We have entered into an agreement to lease three floors comprising a total of approximately 15,000 square feet in Hamilton, Bermuda for our holding company and Bermuda operations. The term of the rental lease agreement is for six years, and we have agreed to pay approximately a total of $1 million per year in rent for the three floors for the first three years and annual service charges of $180,000 per year. We moved into these new premises on January 30, 2006.
The following table sets forth our selected historical financial information for the period ended and as of the dates indicated. The summary income statement data for the twelve months ended December 31, 2006, 2005, 2004 and 2003 and for the period from our incorporation on May 23, 2002 to December 31, 2002 and the balance sheet data as of December 31, 2006, 2005, 2004, 2003 and 2002 are derived from our audited consolidated financial statements. The consolidated financial statements as of December 31, 2006, and for each of the twelve months ended December 31, 2006, 2005 and 2004, and the reports thereon of KPMG Audit Plc, an independent registered public accounting firm, are included elsewhere in this report. These historical results are not necessarily indicative of results to be expected from any future period. Due to our limited operating history, the ratios presented may not be indicative of our future performance. You should read the following selected consolidated financial information along with the information contained in this report, including Item 8, ‘‘Financial Statements and Supplementary Data’’ and Item 7, ‘‘Management’s Discussion and Analysis of Financial Condition and Results of Operations’’ and the audited consolidated financial statements, condensed consolidated financial statements and related notes included elsewhere in this report.
(2) The loss ratio is calculated by dividing losses and loss adjustment expenses by net premiums earned.
(6) Book value per ordinary share is based on total shareholders’ equity, excluding the aggregate value of the liquidation preferences of our preference shares (in respect of 2005 and 2006), divided by the number of shares outstanding of 58,876,360, 69,179,303, 69,315,099, 95,209,008 and 87,788,375 at December 31, 2002, 2003, 2004, 2005 and 2006 respectively. In calculating the number of shares outstanding as at December 31, 2006 for this purpose, we have deducted shares delivered to us and canceled on January 22, 2007 pursuant to our accelerated share repurchase agreement referred to in Part II, Item 5(e) ‘‘Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities’’.
The following is a discussion and analysis of the results of our operations for the twelve months ended December 31, 2006, 2005 and 2004 and of our financial condition at December 31, 2006. 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 1, Item 1A and Part I of this report, respectively.
Our principal financial objective for 2006 and beyond is to reduce the volatility of our annual earnings while continuing to deliver superior returns to our ordinary shareholders. During 2006 we made significant changes to our business model consistent with this objective.
Catastrophe risk management. The biggest change for 2006 compared to previous years was in our approach to the management of natural catastrophe risk. Following the two active Atlantic hurricane seasons of 2004 and 2005 we concluded that we needed to increase both our assessment of the quantum of risk from any given exposure and the prices we should charge for assuming that exposure. The result has been a reduction in the absolute value of property limits exposed to hurricane and earthquake risk. We have also reduced our maximum exposure to catastrophe risk, based on the output of statistical models, to 17.5% (2005-20%) of total shareholders’ equity for an event with a return period of 1 in 100 years and 25% (2005-35%) for an event with a return period of 1 in 250 years.
Portfolio diversification. 2006 was the first full year of operations of our specialty insurance and reinsurance segment which completed a key phase of the diversification strategy we have been pursuing since formation. The benefits of this investment in quality underwriting teams can be seen in the results of that segment for 2006 which produced a combined ratio of 78.2%.
Gross written premiums. Total gross written premiums decreased by 7.0% in 2006 compared to 2005. The changes in gross premiums written in each of our segments for the twelve months ended December 31, 2006 and 2005 are as follows, with reductions shown as negative percentages.
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 four business segments for the twelve months ended December 31, 2006, 2005 and 2004 were as follows:
The most significant factor in the reduction of loss ratios in 2006 was the benign loss experience of our property reinsurance segment compared to the significant hurricane losses in 2005 and 2004. Casualty reinsurance continued to have good experience in the 2006 accident year and has benefited from $60.3 million of reserve releases from prior years following favorable loss experience. Specialty insurance and reinsurance has had good loss experience in 2006 across most of its business lines and also benefited from a $9.4 million prior year reserve release. The only increase in loss ratio over the prior year was in our property and casualty insurance segment which was due to disappointing results in our U.S. surplus lines property insurance business.
