(1) Includes $12.7 million, $5.7 million, $37.4 million, $66.9 million and $45.3 million of premium assumed from our Individual Risk segment in the years ended December 31, 2009, 2008, 2007, 2006 and 2005, respectively.
Our revenues are principally derived from three sources: 1) net premiums earned from the reinsurance and insurance policies we sell; 2) net investment income and realized and unrealized gains from the investment of our capital funds and the investment of the cash we receive on the policies which we sell; and 3) other income received from our joint ventures, advisory services, weather and energy risk management operations and various other items.
The operating results, also known as the underwriting results, of an insurance or reinsurance company are discussed frequently by reference to its net claims and claim expense ratio, underwriting expense ratio, and combined ratio. The net claims and claim expense ratio is calculated by dividing net claims and claim expenses incurred by net premiums earned. The underwriting expense ratio is calculated by dividing underwriting expenses (acquisition expenses and operational expenses) by net premiums earned. The combined ratio is the sum of the net claims and claim expense ratio and the underwriting expense ratio. A combined ratio below 100% generally indicates profitable underwriting prior to the consideration of investment income. A combined ratio over 100% generally indicates unprofitable underwriting prior to the consideration of investment income. We also
We currently conduct our business through two reportable segments, Reinsurance and Individual Risk. Those segments are more fully described as follows:
2) Specialty reinsurance, written for our own account and for DaVinci, covering certain targeted classes of business where we believe we have a sound basis for underwriting and pricing the risk that we assume. Our portfolio includes various classes of business, such as catastrophe exposed workers’ compensation, surety, terrorism, political risk, trade credit, medical malpractice, catastrophe-exposed personal lines property, casualty clash, certain other casualty lines and other specialty lines of reinsurance that we collectively refer to as specialty reinsurance. We believe that we are seen as a market leader in certain of these classes of business, such as casualty clash, surety, catastrophe-exposed workers’ compensation and terrorism.
Our Individual Risk business is primarily produced through four distribution channels: 1) wholly owned program managers - where we write primary insurance through our own subsidiaries; 2) third party program managers - where we write primary insurance through third party program managers, who produce business pursuant to agreed-upon underwriting guidelines and provide related back-office functions; 3) quota share reinsurance - where we write quota share reinsurance with primary insurers who, similar to our third party program managers, provide most of the back-office and support functions; and 4) brokers and agents - where we write primary insurance produced through licensed intermediaries on a risk-by-risk basis.
In addition to the potential growth of our existing reinsurance and insurance businesses, from time to time we consider diversification into new ventures, either through organic growth, the formation of new joint ventures, or the acquisition of or the investment in other companies or books of business of other companies. This potential diversification includes opportunities to write targeted, additional classes of risk-exposed business, both directly for our own account and through possible new joint venture opportunities. We also regularly evaluate opportunities to grow our business by utilizing our skills, capabilities, proprietary technology and relationships to expand into further risk-related coverages, services and products. Generally, we focus on underwriting or trading risks where reasonably sufficient data may be available, and where our analytical abilities may provide us a competitive advantage, in order for us to seek to model estimated probabilities of losses and returns in accordance with our approach in respect of our current portfolio of risks. We also regularly review potential new investments, in both operating entities and financial instruments.
In evaluating potential new ventures or investments, we generally seek an attractive estimated return on equity, the ability to develop or capitalize on a competitive advantage, and opportunities which we believe will not detract from our core Reinsurance and Individual Risk operations. Accordingly, we regularly review strategic opportunities and periodically engage in discussions regarding possible transactions, although there can be no assurance that we will complete any such transactions or that any such transaction would be successful or contribute materially to our results of operations or financial condition. We believe that our ability to potentially attract investment and operational opportunities is supported by our strong reputation and financial resources, and by the capabilities and track record of our ventures unit.
Our estimates of claims and claim expense reserves are not precise in that, among other matters, they are based on predictions of future developments and estimates of future trends and other variable factors. Some, but not all, of our reserves are further subject to the uncertainty inherent in actuarial methodologies and estimates. Because a reserve estimate is simply an insurer’s estimate at a point in time of its ultimate liability, and because there are numerous factors which affect reserves and claims payments but cannot be determined with certainty in advance, our ultimate payments will vary, perhaps materially, from our estimates of reserves. If we determine in a subsequent period that adjustments to our previously established reserves are appropriate, such adjustments are recorded in the period in which they are identified. During the years ended December 31, 2009, 2008 and 2007, changes to prior year estimated claims reserves increased our net income by $244.5 million, $234.8 million and $233.2 million, respectively, excluding the consideration of changes in reinstatement premium, profit commissions, redeemable noncontrolling interest - DaVinciRe and income tax expense.
and/or discussions with ceding companies or their brokers. This information can be received on a monthly, quarterly or transactional basis and normally includes estimates of paid claims and case reserves. We sometimes also receive an estimate or provision for IBNR. This information is often updated and adjusted from time-to-time during the loss settlement period as new data or facts in respect of initial claims, client accounts, industry or event trends may be reported or emerge in addition to changes in applicable statutory and case laws.
Our reserving techniques, assumptions and processes differ between our Reinsurance and Individual Risk segments, as well as between our property catastrophe reinsurance and specialty reinsurance businesses within our Reinsurance segment. Following is a discussion of the risks we insure and reinsure, the reserving techniques, assumptions and processes we follow to estimate our claims and claim expense reserves, and our current estimates versus our initial estimates of our claims reserves, for each of these units.
reporting agencies, although we generally make significant adjustments based on our current exposure to the geographic region involved as well as the size of the loss and the peril involved. This approach supplements our approach for estimating losses for larger catastrophes, which as discussed above, includes discussions with brokers and ceding companies, reviewing individual contracts impacted by the event, and modeling the loss in our REMS© system. Approximately one year from the date of loss for these small events, we estimate IBNR for these events by using an actuarial technique. The actuarial technique is to use a paid Bornhuetter-Ferguson actuarial technique in estimating IBNR. The paid Bornhuetter-Ferguson actuarial technique loss development factors are selected based on a review of our historical experience and these factors are reviewed at least annually. There were no changes to the paid loss development factors over the last three years.
In general, our property catastrophe reinsurance reserves for our more recent reinsured catastrophic events are subject to greater uncertainty and, therefore, greater potential variability, and are likely to experience material changes from one period to the next. This is due to the uncertainty as to the size of the industry losses from the event, uncertainty as to which contracts have been exposed to the catastrophic event, uncertainty due to complex legal and coverage issues that can arise out of large or complex catastrophic events such as the events of September 11, 2001 and hurricane Katrina, and uncertainty as to the magnitude of claims incurred by our customers. As our property catastrophe reinsurance claims age, more information becomes available and we believe our estimates become more certain, although there is no assurance this trend will continue in the future. As seen in the Actual vs. Initial Estimated Property Catastrophe Reinsurance Claims and Claim Expense Reserve Analysis table below, 67.3% of our inception to date claims and claim expenses in our property catastrophe reinsurance unit were incurred in the 2004, 2005 and 2008 accident years, due principally to the losses from hurricanes Charley, Frances, Ivan, Jeanne, Katrina, Rita, Wilma, Gustav and Ike. Due to the size and complexity of the losses in these accident years, there still remains considerable uncertainty as to the ultimate settlement costs associated with these accident years.
