Results by Segment: Years ended December 31, 2010, 2009 and 2008
Total cash and investments of $12.6 billion; fixed maturities, cash and short-term securities comprise 93% of total cash and investments and have an average credit rating of AA
Total debt of $994 million and a debt to total capitalization ratio of 15.0%
the launch of our Global Accident & Health operations, focused on specialty accident products rather than traditional medical coverages.
locked in $500 million of capital for 10 years at 5.875% via issuance of senior notes in March;
replaced our existing credit facility with a new credit facility and a new secured letter of credit facility.
2010 versus 2009: Total underwriting income was $409 million for 2010, a decrease of 22%.
current accident year loss ratios, most notably for professional lines. Reduced ceded reinsurance costs due to the restructuring of certain programs on renewal in the second quarter of 2010 increased net premiums earned. These factors were partially offset by a $93 million reduction in net favorable prior period reserve development and increases in acquisition costs and general and administrative expenses. In addition, the segment’s 2010 underwriting results were not impacted by our indemnity contract exposed to longevity risk. During 2009, we recognized net losses of $133 million in relation to this contract, which was cancelled during the fourth quarter of that year.
2010 versus 2009: The $58 million decrease in 2010 primarily resulted from lower reinvestment yields on our fixed maturity portfolio. Our alternative investment portfolio (“other investments”) also contributed to the decrease; although these investments performed well in both years, our hedge funds and credit funds generated higher returns in 2009.
The movements in other revenues and expenses were primarily due to foreign exchange rate movements. We recognized $16 million and $44 million in foreign exchange gains in 2010 and 2008, respectively, primarily due to the remeasurement of net liabilities denominated in the Euro, following its depreciation against the U.S. Dollar. In 2009, the U.S. Dollar equivalent of our net liability balances denominated in foreign currencies increased due to a weakening U.S. Dollar and we recognized foreign exchange losses of $29 million. An increase in interest expense following our March 2010 senior note issuance also contributed to the higher expense levels for 2010.
Our objective is to generate superior returns on capital that appropriately reward our common shareholders for the risks we assume and to grow revenue only when we expect the returns will meet or exceed our requirements. We recognize that the nature of underwriting cycles and the frequency or severity of large loss events in any year may make it difficult to achieve a profitability target in any specific period and, therefore, established a ROACE target of at least 15% over the full underwriting cycle. Our average annual ROACE since inception is approximately 16%, in-line with this long-term goal.
in average common equity was driven by a global recovery in financial markets and our net income available to common shareholders; these increases were partially offset by more significant common share repurchases.
versus 2008: Our 2009 operating ROACE improved relative to 2008 as a result of minimal catastrophe activity; 2008 results were adversely impacted by losses incurred in relation to Hurricanes Ike and Gustav. In addition, strong performance from our investments in hedge and credit funds in 2009 also contributed to the increase. Partially offsetting these improvements were a $92 million increase in net losses related to our indemnity contract exposed to longevity risk and lower reinvestment yields on our fixed maturities portfolio.
The higher ROACE in 2009 was driven by the factors noted above for operating ROACE. However, the increase was partially offset by the previously discussed increase in OTTI charges.
We believe in returning excess capital to our shareholders by way of dividends (as well as stock repurchases) and, accordingly, our dividend policy is an integral part of the value we create for our shareholders. Our strong earnings in recent years have permitted our Board of Directors to approve successive annual increases in quarterly common share dividends for the past three years.
2010 versus 2009: The increase in net premiums earned for our insurance segment resulted from the previously discussed changes in our ceded reinsurance programs and an 8% increase in gross premiums written. The increase for our reinsurance segment reflects premium growth on certain lines of business.
(1) The general and administration expense ratio includes corporate expenses not allocated to underwriting segments of 2.5%, 2.7% and 2.7% for 2010, 2009 and 2008, respectively. These costs are discussed further in the ‘Other Revenue and Expenses’ section below.
2010 versus 2009: The 1.3 percentage point increase in our current accident year loss ratio was primarily driven by a higher level of catastrophe activity, most notably with respect to major earthquakes in Chile and New Zealand. On February 27, 2010, a magnitude 8.8 earthquake occurred off the coast of the Maule Region of Chile. The earthquake and following tsunami and aftershocks caused significant destruction to areas in Chile. We recognized estimated pre-tax net losses (net of related reinstatement premiums) of $110 million for this event. On September 4, 2010, a magnitude 7.1 earthquake occurred near Christchurch, New Zealand; the earthquake and associated aftershocks caused significant destruction in the Christchurch region. We recognized estimated pre-tax net losses of $138 million for this event. There were a number of other weather-related loss events of note during 2010, including Australian and U.S. storms and Windstorm Xynthia in the first quarter and further Australian storms and flooding and U.S. storms in the fourth quarter. In contrast, catastrophe losses were notably lower in 2009.
The following factors partially offset the impact of a higher level of catastrophe activity on the current accident year loss ratio:
estimates, market share analyses, catastrophe modeling analyses and the information available to date from clients, brokers and loss adjusters. There are a number of potential complications involved with the investigation, adjustment and handling of insurance claims arising from the Chilean earthquake which may result in a longer development tail than that observed for other catastrophes of a similar magnitude. These include restrictions on who is permitted to adjust claims, the scope of the coverage on the original policies and the practical and logistical issues associated with adjusting property damage and business interruption losses across such a vast area. Industry-wide insured loss estimates for these events, as well as our own estimates, remain subject to change as additional actual loss data becomes available. Actual losses in relation to these events may ultimately differ materially from current loss estimates.
During 2010, we recognized net favorable prior period reserve development of $38 million on our trade credit and bond reinsurance business, primarily on the 2009 accident year and, to a lesser extent, the 2007 and 2008 accident years, in recognition of better than expected loss experience. In contrast, we recognized $18 million net adverse prior period reserve development on this business during 2009 to reflect updated information from our cedants.
We recognized $18 million of net adverse prior period reserve development on our credit and political risk insurance business during 2010, as we worked towards finalizing settlements for certain loss events and reductions in recovery estimates for the latest available information. During 2009 and 2008, respectively, we recognized $35 million and $65 million of net favorable development on this business, primarily in relation to credit-related classes. Better than expected loss emergence contributed to the favorable development in both years. In addition, the adoption of a more accelerated loss development profile and development on 2004 and prior accident year traditional political risk business contributed to the favorable development in 2008.