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 and administrative expenses to the expense ratio and the total expense ratios for each of the years ended December 31, 2006, 2005 and 2004:
The increases in the policy acquisition expense ratio over the last two years principally reflect changing business mix. Higher levels of acquisition costs do not necessarily imply lower potential underwriting margins because the cost of acquisition is factored into our premium pricing models whenever possible. Over the same period our operating and administrative expenses have increased in Bermuda, the U.S and the U.K. due to the hiring of new teams of underwriters and increased investment in support functions and infrastructure.
Investment income. In 2006, we generated net investment income of $204.4 million (2005- $121.3 million, 2004-$68.3 million). The increases over the last two years equate to a compound average annual increase of 73.0% and were attributable to both positive cash flow and rising book yields.
Taxes. We incurred a tax expense in 2006 of $92.3 million (2005-$17.4 million), equivalent to a consolidated rate on income before tax of 19.6%. In 2005, we reported a loss before taxation but also a tax charge of $17.4 million because Aspen Re was profitable in 2005 notwithstanding our hurricane losses. The consolidated tax rate in 2004 was 25.9%.
• net income after tax for the year of $378.1 million;
As at December 31, 2006 total ordinary shareholders’ equity was $1,970.1 million compared to $1,846.0 million at December 31, 2005.
As at December 31, 2006, 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 $419.2 million. (2005: $193.8 million).
The amounts outstanding under our senior notes were the only material debt that we had outstanding as of December 31, 2005 and 2006. Management monitors the ratio of debt to total capital, with total capital being defined as shareholders’ equity plus outstanding debt. At December 31, 2006, this ratio was 9.4% (2005-10.9%; 2004-14.4%).
Liquidity. Management monitors the liquidity of Aspen Holdings and of each of its Insurance Subsidiaries. With respect to Aspen Holdings, management monitors its ability to service debt, to finance dividend payments and to provide financial support to the Insurance Subsidiaries. During 2006, Aspen Holdings received $35.0 million in dividends from Aspen U.K. Holdings and $26.0 million in interest payments under our intercompany loan. As at December 31, 2006, Aspen Holdings held $46.0 million in cash and cash equivalents which, taken together with our credit facilities, management considered sufficient to provide us liquidity at such time.
At December 31, 2006, the Insurance Subsidiaries held $449.0 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 they are able to meet their insurance and other liabilities as they become due and was satisfied that there was a comfortable margin of liquidity as at December 31, 2006 and for the foreseeable future.
Specialty Insurance and Reinsurance. In our specialty insurance and reinsurance segment, prices remained flat on average for business written in January. This figure excludes aviation insurance, which has little renewal activity during the first two months of the year.
In marine hull insurance, rates have remained firm and we achieved an average rate increase of approximately 9% on renewal business. Rates for our offshore energy physical damage account are flat or declining slightly. In our marine liability lines we have achieved modest rate increases of about 2%. Within our specialty reinsurance account, we experienced a better-than-expected rate reduction of approximately 3%.
Reinsurance Ceded. In 2007 we will continue to purchase reinsurance protection for our insurance lines of business broadly in line with previous years. However, we will substantially reduce our purchase of property retrocessional cover in 2007 compared to previous years. This follows a systematic repositioning during 2006 of our portfolio designed to reduce volatility and diversify our exposures. Starting January 1, 2006, we set out to reduce our in-force exposures to peak zone catastrophe risk, but because those exposures were still very significant at the beginning of the year, we bought a large amount of property retrocessional cover at a cost of $171.1 million. We start 2007 with this repositioning successfully completed and in 2007 we do not expect to exceed an expenditure of $50 million on property retrocessional coverage. We have the ability to do this because our reduced catastrophe exposures allow us to stay within our risk tolerances without reliance on retrocession.
We have made a first assessment of the limited loss information now available and of our potential exposures to windstorm Kyrill in January 2007 and our initial estimate is that the impact before tax on the Company will be in the range of $20 to $35 million.
Written premiums. Written premiums are comprised of the estimated premiums on contracts of insurance and reinsurance entered into in the reporting period, except in the case of proportional reinsurance contracts, where written premium relates only to our estimated proportional share of premiums due on contracts entered into by the ceding company prior to the end of the reporting period.
All premium estimates are reviewed regularly, comparing actual reported premiums to expected ultimate premiums along with a review of the collectability of premiums receivable. Based on
management’s review, the appropriateness of the premium estimates is evaluated, and any adjustments to these estimates are recorded in the periods in which they become known. Adjustments to original premium estimates could be material and these adjustments may directly and significantly impact earnings in the period they are determined because the subject premium may be fully or substantially earned.
We refer to premiums receivable which are not fixed at the inception of the contract as adjustment premiums. The proportion of adjustable premiums included in the premium estimates varies between business lines with the largest adjustment premiums associated with property reinsurance business and the smallest with property and liability insurance.