In 2009, we reviewed our processes and methodology for estimating the ultimate expected cost to settle all claims arising from certain mature large U.S. hurricanes. During this process, we evaluated several actuarial methodologies including using paid loss development factors, reported loss development factors and ratios of IBNR to case reserves. In this review, among other things, we looked at our historical claims experience on these mature large U.S. hurricanes, the number of claims associated with these mature large U.S. hurricanes and available industry claims information on the same or similar events. We determined that the use of the reported loss development factor methodology for these mature large U.S. hurricanes would provide us with the best estimate of ultimate losses in respect of these events. Currently, we believe this approach is only applicable for the 2004 and 2005 large hurricanes as we believe that (i) these events have a large enough number of reported claims to be statistically sound, (ii) these events have available industry reported claims information to supplement our own historical reported loss information, and (iii) a sufficient amount of time has passed from the date of loss that the use of an actuarial method could assist in estimating the ultimate costs. We implemented this actuarial methodology in the fourth quarter of 2009 with respect to our 2004 and 2005 hurricane losses. In the future, we expect to evaluate applying this methodology to other mature large U.S. hurricanes as we deem appropriate. In implementing this actuarial technique, we adjusted our ultimate losses at December 31, 2009 on the 2004 hurricanes from 96.6% reported to 98.1% reported and from 93.6% reported to 95.8% reported for the 2005 hurricanes. The impact of these changes within our property catastrophe reinsurance unit was a decrease in ultimate losses on the 2004 hurricanes by $12.3 million and by $28.1 million for our 2005 hurricane losses. The net positive impact to our financial results was $26.9 million after considering offsetting changes in reinsurance recoveries, reinstatement premiums, profit commissions and redeemable noncontrolling interest - DaVinciRe.
Within our property catastrophe reinsurance business, we seek to review our claims and claim expense reserves quarterly. Our quarterly review procedures include identifying events that have occurred up to the latest balance sheet date, determining our best estimate of the ultimate expected cost to settle all claims and administrative costs associated with those new events which have arisen during the reporting period, reviewing the ultimate expected cost to settle claims and administrative costs associated with those events which occurred during previous periods, and considering new estimation techniques, such as additional actuarial methods or other statistical techniques, that can assist us in developing a best estimate. This process is judgmental in that it involves reviewing changes in paid and reported losses each period and adjusting our estimates of the ultimate expected losses for each event if there are developments that are different from our previous expectations. If we determine that adjustments to an earlier estimate are appropriate, such adjustments are recorded in the period in which they are identified. During the years ended December 31, 2009, 2008 and 2007, changes to our prior year estimated claims reserves in our property catastrophe reinsurance unit increased our net income by
$184.4 million, $131.6 million and $93.1 million, respectively, excluding the consideration of changes in reinstatement premium, profit commissions, redeemable noncontrolling interest - DaVinciRe and income tax expense.
Our favorable development on prior years estimated ultimate claim reserves in our property catastrophe reinsurance unit of $131.6 million in 2008 was principally as a result of a comprehensive review of the Company’s expected ultimate net losses associated with the 2005 hurricanes, Katrina, Rita and Wilma, which resulted in an $82.7 million decrease in net losses from these events. The comprehensive review of the 2005 hurricanes included a case-by-case review of the claims for our largest outstanding additional case reserves by cedant for each hurricane, reviewing updated information received from customers, brokers and other industry sources regarding these claims, reviewing industry paid and reported loss development patterns for hurricanes Katrina, Rita and Wilma and comparing these statistics to our paid and reported loss development patterns for these events, and reviewing our historical experience for previous large catastrophes, including the 2004 hurricanes. Based on the work completed, we determined to reduce our current best estimate of the ultimate net losses arising from these events by $82.7 million. The $82.7 million decrease in ultimate net losses was comprised of a $58.6 million decrease in additional case reserves and a $28.3 million decrease in IBNR and partially offset by a corresponding $4.2 million decrease in losses recoverable. We did not change our reserving methodology in 2008 as a result of this review.
The percentage of claims unpaid at December 31, 2009 for each accident year reflects both the speed at which claims and claim expenses for each accident year have been paid and our estimate of claims and claim expenses for that accident year. As seen above, claims and claim expenses for the 2004 accident year have to date been paid quickly compared to prior accident years. This is due to the fact that hurricanes Charley, Frances, Ivan and Jeanne which occurred in 2004 have been relatively rapid claims paying events. This is driven in part by the mix of our business in Florida, which primarily includes property catastrophe excess of loss reinsurance for personal lines property coverage, rather than commercial property coverage or retrocessional coverage, and the speed of the settlement and payment of claims by our underlying cedants. In contrast, our 2001 accident year, which includes losses from the events of September 11, 2001, and our 2005 accident year, which includes significant losses from hurricane Katrina, includes a higher mix of commercial business and retrocessional coverage where the underlying claims of our cedants tend to be settled and paid more slowly. In addition, claims from our underlying cedants for the 2001 and 2005 accident years are subject to more complex coverage and legal matters due to the complexity of the catastrophic events taking place in those years.
When initially developing our reserving techniques for our specialty reinsurance coverages, we considered estimating reserves utilizing several actuarial techniques such as paid and reported loss development methods. We elected to use the Bornhuetter-Ferguson actuarial technique because this method is appropriate for lines of business, such as our specialty reinsurance business, where there is a lack of historical claims experience. This method allows for greater weight to be applied to expected results in periods where little or no actual experience is available, and, hence, is less susceptible to the potential pitfall of being excessively swayed by one year or one quarter of actual paid and/or reported loss data. This method uses initial expected loss ratio expectations to the extent that losses are not paid or reported, and it assumes that past experience is not fully representative of the future. As the Company’s reserves for claims and claim expenses age, and actual claims experience becomes available, this method places less weight on expected experience and places more weight on actual experience. We reevaluate our actuarial reserving techniques on a periodic basis.
The utilization of the Bornhuetter-Ferguson actuarial technique requires us to estimate an expected ultimate claims and claim expense ratio and select an expected loss reporting pattern. We select our estimates of the expected ultimate claims and claim expense ratios and expected loss reporting patterns by reviewing industry standards and adjusting these standards based upon the terms of the coverages we offer. The estimated expected claims and claim expense ratio may be modified to the extent that reported losses at a given point in time differ from what would be expected based on the selected loss reporting pattern. Our estimate of IBNR is the product of the premium we have earned, the initial expected ultimate claims and claim expense ratio and the percentage of estimated unreported losses. In addition, certain of our specialty reinsurance coverages may be impacted by natural and man-made catastrophes. We estimate claim reserves for these losses after the event giving rise to these losses occur, following a process that is similar to our property catastrophe reinsurance unit described above.
As noted above, some of our specialty reinsurance contracts are exposed to net claims and claim expenses from large natural and man-made catastrophes. Net claims and claim expenses from these large catastrophes are reserved for after the events which gave rise to the claims in a manner which is consistent with our property catastrophe reinsurance reserving practices as discussed above. The large catastrophes occurring during the period from 2003 to 2008 impacting our specialty unit principally include hurricanes Katrina, Rita and Wilma, which occurred in 2005. Our estimate of ultimate net claims and claim expenses from hurricanes Katrina, Rita and Wilma, within our specialty reinsurance unit, net of reinsurance recoveries and assumed and ceded loss related premium, totaled $98.8 million, $77.1 million, $73.1 million, $73.1 million and $63.1 million at December 31, 2005, 2006, 2007, 2008 and 2009, respectively.
We believe that ultimate claims and claim expense ratios 25.0% above or below our estimated assumptions constitute reasonably likely outcomes based on our experience to date and our future expectations. In addition, we believe that the adjustments that we made to speed up or slow down our estimated loss reporting patterns are reasonably likely changes. While we believe these are reasonably likely changes, we do not believe the reader should consider the above sensitivity analysis an actuarial reserve range. In addition, we caution the reader that the above sensitivity analysis only reflects reasonably likely changes. It is possible that our initial estimated claims and claim expense ratios and loss reporting patterns could be significantly different from the sensitivity analysis described above. For example, we could be liable for events which we have not estimated reserves for or for exposures we do not currently think are covered under our contracts. These changes could result in significantly larger changes to reserves for claims and claim expenses, net income and shareholders’ equity than those noted above. We also caution the reader that the above sensitivity analysis is not used by management in developing our reserve estimates and is also not used by management in managing the business.
