Our international offices for our subsidiaries include locations in Paris, Zurich, Singapore, Cologne and Dublin.
The loss ratio is calculated by dividing losses and loss adjustment expenses by net premiums earned.
Book value per ordinary share is based on total shareholders’ equity excluding the aggregate value of the liquidation preferences of our preference shares, divided by the number of shares outstanding of 87,788,375, 85,510,673, 81,506,503, 83,327,594 and 70,508,013 at December 31, 2006, 2007, 2008, 2009 and 2010, respectively. In calculating the number of shares outstanding as at December 31, 2007 for this purpose, we have deducted shares delivered to us and canceled on January 22, 2008 pursuant to our accelerated share repurchase agreement.
Diluted book value per share is calculated based on total shareholders’ equity excluding the aggregate value of the liquidation preferences of our preference shares, at December 31, 2006, 2007, 2008, 2009 and 2010, divided by the number of dilutive equivalent shares outstanding of 89,876,459, 88,268,968, 83,705,984, 86,465,357 and 74,172,657 at December 31, 2006, 2007, 2008, 2009 and 2010, respectively. At December 31, 2006, 2007, 2008, 2009 and 2010, there were 2,088,084, 2,758,295, 2,199,481, 3,137,763 and 3,664,644 of dilutive equivalent shares, respectively. Potentially dilutive shares outstanding are calculated using the treasury method and all relate to employee, director and investor options. In calculating the number of shares outstanding as at December 31, 2007 for this purpose, we have deducted shares delivered to us and canceled on January 22, 2008 pursuant to our accelerated share repurchase agreement.
The following is a discussion and analysis of the results of our operations for the twelve months ended December 31, 2010, 2009 and 2008 and of our financial condition at December 31, 2010. This discussion and analysis should be read in conjunction with our audited consolidated financial statements and accompanying Notes included in this report. This discussion contains forward-looking statements that involve risks and uncertainties and that are not historical facts, including statements about our beliefs and expectations. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and particularly under the headings “Risk Factors,” “Business” and “Forward-Looking Statements” contained in Item 1A, Item 1, and Part I of this report, respectively.
Our principal objectives in 2010 were to continue to create value for our shareholders, growing book value per share through superior risk selection, maintenance of a high quality investment portfolio and capital management initiatives, returning capital to shareholders when surplus funds could not be put to work to provide appropriate returns. We have also looked to expand into the admitted insurance market in the U.S. and the regional distribution of insurance products in the United Kingdom, acquiring experienced underwriting teams with demonstrable track records while building our infrastructure in support of these initiatives. These investments will position the Company to take advantage of significant growth opportunities when market conditions improve.
Acquisitions. In 2010, we completed two acquisitions that complement our diversification and targeted growth strategy. While a small acquisition, our purchase of APJ, a specialist K&R business, complemented our existing political and financial risk portfolio. We also purchased AAIC, a U.S. insurance company with licenses to write insurance business on an admitted basis in the U.S. which will facilitate our growth strategy in the U.S.
Capital management. As we have mentioned previously, we will look to return capital to shareholders when we are unable to deploy our capital to produce acceptable returns. In 2010, we returned $407.8 million to shareholders, through a combination of two separate accelerated share repurchases and open market purchases, underlining our commitment to active capital management. In the fourth quarter of 2010, we also issued $250.0 million of 10-year Senior Notes at a 6% coupon taking advantage of favorable market conditions.
Investment management. During 2010, we entered into interest rate swaps with a total notional amount of $500.0 million, due to mature between August 2, 2012 and November 9, 2020. The swaps are part of our ordinary course investment activities to partially mitigate the negative impact of rises in interest rates on the market value of our fixed income portfolio.
Net income. For 2010, we reported income after taxes of $312.7 million, compared to $473.9 million in 2009 and $103.8 million in 2008. The decrease over the prior year was due to a combination of reduced underwriting performance mainly arising from $180.7 million of pre-tax catastrophe losses, following earthquakes in Chile and New Zealand and a $63.0 million pre-tax reduction in prior year reserve releases. Results for 2008 were impacted by adverse underwriting performance mainly arising from losses of $171.4 million, net of reinsurance recoveries, reinstatement
premiums and tax following Hurricanes Ike and Gustav and adverse investment performance due to the turmoil in the financial markets which resulted in losses of $97.3 million from our investment in funds of hedge funds and $59.6 million of investment impairment charges.
Loss ratio. We monitor the ratio of losses and loss adjustment expenses to net earned premium (the “loss ratio”) as a measure of relative underwriting performance where a lower ratio represents a better result than a higher ratio. The loss ratios for our two business segments for the twelve months ended December 31, 2010, 2009 and 2008 were as follows:
The increase in the reinsurance loss ratio in 2010 was due mainly to $180.7 million of losses, associated with the earthquakes in Chile and New Zealand. The loss ratio in the reinsurance segment for 2009 was lower due to the absence of major catastrophes when compared to 2010. In 2008, our
reinsurance segment loss ratio was impacted by $128.3 million of net losses associated with Hurricanes Ike and Gustav. The increase in the insurance loss ratio in 2010 was mainly due to additional prior year reserve strengthening of $44.2 million compared to $19.4 million of strengthening in 2009. The insurance loss ratio decreased in 2009 from 2008 mainly due to the 2008 results being impacted by losses following Hurricanes Ike and Gustav.
