors, the statistical estimates of parameter assumptions are modified to reflect the direction of the change. The main underlying factors upon which the estimates of reserving parameters are predicated are:
(i) the cedant’s business practices will proceed as in the past with no material changes either in submission of accounts or cash flows;
(ii) any internal delays in processing accounts received by the cedant are not materially different from that experienced historically, and hence the implicit reserving allowance made in loss reserves through the methods continues to be appropriate;
(v) historical levels of claim inflation can be projected into the future and will have no material effect on either the acceleration or deceleration of claim reporting and payment patterns;
The Company’s best estimate of total loss reserves is typically in excess of the midpoint of the actuarial ultimate liability estimate. The Company believes that there is potentially significant risk in estimating loss reserves for long-tail lines of business and for immature underwriting years that may not be adequately captured through traditional actuarial projection methodologies as these methodologies usually rely heavily on projections of prior year trends into the future. In selecting its best estimate of future liabilities, the Company considers both the results of actuarial point estimates of loss reserves as well as the potential variability of these estimates as captured by a reasonable range of actuarial liability estimates. The selected best estimates of reserves are always within the reasonable range of estimates indicated by the Company’s actuaries. In determining the appropriate best estimate, the Company reviews (i) the position of overall reserves within the actuarial reserve range, (ii) the result of bottom up analysis by underwriting year reflecting the impact of parameter uncertainty in actuarial calculations, and (iii) specific qualitative information on events that may have an effect on future claims but which may not have been adequately reflected in actuarial estimates, such as potential for outstanding litigation, claims practices of cedants, etc.
The net Non-life prior year favorable loss development for the years ended December 31, 2012, 2011 and 2010 was driven by the following factors (in millions of U.S. dollars):
Agriculture: Aggregate losses reported in 2012 for North America business related to the 2011 underwriting year were below the Company’s expectations. In addition, the Company’s Global (Non-U.S.) business experienced lower than expected reported losses. The Company lowered its loss ratios, however, it did not otherwise materially alter its reserving assumptions.
Casualty / Specialty Casualty: Aggregate losses reported in 2012 for North America business were below the Company’s expectations as losses for all underwriting years for 2009 and prior continue to emerge at levels significantly below expectations. For Global (Non-U.S.) lines, aggregate losses reported in 2012 were below the Company’s expectations for underwriting years 2004 to 2011 for both Global (Non-U.S.) P&C and Global (Non-U.S.) Specialty sub-segments. The Company reflected this experience by reducing the loss ratios as well as by changing the initial expected loss ratios.
Catastrophe: Reserves established for the catastrophe line are primarily a function of the presence or absence of catastrophic events during the year, and the complexity and uncertainty associated with estimating unpaid losses from these large disclosed events. In addition, reserves are established in consideration of mid-sized and attritional loss events that occur during a year. The Company has not significantly changed its loss estimates for the Japan Earthquake and the 2010 and the February and June 2011 New Zealand Earthquakes, however, it has reflected reserve releases related to other prior years’ loss events and lower than expected emergence of attritional losses.
Marine/Energy Offshore: Aggregate losses reported in 2012 were significantly lower than expected and impacted most underwriting years. The Company reduced its loss ratios for underwriting years 2006 to 2011 to reflect the lower than expected loss emergence.
Property / Specialty Property: Aggregate reported losses in 2012 were lower than expected for North America business and were driven by loss activity related to large property events and attritional property losses from most underwriting years. Aggregate losses reported in 2012 in the Global (Non-U.S.) property lines were lower than expected for most underwriting years. The Company reflected this experience by reducing its loss ratios for most underwriting years.
Some reserving lines show little sensitivity to a priori loss ratio, loss development factor or tail factor as the Company may use reserving methods such as the Expected Loss Ratio method in several of its reserving cells within those lines. It is not appropriate to sum the total impact for a specific factor or the total impact for a specific reserving line as the lines of business are not perfectly correlated.
The net loss reserves represent the Company’s best estimate of future losses and loss expense amounts based on the information available at December 31, 2012. Loss reserves rely upon estimates involving actuarial and statistical projections at a given time that reflect the Company’s expectations of the costs of the ultimate settlement and administration of claims. Estimates of ultimate liabilities are contingent on many future events and the eventual outcome of these events may be different from the assumptions underlying the reserve estimates. In the event that the business environment and social trends diverge from historical trends, the Company may have to adjust its loss reserves to amounts falling significantly outside its current estimate. These estimates are continually reviewed and the ultimate liability may be in excess of, or less than, the amounts provided, for which any adjustments will be reflected in the period in which the need for an adjustment is determined.
The point estimates related to net loss reserves recorded by the Company and the range of actuarial estimates at December 31, 2012 and 2011 were as follows for each sub-segment of the Non-life segment (in millions of U.S. dollars):
It is not appropriate to add together the ranges of each sub-segment in an effort to determine a high and low range around the Company’s total Non-life carried loss reserves.
Based upon information currently available and the estimated range of potential ultimate liabilities, the Company believes that unpaid loss and loss expense reserves contemplate a reasonable provision for exposure related to the 2011 catastrophic events. In addition to the sum of the point estimates recorded for each of the 2011 catastrophic events, at December 31, 2011 the Company recorded additional gross reserves of $50 million (net reserves of $48 million after the impact of retrocession), specifically related to the 2011 catastrophic events within its Catastrophe sub-segment. The additional gross reserves recorded were in consideration of the number of events, the complexity of certain events and the continuing uncertainties in estimating the ultimate losses for these events in the aggregate. The Company continues to evaluate the additional gross reserves that were recorded as part of its periodic reserving process. At December 31, 2012, the Company decided to maintain the
additional gross reserves and did not record any changes during the year ended December 31, 2012 given the uncertainties described above remain. Any changes to the amounts recorded will be based on updated or new information and Management’s assessment of remaining uncertainty related to the specific factors regarding the 2011 catastrophic events. Changes to the amounts recorded may either result in: i) the reallocation of some or all of the additional reserves to one or more of the 2011 catastrophic events; or ii) the release of some or all of the additional reserves to net income in future periods; or iii) an increase in additional reserves recorded.
Included in the business that is considered to have a long reporting tail is the Company’s exposure to asbestos and environmental claims. The Company’s net reserves for unpaid losses and loss expenses at December 31, 2012 included $199 million that represents estimates of its net ultimate liability for asbestos and environmental claims. The gross liability for such claims at December 31, 2012 was $205 million, which primarily relates to Paris Re’s gross liability for asbestos and environmental claims for accident years 2005 and prior of $125 million, with any favorable or adverse development being subject to the Reserve Agreement. Of the remaining $80 million in gross reserves, the majority relates to casualty exposures in the United States arising from business written by PartnerRe SA and PartnerRe U.S..