In 2010, we recognized $118 million of net favorable prior period reserve development, the principal components of which were:
$18 million of net adverse prior period reserve development on credit and political risk business. This balance consisted of net adverse development of $54 million on the 2009 accident year, as we worked towards finalizing settlements for certain loss events and reduced our collateral estimates for the latest
$57 million of net favorable prior period reserve development on professional lines business, primarily generated from the 2004 through 2006 accident years, for reasons discussed in the overview.
In 2009, we recognized $211 million of net favorable prior period reserve development, the principal components of which were:
$73 million of net favorable prior period reserve development on professional lines business. This was driven by net favorable development on the 2005 accident year, as well as the 2004 and 2006 accident years to a lesser extent, for the reasons discussed in the overview above. This was partially offset by net adverse development of $44 million on the 2008 accident year, primarily reflecting higher than expected loss activity on financial institutions business as a result of the global financial crisis.
$16 million of net adverse prior period reserve development on liability lines of business. This was driven by $24 million of net adverse development on E&S liability business, primarily impacting the 2007 accident year, as well as the 2008 accident year to a lesser extent. We adjusted our loss development profiles for these accident years, having observed higher than expected frequency and severity of claims emergence on this business over the previous twelve months. This was partially offset by net favorable development on E&S umbrella business, predominately from the 2004 and 2005 accident years, reflecting the incorporation of more of our own actual experience with respect to reinsurance recoveries.
$8 million of net adverse prior period reserve development on our liability business, largely due to higher than expected loss emergence on a specific program across several accident years.
$94 million of net favorable prior period reserve development on catastrophe and property business largely consisting of:
$11 million of net favorable prior period reserve development on catastrophe business, primarily related to the 2009 and 2005 accident years. Development on the 2009 accident year was primarily driven by better than expected loss emergence, while the development on the 2005 accident year largely related to a reduction in our reserve for one particular claim following receipt of updated information. Partially offsetting this, we recognized net adverse development of $33 million on the 2008 accident year, largely related to updated information with respect to Hurricane Ike losses.
$38 million of net favorable prior period development on trade credit and bond reinsurance lines of business, largely related to the 2009 accident year and, to a lesser extent the 2007 and 2008 accident years, in recognition of better than expected loss emergence and updated information from our cedants.
$60 million of net favorable prior period reserve development on professional lines reinsurance business, primarily on the 2006 accident year and, to a lesser extent the 2007, 2005 and 2004 accident years, for the reasons discussed in the overview above.
In 2009, we recognized $212 million of net favorable prior period reserve development, the principal components of which were:
$68 million of net favorable prior period reserve development on catastrophe business, primarily related to the 2008 and 2007 accident years and emanating from property-related catastrophe business ($63 million) and workers compensation catastrophe business ($5 million). This development was primarily driven by better than expected loss emergence, including a $7 million reduction in our estimate for Hurricanes Ike and Gustav due to a reduction in reported losses.
$172 million of net favorable prior period reserve development on catastrophe and property business largely consisting of:
$10 million of net favorable prior period reserve development on crop business, primarily relating to the 2007 and 2006 accident years and driven by better than expected loss emergence.
$7 million of net adverse development on our 2003 accident year liability business, reflecting greater than expected loss emergence on a stop-loss contract.
2009 versus 2008: The reduction in gross premiums written primarily reflected limited credit and political risk underwriting opportunities in the weakened global economy. Gross premiums written were also impacted by our decision to reduce peak zone catastrophe exposures in property and marine lines of business during 2009, as part of our ongoing diversification strategy within those lines. Gross premiums written in 2009 did, however, benefit from a general improvement in rates, particularly for more volatile, loss-affected lines such as those with catastrophe exposure, energy and financial institutions business. Our 2009 gross premiums written also benefited from the maturing of certain property and liability programs, having established business with managing general agents and other producers in prior years. Gross premiums written in 2009 further benefited from certain new opportunities for financial institutions business.
versus 2008: Premiums ceded in 2009 were $751 million, or 42% of gross premiums written, compared to $708 million, or 38%, in the same period of 2008. The increase in the ceded premium ratio in 2009 primarily reflected a combination of business mix changes and rate increases on our property reinsurance program. Business mix changes primarily related to the growth of our professional lines business in 2009 and a reduction in credit and political risk premiums, a line for which we do not purchase reinsurance cover.
The 14.1 percentage point reduction in our current accident year loss ratio primarily resulted from a lower level of claims activity in our credit and political risk business relative to 2009. Loss activity on this line was elevated in 2009 due to the global financial crisis, resulting in a 133% current accident year loss ratio. In 2010, we considered
the recovery in global economic conditions and established a 70% current accident year loss ratio for this line. In addition, the lower current accident year loss ratio for the segment was driven by business mix changes and the previously discussed consideration of our own loss experience in establishing loss ratios for our medium-tail business in 2010, most notably for professional lines. We also considered the global economic recovery when establishing our 2010 current accident year loss ratio for our professional lines business. As a result of these factors, our current accident year loss ratio on professional lines business declined from 72% in 2009 to 61% in 2010.
Our insurance segment’s exposures to the Chilean and New Zealand earthquakes were not significant.
Lower catastrophe activity in 2009 relative to 2008, which included net losses incurred of $127 million, or 10.7 points, related to Hurricanes Ike and Gustav.
A reduction in the current accident year loss ratio of our overall professional lines business from 77% in 2008 to 72% for 2009. The 2008 ratio contemplated additional loss activity emanating from the global financial crisis.
The incorporation of more of our own historical loss experience within short-tail lines of business. Given that this experience has generally been better than we expected, this reduced our 2009 current accident year loss ratio on several lines of business relative to 2008.
General and Administrative Expense Ratio: Total general and administrative expenses increased in 2010, reflecting additional staffing and IT costs associated with the build-out of the segment’s platform and higher performance-related compensation expenses. Increased staffing and IT costs, combined with a reduction in net premiums earned contributed to the higher ratio in 2009 relative to 2008.
Other Insurance Related Income/Loss: During 2009 and 2008, we recorded net losses associated with our indemnity contract exposed to longevity risk of $133 million and $41 million, respectively. As we negotiated the cancellation of this contract during the fourth quarter of 2009 and this was the only contract of this kind in our portfolio, there was no corresponding amount for 2010.