Expense ratio. We monitor the ratio of expenses to net earned premium (the “expense ratio”) as a measure of the cost effectiveness of our business acquisition, operating and administrative processes. The table below presents the contribution of the policy acquisition expenses and operating, administrative and corporate expenses to the expense ratio and the total expense ratios for the twelve months ended December 31, 2010, 2009 and 2008:
Net investment income. In 2010, we generated net investment income of $232.0 million, down 6.6% on the prior year (2009 - $248.5 million, 2008 - $139.2 million). Investment income in 2009 benefited from a $19.8 million contribution from our investments in funds of hedge funds which we exited on June 30, 2009. In 2010, the lower interest rate environment combined with our exit from the
funds of hedge funds, resulted in a lower net investment income for the year. In 2008, we suffered a loss of $97.3 million from our investments in funds of hedge funds.
At December 31, 2010 and December 31, 2009, there were no outstanding foreign currency contracts. At December 31, 2008, we held foreign currency derivative contracts to purchase $18.8 million of U.S. and foreign currencies. The foreign currency contracts are recorded as derivatives at fair value with changes recorded as a realized foreign exchange gain or loss in our statement of operations. For the twelve months ended December 31, 2010, the impact of foreign currency contracts on net income was $Nil (2009 - $1.8 million).
Other revenues and expenses. Other revenues and expenses in 2010 included $2.2 million of foreign currency exchange gains (2009 - $2.0 million gains; 2008 - $8.2 million losses) and $50.6 million of realized investment gains (2009 - $11.4 million gains; 2008 - $47.9 million losses). The increase in realized investment gains in 2010 has resulted mainly from the sale of investments which funded our share repurchases in 2010, in addition to a reduction in charges associated with investments we believe to be other-than-temporarily impaired from $23.2 million in 2009 to $0.3 million in 2010 (2008 - $59.6 million). Interest payable was $16.5 million in 2010 (2009 - $15.6 million; 2008 - $15.6 million), marginally higher than the previous year as we issued $250.0 million additional Senior Notes in December 2010.
Taxes. We incurred a tax expense in 2010 of $27.6 million (2009 - $60.8 million), equivalent to a consolidated rate on income before tax of 8.1% compared to 11.4% in 2009 and 26.0% in 2008. The reduction in the effective tax rate is the result of proactive fiscal and balance sheet management and distribution of underwriting results across our entity balance sheets.
Shareholders’ equity and financial leverage. Total shareholders’ equity decreased from $3,305.4 million at the end of December 31, 2009 to $3,241.9 million as at December 31, 2010. The most significant movements were:
an increase in net of tax unrealized gains on investments of $56.8 million, accounted for in other comprehensive income; and
As at December 31, 2010, the remainder of our total shareholders’ equity was funded by two classes of preference shares with a total value as measured by their respective liquidation preferences of $363.2 million (2009 - $363.2 million) less issue costs of $9.6 million (2009 - $9.6 million).
Our Senior Notes were the only material debt that we had issued as of December 31, 2010 and 2009 (2010 - $500.0 million; 2009 - $250.0 million). Management monitors the ratio of debt to total capital,
with total capital being defined as shareholders’ equity plus outstanding debt. At December 31, 2010, this ratio was 13.3% (2009 - 7.0%; 2008 - 8.2%).
Our preference shares are classified in our balance sheet as equity but may receive a different treatment in some cases under the capital adequacy assessments made by certain rating agencies. We also monitor the ratio of the total of debt and hybrids to total capital which was 22.8% as of December 31, 2010 (2009 - 17.0%; 2008 - 22.1%). The increase in the ratio reflects our most recent issuance of $250.0 million 6% Senior Notes in December 2010. We set targets for financial leverage which we believe provide an appropriate balance between improving returns to our ordinary shareholders while maintaining the levels of financial strength expected by our customers and by the rating agencies. For this purpose, we define financial leverage as the ratio of long-term debt and ‘hybrid’ capital to total capital. The term ‘hybrid’ refers to securities, such as our preference shares, which have characteristics of both debt and equity.
Diluted tangible book value per ordinary share at December 31, 2010, was $38.90, an increase of 13.9% compared to $34.14 at December 31, 2009.
As at December 31, 2010, Aspen Holdings held $354.0 million in cash and cash equivalents which was higher than in prior years due to the receipt of funds following the receipt of proceeds from our issuance of $250.0 million of 6% Senior Notes on December 10, 2010. Excluding the additional funds from the debt issue, we believe that taken together with our credit facilities and expected levels of future inter-company dividends, our holdings of cash and cash equivalents are sufficient to provide us with an appropriate level of liquidity.
At December 31, 2010, the Insurance Subsidiaries held $818.4 million in cash and cash equivalents that are readily realizable securities. Management monitors the value, currency and duration of the cash and investments within its Insurance Subsidiaries to ensure that individually, they are able to meet their insurance and other liabilities as they become due; and that a margin of liquidity was held as at December 31, 2010 and for the foreseeable future.