Ultimate loss estimates for such claims cannot be estimated using traditional reserving techniques and there are significant uncertainties in estimating the amount of the Company’s potential losses for these claims. In view of the legal and tort environment that affect the development of such claims, the uncertainties inherent in estimating asbestos and environmental claims are not likely to be resolved in the near future. There can be no assurance that the reserves established by the Company will not be adversely affected by development of other latent exposures, and further, there can be no assurance that the reserves established by the Company will be adequate. The Company does, however, actively evaluate potential exposure to asbestos and environmental claims and establishes additional reserves as appropriate. The Company believes that it has made a reasonable provision for these exposures and is unaware of any specific issues that would materially affect its unpaid losses and loss expense reserves related to this exposure (see Note 8 to Consolidated Financial Statements in Item 8 of Part II of this report).
Policy benefits for life and annuity contracts relate to the business in the Company’s Life segment, which predominantly includes reinsurance of longevity, subdivided into standard and non-standard annuities, and mortality business, which includes death and disability covers (with various riders) primarily written in Continental Europe, TCI primarily written in the U.K. and Ireland, and GMDB business primarily written in Continental Europe. Effective December 31, 2012, following the acquisition of Presidio, the Company writes specialty accident and health business, predominantly in the U.S.. Presidio’s primary lines of business include HMO reinsurance, medical reinsurance and provider and employer excess of loss programs.
For standard annuities, the main risk is a faster increase in future life span than expected in the medium to long term. Non-standard annuities are annuities sold to people with aggravated health conditions and are usually medically underwritten on an individual basis and the main risk is the inadequate assessment of the future life span of the insured.
The reserves for the long-term traditional mortality and TCI reinsurance portfolio are established in accordance with the provisions for long duration insurance contracts under U.S. GAAP and follow the reserving methodology discussed under the Longevity section above. In addition to the assumptions discussed above, persistency and critical illness assumptions are considered in the reserving process for mortality lines.
The following table provides the Company’s gross and net policy benefits for life and annuity contracts by reserving line at December 31, 2012 (in millions of U.S. dollars):
Total gross policy benefits for life and annuity contracts include provisions for adverse deviation of $104 million and $108 million at December 31, 2012 and 2011, respectively.
The following table shows the amounts recorded within net premiums written and earned that related to changes in prior year premium estimates reported by cedants for each Non-life sub-segment for the year ended December 31, 2012 (in millions of U.S. dollars):
As an example of the sensitivity of the Company’s Non-life net premiums written and acquisition costs to changes in estimates, the table below summarizes the effect of different assumption selections on pre-tax net income based on amounts recorded for the year ended December 31, 2012 (in millions of U.S. dollars):
(1) The estimate assumes that the changes in net premiums written become known at the mid-point of the risk period and is made by applying the reported technical ratio for the year ended December 31, 2012.
The Company has estimated the future tax effects attributed to temporary differences and has a deferred tax asset at December 31, 2012 of $142 million, after a valuation allowance of $47 million. The most significant components of the deferred tax asset relate to loss reserve discounting for tax purposes and tax loss carryforwards.
The Company has projected future taxable income in the tax jurisdictions in which the deferred tax assets arise. These projections are based on Management’s projections of premium and investment income, capital gains and losses, and technical and expense ratios. Based on these projections and an analysis of the ability to utilize loss and foreign tax credits carryforwards at the taxable entity level, Management evaluates the need for a valuation allowance. The valuation allowance of $47 million, recorded at December 31, 2012, primarily related to a tax loss carryforward in Singapore.
The Company must determine the appropriate level in the hierarchy for each financial instrument that it measures at fair value. In determining fair value, the Company uses various valuation approaches, including market, income and cost approaches. See Note 3 to Consolidated Financial Statements in Item 8 of Part II of this report for more detail on the valuation techniques, methods and assumptions that were used by the Company to estimate the fair value of its fixed maturities and short-term investments, equities, other invested assets and its fixed maturities and other invested assets underlying the funds held - directly managed account. See Note 6 to Consolidated Financial Statements in Item 8 of Part II of this report for more discussion of the Company’s use of derivative financial instruments.
The Company records all of its fixed maturities, short-term investments and equities, certain other invested assets, including derivative financial instruments, and its fixed maturities and certain other invested assets underlying the funds held - directly managed account at fair value in its Consolidated Balance Sheets. The changes in fair value of all of the Company’s investments, carried at fair value, are recorded in net realized and unrealized investment gains and losses in the Consolidated Statements of Operations and are included in the determination of net income or loss in the period in which they are recorded.
In aggregate, the Company is not significantly exposed to changes in the valuation of its total return and interest rate swap portfolio due to changes in the general level of interest rates. At December 31, 2012, the Company estimated that a 100 basis point increase or decrease in all risk spread assumptions used in the Company’s internal valuation models would result in a $4 million decrease or a $5 million increase, respectively, in the fair value of its total return and interest rate swap portfolio categorized as Level 3.
At December 31, 2012, the Company’s insurance-linked securities that are classified as Level 3 include longevity swaps and weather derivatives, with a combined fair value of $2 million net unrealized loss. At
December 31, 2012, the notional exposure of the longevity swaps and weather derivatives classified as Level 3 was $136 million and $nil, respectively. At December 31, 2012, the Company estimated that a 10% improvement in the mortality assumption used in the Company’s internal valuation models for its longevity swaps would result in a $5 million decrease in the fair value of its longevity swap portfolio. The weather derivatives categorized as Level 3 are exposed to various wind events, and any change in the assumptions used in the Company’s internal models would have an insignificant impact on the fair value of weather derivatives at December 31, 2012.
Goodwill represents the excess of the purchase price over the fair value of the net assets acquired of PartnerRe SA, Winterthur Re, Paris Re and Presidio. The Company assesses the appropriateness of its valuation of goodwill on at least an annual basis. If, as a result of the assessment, the Company determines that the value of its goodwill is impaired, goodwill will be written down in the period in which the determination is made. Neither the Company’s initial valuation nor its subsequent valuations has indicated any impairment of the Company’s goodwill asset of $456 million at December 31, 2012.