Adjustment premiums are most significant in relation to reinsurance contracts. Differing considerations apply to non-proportional and proportional treaties as follows.
The segment for which treaty pro rata is most relevant is our property reinsurance segment in which we wrote $119.1 million in gross written premium in 2006 or 19.6% of our property reinsurance segment, of which $28.9 million was estimated, and $84.2 million was reported by the cedents. 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 $20,000 on our net income before tax for our property reinsurance segment, excluding the impact of fixed costs such as reinsurance premiums and operating expenses.
• changes in the renewal rate or rate of new business acceptances by the cedent insurance companies leading to lower or greater volumes of ceded premiums than our estimate, which could result from changes in the relevant primary market that could affect more than one of our cedents or could be a consequence of changes in marketing strategy or risk appetite by a particular cedent;
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 $119.1 million in our property reinsurance treaty pro rata account as of December 31, 2006, a variation of 5% could increase or reduce net income before taxation by approximately $0.1 million.
Risk transfer swap. Our catastrophe risk transfer swap falls under the requirement of Statement of Financial Accounting Standards (‘‘SFAS’’) No. 133 ‘Accounting for Derivative Instruments and Hedging Activities,’ as amended (‘‘SFAS 133’’) and is therefore recorded in the balance sheet at fair value with any changes in the fair value shown on the consolidated statement of operations. This contract requires us to make quarterly payments in return for which we are entitled to receive a total of up to $100 million on the occurrence of hurricanes making landfall in Florida and causing insured damage in excess of $39 billion or earthquakes in California causing insured damage in excess of $23 billion. The determination of whether or not we are entitled to a recovery depends on estimates of insured damage published PCS. The amount of any recovery due increases on a linear basis from $0 to $100 million depending on the PCS estimate with the full amount of $100 million receivable at or above $47 billion for a hurricane event or $29 billion for an earthquake event. If a recovery becomes due then the future payments under the contract may be reduced. As we provided in full for these future payments when the contract commenced any actual or projected reduction in this liability is also reflected as a gain in the statement of operations.
Credit insurance contract. On November 28, 2006, the Company entered into a credit insurance contract which, subject to its terms, insures the Company against losses due to the inability of one or
As a result of the application of derivative accounting rules under SFAS 133, the contract is 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. The contract is for a maximum of five years and provides 90% cover for a named panel of reinsurers up to individual defined sub-limits. The contract does allow, subject to certain conditions, for substitution and replacement of panel members if the Company’s panel of reinsurers changes. Payments are made on a quarterly basis throughout the period of the contract based on the aggregate limit, which was set initially at $477 million but is subject to adjustment.
Reserving approach. We take all reasonable steps to ensure that we have appropriate information regarding our claims exposures. However, given the uncertainty in establishing claims liabilities, it is likely that the final outcome will prove to be different from the original provision established. Prior to the selection by management of our best estimate of our reserves, our actuarial team employs a number of techniques to establish a range of estimates (the ‘‘actuarial range’’).
Reported claims. For reported claims, reserves are established on a case by case basis within the parameters of coverage provided in the insurance policy or reinsurance agreement. In estimating the cost of these claims, we consider circumstances related to the claims as reported, any information available from cedents 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 hurricanes in 2005, for example, the detailed analysis of our potential exposures included information obtained directly from cedents 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 cedents but we establish all reserves. In addition, we may engage loss adjusters and perform on site cedent audits to validate the information provided. Disputes do occur with cedents, 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.
IBNR claims. We establish reserves for IBNR claims using established actuarial methods which generally rely to a greater or lesser extent on historical information but also consider such variables as changes in policy terms and coverage, changes in legislative conditions and judicial interpretation of insurance policies and inflation. We take into account the quality of the historical information available and where appropriate historical trends are used to validate information received from cedents.
For classes of business where early claims experience may not provide a sound statistical basis to estimate the loss reserves, our approach is to establish an initial expected loss and loss expense ratio.
This is based on one or more of (a) an analysis of our own claims experience to date, (b) market benchmark data, (c) a contract by contract analysis, and (d) an analysis of a portfolio of similar business written by Syndicate 2020, as available, adjusted by an index reflecting how insurance rates, terms and conditions have changed. This initial expected loss and loss expense ratio is then modified in light of the actual experience to date measured against the expected experience. Loss reserves for known catastrophic events are based upon a detailed analysis of our reported losses and potential exposures conducted in conjunction with our underwriters.