As of December 31, 2010, we had in issue $462.1 million and £28.3 million in letters of credit to cedants, against which we held $699.9 million and £30.0 million of collateral. Our reinsurance receivables decreased by 12.9% from $321.5 million at December 31, 2009, to $279.9 million at December 31, 2010, mainly as a result of the settlement of claims associated with the 2008 Hurricanes Ike and Gustav and the 2005 Hurricanes Katrina, Rita and Wilma.
Reinsurance. For property reinsurance, the January 1, 2011, renewals were competitive, as ample capacity, exacerbated by the weak economy and higher cedant retentions, impacted pricing. We have seen on average a 7% decline in rates although loss-affected areas have seen some rises. Terms and conditions remain stable although we are increasingly seeing requests for widening of coverage in both reinsurance contracts and in the original business. Competitive pressure was particularly acute on European and Asian business.
Within specialty reinsurance, for our London account, treaties with energy and energy liability exposures and losses from Deepwater Horizon have seen rate increases between 10% and 40%, averaging at around 20%. The non-U.S. reinsurance market remains highly competitive. We have reduced our exposure to terrorism business overall as rates have continued to reduce with broadening of terms and conditions away from pure terrorism cover to include cover for strikes, riots and civil commotions along with coup d’état and civil insurrection.
than 1% of the estimated market loss. In respect of the fourth flood event which commenced in Victoria on January 13, 2011, based on estimated market losses of $500 million to $1 billion, we expect again our losses to be less than 1% of the estimated market loss. Lastly, in respect of Cyclone Yasi which made landfall on the February 2, 2011, based on an initial market loss estimate of $360 million to $1.5 billion, our losses are not expected to be material. These are early estimates and as time goes by there is a potential for significant individual risk losses to emerge which could ultimately require us to revise these estimates.
Non-proportional treaties. A large number of the reinsurance contracts we write are written on a non-proportional or excess of loss treaty basis. As the ultimate level of business written by each cedant can only be estimated at the time the reinsurance is placed, the reinsurance contracts generally stipulate a minimum and deposit premium payable under the contract with an adjustable premium determined by variables such as the number of contracts covered by the reinsurance, the total premium received by the cedant and the nature of the exposures assumed. Minimum and deposit premiums generally cover the majority of premiums due under such treaty reinsurance contracts and the adjustable portion of the premium is usually a small portion of the total premium receivable. For excess of loss contracts, the
Property treaty pro rata made a significant contribution to our reinsurance segment where we wrote $135.0 million in gross written premium in 2010 (2009 - $181.4 million) or 11.6% of our reinsurance segment, of which $31.8 million was estimated (2009 - $15.7 million) and $103.2 million was reported by the cedants (2009 - $165.7 million). We estimate that the impact of a $1 million change in our estimated gross premiums written in our property treaty pro rata business would have an impact of $0.2 million on our net income before tax for our property reinsurance segment at December 31, 2010 (2009 - $0.2 million), excluding the impact of fixed costs such as reinsurance premiums and operating expenses.
We anticipate that ultimate premiums might reasonably be expected to vary by up to 5% as a result of variations in one or more of the assumptions described above, although larger variations are possible. Based on gross written premiums of $135.0 million (2009 - $181.4 million) in our property reinsurance treaty pro rata account as of December 31, 2010, a variation of 5% could increase or reduce net income before taxation by approximately $1.2 million (2009 - $1.8 million).
As a result of the application of derivative accounting rules under ASC 815, the contract was treated as an asset and measured at the directors’ estimate of its fair value. Changes in the estimated fair value from time to time will be included in the consolidated statement of operations. On October 26, 2010, we gave notice of our intention to cancel our credit insurance contract with effect from November 28, 2010. The notice of cancellation has triggered a final payment of $1.9 million to the contract counter-parties.
Interest rate swaps. During 2010, we entered into interest rate swaps with a total notional amount of $500.0 million, due to mature between August 2, 2012 and November 9, 2020. The swaps are part of our ordinary course investment activities to partially mitigate the negative impact of rises in interest rates on the market value of our fixed income portfolio. As at December 31, 2010, there was a credit in respect of the interest rate swaps of $6.8 million (2009 - $Nil). Non-cash collateral with a fair value of $7.7 million as at December 31, 2010 (2009 - $Nil) was transferred by our counterparty. In accordance with FASB ASC 860 Topic Transfers and Servicing, no amount has been recorded in our balance sheet for the pledged assets. None of the collateral has been sold or re-pledged.
Prior to the selection by management of the reserves to be included in our financial statements, our actuarial team employs a number of techniques to establish a range of estimates from which they consider it reasonable for management to select a ‘best estimate’ (the “actuarial range”).
from cedants, lawyers and loss adjustors and information on the cost of settling claims with similar characteristics in previous periods. In addition, for significant events such as the 2005 and 2008 hurricanes, for example, the detailed analysis of our potential exposures includes information obtained directly from cedants which has yet to be processed through market systems enabling us to reduce the time lag between a significant event occurring and establishing case reserves. This additional information is also incorporated into the analysis used to determine the actuarial IBNR. Reinsurance intermediaries are used to assist in obtaining and validating information from cedants but we establish all reserves. In addition, we may engage loss adjusters and perform on site cedant audits to validate the information provided. Disputes do occur with cedants, but the number and frequency are generally low. In the event of a dispute, intermediaries are used to try to resolve the dispute. If a resolution cannot be reached, then the contracts typically provide for binding arbitration.