$15 million and $2 million in 2010 and 2009, respectively. Refer to the ‘Critical Accounting Estimate-Premiums’ for a further discussion of these estimates. Property premiums also increased, due to both new business opportunities and an increase in our share on certain treaty renewals. Partially offsetting these increases was a reduction in our liability premiums, which was largely driven by the non-renewal of a significant contract following a material change to the cedant’s business. In addition, net adjustments to premium estimates on proportional contracts written in prior years for professional lines business were lower in 2010; we recognized $1 million in net adverse estimate revisions in 2010, compared to net favorable revisions of $12 million in 2009.
Gross premiums written in 2009 were also negatively impacted from a stronger U.S. dollar relative to 2008. In particular, the U.S. dollar was stronger against the Euro and Sterling at our major renewal of January 1. Gross premiums written excluding the effect of exchange rate movements increased 19% in 2009.
A lower level of claims activity in our trade credit and bond business relative to the prior year; loss activity on this line was elevated in 2009 as a result of the global financial crisis. Our current accident year loss ratio on this business was 61% in 2010, compared to 89% for 2009;
The continued incorporation of more of our own historical loss experience within short-tail lines of business, which has reduced our current accident year loss ratio because our experience has generally been better than we expected; and
A benign North Atlantic hurricane season in comparison to 2008, when we recognized pre-tax net losses of $281 million, or 18.7 points, in relation to Hurricanes Ike and Gustav.
A reduction in other catastrophe losses in 2009 relative to 2008, which included flood, hail and tornado activity in the U.S., an earthquake in China and storms in Australia. The most significant catastrophe losses in 2009 related to European windstorm activity in the first and third quarters, with total incurred net losses estimated at $27 million.
An increase in Canadian crop losses in 2009 relative to 2008.
Acquisition Cost Ratio: The increase in the acquisition cost ratio of our reinsurance segment in 2009 versus 2008 primarily reflected changes in business mix and growth in lines with higher acquisition costs.
Foreign Exchange Losses (Gains): Some of our business is written in currencies other than the U.S. Dollar. The foreign exchange gains in 2010 and 2008 were largely attributable to the remeasurement of net liabilities denominated in Euro, following the depreciation of the Euro against the U.S. Dollar in those years. The appreciation of the Euro and Sterling against the U.S. Dollar in 2009 drove the foreign exchange loss for that year.
Income Tax Expense: Income tax expense is generated primarily through our foreign operations in the United States and Europe. Our effective tax rate, which is calculated as income tax expense divided by income before tax, was 4.3%, 7.8% and 4.9% in 2010, 2009 and 2008, respectively. This effective rate can vary between periods depending on the distribution of net income (loss) amongst tax jurisdictions, as well as other factors.
The following table provides a breakdown of income earned from our cash and investment portfolio by major asset class:
2009 versus 2008: The 10% reduction in investment income was primarily due to lower reinvestment yields as a result of significant tightening of credit spreads. This reduction was partially offset by growth of 12% on our average fixed maturities balances in the current year.
We record the change in fair value on our other investments in net investment income and consequently, the pre-tax return on other investments may vary materially period over period, in particular during volatile credit and equity markets.
The following table provides a breakdown of net investment income (loss) from other investments:
(1) The pre-tax return on other investments is calculated by dividing total income (loss) from other investments by the average month-end fair value balances held for the periods indicated.
2010 versus 2009: The pre-tax return on other investments declined by 3.7% to 12.1% in 2010 primarily due to lower returns from our investments in hedge and credit funds. Our hedge fund investments have exposures primarily to net long equity positions. Credit funds also advanced on modest improvement in the pricing of the underlying bank loans that form the collateral of these funds; however, we did not achieve the outsized returns of 2009 when the valuation of the underlying collateral recovered from historic lows. The decline in income from short duration high yield fund was due to its full redemption in 2010.
Partially offsetting the decline in the pre-tax return was the recovery in fair value for our CLO equity tranched securities (“CLO Equities”) in 2010. The increase in fair value was driven primarily by lower than anticipated default rates, partially offset by lower recovery rates, resulting in higher cash distributions from CLO Equities than previously expected. In light of this development, we slightly reduced our default rate and recovery rate assumptions for the remaining lives of the CLO Equities in our valuation models during the fourth quarter of 2010 (refer to the ‘Critical Accounting Estimates-Fair Value Measurements’ for further details).
2010 versus 2009: The 30% reduction in investment income was driven mainly by continuing lower global short-term interest rates, compounded with lower average cash and cash equivalent balances.
2010 versus 2009: Substantial gains were realized primarily on fixed maturities as a result of the significant narrowing of credit spreads and, to a lesser extent, lower U.S. Treasury rates. Improvements in global equity markets also enabled us to realize gains on our equity holdings. The realized losses on our equities in 2009 were primarily driven by the sale of preferred shares in the financial sector in the first quarter.
In accordance with the new accounting guidance issued and effective April 1, 2009, the OTTI charge to earnings in 2010 reflects only credit impairments, where projected cash flows are less than the amortized cost of a security, or the full unrealized loss position if we intend to sell a fixed maturity security or it is more likely than not that we will need to sell it to meet our liabilities. This guidance does not allow for retrospective application, therefore the
(1) Includes restricted cash and cash equivalents of $116 million and $75 million for 2010 and 2009, respectively.
During 2010, we reduced our U.S. government and agency holdings, as well as our investment in non-agency CMBS. The proceeds, along with partial proceeds from our senior unsecured debt issued in March, were allocated primarily to corporate debt, agency MBS and ABS. New investments in corporate debt were made in 2010 due to our positive outlook for further credit spread tightening and the funding of a new short duration high yield portfolio. This consists of a well diversified portfolio of short duration high yield debt securities with a fair value of $277 million and a weighted-average credit rating of B+. The increase in non-investment grade holdings since December 31, 2009, was primarily due to the funding of this new portfolio. Our ABS holdings increased in 2010 due to the availability of higher quality new issues with shorter durations.
At December 31, 2010, our corporate debt portfolio had a weighted average credit rating of A- (2009: A), a duration of 3.5 years (2009: 3.2 years) and a weighted average life of 4.4 years (2009: 4.5 years).
Non-financial exposures are primarily related to communications (20%), consumer non-cyclicals (19%) and electric (14%), with the remainder diversified across several other sub-sectors. The decline in the weighted average credit rating to BBB+ since December 31, 2009, was primarily due to the addition of a new short duration high yield portfolio (as mentioned above).
In general, our MTN holdings are collateralized by a pool of European fixed maturity securities diversified by country and asset sector with the majority of the exposure consisting of investment grade corporate and sovereign debt. During 2010, we have reduced our allocation to MTNs and redeployed the proceeds to fund the new short duration high yield portfolio. Subsequent to December 31, 2010, we further reduced our holdings in MTNs by another $93 million and, accordingly, our remaining exposure to MTNs is insignificant.