We use the Bornhuetter-Ferguson actuarial technique to estimate claims and claim expenses within our Individual Risk segment for our property and casualty business. The comments discussed above relating to our reserving techniques and processes for our specialty reinsurance unit also apply to our Individual Risk segment. In addition, certain of our coverages may be impacted by natural and man-made catastrophes. We estimate claim reserves for these losses after the event giving rise to these losses occurs, following a process that is similar to our property catastrophe reinsurance unit including, starting in 2009, the use of reported loss development factors for the 2004 and 2005 large hurricanes, as described in more detail above. In addition, for our crop insurance business we estimate our claims and claim expenses using an expected loss ratio method. Our expected loss ratio is developed based on our current best estimate of the ultimate costs to settle all claims arising out of the risks we have covered under these policies and takes into consideration our historical experience, historical industry experience, current and estimated future commodity prices, as well as events which have occurred which are estimated to impact future crop yields such as droughts, hail, windstorms and flooding. Reserving for our crop insurance business is generally much more uncertain in the first few quarters after the issuance of a policy due to the difficulty in estimating the aforementioned variables, but since principally all claims have historically been settled within fifteen months of the issuance of a policy this uncertainty is generally resolved in a relatively short period of time compared to other insurance lines of business.
During the years ended December 31, 2009, 2008 and 2007, changes to our prior year estimated claims reserves in our Individual Risk unit decreased our net income by $5.0 million, increased our net income by $46.7 million and increased our net income by $38.8 million, respectively, excluding the consideration of changes in reinstatement premium, profit commissions and income tax expense.
The adverse development within our Individual Risk segment of $5.0 million in 2009 was principally driven by $26.9 million of adverse development in our crop insurance business primarily due to an increase in the severity of reported loss activity in 2009 on the 2008 crop year. This more than offset a $2.4 million reduction in ultimate net losses on the 2004 and 2005 hurricanes principally due to the adoption of a new actuarial technique using reported loss development factors to estimate the ultimate losses for these events, as discussed in more detail in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, Summary of Critical Accounting Estimates, Claims and Claim Expense Reserves, Individual Risk”, $2.1 million of favorable development due to changes in actuarial assumptions and $17.4 million of favorable development principally driven by the application of our formulaic actuarial reserving methodology for this business with the reductions being due to actual paid and reported loss activity being more favorable to date than what was originally anticipated when setting the initial IBNR reserves.
We believe that ultimate claims and claim expense ratios 10.0% above or below our estimated assumptions constitute reasonably likely outcomes based on our experience to date and our future expectations. In addition, we believe that the adjustments that we made to speed up or slow down our estimated loss reporting patterns are reasonably likely changes. While we believe these are reasonably likely changes, we do not believe the reader should consider the above sensitivity analysis an actuarial reserve range. In addition, we caution the reader that the above sensitivity analysis only reflects reasonably likely changes. It is possible that our initial estimated claims and claim expense ratios and loss reporting patterns could be significantly different from the sensitivity analysis described above. For example, we could be liable for events which we have not estimated reserves for or for exposures we do not currently think are covered under our contracts. These changes could result in significantly larger changes to our reserves for claims and claim expenses, net income and shareholders’ equity than those noted above. We also caution the reader that the above sensitivity analysis is not used by management in developing our reserve estimates and is also not used by management in managing the business.
accounting guidance currently applicable to us to be the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between open market participants at the measurement date. We recognize the change in unrealized gains and losses arising from changes in fair value in our consolidated statements of operations, with the exception of changes in unrealized gains and losses on our fixed maturity investments available for sale, which are recognized as a component of accumulated other comprehensive income in shareholders’ equity.
Level 3 inputs are based on unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. In these cases, significant management assumptions can be used to establish management’s best estimate of the assumptions used by other market participants in determining the fair value of the asset or liability.
As at December 31, 2009, we classified $433.0 million and $35.5 million of assets and liabilities, respectively, at fair value on a recurring basis using Level 3 inputs. This represented 5.5% and 1.1% of our total assets and liabilities, respectively. Level 3 fair value measurements are based on valuation techniques that use at least one significant input that is unobservable. These measurements are made under circumstances in which there is little, if any, market activity for the asset or liability. We use valuation models or other pricing techniques that require a variety of inputs including contractual terms, market prices and rates, yield curves, credit curves, measures of volatility, prepayment rates and correlations of such inputs, some of which may be unobservable, to value these Level 3 assets and liabilities. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment. In making the assessment, we considered factors specific to the asset or liability. In certain cases, the inputs used to measure fair value of an asset or a liability may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety is classified is determined based on the lowest level input that is significant to the fair value measurement of the asset or liability.
Under the pre-existing guidance, which was in effect for 2007, 2008 and the three months ended March 31, 2009, the Company assessed, on a quarterly basis, whether declines in the fair value of its fixed maturity investments available for sale represented impairments that were other-than-temporary based on several factors. The factors the Company considered in the assessment of a security included: (i) the time period during which there had been a significant decline below cost; (ii) the extent of the decline below cost; (iii) the Company’s intent and ability to hold the security; (iv) the potential for the security to recover in value; (v) an analysis of the financial condition of the issuer; and (vi) an analysis of the collateral structure and credit support of the security, if applicable. Where the Company determined that there was an other-than-temporary decline in the fair value of the security, the cost of the security was written down to its fair value and the unrealized loss at the time of determination was reflected in the Company’s consolidated statements of operations.
We recognize premiums as revenue over the terms of the related contracts and policies. Our written premiums are based on policy and contract terms and include estimates based on information received from both insureds and ceding companies. The information received is typically in the form of bordereaux, broker notifications and/or discussions with ceding companies or their broker. This information can be received on a monthly, quarterly or transactional basis and normally includes estimates of written premium (including adjustment and reinstatement premium), earned premium, acquisition costs and ceding commissions.
We book premiums on non-proportional contracts in accordance with the contract terms. Premiums written on losses occurring contracts are typically earned over the contract period. Premiums on risks attaching contracts are either estimated or earned as reported by the cedants, which may be over a period more than twice as long as the contract period. For multi-year policies, only the initial annual premium is included as written at policy inception. The remaining annual premiums are included as written at each successive anniversary date within the multi-year term. Management is required to make estimates based on judgment and historical experience for periods during which information has not yet been received.
Since premiums for our Reinsurance segment are contractually driven and the reporting lag for such premiums is minimal, estimates for premiums written for this segment are usually not significant. The minimum and deposit premiums on excess policies are usually set forth in the language of the contract and are used to record premiums on these policies. Actual premiums are determined in subsequent periods based on actual exposures and any adjustments are recorded in the period in which they are identified. In recent periods, the complexity of estimating reinsurance premiums has been impacted by the financial difficulties being experienced in certain of our target markets, which has contributed to circumstances in which primary insurers have been unable to make, or have sought to defer, premium payments due to us. We cannot assure you that our estimates of the collectability of premiums are accurate or that these trends will not be accelerated in future periods.
Income taxes have been provided in accordance with the provisions of FASB ASC Topic Income Taxes, on those operations which are subject to income tax. Deferred tax assets and liabilities result from temporary differences between the amounts recorded in our consolidated financial statements and the tax basis of the Company’s assets and liabilities. Such temporary differences are primarily due to the tax basis discount on unpaid losses and loss expenses, unearned premium reserves, net operating loss carryforwards, intangible assets, accrued expenses, deferred policy acquisition costs and certain investments. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance against deferred tax assets is recorded if it is more likely than not that all, or some portion, of the benefits related to deferred tax assets will not be realized.