Initial expected loss ratio method: This method calculates an estimate of ultimate losses by applying an estimated loss ratio to an estimate of ultimate earned premium for each accident year. The estimated loss ratio is based on one or more of (a) an analysis of our own claims experience to date, (b) pricing information (c) industry data and (d) an analysis of a portfolio of similar business written by Syndicate 2020, as available, adjusted by an index reflecting how insurance rates, term and conditions have changed
few reported claims and a relatively less stable pattern of reported losses. Typical examples would be our treaty risk excess line of business in our property reinsurance segment and marine hull line of business in our international insurance segment. The Chain Ladder method is appropriate when there are relatively stable patterns of loss emergence and a relatively large number of reported claims. Typical examples are the U.K. commercial property and U.K. commercial liability lines of business in the international insurance segment.
Estimates of IBNR are generally subject to a greater degree of uncertainty than estimates of the cost of settling claims already notified to us, where more information about the claim event is generally available. IBNR claims often may not be apparent to the insured until many years after the event giving rise to the claims has happened. Lines of business where the IBNR proportion of the total reserve is
high, such as liability insurance, will typically display greater variations between initial estimates and final outcomes because of the greater degree of difficulty of estimating these reserves.
Allowance is made, however, for changes or uncertainties which may create distortions in the underlying statistics or which might cause the cost of unsettled claims to increase or reduce when compared with the cost of previously settled claims including:
These factors are incorporated in the recommended reserve range from which management selects its best point estimate. As at December 31, 2010, a 5% change in the gross reserve for IBNR losses would have equated to a change of approximately $103.7 million in loss reserves which would represent 30.5% of income before income tax for the twelve months ended December 31, 2010. As at December 31, 2009, a 5% change in the gross reserve for IBNR losses would have equated to a change of approximately $97.3 million in loss reserves which would represent 18.2% of net income before income tax for the twelve months ended December 31, 2009.
There are specific areas of our selected reserves which have additional uncertainty associated with them. In property reinsurance, there is still the potential for adverse development from litigation associated with Hurricane Katrina. In casualty reinsurance, there are additional uncertainties associated with claims emanating from the global financial crisis. There is also a potential for new areas of claims to emerge as underlying this segment are many long-tail lines of business. In the insurance segment, we wrote a book of financial institutions risks which have a number of notifications relating to the financial crisis in 2008 and 2009 and there is also a specific area of uncertainty relating to a book of New York Contractor business. In each case, management believes that they have selected an appropriate best estimate based on current information and current analyses.
The selected best estimate of reserves is typically in excess of the mean of the actuarial reserve estimates. The Company believes that there is potentially significant risk in estimating loss reserves for long-tail lines of business and for immature accident years that may not be adequately captured through traditional actuarial projection methodologies. As discussed above, these methodologies usually rely
The 10th percentile represents a 1 in 10 chance that, for example, reinsurance reserves will be at or lower than $1,691.9 million. The 90th percentile represents a 1 in 10 chance that reserves will be at or greater than $2,614.2 million. Diversification reflects the fact that not all the segments are perfectly correlated; that is, we would not expect all lines of business to run off better than or worse than the mean at the same time.
Conversely, if the ultimate liabilities equate to the estimated 90th percentile, then the impact from the change in loss reserves would be to reduce net income before tax by $49.6 million (being the difference between the selected loss reserves of $3,820.5 million and the 90th percentile value of $3,870.1 million), although the impact of such a change is again unlikely to be recognized in one calendar year.
Actuarial range of net reserves. In determining the range of net reserves, we estimate recoveries due under our proportional and excess of loss reinsurance programs. For proportional reinsurance we apply the appropriate cession percentages to estimate how much of the gross reserves will be collectable. For excess of loss recoveries, individual large losses are modeled through our reinsurance program. An assessment is also made of the collectability of reinsurance recoveries taking into account market data on the financial strength of each of the reinsurance companies. The net actuarial range for reserves for losses and loss expenses assuming that net reserves move in proportion to gross would be between $3,179.6 million at the 10th percentile and $3,870.1 million at the 90th percentile. The actual net reserves established as at December 31, 2010 were $3,820.5 million.
Our financial statements are prepared in accordance with U.S. GAAP. The discussions that follow include tables and discussions relating to our consolidated income statement and our segmental operating results for the twelve months ended December 31, 2010, 2009 and 2008.
Gross written premiums. The following table analyzes the overall change in gross written premiums in the twelve months ended December 31, 2010, 2009 and 2008. The amounts shown as ‘underlying premiums’ exclude reinstatement premiums and other premiums receivable directly related to losses arising from Hurricanes Katrina, Rita and Wilma in 2005, Hurricanes Ike and Gustav in 2008 and the Chilean Earthquake in 2010.