Our RMBS portfolio is supported by loans that are diversified across geographical areas. During 2010, we increased our holdings in new issues of AAA rated non-agency RMBS to take advantage of higher yields. At December 31, 2010, the average duration and weighted average life was 0.2 years (2009: 0.1 years) and 8.3 years (2009: 3.7 years), respectively, for non-agency RMBS. Based on fair value, the largest vintages in non-agency RMBS were years 2010 (25%) and 2005 (23%). Our total exposure to subprime and Alt-A collateral decreased to $70 million at December 31, 2010 from $88 million at December 31, 2009, primarily due to sales and paydowns. Of these securities, 50% (2009: 50%) are rated AAA by S&P.
Our exposure to this asset class decreased in 2010 primarily due to sales as the valuation on our CMBS holdings increased significantly during the year. Our remaining non-agency CMBS portfolio continues to be rated highly, with approximately 84% rated AA or better (2009: 89%) by S&P. Additionally, the weighted average estimated subordination percentage for the non-agency portfolio was 27% at December 31, 2010 (2009: 27%), which represents the current weighted average estimated percentage of the capital structure subordinated to the investment holding that is available to absorb losses before the security incurs the first dollar loss of principal. At December 31, 2010, the average duration and weighted average life was 3.4 years (2009: 3.6 years) and 5.2 years (2009: 4.4 years), respectively. Based on fair value, our non-agency CMBS portfolio primarily originates from years 2005 (22%) and 2006 (22%).
Our holdings in municipal debt are primarily held within the taxable portfolios of our U.S. subsidiaries and include debt issuance from states, municipalities and political subdivision. The following table provides a breakdown of the fair value of our municipal debt portfolio between Revenue and General Obligation bonds:
General obligation bonds are backed by the full faith and credit of the authority that issued the debt and are secured by the taxing powers of those authorities. Revenue bonds are backed by the revenue stream generated by the services provided by the issuer (e.g. sewer, water or utility projects).
During 2010, net unrealized gains on our municipal debt portfolio decreased from $14 million at December 31, 2009 to less than $1 million at December 31, 2010 as credit spreads on municipal debt widened, particularly during the final quarter of 2010. At December 31, 2010, our top three municipal debt holdings were from California -14%, New York - 11%, and Texas - 9% (2009: California - 17%, New Jersey - 11% and New York - 8%).
Additionally, certain of our holdings in municipal debt were insured by financial guarantee companies. At December 31, 2010, we held insurance enhanced municipal bonds in the amount of $163 million (2009: $195 million), with a weighted average credit rating of AA (2009: AA) by S&P. In the event the financial guarantors are unable to make good on their guarantee on a defaulted security, we would then be exposed to the credit loss. Excluding the insurance benefit from the financial guarantee companies, the weighted average credit quality of our insured bond holdings was AA- (2009: AA-) by S&P. At December 31, 2010, our largest exposures to financial guarantors were Assured Guaranty Corp. for $61 million (2009: $8 million), National Public Finance Guarantee Corporation for $56 million (2009: $60 million) and Ambac Financial Group, Inc. for $23 million (2009: $53 million). We had no direct investments in these companies at December 31, 2010 and 2009.
The following table provides information on the severity of the unrealized loss position as a percentage of amortized cost for all non-investment grade fixed maturities in an unrealized loss position at December 31, 2010 and 2009.
The $7 million increase in our total hedge funds investment in 2010 reflects a $26 million increase in valuation due to continuing favorable global financial markets, partially offset by $19 million of net redemptions including proceeds from a fund closure. The decrease in our total credit funds investment was due to $16 million of cash distributions, partially offset by $14 million of improved valuations due to positive performance of its underlying loan collateral. Certain hedge and credit fund investments may be subject to restrictions on redemptions which may limit our ability to liquidate these investments in the short term. Refer to Item 8, Note 5 (b) of our Consolidated Financial Statements for further details.
As previously noted, the short duration high yield fund was redeemed during 2010 and the cash proceeds of $53 million were used to partially fund a new segregated short duration high yield corporate debt portfolio managed by an external manager.
To support our insurance and reinsurance operations we provide collateral (fixed maturities and short-term investments) in various forms. We primarily utilize trust arrangements for U.S. insurance obligations, and to a lesser extent issue letters of credit, for reinsurance business. The new letter of credit facility (see ‘Liquidity and Capital Resources’) is secured with fixed maturity investments. We are also required to maintain securities on deposit with various regulatory authorities. The fair value of our restricted investments was as follows:
The $659 million increase of restricted investments in 2010 was primarily due to the new secured letter of credit facility, whereas previously letters of credit were issued on an unsecured basis.
All of the above restricted investments are available to settle insurance and reinsurance liabilities.
Liquidity is a measure of a company’s ability to generate cash flows sufficient to meet the short-term and long-term cash requirements of its business operations. We manage liquidity at both the holding company and operating subsidiary level. In recent years, global economic conditions deteriorated and financial markets experienced unprecedented volatility and disruption. This market turmoil affected (among other aspects of our business) the demand for and claims made under our products, the ability of customers, counterparties and others to establish or maintain their relationships with us, our ability to access and efficiently use internal and external capital resources and the performance of our investment portfolio.
AXIS Capital’s operating subsidiaries generally derive cash from investment income, as well as the net receipt of premiums less losses and loss expenses related to their underwriting activities. Historically, these cash receipts have been sufficient to fund the operating expenses of these subsidiaries, as well as to fund sufficient dividend payments to AXIS Capital. The remaining cash flows from subsidiaries are reinvested in our investment portfolio.
The insurance and reinsurance business of our operating subsidiaries provides liquidity in that premiums are received in advance, sometimes substantially in advance, of the time claims are paid. However, operating cash flows can be affected by claim payments that, due to the nature of our operations, may comprise large loss payments on a limited number of claims and can fluctuate significantly from period to period.
Net cash flows used in financing activities in 2010 primarily relate to common share repurchases of $710 million ($699 million from the market, with the remainder from employees to satisfy withholding tax liabilities upon vesting of restricted stock awards and stock option exercises) (2009: $176 million; 2008: $291 million), dividends paid on common shares of $108 million (2009: $113 million; 2008: $106 million) and dividends paid on preferred shares of $37 million (2009: $37 million; 2008: $37 million). During 2010, this was partially offset by the $495 million net proceeds received from our senior notes issuance (discussed below and in Item 8, Note 10(a) of our Consolidated Financial Statements).