The Company had no unrecognized tax benefits upon adoption of guidance under FASB ASC Topic Income Taxes and has no unrecognized tax benefits as of December 31, 2009. Tax years 2006 through 2008, 2005 through 2008 and 2008, are open for examination by the Internal Revenue Service, Irish tax authorities and U.K. tax authorities, respectively.
We generated $838.9 million of net income available to RenaissanceRe common shareholders in 2009, which represents the highest net income available to RenaissanceRe common shareholders that the Company has recorded since its inception, compared to a net loss attributable to RenaissanceRe common shareholders of $13.3 million in 2008, an increase of $852.1 million. In 2007, we generated $569.6 million of net income available to RenaissanceRe common shareholders. As a result of our net income available to RenaissanceRe common shareholders in 2009, we generated a 30.2% return on average common equity and our book value per common share increased from $38.74 at December 31, 2008 to $51.68 at December 31, 2009, a 35.9% increase, after considering dividends paid to our common shareholders. In 2008 and 2007, we generated returns on average common equity of (0.5%) and 20.9%, respectively, and (decreased) increased our book value per common share plus the change in accumulated dividends by (3.3%) and 21.9%, respectively.
Significantly Improved Investment Results - our net investment income was $324.0 million in 2009, a $299.8 million increase from $24.2 million in 2008, we generated $93.2 million of net realized and
Higher Underwriting Income - our underwriting income increased $406.5 million to $697.1 million in 2009 and our combined ratio decreased 33.7 percentage points to 45.3% for 2009, compared to $290.6 million of underwriting income and a combined ratio of 79.0% in 2008. The increase in our underwriting income and decrease in our combined ratio were principally driven by a decrease in current accident year net claims and claim expenses due to a comparably low level of insured catastrophes occurring during 2009, compared to 2008, specifically the comparative impact of hurricanes Gustav and Ike, which occurred during 2008 and resulted in $419.1 million of underwriting losses and increased our combined ratio by 32.3 percentage points; and partially offset by
Following is supplemental financial data regarding the net financial statement impact on our results for 2008 due to hurricanes Gustav and Ike:
Reinsurance Segment Gross Premiums Written - Gross premiums written in our Reinsurance segment increased by $56.4 million, or 4.9%, to $1,210.8 million in 2009, compared to $1,154.4 million in 2008, due to growth in gross premiums written in our catastrophe unit of $101.8 million, which benefited from our ability and determination to increase the capacity provided to our customers in light of, among other things, continuing attractive market conditions, the inception of several new programs, and $32.0 million of gross premiums written by Tim Re II, a fully-collateralized joint venture established by us in 2009 for the 2009 U.S. hurricane season, partially offset by a decline in our specialty reinsurance premiums of $45.4 million, as discussed below. Gross premiums written in our Reinsurance segment for 2008 includes $58.4 million of loss related reinstatement premiums as a result of hurricanes Gustav and Ike. Our Reinsurance segment results have been increasingly impacted in recent periods by a relatively small number of comparably large transactions with significant customers.
(2) The category Specialty reinsurance consists of contracts that are predominantly exposed to U.S. and, to a lesser extent, worldwide risks.
(3) Reinsurance segment gross premiums written excludes $12.7 million, $5.7 million and $37.4 million of premiums assumed from the Individual Risk segment in 2009, 2008 and 2007, respectively.
Due to the potential volatility of the property catastrophe reinsurance contracts which we sell, we purchase reinsurance to reduce our exposure to large losses and to help manage our risk portfolio. We use our REMS© modeling system to evaluate how each purchase interacts with our portfolio of reinsurance contracts we write, and with the other ceded reinsurance contracts we purchase, to determine the appropriateness of the pricing of each contract and whether or not it helps us to balance our portfolio of risks.
Operating expenses consist of salaries and other general and administrative expenses. For 2009, our operating expenses increased $57.5 million, or 70.3%, to $139.3 million, compared to $81.8 million in 2008, primarily as a result of an increase in our employee base and our strong financial results in 2009 which has increased compensation cost, as well as the impact of the larger employee base on technology, occupancy, consulting and related general and administrative expenses. In 2008, operating expenses increased $13.8 million to $81.8 million primarily as a result of increased headcount and the related increase in compensation, general and administrative expenses. Our operating expense ratio may increase over time, as a result of factors including the absolute and comparative growth of our operating expenses, further refinements to internal expense allocations, and market trends and dynamics.
We have entered into joint ventures and specialized quota share cessions of our book of business. In accordance with the joint venture and quota share agreements, we are entitled to certain profit commissions and fee income. We record these profit commissions and fees as a reduction in acquisition and operating expenses and, accordingly, these fees have reduced our underwriting expense ratios. These fees totaled $70.0 million, $47.8 million and $29.5 million in 2009, 2008 and 2007, respectively, and resulted in a corresponding decrease to the Reinsurance segment underwriting expense ratio of 8.2%, 5.3% and 3.1% for the years ended December 31, 2009, 2008 and 2007, respectively. In addition, we are entitled to certain fee income and profit commissions from DaVinci. Because the results of DaVinci, and its parent DaVinciRe, are consolidated in our results of operations, these fees and profit commissions are eliminated in our consolidated financial statements and are principally reflected in redeemable noncontrolling interest - DaVinciRe. The net impact of all fees and profit commissions related to these joint ventures and specialized quota share cessions within our Reinsurance segment was $124.0 million, $77.3 million and $80.6 million for the years ending December 31, 2009, 2008 and 2007, respectively.
Catastrophe Reinsurance Gross Premiums Written - In 2009, our catastrophe reinsurance gross premiums written increased by $101.8 million, or 10.2%, to $1,096.4 million, compared to 2008. The growth in our catastrophe reinsurance gross premiums written principally reflected our ability and determination to increase the capacity provided to our customers in light of, among other things, attractive market conditions for the 2009 underwriting year, the inception of several new programs, and $32.0 million of gross premiums written by our Tim Re II joint venture established during the second quarter of 2009 for the 2009 underwriting year. Included in gross premiums written in 2008 was $58.4 million of loss related reinstatement premiums as a result of hurricanes Gustav and Ike. Our catastrophe reinsurance results can be substantially impacted, and have been in recent periods, by a relatively small number of comparably large transactions with significant customers.
Catastrophe Reinsurance Underwriting Results - In 2009, our catastrophe unit generated $649.4 million of underwriting income and reported a combined ratio of 8.0%, compared to $220.1 million of underwriting income and a combined ratio of 69.3% in 2008, an increase in underwriting income of $429.3 million and a decrease in the combined ratio of 61.3 percentage points. The increase in underwriting income and decrease in the combined ratio in 2009 were primarily due to a decrease in net claims and claim expenses incurred of $474.8 million, and partially offset by an increase in underwriting expenses of $33.6 million, compared to 2008. In 2009, our catastrophe unit generated a net claims and claim expense ratio of negative 14.5%, an underwriting expense ratio of 22.5% and a combined ratio of 8.0%, compared to 51.9%, 17.4% and 69.3%, respectively, in 2008. Current accident year losses of $82.3 million decreased $422.0 million from $504.4 million in 2008, principally due to the comparably low level of insured catastrophes during 2009, compared to 2008, specifically the comparative impact of hurricanes Gustav and Ike which resulted in $432.5 million of net claims and claim expenses incurred in the catastrophe unit in 2008 and added 60.2 percentage points to the catastrophe unit’s combined ratio as detailed in the table below. The 5.1 percentage point increase in our underwriting expense ratio in 2009, compared to 2008, was principally driven by an increase in operational expenses of $40.4 million primarily as a result of an increase in our employee base which has increased compensation and related operating expenses as discussed above, and partially offset by a $6.8 million decrease in acquisition expenses, primarily as a result of higher profit commissions on ceded premiums earned.