Net premiums written. While gross written premiums have only increased by 0.5%, net premiums written have increased by 3.0% in 2010 compared to 2009 due to a reduction of $44.6 million in ceded written premiums. The overall decrease in the insurance segment reflects the cancellation of a reinsurance quota share for U.S. property insurance and lower costs of quota share reinsurance resulting from reduced gross written premium.
In 2009, although total gross written premiums increased by 3.3%, net premiums written had increased by only 0.1% compared to 2008 as a result of the $64.1 million increase in ceded written premiums when compared to 2008. The lower ceded written premium in 2008 reflects the purchase of catastrophe cover in 2007 which protected both the 2007 and 2008 wind seasons.
Gross premiums earned in 2009 were $146.3 million higher than in 2008 reflecting the full year impact of gross premium written by the new underwriting teams in 2008 in addition to premium written in our credit and surety reinsurance line which was established in 2009.
Net premiums earned. Net premiums earned have increased by $75.9 million or 4.2% in 2010 compared to 2009 which is consistent with the increase in gross earned premiums and the reduction in the cost of our reinsurance purchased in that period. Net premiums earned in 2009 increased by 7.1% compared to 2008 mainly as a result of the increase in gross earned premium. The changes in net premiums earned for each of our segments were as follows:
Losses and loss adjustment expenses. In 2010, we suffered $127.9 million of net losses from the Chilean earthquake and $52.8 million for the New Zealand earthquake. In 2009, we had no significant catastrophe loss events, with the only notable loss events being the recognition of $13.4 million of European and Canadian storm losses and $11.4 million of net losses from the Air France disaster. In 2008, we suffered $200.2 million of losses from Hurricanes Ike and Gustav before reinstatements and tax, a $49.7 million provision against potential losses as a result of the ongoing financial crisis. Further information relating to movements in prior year reserves can be found below under “Reserves for Loss and Loss Adjustment Expenses.” Our insurance losses and loss adjustment expenses included paid claims of $1,248.7 million in 2010, $808.6 million in 2009 and $739.4 million in 2008.
The 2009 prior year adjustment for our reinsurance segment was due to favorable loss development on all business lines, particularly in our property catastrophe account which saw favorable development on losses associated with the 2007 U.K. floods and Hurricanes Ike and Gustav. Reserve releases in the reinsurance segment were generated mainly by our U.S treaty business. The prior year adjustment for the insurance segment was attributable mainly to reserve strengthening for the casualty line of business which experienced deterioration particularly in our New York contractors’ business.
Expenses. We monitor the ratio of expenses to gross earned premium (the “gross expense ratio”) as a measure of the cost effectiveness of our business acquisition, operating and administrative processes. The table below presents the contribution of the policy acquisition expenses and operating and administrative expenses to the gross expense ratios and the total net expense ratios for the twelve months ended December 31, 2010, 2009 and 2008. We also show the effect of reinsurance purchased which impacts the reported net expense ratio by expressing the expenses as a proportion of net earned premiums.
The policy acquisition ratio, gross of the effect of reinsurance, has reduced to 15.7% for the twelve months ended December 31, 2010 from 16.4% for the comparative period in 2009 mainly as a result of a reduction in profit related commissions in our reinsurance segment. In 2009, the policy acquisition expense ratio increased to 18.3% from 17.6% in 2008 due to the impact of profit-related commissions. Operating and administrative expenses were broadly in line with 2009 with the increased expenditure associated with our expansion into the U.S. admitted market and U.K. regional distribution network being balanced by reductions in profit-related compensation in 2010. The 2009 increase over 2008 was due to higher performance-related costs in a year which did not experience significant catastrophic activity.
Other revenues and expenses. Other revenues and expenses in 2010 included $2.2 million of foreign currency exchange gains (2009 - $2.0 million gains; 2008 - $8.2 million losses) and $50.6 million of realized investment gains (2009 - $11.4 million gains; 2008 - $47.9 million losses). The increase in realized investment gains in 2010 has resulted mainly from the sale of investments which funded our share repurchases in 2010, in addition to a reduction in charges associated with investments we believe to be other-than-temporarily impaired from $23.2 million in 2009 to $0.3 million in 2010 (2008 - $59.6 million). Interest payable was $16.5 million in 2010 (2009 - $15.6 million; 2008 - $15.6 million).
Income tax expense. Income tax expense decreased to $27.6 million in 2010 from $60.8 million in 2009 and from $36.4 million in 2008. The effective tax rate in 2010 was 8.1% compared to 11.4% in 2009 and 26.0% in 2008. The reduction in the effective tax in 2010, is the result of proactive fiscal and balance sheet management and the distribution of underwriting results across our entity balance sheets. The reduction in tax rate for 2009 was mainly driven by the distribution of insurance and investment-related losses within the group in the fourth quarter of 2008.
We are organized into two business segments: Reinsurance and Insurance. We have considered similarities in economic characteristics, products, customers, distribution, the regulatory environment of our operating segments and quantitative thresholds to determine our reportable segments.