Selection of reported gross reserves. In selecting our best estimates of the reserves for each line of business we take into account all of the factors set out above, and in particular the quality of the historical information we have on which to establish our reserves. In addition, consideration is given to the point estimate produced by our independent consulting actuaries, which was towards the upper end of the range for each of the years ended December 31, 2006 and 2005.
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, 2006, 2005 and 2004.
Gross premiums written. The following table analyses the overall change in gross premiums written in the twelve months ended December 31, 2006, 2005 and 2004. The amounts shown as ‘underlying premiums’ exclude reinstatement premiums and other premiums receivable directly related to losses arising from Hurricanes Katrina, Rita and Wilma (‘‘KRW’’) in 2005 and Hurricanes Charley, Frances, Ivan, Jeanne and Typhoon Songda in 2004 (‘‘2004 Catastrophe’’).
Net premiums written. Net premiums written increased by 0.7% in 2006 compared to 2005. The increase was not in line with the 7.0% reduction in gross written premiums due to the significantly higher reinsurance costs in 2005. The high costs in 2005 were a result of the hurricanes in 2005 as, under the terms of our reinsurance contracts, we were obligated to make certain additional payments usually in the form of reinstatement premiums to provide recoveries in respect of more than one loss. The amount of the additional payment obligations arising as a result of the 2005 hurricanes was $149.7 million or 7.2% of the gross premiums written for the year, whereas in 2004, we had reinstatement premiums of $22.9 million or 1.4% of gross premiums written.
Gross premiums earned. Gross premiums earned reflect the portion of gross premiums written which are recorded as revenues over the policy periods of the risks we write. Therefore, the earned premium recorded in any year includes premium from policies incepting in prior years and excludes premium to be earned subsequent to the balance sheet date. Gross premiums earned in 2006 increased by 3.5% compared to 2005 and by 31.6% in 2005 compared to 2004. In both years the growth in gross premiums earned was primarily as a result of the growth in business written in our marine, specialty liability, energy and aviation insurance lines, which increased by $155.3 million in 2006 and $221.6 million in 2005.
Net premiums earned. Net premiums earned increased by 11.1% in 2006 compared to 2005 and by 22.4% in 2005 compared to 2004. The increases for each of our segments were as follows:
The largest percentage increase in 2006 related to our marine and aviation insurance business written in our specialty segment and was driven primarily by increases in written premium in our energy and aviation accounts.
Insurance losses and loss adjustment expenses. Our losses and loss adjustment expenses decreased significantly in the year mainly due to the absence of catastrophic losses in the year compared to 2005 and 2004. In 2004 we suffered $196.1 million of losses net of reinsurance from Hurricanes Charley, Frances, Ivan, Jeanne and Typhoon Songda and in 2005 $594.6 million of losses net of reinsurance from Hurricanes Katrina, Rita and Wilma before potential receipts under our cat swap. Our insurance losses and loss adjustment expenses included paid claims of $469.7 million in 2006, $551.9 million in 2005 and $164.6 million in 2004.
Prior year adjustments are changes in the reserves for prior year losses and loss adjustment expenses, as described further below. See ‘‘-Reserves for Losses and Loss Adjustment Expenses’’ below.
Unrealized gains and losses on derivatives. The gains and losses result from changes in the estimated fair value of a catastrophe risk transfer swap contract entered into for a three-year period in August 2004. Hurricane Katrina has triggered the contract and we first recognized this at a value of $25 million in the fourth quarter of 2005 resulting, net of other valuation changes, in a gain of $19.4 million being recorded in 2005. The latest estimate of the insured losses arising from Hurricane Katrina published by PCS on December 8, 2006 was $40.679 billion which entitles us to a cumulative recovery of approximately $21 million of which $19.7 million was received during 2006. Based on the record of increasing PCS estimates following previous natural catastrophes in the United States, we expect that future estimates by PCS of this loss will increase and have therefore maintained a residual valuation of $4 million for our Hurricane Katrina recovery. The valuation losses recorded in 2004 and 2006 relate to changes in the non-Hurricane Katrina part of our fair valuation of the overall contract which are determined by the directors, taking into account the passage of time and any material changes in pricing of similar contracts in the market. We determine these valuations taking into account the illiquid nature of the catastrophe risk transfer swap market. See above ‘‘-Critical Accounting Policies-Risk Transfer Swap.’’
Income/(loss) before tax. In 2006, income before tax was $470.4 million and comprised $295.6 million of underwriting profit, $204.4 million in net investment income, $9.5 million of net exchange gains, $16.9 million of interest payable and $22.2 million of other expenses. In 2005 we incurred losses before tax of $160.4 million. The principal source of the loss in 2005 was underwriting losses of $358.2 million in our property reinsurance segment resulting from the 2005 hurricanes. Our underwriting losses were offset by $121.3 million in respect of net investment income and a $19.4 million net unrealized gain on derivatives. We also incurred losses of $18.2 million from the revaluation or sale of non-functional foreign currencies and $4.4 million from the sale of investments.