Our catastrophe reinsurance unit experienced $131.6 million of favorable development in 2008 principally as a result of a reduction in ultimate net losses associated with the 2005 hurricanes, Katrina, Rita and Wilma. In 2007, we experienced $93.1 million of favorable development which improved our calendar year loss ratio by 12.8 percentage points, principally as a result of a reduction of ultimate losses for the 2006 and 2005 accident years, due to lower than expected reported claims. We cannot provide assurance that favorable reserve releases will continue, or that we will not experience unfavorable reserve development in the future.
In 2008, our specialty reinsurance gross premiums written decreased $127.5 million, or 44.4%, to $159.8 million, compared to $287.3 million of gross premiums written in 2007. The decrease is principally due to one large contract incepted in 2007 that renewed in 2008 at a lower participation rate and on a smaller premium base than in 2007, resulting in a $66.4 million decrease in gross premiums written from this contract, combined with the then softening market conditions experienced in 2008, compared to 2007, which impacted principally all lines of business.
Below is a summary of the underwriting results and ratios for the years ended December 31, 2009, 2008 and 2007 for our Individual Risk segment:
Gross premiums written for our Individual Risk segment decreased $56.5 million, or 9.6%, to $530.8 million in 2009 compared to $587.3 million in 2008. The decrease in gross premiums written was primarily due to decreases of $49.8 million, $13.8 million and $10.7 million from our commercial property, commercial multi-line and personal lines property businesses, respectively, as a result of our decision in late 2008 to terminate several program manager relationships and a commercial property quota share contract as a result of the then softening market conditions and, during the second quarter of 2009, to reduce our participation on a personal lines property quota share contract. Offsetting these decreases in gross premiums written for 2009, was a $17.8 million, or 6.5% increase, in our crop insurance gross premiums written, principally driven by an increase in policy count, which more than offset a decline in commodity prices used in determining the policy premium.
Gross premiums written for our Individual Risk segment increased $30.7 million, or 5.5%, to $587.3 million in 2008, compared to $556.6 million in 2007. The increase in gross premiums written for our Individual Risk segment is primarily due to a $93.8 million increase in the crop insurance business due principally to higher
Our Individual Risk premiums can fluctuate significantly between quarters and between years based on several factors, including, without limitation, the timing of the inception or cessation of new program managers and quota share reinsurance contracts, including whether or not we have portfolio transfers in or portfolio transfers out, of quota share reinsurance contracts of in-force books of business. In addition, our gross premiums written in respect of our crop insurance business are subject to fluctuations from a number of factors including the impact of relevant commodity prices.
(1) Program managers - wholly owned represents Agro National which we acquired in an asset purchase on June 2, 2008, and for 2009, our commercial property operations. The table above is presented as if Agro National has been a wholly owned subsidiary since the first period presented.
The RMA has currently proposed several changes to the SRA that, if ultimately adopted, would adversely affect the financial results of MPCI insurers such as ours, in 2011. Industry feedback to the draft of the SRA has to date not been positive and the RMA is expected to circulate further drafts of the agreement before it becomes final. However, we cannot predict what changes the final version will have, if any, and therefore what impact the changes will have on our future profitability, or whether we would enter into the new SRA for Reinsurance Year 2011.
In 2008, our Individual Risk segment generated $9.0 million of underwriting income and recorded a net claims and claim expense ratio of 67.0%, an expense ratio of 31.1% and a combined ratio of 98.1%, compared to $51.0 million of underwriting income, a net claims and claim expense ratio of 51.0%, an expense ratio of 38.1% and a combined ratio of 89.1%, in 2007. The decrease in our Individual Risk segment underwriting income in 2008 was principally driven by an increase in net claims and claim expenses incurred of $81.4 million, principally due to $35.5 million of net incurred losses associated with hurricanes Gustav and Ike, and a higher level of attritional losses in our crop insurance business. Hurricanes Gustav and Ike resulted in $40.3 million of underwriting losses, inclusive of $4.8 million of ceded reinstatement premiums earned, and added 8.4 percentage points to our Individual Risk segment’s 2008 combined ratio, as detailed in the table below.
In 2007, the Individual Risk current accident year net claims and claim expense ratios were positively impacted by the absence of large losses as a result of minimal catastrophe loss activity in the U.S.
The reduction in prior years estimated ultimate net claims reserves in 2008 and 2007 was principally driven by the application of our formulaic reserving methodology used for the Individual Risk book of business and is primarily due to actual paid and reported loss activity being better than what we had anticipated when estimating the initial ultimate claims and claims expense ratios and the initial loss reporting patterns. In addition, during 2008 we revised our reported loss development patterns for several of our liability lines of business to reflect the Company’s actual experience to date with these lines. The impact of this was a $7.8 million reduction in prior year reserves.
Our underwriting expenses consist of acquisition expenses and operational expenses. Acquisition expenses consist of costs to acquire premiums and are comprised of fees and expenses paid to: 1) third party program managers, who source primary insurance premiums for us through specialized programs; 2) primary insurers, for whom we write quota share reinsurance; and 3) broker commissions and excise taxes paid to brokers, who source insurance for us on a risk-by-risk basis. Acquisition expenses are driven by contract terms and are generally determined based on a set percentage of premiums. Acquisition expenses as a percentage of net premiums earned in 2009 were 26.2%, compared to 22.7% and 28.9% in 2008 and 2007, respectively. The increase in the acquisition expense ratio in 2009 is primarily due to profit sharing commissions due to favorable development increasing our underwriting results on older accident years. In 2008, certain components of underwriting expenses that were incurred in 2007 with respect to the crop insurance business are no longer reflected due to our acquisition of substantially all of the assets of Agro National, LLC, the agency that produces this business, in the second quarter of 2008. Operating expenses consist of compensation and other general and administrative expenses. Our Individual Risk business historically operated with a relatively small number of employees and, accordingly, we have outsourced much of the administration in our Individual Risk business to third party program managers and third party administrators. However we continuously monitor and analyze opportunities to internalize such services and in recent years we have increased our headcount and related
Reductions in the Federal Funds rate by the Board of Governors of the Federal Reserve Board and corresponding decline in interest rates has lowered the interest rate at which we invest our assets. We expect these developments, combined with the current composition of our investment portfolio and other factors, to put downward pressure on our net investment income for the foreseeable future. Among other factors, our current asset allocations reflect a relative reduction from earlier periods of the number of classes of securities characterized by higher estimated yields and expected risk, which has reduced the yield to maturity for our investment portfolio and which we expect will also impact future net investment income.
During the fourth quarter of 2009, we started designating, upon acquisition, certain fixed maturity investments as trading, rather than as available for sale and, as a result, we recognized $11.4 million of net unrealized losses on these securities in our consolidated statements of operations in 2009. We made this change, due in part to the new authoritative other-than-temporary impairment GAAP guidance that became effective in 2009 which has resulted in additional accounting judgments required to be made on a quarterly basis, combined with an effort to report our fixed maturity investment portfolio results in our consolidated statements of operation in a manner consistent with the way in which we manage the portfolio, which is on a total investment return basis. We currently expect to continue to designate, in future periods, upon acquisition, certain fixed maturity investments as trading, rather than as available for sale, and, as a result, we currently expect our fixed maturity investments available for sale balance to decrease and our fixed maturity trading balance to increase over time, resulting in a reduction in other-than-temporary accounting judgments we make. This change will over time result in additional volatility in our net income (loss) in future periods as net unrealized gains and losses on these fixed maturity investments will be recorded currently in net income (loss), rather than as a component of accumulated other comprehensive income (loss) in shareholders’ equity.