The following discussion of Results of Operations contains forward-looking statements based upon assumptions and expectations concerning the potential effect of future events that are subject to uncertainties. See Item 1A of Part I of this report for a complete list of the Company’s risk factors. Any of these risk factors could cause actual results to differ materially from those reflected in such forward-looking statements.
the U.S. dollar average exchange rate was stronger against most currencies, except the Japanese yen, in 2012 compared to 2011 and was weaker against most currencies in 2011 compared to 2010; and
The following table provides the components of the underwriting result and combined ratio for the Non-life segment for the years ended December 31, 2012, 2011 and 2010 and the components are discussed further below (in millions of U.S. dollars):
Other operating expenses-a decrease of $26 million (a decrease of 0.4 points on the combined ratio) from $283 million (7.4 points on the combined ratio) in 2011 to $257 million (7.0 points on the combined ratio) in 2012, primarily resulting from a favorable impact of foreign exchange fluctuations and lower information technology costs.
The current accident year technical result, adjusted for large catastrophic losses and large losses-a decrease of $113 million (an increase of 2.6 points on the technical ratio) from $509 million (86.5 points on the technical ratio) in 2011 to $396 million (89.1 points on the technical ratio) in 2012. The decrease was driven by a lower level of net premiums earned in the Catastrophe sub-segment, which absent catastrophe losses, directly reduces the underwriting result, and a lower level of losses recovered under the retrocessional programs. These decreases were partially offset by a lower level of mid-sized loss activity in the Global (Non-U.S.) Specialty and North America sub-segments.
The underwriting result for the Life segment, which does not include allocated investment income, improved by $11 million, from a loss of $27 million in 2011 to a loss of $16 million in 2012, primarily due to higher net favorable prior year loss development, which was driven by the mortality line of business. See Results by Segment below.
Net investment income decreased by $58 million, from $629 million in 2011 to $571 million in 2012. The decrease in net investment income is primarily attributable to a decrease in net investment income from fixed maturities due to lower reinvestment rates. See Corporate and Other - Net Investment Income below for more details.
Net realized and unrealized investment gains increased by $427 million, from $67 million in 2011 to $494 million in 2012. The net realized and unrealized investment gains of $494 million in 2012 were primarily due to narrowing credit spreads, improvements in worldwide equity markets and decreases in U.S. and European risk-free interest rates. See Corporate and Other - Net Realized and Unrealized Investment Gains below for more details.
Net foreign exchange gains decreased by $34 million, from $34 million in 2011 to $nil in 2012. The net foreign exchange result in 2012 was primarily due to losses related to the timing of hedging activities, which were offset by gains arising from the difference in the forward points embedded in the Company’s hedges. The Company hedges a significant portion of its currency risk exposure as discussed in Quantitative and Qualitative Disclosures about Market Risk in
PartnerRe Ltd. (the Company) predominantly provides reinsurance on a worldwide basis, and certain specialty insurance lines, through its principal wholly-owned subsidiaries, including Partner Reinsurance Company Ltd. (PartnerRe Bermuda), Partner Reinsurance Europe SE (PartnerRe Europe) and Partner Reinsurance Company of the U.S. (PartnerRe U.S.). Risks reinsured include, but are not limited to, property, casualty, motor, agriculture, aviation/space, catastrophe, credit/surety, engineering, energy, marine, specialty property, specialty casualty, multiline and other lines, mortality, longevity and health and alternative risk products. The Company’s alternative risk products include weather and credit protection to financial, industrial and service companies on a worldwide basis.
The Company completed the acquisition of SAFR (subsequently renamed PartnerRe SA) in 1997, the acquisition of the reinsurance operations of Winterthur Group (Winterthur Re) in 1998 and the acquisition of PARIS RE Holdings Limited (Paris Re) in 2009.
Effective December 31, 2012, the Company completed the acquisition of Presidio Reinsurance Group, Inc. (Presidio), a California-based U.S. specialty accident and health reinsurance and insurance writer. Given the effective date, the Consolidated Statements of Operations and Cash Flows for the year ended December 31, 2012 do not include Presidio’s results.
Premiums related to individual life and annuity business are recorded over the premium-paying period on the underlying policies. Premiums on annuity and universal life contracts for which there is no significant mortality or critical illness risk are accounted for in a manner consistent with accounting for interest-bearing financial instruments and are not reported as revenues, but rather as direct deposits to the contract. Amounts assessed against annuity and universal life policyholders are recognized as revenue in the period assessed.
The Company elects the fair value option for all of its fixed maturities, short-term investments, equities and certain other invested assets (excluding those that are accounted for using the cost or equity methods of accounting or investment company accounting). All changes in the fair value of investments are recorded in net realized and unrealized investment gains and losses in the Consolidated Statements of Operations. The Company defines fair value as the price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company measures the fair value of financial instruments according to a fair value hierarchy that prioritizes the information used to measure fair value into three broad levels. The Company’s policy is to recognize transfers between the hierarchy levels at the beginning of the period. See Note 3 for additional information on fair value.
Goodwill represents the excess of the purchase price over the fair value of the net assets acquired of PartnerRe SA, Winterthur Re, Paris Re and Presidio. The Company assesses the appropriateness of its valuation of goodwill on at least an annual basis. If, as a result of the assessment, the Company determines that the value of its goodwill is impaired, goodwill will be written down in the period in which the determination is made.
Intangible assets represent the fair value adjustments related to unpaid losses and loss expenses and the fair values of renewal rights, customer relationships, U.S. licenses and fronting arrangements arising from the acquisitions of Paris Re and Presidio. Definite-lived intangible assets are amortized over their useful lives, generally ranging from one to thirteen years. The Company recognizes the amortization of all intangible assets in the Consolidated Statement of Operations. Indefinite-lived intangible assets are not subject to amortization. The carrying values of intangible assets are reviewed for indicators of impairment on at least an annual basis. Impairment is recognized if the carrying values of the intangible assets are not recoverable from their undiscounted cash flows and are measured as the difference between the carrying value and the fair value.
As part of its overall strategy to manage its level of currency exposure, from time to time the Company uses forward foreign exchange derivatives to hedge or partially hedge the net investment in certain non-U.S. dollar functional currency subsidiaries and branches. These derivatives are designated as net investment hedges, and accordingly, the changes in fair value of the derivative and the hedged item related to foreign currency are recognized in currency translation adjustment in the Consolidated Balance Sheets. The Company also uses, from time to time, interest rate derivatives to mitigate exposure to interest rate volatility.