In 2006, we wrote property reinsurance on both a treaty and facultative basis. The property treaty reinsurance we write includes catastrophe, including, until the end of 2005, a small retrocession account, risk excess and pro rata. For a more detailed description of this segment, see Part I, Item 1, ‘‘Business-Business Segments-Property Reinsurance.’’
Gross premiums written. Gross premiums written in this segment decreased by 25.1% compared to 2005. The table below shows our gross premiums written for each line of business for each of 2006, 2005 and 2004, and the percentage increase/decrease in gross premiums written for each line:
The risk excess and proportional treaty accounts included $103.3 million of premium from Aspen Re America in 2006 with $74.6 million in 2005 and $47.1 million in 2004. This business is generally less exposed to catastrophe risk than the risk excess and proportional treaties written by Aspen Re and Aspen Bermuda.
Losses and loss adjustment expenses. Losses and loss adjustment expenses includes the following losses:
Policy acquisition, operating and administrative expenses. Policy acquisition expenses increased by 1.7 percentage points between 2006 and 2005 due to the recognition of profit commission and no
claims bonuses on certain contracts, the impact of higher average commission rates for non-U.S. treaty business and the greater proportion of structured business which attracts higher commission rates than the balance of the book. The operating expense ratio has fallen by 0.6 percentage points in 2006 compared to 2005 due to the impact of a reduction in reinsurance costs and a slight reduction in allocated indirect costs.
The expense ratio for 2005 was approximately 3.9 percentage points higher than in 2004 because U.S. treaty which incurs higher commission rates than other lines of business made up a greater proportion of the business written. In addition, a greater proportion of central administrative costs were allocated to this segment in 2005 compared to 2004 commensurate with the proportional increase of the business written by this segment.
Losses and loss adjustment expenses. The 2006 year has suffered from a greater than anticipated frequency of aviation and marine hull losses which were offset to some degree by the favorable experience of the liability, energy and specialty reinsurance lines. Large losses in this segment are set out below:
This segment has also suffered in 2006 from $19.0 million of deterioration on 2005 hurricane losses which reduced significantly the impact of a $28.4 million favorable development on the balance of the account.
Policy acquisition, operating and administrative expenses. The expense ratio increased in 2006 by 1.5 percentage points due to changes in business mix and an increase in profit commission accruals for specialty reinsurance, partly offset by a reduction in reinsurance ceded. Total expenses increased by $38.3 million or 171.7% in 2005, mostly attributable to the first full year of underwriting by our specialty insurance lines.
Gross premiums written. Gross written premiums decreased by 11.6% compared to 2005 due to greater competition in the U.K. where we have declined a number of risks to maintain pricing integrity and the quality of our account. Gross premiums written in this segment increased by 5.3% in 2005 compared to 2004. The table below shows our gross premiums written for each line of business for each of 2006, 2005 and 2004, and the percentage change in gross premiums written for each line:
Although the premiums written under the heading ‘worldwide property’ are at similar levels in 2006 and 2005 there has been a significant change in this account. In 2005 and previously, it included significant amounts of U.S. direct and facultative business, which we ceased to underwrite at the end of 2005, whereas in 2006, following the appointment of a new team, it comprises international facultative property business with incidental U.S. exposure.
In 2005, we increased our U.S. surplus lines in both property (2005-$67.0 million; 2004- $40.4 million) and casualty (2005-$74.8 million; 2004-$30.3 million). We wrote less U.K. liability business than in 2004 as rates had dropped.
The gross reserves may be further analyzed between outstanding or reported claims and IBNR as at December 31, 2006 and 2005, as follows:
Prior year loss reserves. In the twelve months ended December 31, 2006, 2005 and 2004, there was a 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, 2006. The analysis of the development by each segment is as follows:
Property Reinsurance. Property reinsurance deteriorated by $40.9 million in 2006 of which $35.6 million is attributable to Hurricanes Katrina, Rita and Wilma and $0.6 million to the 2004 hurricanes. The methodology we use to determine the hurricane ultimates is to review each cedent’s position with respect to its reported claims and establish an expected IBNR utilizing information from that client. At year-end we held a total IBNR for Hurricane Katrina for property reinsurance of $41.5 million. In setting our loss estimates for Hurricane Katrina, we have taken account of evolving litigation relating
to coverage issues and included additional provisions where appropriate. Because of this ongoing litigation, there remains significant uncertainty as to our ultimate costs of Hurricane Katrina.