2007, respectively. Other-than-temporary impairments in 2008 were driven by the turmoil in the financial markets and widening credit spreads. During 2007, our $25.5 million of other-than-temporary impairment charges was a result of a falling interest rate environment during the year which resulted in lower unrealized losses on our fixed maturity securities, prior to the recognition of other-than-temporary impairment losses on such securities. Credit-related other-than-temporary impairment charges totaled $8.3 million and $nil for 2008 and 2007, respectively. The credit-related other-than-temporary impairment charges in 2008, which includes impairments for which the Company believes it will not be able to recover the full principal amount if held to maturity, were principally driven by our direct holdings of fixed maturity securities issued by Lehman Brothers.
The equity pick-up for our earnings in Tower Hill and the Tower Hill Companies is recorded one quarter in arrears.
We have expanded our weather and energy risk management operations in the last several years to include products such as weather derivatives and energy derivatives. The weather and energy risk management operations results include net realized and unrealized gains and losses on agreements with end users and net realized and unrealized gains and losses on hedging and trading activities. The end user contracts we enter into and our trading activities are based in part on proprietary weather forecasts provided to us by our Weather Predict subsidiary. As noted above, the pre-tax profits from our weather and energy risk management operations increased to $37.2 million in 2009 from $25.1 million in 2008 and a loss of $8.8 million in 2007. The weather products and trading activities in which we engage are both seasonal and volatile, and there is no assurance that our performance to date will be indicative of future periods. We are currently in the process of enhancing our weather and energy risk management infrastructure and operations to engage in the physical delivery and settlement of various of our energy products with our customers.
In October 2001, we formed DaVinciRe and DaVinci with other equity investors. The Company owns a noncontrolling economic interest in DaVinciRe; however, because we control a majority of DaVinciRe’s outstanding voting rights, the consolidated financial statements of DaVinciRe are included in our consolidated financial statements. Redeemable noncontrolling interest - DaVinciRe represents the portion of DaVinciRe’s earnings owned by third parties for the years ended December 31, 2009, 2008 and 2007. In 2009, 2008 and 2007, DaVinciRe generated net income which resulted in net income attributable to redeemable noncontrolling interest expense - DaVinciRe. Our economic ownership interest in DaVinciRe at December 31, 2009, 2008 and 2007 was approximately 38.2%, 22.8% and 20.5%, respectively.
In January 2010, DaVinciRe redeemed the shares of certain third party DaVinciRe shareholders and in a separate transaction, we sold a portion of our shares in DaVinciRe to a third party shareholder. As a result of these transactions, our ownership interest in DaVinciRe has increased to 41.2%. We expect our ownership in DaVinciRe to fluctuate over time.
Cash flows provided by operating activities. Cash flows provided by operating activities in 2009 were $588.9 million, which principally consisted of our net income of $1,052.7 million and an increase in reinsurance balances payable of $66.1 million, partially offset by a decrease in our reserve for unearned premiums of $63.6 million, a decrease in claims and claim expenses, net of $353.3 million, an unrealized gain included in net investment income of $88.5 million related to our other investments and net realized and unrealized investment gains on fixed maturity investments of $93.2 million. As discussed under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, Summary of Results of Operations for 2009, 2008 and 2007”, we generated strong underwriting results and significantly improved investment results, which contributed to cash flows provided by operating activities. In addition, as noted above, claims and claim expenses, net decreased $353.3 million in 2009, compared to 2008, primarily as a result of $550.6 million of paid claims and claim expenses during 2009, partially offset by incurred claims and claim expenses of $197.3 million. Our 2009 cash flows provided by operating activities were primarily used to support our investing and financing activities as discussed below.
Cash flows used in investing activities. During 2009, our cash flows used in investing activities in 2009 were $115.8 million, which principally reflects our decision to decrease our allocation to short term investments by $1.2 billion, and increase our allocation to fixed maturity investments by $1.3 billion, as a result of the low interest rate environment experienced during 2009. In addition, we made several strategic investments during 2009, including the acquisition of Spectrum during the fourth quarter of 2009.
Cash flows used in financing activities. Our cash flows used in financing activities in 2009 were $485.8 million, primarily as a result of the repurchase of $51.0 million of our common shares and the repayment of the $150.0 million borrowed under our prior revolving credit facility during the fourth quarter of 2009, the repurchase of $132.7 million of the outstanding shares of DaVinciRe from third party shareholders in the first quarter of 2009 and the payment of $59.7 million and $42.3 million in dividends to our common and preferred shareholders, respectively.
Our reserving methodology for each line of business uses a loss reserving process that calculates a point estimate for the Company’s ultimate settlement and administration costs for claims and claim expenses. We do not calculate a range of estimates. We use this point estimate, along with paid claims and case reserves, to record our best estimate of additional case reserves and IBNR in our consolidated financial statements. Under GAAP, we are not permitted to establish estimates for catastrophe claims and claim expense reserves until an event occurs that gives rise to a loss.
We recorded $586.3 million of gross claims and claim expenses incurred in 2008 as a result of losses arising from hurricanes Gustav and Ike which struck the U.S. in the third quarter of 2008. Our estimates of losses from hurricanes Gustav and Ike are based on factors including currently available information derived from the Company’s preliminary claims information from certain customers and brokers, industry assessments of losses from the events, proprietary models, and the terms and conditions of our contracts. Given the magnitude and
Effective April 9, 2009, we amended and restated our Credit Agreement. The Credit Agreement provides for a revolving commitment of $345.0 million. As part of the $345.0 million commitment, letters of credit may be issued for the account of the Company’s subsidiaries in an aggregate amount up to $150.0 million, of which up to $75.0 million may be used for the issuance of letters of credit for the account of the Company’s non-insurance subsidiaries. On November 9, 2009, the Company repaid $150.0 million previously borrowed under the Credit Agreement. The Company has the right, subject to satisfying certain conditions, to increase the size of the facility up to $500.0 million, until the expiration of the current term. Amounts borrowed under the Credit Agreement bear interest at a rate selected by the Company equal to the Base Rate or LIBOR plus a margin, all as more fully set forth in the Credit Agreement. The scheduled commitment termination date under the Credit Agreement is March 31, 2010.
The Credit Agreement contains representations, warranties and covenants we believe to be customary for bank loan facilities of this type, including customary covenants limiting the Company’s ability to merge, consolidate, enter into negative pledge agreements, sell a substantial amount of assets, incur liens and declare or pay dividends under certain circumstances. The Credit Agreement also contains certain financial covenants we believe to be customary for reinsurance and insurance companies in revolving credit facilities of this type, which generally provide that the Company’s consolidated debt to capital shall not exceed the ratio of 0.35:1 and that the consolidated net worth (the “Net Worth Requirements”) of the Company and Renaissance Reinsurance shall equal or exceed $1.8 billion and $960.0 million, respectively, subject to a grace period in the case of the Net Worth Requirements which is conditioned on, among other things, Renaissance Reinsurance maintaining a certain financial strength rating, all as more fully set forth in the Credit Agreement. The Company was in compliance with the financial covenants under the Credit Agreement as of February 18, 2010.
We are currently engaged in discussions with our lenders to renew the Principal Facility, although it is possible that such renewal, if any, may be on terms that are less favorable to us than those contained in the existing Principal Facility, particularly in light of the ongoing disruptions, uncertainty and volatility in the capital and credit markets, during which access to capital on attractive terms has been challenging for many companies. Our ability to renew the Principal Facility, and the terms of such renewal, if any, will depend upon the facts and circumstances at the time, including our financial position, operating results and credit and capital market conditions. In the event that we are unable to renew the Principal Facility at a reasonable price and otherwise on terms satisfactory to us or at all, we may have to seek alternative means of supporting the operations of our Bermuda-based entities, which could include utilizing holding company funds. These alternatives, if required, could increase our operating expenses on an absolute and relative basis compared to past periods.