The Company also has three indirect 100% owned subsidiaries, PartnerRe Finance A LLC, PartnerRe Finance B LLC and PartnerRe Finance II Inc., that are considered to be VIEs, which were utilized to issue the Company’s Senior Notes and Capital Efficient Notes (CENts). The Company determined that it was not the primary beneficiary of any of these VIEs at December 31, 2012. As a result, the Company has not consolidated PartnerRe Finance A LLC, PartnerRe Finance B LLC and PartnerRe Finance II Inc., and has reflected the debt issued by the Company related to the Senior Notes and CENts as liabilities in the Consolidated Balance Sheets (see Note 10). The interest on the debt related to the Senior Notes and CENts is reported as interest expense in the Consolidated Statements of Operations.
The Company’s financial instruments that it measures at fair value using Level 1 inputs generally include: equities and real estate investment trusts listed on a major exchange, exchange traded funds and exchange traded derivatives, including futures and that are actively traded.
At December 31, 2012 and 2011, the aggregate carrying amounts of items included in Other invested assets that the Company did not measure at fair value were $262.2 million and $267.6 million, respectively, which related to the Company’s investments that are accounted for using the cost method of accounting, equity method of accounting or investment company accounting.
In addition to the investments underlying the funds held - directly managed account held at fair value of $833.2 million and $1,057.6 million at December 31, 2012 and 2011, respectively, the funds held - directly managed account also included cash and cash equivalents, carried at fair value, of $53.7 million and $176.3 million, respectively, and accrued investment income of $10.2 million and $13.7 million, respectively. At December 31, 2012 and 2011, the aggregate carrying amounts of items included in the funds held - directly managed account that the Company did not measure at fair value were $33.6 million and $20.4 million, respectively, which primarily related to other assets and liabilities held by Colisée Re related to the underlying business, which are carried at cost (see Note 5).
The following tables are reconciliations of the beginning and ending balances for all financial instruments measured at fair value using Level 3 inputs for the years ended December 31, 2012 and 2011 (in thousands of U.S. dollars):
(1) Purchases and issuances of derivatives includes issuances of $5.1 million.
During the year ended December 31, 2012, an equity traded on a foreign exchange with a fair value of $6.8 million was transferred from Level 3 into Level 2 given it was valued using observable inputs at December 31, 2012.
During the year ended December 31, 2011, a catastrophe bond (included within corporate fixed maturities) with a fair value of $40.2 million was transferred from Level 2 into Level 3. The transfer into Level 3 was due to the lack of observable market inputs at March 31, 2011, leading the Company to apply inputs that were not directly observable. The catastrophe bond matured during the year ended December 31, 2011.
The following table shows the significant unobservable inputs used in the valuation of financial instruments measured at fair value using Level 3 inputs at December 31, 2012 (in thousands of U.S. dollars):
The table above does not include financial instruments that are measured using unobservable inputs (Level 3) where the unobservable inputs were obtained from external sources and used without adjustment. These financial instruments include mortality bonds (included within corporate fixed maturities), mutual fund investments (included within equities), and certain insurance-linked securities (included within other invested assets).
The Company has established a Valuation Committee which is responsible for determining the Company’s invested asset valuation policy and related procedures, for reviewing significant changes in the fair value measurements of securities classified as Level 3 from period to period, and for reviewing in accordance with the invested asset valuation policy an independent internal peer analysis that is performed on the fair value measurements of all securities that are classified as Level 3. The Valuation Committee is comprised of members of the Company’s senior management team and meets on a quarterly basis. The Company’s invested asset valuation policy is monitored by the Company’s Audit Committee of the Board of Directors (Board) and approved annually by the Company’s Risk and Finance Committee of the Board.
Changes in the fair value of the Company’s financial instruments subject to the fair value option during the years ended December 31, 2012, 2011 and 2010 were as follows (in thousands of U.S. dollars):
Corporate-Corporate securities consist primarily of bonds issued by U.S. and foreign corporations covering a variety of industries and issuing countries. These securities are generally priced by independent pricing services and brokers. The pricing provider incorporates information including credit spreads, interest rate data and market news into the valuation of each security. The Company generally classifies these securities in Level 2. When a corporate security is inactively traded or the valuation model uses unobservable inputs, the Company classifies the security in Level 3. The significant unobservable input used in the fair value measurement of corporate securities classified as Level 3 is discount rates. A significant increase (decrease) in discount rates in isolation could result in a significantly lower (higher) fair value measurement.
Residential mortgage-backed securities-Residential mortgage-backed securities primarily consist of bonds issued by the Government National Mortgage Association, the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, as well as private, non-agency issuers. With the exception of private, non-agency issuers, these residential mortgage-backed securities are generally priced by independent pricing services and brokers. When current market trades are not available, the pricing provider or the Company will employ proprietary models with observable inputs including other trade information, prepayment speeds, yield curves and credit spreads. The Company generally classifies these securities in Level 2.
In general, the methods employed by the independent pricing services to determine the fair value of the securities that have not been actively traded involve the use of “matrix pricing” in which the independent pricing source applies the credit spread for a comparable security that has traded recently to the current yield curve to determine a reasonable fair value. The Company uses a pricing service ranking to consistently select the most appropriate pricing service in instances where it receives multiple quotes on the same security. When fair values are unavailable from these independent pricing sources, quotes are obtained directly from broker-dealers who are active in the corresponding markets. Most of the Company’s fixed maturities are priced from the pricing services or dealer quotes. The Company will typically not make adjustments to prices received from pricing services or dealer quotes; however, in instances where the quoted external price for a security uses significant unobservable inputs, the Company will classify that security as Level 3. The methods used to develop and substantiate the unobservable inputs used are based on the Company’s valuation policy and are dependent upon the facts and circumstances surrounding the individual investments which are generally transaction specific. The Company’s inactively traded fixed maturities are classified as Level 3. For all fixed maturity investments, the bid price is used for estimating fair value.
Equity securities include U.S. and foreign common and preferred stocks, mutual funds and exchange traded funds. Equities and exchange traded funds are generally classified in Level 1 as the Company uses prices received from independent pricing sources based on quoted prices in active markets. Equities classified as Level 2 are generally mutual funds invested in fixed income securities, where the net asset value of the fund is provided on a daily basis, and common stocks traded in inactive markets. Equities classified as Level 3 are generally mutual funds invested in securities other than the common stock of publicly traded companies, where the net asset value is not provided on a daily basis, and inactively traded common stocks. The significant unobservable input used in the fair value measurement of inactively traded common stocks classified as Level 3 is market return information, weighted using management’s judgment, from comparable selected publicly traded companies in the same industry, in a similar region and of a similar size. Significant increases (decreases) in the market return information could result in a significantly higher (lower) fair value measurement.