In addition to common equity, we have utilized other external sources of financing, including debt, preferred shares and letters of credit to support our business operations. We believe that we hold sufficient capital to allow us to take advantage of profitable opportunities and to maintain our financial strength ratings, as well as to comply with various local statutory regulations. We monitor our capital adequacy on a regular basis and will seek to adjust our capital base (up or down) according to the needs of our business. The following table summarizes our consolidated capitalization position for the periods indicated:
We finance our operations with a combination of debt and equity capital. Our debt to total capital and debt and preferred equity to total capital ratios provide an indication of our capital structure, along with some insight into our financial strength. A company with higher ratios in comparison to industry average may show weak financial strength because the cost of its debts may adversely affect results of operations and/or increase its default risk. Although our ratios increased following our March 2010 senior note issuance (discussed below), our financial flexibility remains strong.
Our syndicated $1.5 billion credit facility (the “Expired Facility”) was terminated in August 2010. Letters of credit outstanding under the Expired Facility at the time of termination remain valid until their expiry. As a condition of the execution of our new syndicated credit facility (discussed below), we agreed to provide collateral to secure our remaining letter of credit obligations under the Expired Facility. In order to preserve the letter of credit and liquidity capacity previously provided by the Expired Facility, we entered into two new facilities during 2010, as described below. Refer to Item 8, Note 10 (b) for additional information on our credit and letter of credit facilities.
(ii) Maintenance of a maximum debt to total capital ratio of 0.35 to 1. For the purposes of this covenant, unrealized appreciation (depreciation) on our available for sale investments is excluded from total capital.
At December 31, 2010, this facility required a minimum consolidated net worth of $3.820 billion and our actual consolidated net worth as calculated under the provisions of the Syndicated Credit Facility was $5.463 billion. We had a consolidated debt to total capital ratio, calculated in accordance with the Syndicated Credit Facility provisions, of 0.15 to 1 and each of our material insurance/reinsurance subsidiaries party to the agreement had an A.M. Best financial strength rating of A.
In the event of default, including a breach of the covenants outlined above, the lenders may exercise certain remedies including the termination of the facility, the declaration of all principal and interest amounts related to facility loans to be immediately due and the requirement that any outstanding letters of credit that we opted to obtained on an unsecured basis be collateralized.
The standby letters of credit we issue are principally issued in the normal course of business to certain U.S.-based insurance and reinsurance operations that purchase reinsurance protection from us. These letters of credit allow those operations to take credit, under U.S. insurance regulations, for the reinsurance obtained in jurisdictions where AXIS Capital’s subsidiaries are not licensed or otherwise admitted as an insurer. The value of our letters of credit outstanding is driven by, amongst other things, loss development on existing reserves, the payment pattern of such reserves, the expansion of business written by us and the loss experience of such business. In addition to letters of credit, we have established insurance trusts in the U.S. that provide certain clients with statutory relief under U.S. insurance regulations.
As part of our capital management program, our Board of Directors has authorized a share repurchase program. At December 31, 2010, the remaining authorization under the program was $593 million (refer to Item 5 ‘Market for Registrant’s Common Equity, Related Stockholder Matters and Issue Purchases of Equity Securities’ for additional information). The timing and amount of the additional repurchase transactions under this program will depend on a variety of factors, including market conditions and corporate and regulatory considerations.
AXIS Capital and our operating subsidiaries are assigned debt and financial strength (insurance) ratings from internationally recognized rating agencies, including Standard & Poor’s, A.M. Best and Moody’s Investors Service. These ratings are publicly announced and are available directly from the agencies as well as on our Internet website.
(2) We lease office space in a number of locations, with such leases expiring at varying dates. We renew and enter into new leases in the ordinary course of business, as required.
(3) During 2010, we purchased reinsurance protection for our insurance lines of business. The minimum premiums for this protection are payable in advance on a quarterly basis.
We believe the most significant accounting judgment we make is the estimate of our reserve for losses and loss expenses (“loss reserves”). Our loss reserves represent management’s estimate of the unpaid portion of our ultimate liability for losses and loss expenses (“ultimate losses”) for insured and reinsured events that have occurred at or before the balance sheet date. Our loss reserves reflect both claims that have been reported to us (“case reserves”) and claims that have been incurred but not yet reported to us (“IBNR”). Our loss reserves represent our best estimate of what the ultimate settlement and administration of claims will cost, based on our assessment of facts and circumstances known at that particular point in time.
Our quarterly reserving process begins with the collection and analysis of paid and incurred claim data for each of our segments. The segmental data is disaggregated by reserving class and further disaggregated by accident year (i.e. the year in which the loss event occurred). We use underwriting year information (i.e. the year in which the contract incepted) to analyze some of our proportional treaties and subsequently allocate reserves to the respective accident years. Our reserving classes are selected to ensure that the underlying contracts have homogeneous loss development characteristics, while remaining large enough to make the estimation of trends credible. We review our reserving classes on a regular basis and adjust them over time as our business evolves. This data serves as a key input to many of the methods employed by our actuaries. Given our relatively limited operating history, this data is also supplemented with industry benchmarks. The relative weights assigned to our own historical loss data versus industry data vary according to the length of the development profile for the reserving class being evaluated. At present, we generally give more weight to our own experience (and, correspondingly, less weight to industry data) for reserving classes with short and medium claim tails; the converse is true for reserving classes with longer claim tails. (See ‘Claim Tail Class Analysis’ for more detailed information by claim tail class.)
Expected Loss Ratio Method (“ELR”): This method estimates ultimate losses for an accident year by applying an expected loss ratio to the earned premium for that accident year. Generally, expected loss ratios are based on one or more of (a) an analysis of historical loss experience to date, (b) pricing information and (c) industry data, adjusted as appropriate, to reflect changes in rates and terms and conditions. This method is insensitive to actual incurred losses for the accident year in question and is, therefore, often useful in the early stages of development when very few losses have been incurred. Conversely, the lack of sensitivity to incurred/paid losses for the accident year in question means that this method is usually inappropriate in later stages of that accident year’s development.