Specialty Insurance and Reinsurance. The specialty insurance and reinsurance reserves release is $9.4 million. This is spread across several lines of which the largest contributors are aviation reinsurance ($4.1 million) and the run-off of quota shares written in 2002 and 2003 ($6.4 million) followed by marine hull insurance ($2.4 million), aviation insurance ($1.8 million) and contingency reinsurance ($1.2 million). We have had increases in Hurricane Katrina in the specialty accounts of $19.0 million partially offset by favorable experience on the balance of the affected classes.
Property and Casualty Insurance. The property and casualty insurance reserves release is $22.5 million. Employers’ and public liability written in the U.K. had a reserves release of $28.7 million with U.S. surplus lines casualty business contributing a further $3.6 million. These are also long-tail classes where claims can take several years to emerge, particularly latent diseases (which are monitored and reserved for separately). Experience has been better than expected leading to the observed reserves release in 2006. Offsetting these releases is a deterioration of $11.4 million in the 2005 hurricane reserves of which $10.1 million is attributable to Hurricane Katrina for the discontinued worldwide property account from late advised claims exceeding IBNR.
Property Reinsurance. The net reserves of the property reinsurance segment as at December 31, 2004 were $222.9 million which included specific case reserves in relation to Hurricanes Charley, Frances, Ivan and Jeanne and Typhoon Songda. Further claims information received in relation to Hurricane Ivan and Typhoon Songda windstorms gave rise to a $7.8 million increase in reserves in the period. In addition, further claims notifications in respect of certain treaty risk excess contracts received during the twelve months to December 31, 2005 highlighted deterioration in claims development resulting in a strengthening in claims reserves of $6.1 million.
Casualty Reinsurance. As at December 31, 2004 the casualty reinsurance segment held net claims reserves of $373.2 million. Favorable trends in claims development in the non-U.S. casualty and U.S. casualty lines have seen claims develop at a slower than expected rate, and led to a release of prior year net reserves of $10.9 million. Most of the release in respect of the U.S. casualty lines relates to workers’ compensation catastrophe excess of loss contracts which have a short reporting period.
Property Reinsurance. The net reserves of the property reinsurance segment as at December 31, 2003 were $95.3 million, which included specific case reserves in relation to brush fires in the United States, Hurricanes Fabian and Isabel and a Phillips factory loss in Normandy, France. Further claims information received during the twelve months ended December 31, 2004 highlighted a lower severity of these reported claims than was originally anticipated and gave rise to a $17.1 million reduction in reserves in the period.
Casualty Reinsurance. The net reserves of the casualty reinsurance segment as at December 31, 2003 were $125.6 million. We do not receive notice of most of the claims in this
During 2006 we began a new phase of capital management which is intended to better manage both the total amount and funding of the capital deployed in our business. While total capital increased during the year the proportion funded by our ordinary shareholders has decreased from 81% to 75%. This was achieved through a repurchase of shares using the proceeds of the issuance of a new class of preference shares.
Issuance of preference shares. On November 15, 2006, we issued 8,000,000 7.401% Perpetual Non-Cumulative Preference Shares, par value 0.15144558¢ each, with liquidation preference of $25 per share (previously defined as the Perpetual Preference Shares) for an aggregate amount of $200 million. On November 15, 2006, in connection with the issuance of the Perpetual Preference
Repurchases of ordinary shares. On December 1, 2006, the Company entered into an agreement with two of its founding shareholders, The Blackstone Group and CSFB Private Equity and their respective affiliates, to repurchase a total of 5,899,770 ordinary shares at a price per share of $26.50 which represented a discount of 1.67% to the closing price of the Company’s shares on November 30, 2006 of $26.95. The total purchase price was $156.3 million. The purchase price was funded with the proceeds of the sale of the Company’s Perpetual Preference Shares, which closed on November 15, 2006. The ordinary shares were repurchased and retired on December 6, 2006.