Included in the Company’s Level 3 classification, in general, are certain inactively traded weather derivatives; notes and loan receivables, notes securitizations, annuities and residuals, private equity funds and longevity and other total return swaps. For Level 3 instruments, the Company will generally (i) receive a price based on a manager’s or trustee’s valuation for the asset; (ii) develop an internal discounted cash flow model to measure fair value; or (iii) use market return information, adjusted if necessary and weighted using management’s judgment, from comparable selected publicly traded equity funds, in a similar region and of a similar size. Where the Company receives prices from the manager or trustee, these prices are based on the manager’s or trustee’s estimate of fair value for the assets and are generally audited on an annual basis. Where the Company develops its own discounted cash flow models, the inputs will be specific to the asset in question, based on appropriate historical information, adjusted as necessary, and using appropriate discount rates. The
The following methods and assumptions were used by the Company in estimating the fair value of each class of financial instrument liability recorded in the Consolidated Balance Sheets for which the Company does not measure that instrument at fair value:
the fair value of the Senior Notes was calculated based on discounted cash flow models using observable market yields and contractual cash flows based on the aggregate principal amount outstanding of $250 million from PartnerRe Finance A LLC and $500 million from PartnerRe Finance B LLC at December 31, 2012 and 2011; and
(1) PartnerRe Finance A LLC and PartnerRe Finance B LLC, the issuers of the Senior Notes, do not meet consolidation requirements under U.S. GAAP. Accordingly, the Company shows the related intercompany debt of $750 million in its Consolidated Balance Sheets at December 31, 2012 and 2011.
(2) PartnerRe Finance II Inc., the issuer of the CENts, does not meet consolidation requirements under U.S. GAAP. Accordingly, the Company shows the related intercompany debt of $71 million in its Consolidated Balance Sheets at December 31, 2012 and 2011.
The components of the net realized and unrealized investment gains for the years ended December 31, 2012, 2011 and 2010 were as follows (in thousands of U.S. dollars):
Other than the funds held - directly managed account, the Company generally earns investment income on funds held by reinsured companies based upon a predetermined interest rate, either fixed contractually at the inception of the contract or based upon a recognized index (e.g., LIBOR). Interest rates ranged from 2.0% to 5.0% for the years ended December 31, 2012 and 2011 and from 3.0% to 6.0% for the year ended December 31, 2010. See Note 5 for additional information on the funds held - directly managed account.
Included within Accounts payable, accrued expenses and other in the Consolidated Balance Sheets at December 31, 2012 and 2011 were amounts of gross receivable balances for securities sold and gross payable balances for securities purchased as follows (in thousands of U.S. dollars):
Following Paris Re’s acquisition of substantially all of the reinsurance operations of Colisée Re (previously known as AXA RE), a subsidiary of AXA SA (AXA), in 2006, Paris Re and its subsidiaries entered into an issuance agreement and a quota share retrocession agreement to assume business written by Colisée Re from January 1, 2006 to September 30, 2007 as well as the in-force business at December 31, 2005. The agreements provided that the premium related to the transferred business was retained by Colisée Re and credited to a funds held account. During the year ended December 31, 2011, the Company and Colisée Re entered into an endorsement to the quota share retrocession agreement, which resulted in a release of assets of approximately $358 million from the funds held - directly managed account to the Company. During the year ended December 31, 2012, pursuant to the terms of the Reserve Agreement with Colisée Re, the Company settled the payable to Colisée Re of approximately $265 million based on the estimated cumulative balance of net favorable prior year loss development related to the guaranteed reserves. The settlement was funded by the sale of assets underlying the funds held - directly managed account (see Note 8 for additional information).
In addition to the investments underlying the funds held - directly managed account in the above table at December 31, 2012 and 2011, were cash and cash equivalents of $53.7 million and $176.3 million, respectively, other assets and liabilities of $33.4 million and $20.3 million, respectively, and accrued investment income of $10.2 million and $13.7 million, respectively. The other assets and liabilities represent working capital assets held by Colisée Re related to the underlying business.
The components of the net realized and unrealized investment gains on the funds held - directly managed account for the years ended December 31, 2012, 2011 and 2010 were as follows (in thousands of U.S. dollars):
hedge a portion of its net investment exposure resulting from the translation of its foreign subsidiaries and branches whose functional currency is other than the U.S. dollar.
The Company utilizes TBAs as part of its overall investment strategy and to enhance investment performance.
The fair values and the related notional values of derivatives included in the Company’s Consolidated Balance Sheets at December 31, 2012 and 2011 were as follows (in thousands of U.S. dollars):
(1) At December 31, 2012 and 2011, insurance-linked securities include a longevity swap for which the notional amount is not reflective of the overall potential exposure of the swap. As such, the Company has included the probable maximum loss under the swap within the net notional exposure as an approximation of the notional amount.
The fair value of all derivatives at December 31, 2012 and 2011 is recorded in Other invested assets in the Company’s Consolidated Balance Sheets. At December 31, 2012 and 2011, none of the Company’s derivatives were designated as hedges.
The gains and losses in the Consolidated Statements of Operations for derivatives not designated as hedges for the years ended December 31, 2012, 2011 and 2010 were as follows (in thousands of U.S. dollars):
The following tables show the Company’s goodwill and intangible assets at December 31, 2012 and 2011 (in thousands of U.S. dollars):
Intangible asset amortization during the years ended December 31, 2012, 2011 and 2010 totaled $31.8 million, $44.8 million and $68.6 million, respectively, of which $nil, $8.4 million and $37.1 million, respectively, is recorded within acquisition costs and $31.8 million, $36.4 million and $31.5 million, respectively, is recorded within amortization of intangible assets in the Consolidated Statements of Operations. The amounts recorded within acquisition costs in the Consolidated Statements of Operations approximates the amount of Paris Re’s deferred acquisition costs that would have been recorded as acquisition costs had they not been fair valued under purchase accounting.
At December 31, 2012 and 2011, the allocation of the goodwill to the Company’s segments and sub-segments was as follows (in thousands of U.S. dollars):
The table below is a reconciliation of the beginning and ending gross and net liability for unpaid losses and loss expenses, excluding policy benefits for life and annuity contracts, for the years ended December 31, 2012, 2011 and 2010 (in thousands of U.S. dollars):
The following table summarizes the net favorable prior year loss development for each of the Company’s Non-life sub-segments for the years ended December 31, 2012, 2011 and 2010 (in thousands of U.S. dollars):
business experienced adverse loss development for prior accident years of $8 million. The net favorable loss development in each year was primarily due to favorable loss emergence.