Loss Development Method (also referred to as the Chain Ladder Method or Link Ratio Method): This method assumes that the losses incurred/paid for each accident year at a particular development stage follow a relatively similar pattern. It assumes that on average, every accident year will display the same percentage of ultimate losses incurred/paid at the same point in time after the inception of the accident year. The percentages incurred/paid are established for each development stage (e.g. 12 months, 24 months, etc.) after examining historical averages from historical loss development data and/or external industry benchmark information. Ultimate losses are then estimated by multiplying the actual incurred/paid losses by the reciprocal of the established incurred/paid percentage. The strengths of this method are that it reacts to loss emergence/payments and that it makes full use of historical claim emergence/payment experience. However, this method has weaknesses when the underlying assumption of stable loss development/payment patterns is not valid. This could be the consequence of changes in business mix, claim inflation trends or claim reporting practices and/or the presence of large claims, amongst
Our credit and political risk insurance business consists primarily of credit insurance and confiscation, expropriation, nationalization and deprivation coverages (“CEND”). Claims for this business tend to be characterized by their severity risk, as opposed to their frequency risk. Therefore, claim payment and reporting patterns are anticipated to be volatile. Under the notification provisions of our credit insurance, we anticipate being advised of an insured event within a relatively short time period. As a result, we generally estimate ultimate losses based on a contract-by-contract analysis which considers the contracts’ terms, the facts and circumstances of underlying loss events and qualitative input from claims managers.
An important and distinguishing feature of many of these contracts, though, is our contractual right, subsequent to payment of a claim to our insured, to be subrogated to, or otherwise have an interest in, the insured’s rights of recovery under an insured loan or facility agreement. These estimated recoveries are recorded as an offset to our credit and political risk loss reserves. The lag between the date of a claim payment and our ultimate recovery from the corresponding security can result in negative case reserves at a point in time (as was the case at December 31, 2010 and 2009). The nature of the underlying collateral is specific to each transaction and we also estimate the value of this collateral on a contract-by-contract basis. This valuation process is inherently subjective and involves the application of management’s judgment because active markets for the collateral often do not exist. Our estimates of value are based on numerous inputs, including information provided by our insured, as well as third party sources including rating agencies, asset valuation specialists and other publicly available information. We also assess any post-event circumstances, including restructurings, liquidations and possession of asset proposals/agreements.
We cannot estimate losses from widespread catastrophic events, such as hurricanes, using the traditional actuarial methods described above. Rather, loss reserves for such events are estimated by management after a catastrophe occurs by completing an in-depth analysis of individual contracts which may potentially be impacted by the catastrophic event. This in-depth analysis may rely on several sources of information, including: (1) estimates of the size of insured industry losses from the catastrophic event and our corresponding market-share; (2) a review of our portfolio of contracts performed to identify those contracts which may be exposed to the catastrophic event; (3) a review of modeled loss estimates based on information previously reported by customers and brokers, including exposure data obtained during the underwriting process; (4) discussions of the impact of the event with our customers and brokers and (5) catastrophe bulletins published by various independent statistical reporting agencies. We generally use a blend of these information sources to arrive at our aggregate estimate of the ultimate losses arising from the catastrophic event. In subsequent reporting periods, we review changes in paid and incurred losses in relation to each significant catastrophe and adjust our estimates of ultimate losses for each event if there are developments that are different from our previous expectations; such adjustments are recorded in the period in which they are identified.
a contract-by-contract review, which considers information provided by clients together with estimates provided by our underwriters and actuaries about the impact of changes in pricing, terms and conditions and coverage. We also consider the market experience of an independent actuarial firm, as appropriate.
The quarterly evaluation process also includes consultation with an independent actuarial firm. The work performed by the actuarial firm is an important part of the reserving process. We compare our recorded loss reserves to those estimated by the actuarial firm to determine whether our single point best estimate is reasonable. On an annual basis, the independent actuarial firm provides an actuarial opinion on the reasonableness of our loss reserves for each of our operating subsidiaries; such actuarial opinions are required to meet various insurance regulatory requirements. The actuarial firm discusses its conclusions with management and presents its findings to our Board of Directors.
increased the weighting assigned to our own historical experience in selecting the expected loss ratios and loss development patterns utilized to establish our initial estimates of ultimate losses. Given that our own loss experience has generally been more favorable than we expected based on industry benchmarks, the incorporation of this data has generally led to a reduction in our loss ratios and the recognition of favorable development on prior accident years. See ‘Underwriting Results - Group - Prior Period Development’ for a discussion of the net favorable development recognized when re-estimating our ultimate losses for our short-tail business in the last three years.
Our medium-tail business primarily consists of professional lines insurance and reinsurance and trade credit and bond reinsurance business. Certain other classes, including aviation hull and offshore energy insurance and engineering reinsurance, are also considered to have a medium-tail. Claim reporting and settlement periods on these reserving classes are generally longer than those of our short-tail reserving classes. We also consider our credit and political risk insurance business to have a medium tail, due to the complex nature of claims and the potential additional time that may be required to realize our subrogation assets.
Refer to the previous discussion of this business under ‘Reserving Process - Actuarial Analysis’ above for a discussion of specific loss reserve issues related to this business. When considering prior accident year reserve development for this line of business, it is important to consider that the multi-year nature of the credit business distorts loss ratios when a single accident year is considered in isolation. In recent years, the average term of these contracts has been four to five years. The premiums we receive are generally earned evenly over the contract term, thus spanning multiple accident years. In contrast, losses incurred on these contracts, which can be characterized as low in frequency and high in severity, are reflected in a single accident year.
Given our relatively short operating history, we do not believe that our own historical loss development for our long-tail business has amassed an appropriate volume to serve as a credible input to the actuarial methodologies previously outlined. As a result, we have predominantly used the ELR Method to derive our initial estimated ultimate loss ratios for all accident years. Our expected loss ratios have been derived almost exclusively from industry benchmarks, rather than our own historical experience. While we utilize industry benchmarks that we believe reflect the nature and coverage of our business, our actual loss experience may differ from industry benchmarks that are based on averages.
The following tables show the effect on our estimate of gross loss reserves of reasonably likely changes in the two key assumptions used to estimate our gross loss reserves at December 31, 2010:
The second estimate is the amount of reinsurance recoverable on unpaid and paid losses that we will ultimately be unable to recover from reinsurers. The majority of our reinsurance recoverable on unpaid losses will not be due for collection until some point in the future. As a result, the amount we ultimately collect may differ from our estimate due to the ability and willingness of reinsurers to pay our claims. This willingness may be negatively impacted by factors such as insolvency, a contractual dispute over contract language or coverage and/or other reasons. Additionally, over the period of time before the amounts become due to us, economic conditions and/or operational performance of a particular reinsurer may deteriorate and this could also affect the willingness and ability of a reinsurer to meet their contractual obligations to us. Accordingly, we review our reinsurance recoverable on a quarterly basis and estimate and record an offsetting provision for uncollectible amounts. Any changes in this provision are reflected in net income. We are selective in choosing our reinsurers, placing reinsurance principally with reinsurers with a strong financial condition and industry ratings.