We historically have managed our business in four segments: property reinsurance, casualty reinsurance, international insurance and U.S. insurance. On January 14, 2010, we announced a new organizational structure where we intended to manage our insurance and reinsurance businesses as two underwriting segments, Aspen Insurance and Aspen Reinsurance, to enhance and better serve our global customer base. As a result of our organizational changes, in 2010 we now manage our underwriting business in two operating segments: Insurance and Reinsurance. The reinsurance segment consists of four principal lines of business: property catastrophe reinsurance, other property reinsurance, casualty reinsurance and specialty reinsurance. The insurance segment consists of property insurance, casualty insurance, marine, energy and transportation insurance and financial and professional lines insurance.
The following tables summarize gross and net premiums written and earned, underwriting results, and combined ratios and reserves for each of our business segments for the twelve months ended December 31, 2010, 2009 and 2008.
Information related to prior periods has been restated to conform to the current period presentation, where applicable.
Reinsurance ceded. Total reinsurance ceded of $43.7 million in 2010 has decreased by $15.6 million from 2009, as we decided to selectively reduce some outwards reinsurance.
Losses and loss adjustment expenses. The net loss ratio for 2010 was 60.7% compared to 42.2% in 2009. The increase in the loss ratio is attributable to losses of $180.7 million ($168.7 million net of reinstatement premiums) relating to the earthquakes in Chile and New Zealand, which had an impact of 15.3 and 14.9 percentage points on the loss ratio and combined ratio, respectively, compared to an absence of significant catastrophe-related losses in 2009. Net reserve releases of $65.6 million (2009 - $103.8 million) were due mainly to favorable claims development in most lines but are significantly lower than 2009, in particular for property catastrophe and specialty reinsurance.
Overall premiums of $914.6 million for 2010 are 2.6% higher than the $891.1 million reported in 2009. Gross written premiums have increased in both property insurance lines and financial and professional business where we saw opportunities to write business that met our profitability requirements. This has compensated for difficult trading conditions in our casualty insurance and marine, energy and transportation lines.
Overall premiums in 2009 were in line with 2008 due to reduced market demand for Gulf of Mexico energy cover, the repositioning of our financial institutions account, our U.K. liability line reducing written premiums in the soft market and adverse exchange rate movements between the British Pound and the U.S. Dollar. These were offset by an increase in premiums written by the new specie and
Losses and loss adjustment expenses. The net loss ratio for the twelve months ended December 31, 2010 was 73.3% compared to 67.3% for 2009, partly due to higher prior year reserve strengthening in 2010 of $48.6 million compared to $19.3 million in 2009. Losses for 2010 also included $10.7 million for the Deepwater Horizon oil spill and $35.3 million of net losses ($39.5 million including reinstatement premiums) from two oil pipeline spills and a gas explosion in California.
The net loss ratio of 67.3% for the twelve months ended December 31, 2009 was lower than the 73.7% in 2008 as 2008 experienced a greater frequency and severity of losses including $45.7 million of losses from Hurricanes Ike and Gustav, a $15.9 million pollution loss in France and increased provisions for those lines affected by the global financial crisis. The 2009 year experienced losses from our aviation and specialty reinsurance lines which suffered from an $11.7 million net loss associated with the Air France disaster and a $7.1 million satellite loss. Prior year reserve releases are further discussed under “Reserves for Losses and Loss Expenses.”
Our fixed income portfolio duration was 2.9 years which included the impact of the interest rate swaps and was down from 3.3 years at the end of 2009.
Mortgage-Backed Securities. The following tables summarize the fair value of our Mortgage-Backed Securities (“MBS”) by rating and class at December 31, 2010:
Our mortgage-backed portfolio is supported by loans diversified across a number of geographic and economic sectors.
Other investments. On May 19, 2009, Aspen Holdings invested $25.0 million in Cartesian Iris 2009A L.P. through our wholly-owned subsidiary, Acorn Limited. Cartesian Iris 2009A L.P. is a Delaware Limited Partnership formed to provide capital to Iris Re, a Class 3 Bermudian reinsurer focusing on insurance-linked securities. On June 1, 2010, the investment in Cartesian Iris 2009A L.P. matured and was reinvested in the Cartesian Iris Offshore Fund L.P. The Company’s involvement with Cartesian Iris Offshore Fund L.P. is limited to its investment in the fund, and it is not committed to making further investments in Cartesian Iris Offshore Fund L.P.; accordingly, the carrying value of the investment represents the Company’s maximum exposure to a loss as a result of its involvement with the partnership at each balance sheet date.
Investment funds. Investment funds have historically represented our investments in funds of hedge funds which were recorded using the equity method of accounting. Adjustments to the carrying value of these investments were made based on the net asset values reported by the fund managers, resulting in a carrying value that approximated fair value. Realized and unrealized gains of $19.8 million (2008 - loss of $97.3 million) were recognized through net investment income in the statement of operations in the year ended December 31, 2009. In 2008, we sold share capital in the funds that cost $198.6 million for proceeds of $177.2 million realizing a loss of $21.4 million. In February 2009, we gave notice to redeem
the balance of the funds with effect at June 30, 2009. As a result, we recognized proceeds from the redemption of funds of $307.1 million at June 30, 2009. Our active investments and other obligations with the funds ceased at June 30, 2009.