For the Global (Non-U.S.) P&C sub-segment, the Company reported net favorable loss development for prior accident years in 2012, 2011 and 2010. The net favorable loss development for prior accident years in 2012 and 2010 was driven by all lines of business, and was most pronounced in the property line. The net favorable loss development for prior accident years in 2011 was driven by all lines of business, and was most pronounced in the motor line. The net favorable loss development in each year was primarily due to favorable loss emergence.
The modest net favorable prior year loss development of $1 million in 2011 was the net result of favorable prior year loss development of $6 million on certain mortality treaties and $5 million related to the GMDB business, which were almost entirely offset by adverse prior year loss development related to disability riders on certain short-term non-proportional treaties in the mortality line following the receipt of updated information from cedants.
The net adverse prior year loss development of $12 million in 2010 was primarily driven by adverse development of $23 million due to an improvement in the mortality trend related to an impaired life annuity treaty in the longevity line and adverse development on certain mortality treaties. This adverse development was partially offset by favorable prior year loss development of $17 million resulting from the GMDB business, which was driven by new cedant information and updated assumptions.
The Company used interest rate assumptions to estimate its liabilities for policy benefits for life and annuity contracts which ranged from 0.2% to 6.6% and 1.0% to 7.0% at December 31, 2012 and 2011, respectively.
Contemporaneously, PartnerRe U.S. Holdings, a wholly-owned subsidiary of the parent company, issued a 5.500% promissory note, with a principal amount of $500 million to PartnerRe Finance B. Under the terms of the promissory note, PartnerRe U.S. Holdings promises to pay to PartnerRe Finance B the principal amount on June 1, 2020, unless previously paid. Interest on the promissory note commenced on June 1, 2010 and is payable semi-annually at an annual fixed rate of 5.500%, and cannot be deferred.
In November 2006, PartnerRe Finance II Inc. (PartnerRe Finance II), an indirect 100% owned subsidiary of the parent company, issued $250 million aggregate principal amount of 6.440% Fixed-to-Floating Rate Junior Subordinated CENts. The CENts will mature on December 1, 2066 and may be redeemed at the option of the issuer, in whole or in part, after December 1, 2016 or earlier upon occurrence of specific rating agency or tax events. Interest on the CENts is payable semi-annually and commenced on June 1, 2007 through to December 1, 2016 at an annual fixed rate of 6.440% and will be payable quarterly thereafter until maturity at an annual rate of 3-month LIBOR plus a margin equal to 2.325%.
PartnerRe Finance II may elect to defer one or more interest payments for up to ten years, although interest will continue to accrue and compound at the rate of interest applicable to the CENts. The CENts are ranked as junior subordinated unsecured obligations of PartnerRe Finance II. The parent company has fully and unconditionally guaranteed on a subordinated basis all obligations of PartnerRe Finance II under the CENts. The parent company’s obligations under this guarantee are unsecured and rank junior in priority of payments to the parent company’s Senior Notes.
Contemporaneously, PartnerRe U.S. Holdings issued a 6.440% Fixed-to-Floating Rate promissory note, with a principal amount of $257.6 million to PartnerRe Finance II. Under the terms of the promissory note, PartnerRe U.S. Holdings promises to pay to PartnerRe Finance II the principal amount on December 1, 2066, unless previously paid. Interest on the promissory note is payable semi-annually and commenced on June 1, 2007 through to December 1, 2016 at an annual fixed rate of 6.440% and will be payable quarterly thereafter until maturity at an annual rate of 3-month LIBOR plus a margin equal to 2.325%.
For each of the years ended December 31, 2012, 2011 and 2010, the Company incurred interest expense of $4.6 million, and paid interest of $4.6 million.
In October 2005, the Company entered into a loan agreement with Citibank, N.A., under which the Company originally borrowed $400 million. On July 12, 2010, the Company repaid the remaining outstanding loan balance of $200 million, which bore interest at a rate of 3-month LIBOR plus 0.85% during 2010.
See Note 22-Subsequent Events for additional information related to the Company’s Preferred Shares.
The reconciliation of basic and diluted net income (loss) per share for the years ended December 31, 2012, 2011 and 2010 is as follows (in thousands of U.S. dollars or shares, except per share amounts):
PartnerRe Bermuda may declare dividends subject to it continuing to meet its minimum solvency and capital requirements, which are to hold statutory capital and surplus equal to or exceeding the Target Capital Level, which is equivalent to 120% of the Enhanced Capital Requirement (ECR). The ECR is calculated with reference to the Bermuda Solvency Capital Requirement model, which is a risk-based capital model. At December 31, 2012, the maximum dividend that PartnerRe Bermuda could pay without prior regulatory approval was approximately $1,369 million.
PartnerRe U.S. may declare dividends subject to it continuing to meet its minimum solvency and capital requirements and is generally limited to paying dividends from earned surplus. The maximum dividend that can be declared and paid without prior approval is limited, together with all dividends declared and paid during the preceeding twelve months, to the lesser of net investment income for the previous twelve months or 10% of its total statutory capital and surplus. At December 31, 2012, the maximum dividend that PartnerRe U.S. could pay without prior regulatory approval was $nil as a result of dividends having already been declared and paid during 2012.
The statutory net income (loss) of the Company’s reinsurance subsidiaries for the years ended December 31, 2012, 2011 and 2010 was as follows (in millions of U.S. dollars):
At December 31, 2012 and 2011, the Company has Swiss and French operations that are branches of PartnerRe Europe and are regulated by the Central Bank of Ireland, as prescribed by the EU Reinsurance Directive.
In addition to the required statutory capital and surplus requirements in the table above, the Company assesses it own solvency capital needs both at a Group and subsidiary level taking into account factors which may not be fully reflected in statutory requirements. The Company’s solvency capital requirements determined under these self assessments may impact the level of the dividends payable by its reinsurance subsidiaries.
Of the Company’s total net assets of $6.9 billion as at December 31, 2012, the total amount of restricted net assets for the Company’s consolidated subsidiaries was $4.6 billion primarily related to statutory dividend restrictions as described above.