In addition, our subsidiary, Stonington, is a party to a collateralized letter of credit and reimbursement agreement, pursuant to which letters of credit in an aggregate amount of $6.6 million have been issued for the benefit of two counterparties. Stonington’s obligations under this facility are secured by cash and eligible marketable securities. Renaissance Reinsurance is also party to a collateralized letter of credit and reimbursement agreement in the amount of $37.5 million that supports our Top Layer Re joint venture. Renaissance Reinsurance is obligated to make a mandatory capital contribution of up to $50.0 million in the event that a loss reduces Top Layer Re’s capital below a specified level.
Our ratings continue to be among the highest in our industry and continue to be supported by our strong financial position. Our credit ratings are also supported by our prudent ERM practices which are rated “excellent” by S&P.
On November 2, 2009, Moody’s raised the insurance FSR of Renaissance Reinsurance to A1 from A2 and the senior debt rating of RenaissanceRe to A3 from Baa1. The outlook is stable for these ratings.
On January 21, 2009, S&P initiated coverage of Renaissance Europe, assigning a rating of “AA-” for both its CCR and FSR. The outlook on Renaissance Europe is stable.
At December 31, 2009, our fixed maturity investments and short term investment portfolio had a dollar-weighted average credit quality rating of AA (2008 - AA). At December 31, 2009, our average yield to maturity on our fixed maturity investments and our short term investment portfolio was 2.3% (2008 - 2.8%). At December 31, 2009, our non-investment grade fixed maturity investments totaled $85.2 million or 2.0% of our fixed maturity investments (2008 - $58.5 million or 2.0%, respectively). In addition, within our other investments category we have several funds that invest in non-investment grade fixed income securities and non-investment grade cat-linked securities. At December 31, 2009, the funds that invest in non-investment grade fixed income securities and non-investment grade cat-linked securities totaled $410.8 million (2008 - $317.1 million).
As of December 31, 2009, we had $1,002.3 million of short term investments (2008 - $2,172.3 million). Short term investments are managed as part of our investment portfolio and have a maturity of one year or less when purchased. Short term investments are carried at fair value. During 2009, we decreased our allocation to short term investments by $1.2 billion, and increased our allocation to fixed maturity investments by $1.3 billion.
Our target benchmark portfolio for our fixed maturity investments and short term investments currently has a 3.2 year duration. Our duration at December 31, 2009 was 2.6 years (2008 - 1.5 years), reflecting our view that the current level of rates affords inadequate compensation for the assumption of additional interest rate risk associated with longer duration. From time to time, we may reevaluate the duration of our portfolio in light of the duration of our liabilities and market conditions.
Our investments in asset-backed securities are subject to prepayment risks, as noted above, and to the structural risks of these securities. The structural risks primarily emanate from the priority of each security in the issuer’s overall capital structure. We are also exposed to widening credit spreads.
During 2009, we recorded $22.5 million (2008 - $217.0 million, 2007 - $25.5 million) in net other-than-temporary impairment charges. The significant decrease in net other-than-temporary impairments is due to a combination of improved economic conditions during 2009, compared to 2008, and the adoption of new authoritative accounting guidance related to the recognition and presentation of other-than-temporary impairments adopted during the second quarter of 2009. The net other-than-temporary impairment charges in 2009 and 2008 were primarily due to widening credit spreads during the early part of 2009 and throughout 2008 as a result of the turmoil in the financial and capital markets and the net other-than-temporary impairment charges in 2007 were principally due to rising interest rates. For the three months ended December 31, 2009, and the years ending December 31, 2008 and 2007, we recognized impairment charges for principally all of our fixed maturity investments available for sale that were in an unrealized loss position at the end of each quarter as under prior authoritative accounting guidance we did not have the intent to hold them until they fully recovered in value. Credit-related impairment charges were $21.2 million, $8.3 million and $nil in 2009, 2008 and 2007, respectively, and relate to impaired securities which we believe we will not be able to recover the full principal amount if held to maturity. At December 31, 2009 and 2008, we held 108 and nil, respectively, fixed maturity investments available for sale securities that were in an unrealized loss position. At December 31, 2009 and 2008, our gross unrealized losses on fixed maturity investments available for sale totaled $17.1 million and $nil, respectively.
The following table summarizes the composition of the amortized cost and fair value of our fixed maturity investments, short term investments and other investments at the date indicated by ratings as assigned by S&P, or Moody’s and/or other rating agencies when S&P ratings were not available and the respective yield to maturity.
(1) Excludes FDIC guaranteed and non-U.S. government backed corporate fixed maturity investments, at fair value.
Private equity partnerships - Included in our investments in private equity partnerships are alternative asset limited partnerships that invest in certain private equity asset classes including U.S. and global leveraged buyouts; mezzanine investments; distressed securities; real estate; oil, gas and power; and secondaries. The fair values of the investments in this category have been estimated using the net asset value per share of the investments. We generally have no right to redeem our interest in any of these private equity partnerships in advance of dissolution of the applicable partnership. Instead, the nature of these investments is that distributions are received by us in connection with the liquidation of the underlying assets of the applicable limited partnership. If these investments were held, it is estimated that the majority of the underlying assets of the limited partnerships would liquidate over 7 to 10 years.
We have committed capital to private equity partnerships and other entities of $650.7 million, of which $424.2 million has been contributed at December 31, 2009. Our remaining commitments to these funds at December 31, 2009 totaled $223.6 million. In the future, we may enter into additional commitments in respect of private equity partnerships or individual portfolio company investment opportunities.
On July 1, 2008, the Company invested $50.0 million in the Tower Hill Companies representing a 25.0% equity ownership. Included in the purchase price was $40.0 million of other intangibles and $7.8 million of goodwill, which, in accordance with generally accepted accounting principles, are recorded as “Investments in other ventures, under equity method” rather than “Goodwill and other intangibles” on the Company’s consolidated balance sheet.
The Company’s share of the equity in earnings of Tower Hill and the Tower Hill Companies are reported one quarter in arrears.
RIHL, a wholly owned subsidiary of the Company, holds investment grade fixed maturity securities and short term investments and was formed to enhance administrative efficiency and take advantage of the increased benefits and reduced costs ordinarily associated with the management of large investment portfolios of different subsidiaries in the same group. In addition, the administrative efficiency afforded by the use of RIHL facilitates the establishment of our collateralized letter of credit facility on advantageous terms that we believe would otherwise not be available. Through RIHL, certain of our operating subsidiaries invest in a diversified portfolio of highly liquid debt securities which are recorded at fair value. RIHL has been assigned a rating of AAAf/S2 by S&P and 100% of the securities held through RIHL have been assigned a rating of A or higher by nationally recognized rating agencies. We may redeem our interests in RIHL at the current net asset value no more frequently than monthly. Third party service providers perform custodial functions in respect of RIHL, including valuation of the investment assets held through RIHL. Currently, external investment managers manage the assets held through RIHL, pursuant to written investment guidelines.
Under the terms of certain reinsurance contracts, certain of our subsidiaries and joint ventures are required to provide letters of credit to reinsureds in respect of reported claims and/or unearned premiums. We maintain a facility which, as of December 31, 2009, makes available to our operating subsidiaries and joint ventures letters of credit having an aggregate face amount not to exceed $1.4 billion. To support the facility, our participating operating subsidiaries and joint ventures have pledged RIHL shares and other securities owned by them as collateral. At February 10, 2010, we had $760.7 million of letters of credit with effective dates on or before December 31, 2009 outstanding under our $1.4 billion letter of credit facility and $847.0 million of total letters of credit outstanding under all facilities.
At December 31, 2009, we have not entered into any off-balance sheet arrangements, as defined by Item 303(a)(4) of Regulation S-K.
In June 2009, the FASB issued Statement No. 168, The FASB Accounting Standards Codification™ and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162 (“FAS 168”).