On December 21, 2006, the Company entered into a Master Confirmation agreement with Goldman, Sachs & Co. (‘‘Goldman Sachs’’) pursuant to which the Company agreed to repurchase $44 million of its ordinary shares from Goldman Sachs in a private transaction in connection with an accelerated stock buyback (‘‘ASB’’) program. The Master Confirmation contains the principal terms and provisions governing the ASB between the Company and Goldman Sachs. The shares were repurchased for an upfront payment of $44 million, subject to collar provisions that establish the minimum and maximum numbers of shares to be repurchased by the Company. In connection with the ASB, Gldman Sachs is expected to purchase the amount of shares required to be delivered to the Company under the terms of the Master Confirmation in the open-market over time. The Company received and cancelled 1,565,751 (the minimum number of shares) from Goldman Sachs on January 22, 2007, based on the Rule 10b-18 volume weighted average price of shares traded during an initial hedging period increased by a pre-agreed percentage to establish the cap or maximum price per share payable under the program. The program is expected to terminate at a date to be selected by Goldman Sachs between one month and three months after the completion of the hedging period which ended on January 17, 2007. At the end of the program, the Company may receive additional shares, if applicable, based on the Rule 10b-18 volume weighted average price of shares traded during the period between January 17, 2007 and the termination date less a discount per share of 18 cents. The maximum additional number of shares that may be received is 143,793. The repurchased shares will be cancelled and retired and the result will be that the average repurchase price will fall between $25.74 and $28.10 per share for a total fixed consideration of $44 million.
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 $2,389.3 million at December 31, 2006 ($2,039.8 million at December 31, 2005). We believe our financial strength provides us with the flexibility and capacity to obtain funds through debt or equity financing. Our continuing ability to access the capital markets is dependent on, among other things, our operating results, market conditions and our perceived financial strength. We continuously 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 New York Stock Exchange.
Under a shelf registration statement filed on October 24, 2005 we have the facility to issue and sell up to approximately $400 million of securities subject to the issuance of one or more supplementary prospectuses and market conditions.
Liquidity is a measure of a company’s ability to generate cash flows sufficient to meet short-term and long-term cash requirements of its business operations. Management monitors the liquidity of Aspen Holdings and of each of its Insurance Subsidiaries and arranges credit facilities to enhance short-term liquidity resources on a stand by basis.
There were no significant restrictions on the ability of Aspen Re and Aspen Bermuda to pay us dividends funded from their respective accumulated balances of retained income as at December 31, 2006.
In addition to its dividend capacity as at December 31, 2006, Aspen Bermuda could also make capital repayments to Aspen Holdings in excess of $140 million without prior approval from the Bermuda Monetary Authority. Aspen Re has $150 million available for capital repayments to Aspen U.K. Holdings which could in turn be used to fund repayments of loans made by Aspen Holdings to Aspen U.K. Holdings. Even though not strictly required, Aspen Re would typically seek FSA approval prior to making such capital repayment.
For a more detailed discussion of our Insurance Subsidiaries’ ability to pay dividends, see note 12 of our financial statements.
Insurance subsidiaries. As of December 31, 2006, the Insurance Subsidiaries held approximately $1,144.5 million (2005 - $1,181.0 million) in cash and short-term investments that are readily realizable securities. Management monitors the value, currency and duration of cash and investments held by its Insurance Subsidiaries to ensure that they are able to meet their insurance and other liabilities as they become due and was satisfied that there was a comfortable margin of liquidity as at December 31, 2006 and for the foreseeable future.
The liquidity of our Insurance Subsidiaries is also affected by the terms of our contractual obligations to U.S policyholders and by undertakings to certain regulatory authorities to facilitate the
(2) As of December 31, 2006, the Company had funds on deposit of $171.2 million and £50.2 million (December 31, 2005-$121.3 million and £65.1 million) as collateral for the secured letters of credit.
U.S. reinsurance trust fund. For its U.S. reinsurance activities, Aspen Re has established and must retain a multi-beneficiary U.S. trust fund for the benefit of its U.S. cedents so that they are able to take financial statement credit without the need to post cedent-specific security. The minimum trust fund amount is $20 million plus a minimum amount equal to 100% of Aspen Re’s U.S. reinsurance liabilities, which were $811.3 million at December 31, 2006 and $954.9 million at December 31, 2005. At December 31, 2006 the total value of assets held in the trust was $1,101.7 million (2005-$1,041.9 million).
U.S. surplus lines trust fund. Aspen Re has also 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, 2006 was $70.6 million (2005-$8.1 million).
Consolidated cash flows for the twelve months ended December 31, 2006. Total net cash flow from operating activities in 2006 was $715.0 million, a reduction of $74.1 million from 2005. For the twelve months ended December 31, 2006, our cash flows from operations provided us with sufficient liquidity to meet our operating requirements. We paid net claims of $469.7 million in 2006 and made net investments in the amount of $934.5 million in market securities during the period. We paid ordinary and preference share dividends of $71.8 million, and raised $225.4 million from our preference share offerings, $200.8 million of which was used to repurchase ordinary shares. At December 31, 2006, we had a cash balance of $495.0 million.