At December 31, 2010, we obtained an average of 2.9 quotes per investment, compared to 3.4 quotes at December 31, 2009. Pricing sources used in pricing our fixed income investments at December 31, 2010 and December 31, 2009, respectively, were as follows:
The value of our investments in funds of hedge funds was based upon monthly net asset values reported by the underlying funds to our funds of hedge fund managers. The financial statements of our funds of hedge funds were subject to annual audits evaluating the net asset positions of the underlying investments. We periodically reviewed the performance of our funds of hedge funds and evaluated the reasonableness of the valuations.
Guaranteed Investments. The following table presents the breakdown of investments which are guaranteed by mono-line insurers (“Wrapped Credit” disclosure) and those that have explicit government guarantees. The standalone rating is determined as the senior unsecured debt rating of the issuer. Where the credit ratings were split between the three main rating agencies (S&P’s, Moody’s, and Fitch), the lowest rating was used.
Our exposure to mono-line insurers was limited to 1 municipal holding (2009 - 1 holding) as at December 31, 2010 with a market value of $0.1 million (2009 - $0.1 million). Our exposure to other third-party guaranteed debt is primarily to investments backed by the Federal Depository Insurance Corporation (FDIC) and non-U.S. government guaranteed issuers.
Prior year loss reserves. In the twelve months ended December 31, 2010, 2009 and 2008, there was an overall reduction of our estimate of the ultimate claims to be paid. An analysis of this reduction by segment is as follows:
For the twelve months ended December 31, 2010. The analysis of the development by each segment is as follows:
For the twelve months ended December 31, 2009. The analysis of the development by each segment is as follows:
Reinsurance: The reserve releases in the year were as a result of better than expected incurred development on nearly all lines in the segment spread across several accident years and including settlement of Hurricane Ike and Gustav claims. Because of ongoing litigation, there remains significant uncertainty as to our ultimate costs of Hurricane Katrina. Just over half of the $103.8 million reserve releases came from property with an even split of casualty and specialty releases for the remainder. Most of the casualty favorable development was in our U.S. casualty treaty reinsurance business line where the experience to year end compared with starting loss ratios and expected patterns was generally better than expected at the aggregate level.
Insurance: The $19.4 million deterioration in the year was the result of strengthening in three out of the four business lines. We released $6.5 million from property from better than expected experience. Casualty was strengthened by $3.0 million which is primarily a result of worse than expected experience in relation to New York contractors’ liability business offset partially by releases in U.K. liability which had better than expected experience. Reserve strengthening from financial and professional lines was attributable to increased reserves on the financial institutions line in response to the global financial crisis. Marine, energy and transportation reserves were strengthened from worse than expected development on the 2007 accident year in our marine, energy and construction liability account.
For the twelve months ended December 31, 2008. The analysis of the development by each segment is as follows:
Insurance. The insurance segment was impacted by $13.5 million of net reserve strengthening during 2008. The reserve strengthening was attributable to deterioration in respect of a loss related to the 2007 California wildfires and also from shipowners’ liability losses, both written in our marine, energy and construction liability account. This was partially offset by favorable development in our U.K. and U.S. liability lines.
Management monitors the ratio of debt to total capital, with total capital being defined as shareholders’ equity plus outstanding debt. At December 31, 2010, this ratio was 13.3% (2009 - 7.0%, 2008 - 8.2%).
Board of Directors and announced on February 6, 2008. The repurchase was funded with cash available and the sale of investment assets.
On September 22, 2010, we initiated an open market purchase program to purchase ordinary shares in the open market. During the third quarter of 2010, we repurchased in the open market and subsequently cancelled a total of 264,555 ordinary shares under the repurchase program at a total cost of $7.7 million. During the fourth quarter of 2010, we repurchased in the open market and subsequently cancelled a total of 550,000 ordinary shares. The total consideration for these open market purchases was $23.6 million.
On December 10, 2010, we issued $250.0 million of 6% Senior Notes due 2020.
On March 31, 2009, we repurchased and cancelled 2,672,500 of our 7.401% $25 liquidation value preference shares (NYSE : AHL-PA) at a price of $12.50 per share. The repurchase resulted in a $31.5 million gain attributable to ordinary shareholders which was not recognized in the income statement but was included in the calculation of earnings per share.
Access to capital. Our business operations are in part dependent on our financial strength and the market’s perception thereof, as measured by shareholders’ equity, which was $3,241.9 million at December 31, 2010 (2009 - $3,305.4 million). We believe our financial strength provides us with the flexibility and capacity to obtain funds through debt or equity financing. However, our continuing ability to access the capital markets is dependent on, among other things, market conditions, our operating results and our perceived financial strength. We regularly monitor our capital and financial position, as well as investment and security market conditions, both in general and with respect to Aspen Holdings’ securities. Our ordinary shares and all our preference shares are listed on the NYSE.
During the period ended December 31, 2010, Aspen U.K. Holdings paid Aspen Holdings dividends of $323.1 million. During the period ended December 31, 2009, Aspen U.K. Holdings paid Aspen Holdings dividends of $401.0 million. Aspen Holdings also received interest of $36.5 million (2009 - $36.5 million) from Aspen U.K. Holdings in respect of an inter-company loan.
For a more detailed discussion of our Insurance Subsidiaries’ ability to pay dividends, see Note 14 of our consolidated financial statements.