See Item 8, Note 8 to the Consolidated Financial Statements for an analysis of reinsurance recoverable and valuation provision by segment. For an analysis of the credit risk associated with our reinsurance recoverable balances at December 31, 2010, refer to Item 8, Note 11 to the Consolidated Financial Statements.
For the majority of our insurance business, we receive a fixed premium which is identified in the policy and recorded as unearned premium on the inception date of the contract. This premium will be adjusted only if the underlying insured values adjust. Accordingly, we actively monitor underlying insured values and record adjustment premiums in the period in which amounts are reasonably determinable. Gross premiums written on a fixed premium basis accounted for approximately 97%, 96% and 95% of the segment’s total for the years ended December 31, 2010, 2009 and 2008, respectively. A portion of this business is written through managing general agents (“MGAs”), third parties granted authority to bind risks on our behalf in accordance with our underwriting guidelines. For this business, we record premiums based on monthly statements received from the MGAs. Due to inherent reporting delays on this business bound by third parties, we generally record premiums written via MGAs one month in arrears. In the event an individual statement, which is considered significant, is not received we would record our best estimate based upon our historical experience.
Our excess of loss reinsurance contracts with cedants generally include provisions for a deposit or minimum premium payable to us. The minimum/deposit premium is generally adjusted at the end of the contract period to reflect changes in the underlying risks in force during the contract period. Minimum/deposit premiums generally cover the majority of premiums due under excess of loss contracts, with the adjustable portion typically comprising an insignificant portion of the total premium receivable by us. Therefore, the deposit/minimum premiums are generally considered to be the best estimate of the reinsurance contracts’ written premiums at inception. We record adjustments to the deposit/minimum premiums in the period during which they become determinable. Excess of loss contracts accounted for 55%, 60% and 67% of our reinsurance segment’s total gross premiums written for the years ended December 31, 2010, 2009 and 2008, respectively.
Many of our excess of loss contracts also include provisions that require an automatic reinstatement of coverage in the event of a loss. In a year of large loss events, reinstatement premiums will be higher than in a year in which there are no such events. Reinstatement premiums are recognized when a triggering loss event occurs and losses are recorded by us. While the reinstatement premium amount is defined by contract terms, our recognition of reinstatement premiums is dependent on our estimate of losses and loss expenses, which reflect management’s best judgment as described above in ‘Reserves for Losses and Loss Expenses’.
Line slip and proportional insurance and reinsurance contracts are generally written on a “risks attaching” basis, covering claims that attach to the underlying policies written during the terms of such contracts. Generally, we earn these premiums evenly over a 24-month period as the underlying exposures incept throughout the contract term, which is typically one year, and such underlying exposures generally have a one year coverage period.
The following section is a summary of the valuation methodologies we used to measure our financial instruments.
At December 31, 2010 and 2009, we have not adjusted any pricing provided by independent pricing services (see ‘Management Pricing Validation’ below). Accordingly, except for U.S. Treasury securities, we have classified all the remaining fixed maturities priced by pricing services as Level 2. As U.S. Treasury securities are liquid and trade in an active market, we have classified these securities as Level 1.
Generally, we obtain quotes directly from broker-dealers who are active in the corresponding markets when prices are unavailable from independent pricing services. This may also be the case if the pricing from these pricing services is not reflective of current market levels, as detected by our pricing control tolerance procedures. Generally, broker-dealers value securities through their trading desks based on observable market inputs. Their pricing methodologies include mapping securities based on trade data, bids or offers, observed spreads and performance on newly issued securities. They may also establish pricing through observing secondary trading of similar securities.
For certain securities within the corporate bond portfolio such as medium-term notes, we use prices provided by independent administrators which are marked to market daily. Pricing is based on the mid point of the bid-ask quotes, where available; otherwise it is obtained from a sample of non-binding quotes from broker-dealers in active markets. For medium-term notes, we have transparency with respect to their underlying securities, and therefore we can corroborate the pricing received with relevant observable market data. Accordingly, these securities were also classified as Level 2.
As management is ultimately responsible for determining the fair value measurements for all securities, we validate prices received by comparing the fair value estimates to our knowledge of the current markets. We challenge any prices we believe may not be representative of fair value under current market conditions. Our review process includes, but is not limited to: (i) initial and ongoing evaluation of the pricing methodologies and valuation models used by outside parties to calculate fair value; (ii) quantitative analysis; (iii) a review of multiple quotes obtained in the pricing process and the range of resulting fair values for each security, if available, and (iv) randomly selecting purchased or sold securities and comparing the executed prices to the fair value estimates provided by the independent pricing sources and broker-dealers.
For hedge and credit funds, we measure fair value by obtaining the net asset value as advised by our external fund manager or third party administrator, which involves limited management judgment. For any funds for which we did not receive a December 31, 2010 net asset value, we have recorded an estimate of the change in fair value for the latest period based on return estimates obtained from the fund managers. Accordingly, we do not have a reporting lag in our fair value measurements for these funds. The financial statements of each fund in our portfolio are generally prepared using fair value measurements for the underlying investments and are audited annually. In addition to reviewing these audited financial statements, we regularly review fund performance directly with the fund managers and perform qualitative analysis to corroborate the reasonableness of the reported net asset values. We have classified the hedge and credit funds as Level 3 within the fair value hierarchy as these funds have redemption restrictions (see Item 8, Note 5(b) of the Consolidated Financial Statements for further details).
We have also invested in equity tranche CLO securities (“CLO - Equities”), also known as “cash flow CLOs” in the industry. For these securities, we estimate fair value based on observable relevant trades in active secondary markets where available or the use of an income approach valuation technique (internal cash flow model) where the market is inactive.
We review quarterly whether a decline in the fair values of available-for-sale (“AFS”) securities below their amortized costs is other-than-temporarily impaired. The OTTI assessment is inherently judgmental, especially where securities have experienced severe declines in fair value in a short period.
Our OTTI review process is a rigorous quantitative and qualitative approach. We identify securities for review based on credit quality, relative health of industry sector, yield analysis, security performance and topical issues. For identified securities, we prepare a fundamental analysis at the security level and consider the following qualitative factors:
The length of time and extent to which the fair value has been less than the amortized cost for fixed maturities or cost for equity securities.