Income tax returns are open for examination for the tax years 2007-2012 in Canada and Switzerland, 2008-2012 in Ireland, 2009-2012 in the United States and 2010-2012 in Singapore and France. As a global organization, the Company may be subject to a variety of transfer pricing or permanent establishment challenges by taxing authorities in various jurisdictions. While management believes that adequate provision has been made in the Consolidated Financial Statements for any potential assessments that may result from tax examinations for all open tax years, the completion of tax examinations for open years may result in changes to the amounts recognized in the Consolidated Financial Statements.
Income (loss) before taxes attributable to the Company’s domestic and foreign operations and a reconciliation of the actual income tax rate to the amount computed by applying the effective tax rate of 0% under Bermuda (the Company’s domicile) law to income (loss) before taxes was as follows for the years ended December 31, 2012, 2011 and 2010 (in thousands of U.S. dollars):
Deferred tax assets and liabilities reflect the tax impact of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. Significant components of the net deferred tax assets and liabilities at December 31, 2012 and 2011 were as follows (in thousands of U.S. dollars):
The components of net tax assets and liabilities at December 31, 2012 and 2011 were as follows (in thousands of U.S. dollars):
Realization of the deferred tax assets is dependent on generating sufficient taxable income in future periods. Although realization is not assured, Management believes that it is more likely than not that the deferred tax assets will be realized. The valuation allowance recorded at December 31, 2012 related to a tax loss carryforward in Singapore of $34.2 million and to a foreign tax credit carryforward in Ireland of $13.2 million. The valuation allowance recorded at December 31, 2011 related to a tax loss carryforward in Singapore.
The total amount of unrecognized tax benefits for the years ended December 31, 2012, 2011 and 2010 was as follows (in thousands of U.S. dollars):
Options and RSUs are awarded on an annual basis under the Directors Share Plan. Prior to May 2012, options generally vested at the time of grant, were expensed immediately and had a ten year contractual term. From May 2012, options generally vest and are expensed ratably over three years and have a ten year contractual term. Prior to May 2010, RSUs generally vested at the time of grant with a delivery date restriction of one year and were expensed immediately. From May 2010, RSUs have a five year cliff vest with no delivery restrictions and are expensed over the vesting period. Prior to the RSU grant, directors have the ability to elect to receive their awards in the form of either 100% RSUs, or split, with 60% of the award being RSUs and 40% of the award being cash upon delivery.
The PartnerRe Ltd. Employee Share Purchase Plan (ESPP), which was approved by the Company’s shareholders, has a twelve month offering period with two purchase periods of six months each. All employees
The Swiss Share Purchase Plan (SSPP) has two offering periods per year with two purchase periods of six months each. Swiss employees, who work at least 20 hours per week, are eligible to participate in the SSPP and can contribute between 1% and 8% of their base salary toward the purchase of the Company’s shares up to a maximum of 5,000 Swiss francs per annum. Employees who enroll in the SSPP may purchase the Company’s shares at a 40% discount of the fair value on the purchase date. There is a restriction on transfer or sale of these shares for a period of two years following purchase. Participants in the SSPP are eligible to receive dividends on their shares as of the purchase date. A total of 0.4 million common shares may be issued under the SSPP. At December 31, 2012, 0.2 million shares remained available for issuance under this plan.
Under each of the Company’s equity plans, the Company issues new shares upon the exercise of share options and SSARs or the conversion of RSUs into shares.
The Company values share options issued with a Black-Scholes valuation model and used the following assumptions for the years ended December 31, 2012, 2011 and 2010:
Expected volatility is based on the historical volatility of the Company’s common shares over a period equivalent to the expected life of the Company’s share options. The risk-free interest rate is based on the market yield of U.S. treasury securities with maturities equivalent to the expected life of the Company’s share options. The dividend yield is based on the average dividend yield of the Company’s shares over the expected life of the Company’s share options.
Of the 869,495 RSUs outstanding at December 31, 2012, 15,388 are subject to a five year delivery date restriction from the grant date and were not released for conversion into shares.
During the years ended December 31, 2012, 2011 and 2010, the Company issued 356,900 SSARs, 210,582 SSARs, and 450,568 SSARs with a weighted average grant date fair value of $7.34, $10.32 and $10.45, respectively.
The activity related to the Company’s SSARs for the year ended December 31, 2012 was as follows:
In 2009, the Company issued 27,655 replacement warrants as part of the acquisition of Paris Re. At December 31, 2012, 11,243 warrants are outstanding and fully vested with a weighted average remaining contractual life of 2.1 years and a weighted average exercise price of $33.26. During the year ended December 31, 2012, 4,027 warrants were exercised with a weighted average exercise price of $33.59.
The Company maintains the Zurich Plan, which is classified as a hybrid plan and accounted for as a defined benefit plan under U.S. GAAP. At December 31, 2012 and 2011, the funded status of the Zurich Plan was as follows (in thousands of U.S. dollars):
At December 31, 2012 and 2011, the funded status was included in Accounts payable, accrued expenses and other in the Consolidated Balance Sheets. The total amounts recognized in Accumulated other comprehensive income (loss) at December 31, 2012 and 2011 were $22.8 million (net of $6.1 million of taxes) and $19.1 million (net of $5.1 million of taxes), respectively.
The net periodic benefit cost for the years ended December 31, 2012, 2011 and 2010 were $8.3 million, $10.0 million and $6.1 million, respectively.
plan contributions and investment returns thereon, which are held in an insurance arrangement that provides at least a guaranteed minimum investment return. The insured funds are held by a collective foundation of AXA Life Ltd. and are guaranteed under the insurance arrangement.
The Company does not believe that any plan assets will be returned to the Company during 2013.
Included in the Company’s Other invested assets are certain notes receivable which meet the definition of financing receivables and are accounted for using the cost method of accounting. These notes receivable are collateralized by commercial or residential property. The Company utilizes a third party consultant to determine the initial investment criteria and to monitor the subsequent performance of the notes receivable. The process undertaken prior to the investment in these notes receivable includes an examination of the underlying collateral. The Company reviews its receivable positions on at least a quarterly basis using actual redemption experience. At December 31, 2012 and 2011, based on the latest available information, the Company recorded an allowance for credit losses related to these notes receivable of $3.0 million and $nil, respectively.
The Company purchased $37.8 million and $84.5 million of financing receivables during the years ended December 31, 2012 and 2011, respectively. There were no significant sales of financing receivables during the years ended December 31, 2012 and 2011, however, the outstanding balances were reduced by settlements of the underlying debt.