On an ongoing basis, our Insurance Subsidiaries’ sources of funds primarily consist of premiums written, investment income and proceeds from sales and redemptions of investments.
We manage these risks by making regular forecasts of the timing and amount of expected cash outflows and ensuring that we maintain sufficient balances in cash and short-term investments to meet these estimates. Notwithstanding this policy, if these cash flow forecasts are incorrect, we could be forced to liquidate investments prior to maturity, potentially at a significant loss. Historically, we have not had to liquidate investments to maintain sufficient levels of liquidity.
The liquidity of the Insurance Subsidiaries is also affected by the terms of contractual obligations to U.S. policyholders and by undertakings to certain regulatory authorities to facilitate the issue of letters of credit or maintain certain balances in trust funds for the benefit of policyholders. The following table shows the forms of collateral or other security provided to policyholders as at December 31, 2010 and 2009:
The amounts provided as Funds at Lloyd’s will be drawn upon and become a liability of the Company in the event of the syndicate declaring a loss at a level that cannot be funded from other
U.S. reinsurance trust fund. For its U.S. reinsurance activities, Aspen U.K. has established and must retain a multi-beneficiary U.S. trust fund for the benefit of its U.S. cedants so that they are able to take financial statement credit without the need to post cedant-specific security. The minimum trust fund amount is $20 million plus a minimum amount equal to 100% of Aspen U.K.’s U.S. reinsurance liabilities, which were $1,065.5 million at December 31, 2010 and $937.1 million at December 31, 2009. At December 31, 2010, the total value of assets held in the trust was $1,227.3 million (2009 - $1,096.6 million).
U.S. surplus lines trust fund. Aspen U.K. has established a U.S. surplus lines trust fund with a U.S. bank to secure liabilities under U.S. surplus lines policies. The balance held in the trust at December 31, 2010 was $140.1 million (2009 - $80.4 million).
Consolidated cash flows for the twelve months ended December 31, 2008. Total net cash flow from operating activities in 2008 was $530.5 million, a reduction of $243.5 million from 2007 due largely to an increase in claims payments. For the twelve months ended December 31, 2008, our cash flows from operations provided us with sufficient liquidity to meet our operating requirements. We paid net claims of $739.4 million in 2008 and made net investments in the amount of $255.3 million in market securities and equipment during the period. We paid ordinary and preference share dividends of $77.9 million, and $100.3 million was used to repurchase ordinary shares. At December 31, 2008, we had a cash and cash equivalents balance of $809.1 million.
The facility can be used by any of the Borrowers to provide funding for our Insurance Subsidiaries, to finance the working capital needs of the Company and our subsidiaries and for general corporate purposes of the Company and our subsidiaries. The revolving credit facility further provides for the issuance of collateralized and uncollateralized letters of credit. Initial availability under the facility is $280.0 million and the Company has the option (subject to obtaining commitments from acceptable lenders) to increase the facility by up to $75.0 million. The facility will expire on July 30, 2013. As of December 31, 2010, no borrowings were outstanding under the credit facilities. The fees and interest rates on the loans and the fees on the letters of credit payable by the Borrowers increased based on the consolidated leverage ratio of the Company.
The following table summarizes our contractual obligations (other than our obligations to employees, our Perpetual PIERS and our Perpetual Preference Shares) under long-term debt, operating leases and reserves relating to insurance and reinsurance contracts as of December 31, 2010:
For our U.K.-based reinsurance and insurance operations, on April 1, 2005, Aspen U.K. signed an agreement for under leases (following our entry in October 2004 into a heads of terms agreement) with B.L.C.T. (29038) Limited (the landlord), Tamagon Limited and Cleartest Limited in connection with leasing office space in London of approximately a total of 49,500 square feet covering three floors. The term of each lease for each floor commenced in November 2004 and runs for 15 years. In 2007, the building was sold to Tishman International. The terms of the lease remain unchanged. Each lease will be subject to 5-yearly upwards-only rent reviews. We also license office space within the Lloyd’s building on the basis of a renewable twelve-month lease. We have also leased additional premises in London covering 9,800 square feet for a period of five years.
We also have entered into leases for office space in locations of our subsidiary operations. These locations include Boston, Massachusetts; Rocky Hill, Connecticut; Alpharetta, Georgia; Scottsdale, Arizona; Pasadena, California; Manhattan Beach, California; Atlanta, Georgia; Miami, Florida; and Jersey City, New Jersey. In 2010, we entered into a five-year lease for office space in Manhattan, New York, covering 24,000 square feet.
Average equity, a non-GAAP financial measure, is calculated by the arithmetic average on a monthly basis for the stated periods excluding (i) preference shares, (ii) after-tax unrealized appreciation or depreciation on investments and (iii) the average after-tax unrealized foreign exchange gains and losses. Unrealized appreciation (depreciation) on investments is primarily the result of interest rate movements and the resultant impact on fixed income securities, and unrealized appreciation (depreciation) on foreign exchange is the result of exchange rate movements between the U.S. dollar and the British pound. Therefore, Aspen believes that excluding these unrealized appreciations (depreciations) provides a more consistent and useful measurement of operating performance, which supplements GAAP information.