Effective for financial statements issued for interim and annual periods ending after September 15, 2009 the FASB ASC (the “Codification”) is now the authoritative source of U.S. GAAP. The Codification changes the structure of authoritative guidance to a Topic based model versus the previous model of Original Pronouncements, modified by Emerging Issues Task Force Abstracts, FASB Staff Positions, etc. Among other things, the Codification is expected to: reduce the amount of time and effort required to solve an accounting research issue; mitigate the risk of noncompliance through improved usability of the literature; provide accurate information with real-time updates as Accounting Standards Updates are released; and assist the FASB with research and convergence efforts. The adoption of the Codification did not impact our consolidated statements of operations and financial condition.
(2) The interest on this facility is based on a spread above LIBOR. We have reflected the interest due in 2010 and 2011 based upon the current interest rate on the facility.
While there have been some indicators of stabilization, the U.S. and numerous other leading markets around the world continue to experience significant recessionary conditions. It is not clear that sustained economic recovery in the principal markets we serve is imminent, or that the pace of recovery, if any, would be rapid. Accordingly, we believe meaningful risk remains for continued uncertainty or disruptions in general economic conditions, including additional dislocations in the financial markets or asset classes or of a “double dip” recession in the U.S. or other key markets. In 2009, many governments, including the U.S. federal government, took substantial steps to stabilize economic conditions, in an effort to increase liquidity and capital availability; these efforts contributed to significant changes in the financial markets in 2009, resulting in rapid recoveries of asset valuations across many sectors, and increased access to private and public sources of capital. However, if these stabilizing efforts were to cease prematurely, or if economic conditions otherwise cease to stabilize and again commence to deteriorate further, the business environment in our principal markets would be further adversely affected, which accordingly could adversely affect demand for the products sold by us or our customers. In addition, during a period of continued economic downturn like the current one, we believe our consolidated
We currently expect that 2010 will be characterized by meaningful returns of capital, both by us and by participants in our industry more generally. However, our operations are subject to the ever present potential for significant volatility in capital due primarily to our exposure to potentially significant catastrophic events; if the current financial market disruptions should continue or worsen, it could prove difficult to raise capital, if needed, on attractive terms or at all, which would have a material negative impact on our operations. In addition, our revolving credit facility and our principal existing letter of credit facility are scheduled to expire on March 31, 2010, and April 27, 2010 respectively. For more information, refer to “Capital Resources” above.
In 2009, U.S. coastal regions exposed to severe hurricane risk benefited from an unusually inactive year meteorologically in the Atlantic basin, which is often attributed to the El Nino effect. As a result, insured industry losses for 2009 were relatively benign, particularly in the Eastern and Southeastern U.S. This is in contrast to 2004, 2005 and 2008, for example, in which hurricanes Katrina, Wilma and Ike, among others, resulted in substantial insured property losses. In addition, the dislocations in the investment markets in 2008 eroded the capital and surplus of many market participants. The combination of the 2008 storms and the effects of the financial crisis resulted in relatively attractive market conditions at the January and June 1, 2009 catastrophe renewals. The January 1, 2010 renewal season was characterized by overall stability; and also by a relative shift toward ample supply of capital, impacted by the recovery in the financial markets, asset valuations and the perception of liquidity; decreasing demand, impacted by the same factors; as well as by exposure reduction. In addition, the competitive conditions in the markets we serve are believed to have been meaningfully impacted in 2009 by the U.S. federal government’s financing and backstopping of certain large market participants, which are deemed by many market observers and participants to have contributed to inadequate pricing conditions in respect of certain lines and coverages.
Absent significant new loss events or the occurrence of other contingencies, we currently expect to see increasingly competitive market conditions for our products throughout 2010, particularly in lines of insurance and reinsurance lacking significant catastrophe exposure. The benign insured catastrophe loss activity in 2009 combined with improvement in the capital markets is likely to have a positive impact on the financial situation and capacity of our customers and our competitors, and is likely to result in increasingly competitive market conditions for our products throughout 2010. Among other things, increased capital levels and appetite for risk among primary insurance companies may continue to lead to increased retentions, impacting the reinsurance marketplace. Despite these possibilities, we believe that our strong relationships, and track record of superior claims paying ability and other client service, will enable us to compete for the business we find attractive. However, it is possible that industry pricing in our core product lines will decrease more rapidly than we anticipate, or that we will encounter more significant competitive barriers than we have in the past.
As previously disclosed, in 2007 the U.S. House of Representatives passed legislation which would expand the National Flood Insurance Program (the “NFIP”) to cover damage to or loss of real or related personal property located in the U.S. arising from any windstorm (any hurricane, tornado, cyclone, typhoon, or other wind event). In addition, in 2007, the House passed legislation (together with the NFIP, the “2007 House Bills”), which would create a National Catastrophe Risk Consortium and would also require the U.S. Treasury Department to establish a national homeowner’s insurance stabilization program. The National Catastrophe Risk Consortium program would allow multiple participating states to pool their respective catastrophic risk insurance or reinsurance wind pools or other residual markets among each other. The stabilization program would allow the Treasury Department to make below-cost loans to participating states or their reinsurance pools and/or residual markets.
exploring the possibility of new legislation which might reshape the federal flood insurance program, perhaps substantially. At this juncture it is not possible to predict whether the program will indeed be amended, and, if so, whether any such changes would impact us. A failure to renew the NFIP program, particularly if unanticipated by industry participants, could have dislocating impacts on the industry and our customers and potentially have an adverse impact on us.
While the Senate has not yet enacted any of the legislation reflected in the 2007 House Bills (and has passed a competing version of the NFIP renewal bill which would not add wind to the program), the respective sponsors of the 2007 House Bills have indicated plans to reintroduce versions of this legislation in the House and Senate in 2010. In 2009, the COGA was introduced in the Senate and House which would provide for the federal guarantee of bond issuances by certain government entities, potentially including the FHCF, the Texas Windstorm Insurance Association, the California Earthquake Authority, and others. If enacted, either of these bills, or legislation similar to these proposals, would, we believe, likely contribute to the growth of these state entities or to their inception or alteration in a manner adverse to us. While none of this legislation has been enacted to date, and although we believe such legislation would be vigorously opposed if introduced in 2010, if enacted these bills would likely further erode the role of private market catastrophe reinsurers and could adversely impact our financial results, perhaps materially.
In 2009, Congress conducted hearings relating to the tax treatment of offshore insurance and is reported to be considering legislation that would adversely affect reinsurance between affiliates and offshore insurance and reinsurance more generally. In July 2009, U.S. Rep. Richard Neal introduced one such proposal, H.R. 3424 (the “Neal Bill”), which provides that foreign insurers and reinsurers would be capped in deducting reinsurance premiums ceded from U.S. units to offshore affiliates. The Neal Bill, which was referred to the House Ways and Means Committee, would limit deductions for related party reinsurance cessions to the average percentage of premium ceded to unrelated reinsurers (determined in reference to individual business lines). In the first quarter of 2010, the current administration released its 2010 initial budget, which included a proposal to raise revenue by enacting increased taxation on international reinsurance via means which appeared to have similarities with the Neal Bill. We can provide no assurance that this legislation or similar legislation will not be adopted. We believe that passage of such legislation would adversely affect us, perhaps materially.
The U.S. Congress and the current administration have made, or called for consideration of, several additional proposals relating to a variety of issues, with respect to, universal healthcare, financial regulation reform, including regulation of the over-the-counter derivatives market, the establishment of a single-state system of
licensure for U.S. and foreign reinsurers, executive compensation and others. We continue to carefully monitor relevant proposals and believe that these and other potential proposals could have varying degrees of impact on the Company ranging from minimal to material. At this time, we are unable to predict with certainty which, if any, proposals may be passed or what level of impact any such proposal could have on the Company.