The Company is also exposed to credit risk in its underwriting operations, most notably in the credit/surety line and for alternative risk products. Loss experience in these lines of business is cyclical and is affected by the state of the general economic environment. The Company provides its clients in these lines of business with reinsurance protection against credit deterioration, defaults or other types of financial non-performance of or by the underlying credits that are the subject of the reinsurance provided and, accordingly, the Company is exposed to the credit risk of those credits. The Company mitigates the risks associated with these credit-sensitive lines of business through the use of risk management techniques such as risk diversification, careful monitoring of risk aggregations and accumulations and, at times, through the use of retrocessional reinsurance protection and the purchase of credit default, total return and interest rate swaps.
The Company has exposure to credit risk related to reinsurance balances receivable and reinsurance recoverable on paid and unpaid losses. The credit risk exposure related to these balances is mitigated by several factors, including but not limited to, credit checks performed as part of the underwriting process, monitoring of aged receivable balances and the contractual right to offset premiums receivable or funds held balances against unpaid losses and loss expenses. The Company regularly reviews its reinsurance recoverable balances to estimate an allowance for uncollectible amounts based on quantitative and qualitative factors. At December 31, 2012 and
2011, the Company has recorded a provision for uncollectible premiums receivable of $8.9 million and $8.2 million, respectively. See also Note 9 for discussion of credit risk related to reinsurance recoverable on paid and unpaid losses.
The Company leases office space under operating leases expiring in various years through 2019. The leases are renewable at the option of the lessee under certain circumstances. The following is a schedule of future minimum rental payments, exclusive of escalation clauses, on non-cancelable leases at December 31, 2012 (in thousands of U.S. dollars):
At December 31, 2012, the Company was not a party to any litigation or arbitration that it believes could have a material effect on the financial condition, results of operations or liquidity of the Company.
In the normal course of its operations, the Company enters into agreements with financial institutions to obtain unsecured and secured credit facilities. At December 31, 2012, the total amount of such credit facilities available to the Company was $1,467 million, with each of the significant facilities described below. These facilities are used primarily for the issuance of letters of credit, although a portion of these facilities may also be used for liquidity purposes. Under the terms of certain reinsurance agreements, irrevocable letters of credit were issued on an unsecured and secured basis in the amount of $189 million and $515 million, respectively, at December 31, 2012, in respect of reported loss and unearned premium reserves.
Included in the total credit facilities available to the Company at December 31, 2012 is a $500 million three-year syndicated unsecured credit facility with the following terms: (i) a maturity date of July 16, 2013, (ii) a $250 million accordion feature, which enables the Company to potentially increase its available credit from $500 million to $750 million, and (iii) a minimum consolidated tangible net worth requirement. The Company’s ability to increase its available credit to $750 million is subject to the agreement of the credit facility participants. The Company’s breach of any of the covenants would result in an event of default, upon which the Company may be required to repay any outstanding borrowings and replace or cash collateralize letters of credit issued under this facility. The Company was in compliance with all of the covenants at December 31, 2012. This facility is predominantly used for the issuance of letters of credit, although the Company and its subsidiaries have access to a revolving line of credit of up to $375 million as part of this facility. During the year ended December 31, 2012, there were no borrowings under this revolving line of credit.
On November 14, 2011, the Company entered into an agreement to modify an existing credit facility. Under the terms of the agreement, this credit facility was increased from a $250 million to a $300 million combined credit facility, with the first $100 million being unsecured and any utilization above the $100 million being secured. This credit facility was renewed on November 14, 2012 and matures on November 14, 2013.
The Company was party to agreements with Atradius N.V. (a company in which a board member was a supervisory director until May 2012), Delta Lloyd (a company in which a board member was a director until September 2011) and ING Group N.V. (a company in which a board member is a supervisory director since May 2012). All agreements entered into with Atradius N.V., Delta Lloyd and ING Group N.V. were completed on an arm’s-length basis.
In the normal course of its underwriting activities, the Company and certain subsidiaries entered into reinsurance contracts with Atradius N.V. The activity included in the Consolidated Statements of Operations related to Atradius N.V. for the years ended December 31, 2012, 2011 and 2010 was as follows (in thousands of U.S. dollars):
Included in the Consolidated Balance Sheets were the following balances related to Atradius N.V. at December 31, 2012 and 2011 (in thousands of U.S. dollars):
In the normal course of its underwriting activities, the Company and certain subsidiaries entered into reinsurance contracts with Delta Lloyd. The activity included in the Consolidated Statements of Operations related to Delta Lloyd for the years ended December 31, 2011 and 2010 includes net premiums earned of $1.9 million and $1.2 million, respectively, and losses and loss expenses and life policy benefits of $0.8 million and $0.3 million, respectively. Included in the Consolidated Balance Sheets at December 31, 2011 were unpaid losses and loss expenses of $7.5 million.
In the normal course of its underwriting activities, the Company and certain subsidiaries entered into reinsurance contracts with ING Group N.V. The activity included in the Consolidated Statements of Operations related to ING Group N.V. for the year ended December 31, 2012 includes net premiums earned of $3.4 million and losses and loss expenses and life policy benefits of $0.8 million. Included in the Consolidated Balance Sheets at December 31, 2012 were unpaid losses and loss expenses of $12.7 million.
Management measures results for the Non-life segment on the basis of the loss ratio, acquisition ratio, technical ratio, other operating expense ratio and combined ratio (all defined below). Management measures results for the Non-life sub-segments on the basis of the loss ratio, acquisition ratio and technical ratio. Management measures results for the Life segment on the basis of the allocated underwriting result, which includes revenues from net premiums earned, other income or loss and allocated net investment income for Life, and expenses from life policy benefits, acquisition costs and other operating expenses.
The Company had two brokers that individually accounted for 10% or more of its gross premiums written during the years ended December 31, 2012, 2011 and 2010. The brokers accounted for 24%, 26%, and 25% and 22%, 21%, and 21% of gross premiums written for the years ended December 31, 2012, 2011 and 2010, respectively.
On or after March 1, 2018, the Company may redeem the Series F preferred shares in whole at any time, or in part from time to time, at $25.00 per share, plus an amount equal to the portion of the quarterly dividend attributable to the then-current dividend period to, but excluding, the redemption date. The Company may also
In the event of liquidation of the Company, the Series F preferred shares rank on parity with each of the Series C, D and E preferred shares and would rank senior to the common shares, and holders thereof would receive a distribution of $25.00 per share, or the aggregate liquidation value of $250 million, plus declared but unpaid dividends, if any.
On February 14, 2013, the Company announced that it expects to redeem the Series C preferred shares for the aggregate redemption value of $290 million plus accrued dividends on March 18, 2013.