Consolidated cash flows for the twelve months ended December 31, 2005. Our total net cash flow from operating activities in 2005 was $789.1 million, a reduction of 17.9% from 2004. This decrease was mainly due to claims paid of $551.9 million (an increase of 235% over 2004) in the period which were mostly in relation to the 2004 and 2005 hurricanes. In 2005, we paid dividends on our ordinary shares totaling $45.5 million and raised approximately $790 million after expenses from our issuance of 25,884,891 ordinary shares and 4,000,000 Perpetual PIERS. As at December 31, 2005, we had a consolidated cash balance of $748.3 million, which we consider to be sufficient to meet our current operating requirements.
Credit Facility. On August 2, 2005, we entered into a five-year $400 million revolving credit facility pursuant to a credit agreement dated as of August 2, 2005 (the ‘‘credit facilities’’) by and among the Company, certain of our direct and indirect subsidiaries (collectively, the ‘‘Borrowers’’) the lenders party thereto, Barclays Bank plc, as administrative agent and letter of credit issuer, Bank of America, N.A. and Calyon, New York Branch, as co-syndication agents, Credit Suisse, Cayman Islands Branch and Deutsche Bank AG, New York Branch, as co-documentation agents and The Bank of New York, as collateral agent. On September 1, 2006 the aggregate limit available under the credit facility was increased to $450 million. The credit facilities replace our $150 million three-year credit agreement dated August 26, 2003, which would have expired on August 29, 2006, and our $50 million 364-day credit agreement, dated as of August 26, 2003, both of which were terminated as of August 2, 2005.
The facility can be used by any of the Borrowers to provide funding for the Insurance Subsidiaries of the Company, 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 provides for a $250 million subfacility for collateralized letters of credit. The facility will expire on August 2, 2010. As of December 31, 2006, no borrowings were outstanding under the credit facilities, though we had $76.0 million and $231.7 million of outstanding collateralized and uncollateralized letters of credit, respectively. The fees and interest rates on the loans and the fees on the letters of credit payable by the Borrowers increase based on the consolidated leverage ratio of the Company.
Under the credit facilities, we must maintain at all times a consolidated tangible net worth of not less than approximately $1.1 billion plus 50% of consolidated net income and 50% of aggregate net cash proceeds from the issuance by the Company of its capital stock, each as accrued from January 1, 2005. On April 13, 2006, the agreement was amended to remove any downward adjustment on maintaining the Company’s consolidated tangible net worth in the event of a net loss. We must also not permit our consolidated leverage ratio of total consolidated debt to consolidated tangible net worth to exceed 35%. In addition, the credit facilities contain other customary affirmative and negative covenants as well as certain customary events of default, including with respect to a change in control. The various affirmative and negative covenants, include, among others, covenants that, subject to important exceptions, restrict the ability of the Company and its subsidiaries to: create or permit liens on assets; engage in mergers or consolidations; dispose of assets; pay dividends or other distributions, purchase or redeem the Company’s equity securities or those of its subsidiaries and make other restricted payments; permit the rating of any insurance subsidiary to fall below A.M. Best financial strength rating of B++ or S&P financial strength rating of A−; make certain investments; agree with others to limit the ability of the Company’s subsidiaries to pay dividends or other restricted payments or to make loans or transfer assets to the Company or another of its subsidiaries. The credit facilities also include covenants that restrict the ability of our subsidiaries to incur indebtedness and guarantee obligations.
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, 2006:
(1) The long term debt obligations disclosed above does not include the $15 million annual interest payable on our outstanding senior notes.
(2) In estimating the time intervals into which payments of our reserves for losses and loss adjustment expenses fall, as set out above, we have utilized actuarially assessed payment patterns. By the nature of the insurance and reinsurance contracts under which these liabilities are assumed, there can be no certainty that actual payments will fall in the periods shown and there could be a material acceleration or deceleration of claims payments depending on factors outside our control. This uncertainty is heightened by the short time in which we have operated, thereby providing limited Company-specific claims loss payment patterns. The total amount of payments in respect of our reserves, as well as the timing of such payments, may differ materially from our current estimates for the reasons set out above under ‘‘-Critical Accounting Policies-Reserves for Losses and Loss Expenses.’’
We have entered into a lease for three floors comprising a total of approximately 15,000 square feet in Hamilton, Bermuda for our holding company and Bermuda operations. The term of the rental lease agreement is for six years, and we have agreed to pay approximately a total of $1 million per year in rent for the three floors for the first three years and annual service charges of $180,000 per year. We moved into these new premises on January 30, 2006.