3) do not anticipate to recover fully the amortized cost based on projected cash flows to be collected.
A security is “impaired” when the fair value is below its amortized cost. If the impaired fixed maturity security meets either of the first two criteria above, the entire difference between the security’s fair value and its amortized cost is recorded as an OTTI charge in the Consolidated Statements of Operations. However, if the impairment arises due to an anticipated credit loss on the security (third criterion above), we recognize only the credit component of the OTTI amount in earnings with a corresponding adjustment to amortized cost (new cost basis). The non-credit component (e.g. interest rates, market conditions, etc.) of the OTTI amount is recognized in other comprehensive income in our shareholders’ equity. The new amortized cost is accreted into net investment income.
The credit loss component of OTTI recognized in earnings is generally calculated based on the difference between the amortized cost of the security and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security prior to the impairment. The significant inputs and the methodology used to estimate the credit losses for which a portion of the OTTI was recognized in other comprehensive income (loss) are disclosed in Item 8, Note 5(d) to the Consolidated Financial Statements.
Because equity securities were specifically excluded from the above new OTTI recognition model, we continue to consider our “ability and intent” to hold an equity security in an unrealized position for a reasonable period of time to allow for a full recovery. As an equity security does not have a maturity date, the forecasted recovery for an equity security is inherently more judgmental than for a fixed maturity security.
In light of the volatile global equity markets we have experienced in the last two years, we generally impair any equities for which we do not forecast a recovery to cost within three years. Further, we generally impair an equity security if its value has declined by more than 30% for nine consecutive months.
See Item 8, Note 2(n) to the Consolidated Financial Statements for a discussion of recently issued accounting pronouncements we have not yet adopted.
In this report, we have presented operating income, which is a “non-GAAP financial measure” as defined in Regulation G. Operating income represents after-tax operational results without consideration of after-tax net realized investment gains (losses). In addition, we have presented diluted operating earnings per share and operating return on average common equity (“operating ROACE”), which are derived from the non-GAAP operating income measure. These measures can be reconciled to the nearest GAAP financial measures as follows:
(1) Tax benefit (cost) of ($1,974), $6,354 and ($194) for 2010, 2009 and 2008, respectively. Tax impact is estimated by applying the statutory rates of applicable jurisdictions, after consideration of other relevant factors including the ability to utilize capital losses.
We present our results of operations in the way we believe will be most meaningful and useful to investors, analysts, rating agencies and others who use our financial information to evaluate our performance. This presentation includes the use of “operating income” and “operating return on average common equity”, which is based on the “operating income” measure. Although the investment of premiums to generate income and realized investment gains (or losses) is an integral part of our operations, the determination to realize investment gains (or losses) is independent of the underwriting process and is heavily influenced by the availability of market opportunities. Furthermore, many users believe that the timing of the realization of investment gains (or losses) is somewhat opportunistic for many companies. In this regard, certain users of our financial statements evaluate earnings excluding after-tax net realized investment gains (losses) to understand the profitability of recurring sources of income.
We believe that showing net income available to common shareholders exclusive of net realized gains (losses) reflects the underlying fundamentals of our business. In addition, we believe that this presentation enables investors and other users of our financial information to analyze performance in a manner similar to how our management analyzes the underlying business performance. We also believe this measure follows industry practice and, therefore, facilitates comparison of our performance with our peer group. We believe that equity analysts and certain rating agencies that follow us, and the insurance industry as a whole, generally exclude realized gains (losses) from their analyses for the same reasons.
Consolidated Statements of Cash Flows for the years ended December 31, 2010, 2009 and
We have audited the accompanying consolidated balance sheets of AXIS Capital Holdings Limited and subsidiaries (the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of operations, comprehensive income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 18, 2011 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) and include the accounts of AXIS Capital and its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated. To facilitate comparison of information across periods, certain reclassifications have been made to prior year amounts to conform to the current year’s presentation.
Our fixed maturities and equities classified as “available for sale” are reported at fair value at the balance sheet date. See Note 6 - Fair Value Measurements for additional information regarding the determination of fair value.
The net unrealized gain or loss on our available for sale investments, net of tax, is included as a separate component of accumulated other comprehensive income (loss) (“AOCI”) in shareholders’ equity. On a quarterly basis, we assess whether unrealized losses on available for sale investments represent impairments that are other than temporary. Several factors are considered in this assessment including, but not limited to: (i) the extent and duration of the decline, (ii) the reason for the decline (e.g. credit spread widening, credit event), (iii) the historical and implied future volatility of the fair value, (iv) the financial condition and near-term prospects of the issuer and (v) the collateral structure and credit support of the security, if applicable.
Under the new guidance, if the impaired fixed maturity security meets the first criteria above, the entire difference between the security’s fair value and its amortized cost is recorded as an OTTI charge in the Consolidated Statements of Operations. However, if the impairment arises due to an anticipated credit loss on the security (i.e. the second criteria above), we recognize only the credit component of the OTTI amount in earnings and make a corresponding adjustment to amortized cost (establishing a new cost basis). The non-credit component (e.g. that related to interest rates, market conditions, etc.) of the OTTI amount is recognized in AOCI. The new amortized cost is subsequently accreted into net investment income.
For equity securities, we consider our ability and intent to hold an equity security in an unrealized loss position for a reasonable period of time to allow for a full recovery. When we determine that the decline in value of an equity security is other-than-temporary, we reduce the carrying value of the equity security to its fair value and recognize a corresponding charge in the Consolidated Statements of Operations.
Reinstatement premiums are recognized at the time a loss event occurs and coverage limits for the remaining life of the contract are reinstated under pre-defined contract terms; such premiums are earned over the remaining risk period. The accrual of reinstatement premiums is based on our estimate of losses and loss adjustment expenses, which reflects management’s judgment, as described in Note 2 (d) - Losses and Loss Expenses below.
In the normal course of business, we purchase reinsurance protection to limit our ultimate losses from catastrophic events and to reduce our loss aggregation risk. The premiums paid to our reinsurers (i.e. premiums ceded) are expensed over the coverage period. Prepaid reinsurance premiums represent the portion of premiums ceded which is applicable to the unexpired term of the contracts in force. Reinstatement-related premiums ceded are recorded at the time a loss event occurs and our coverage limits for the remaining life of a contract are reinstated under pre-defined contract terms; such premiums are expensed over the remaining risk period.
The Company is authorized to issue restricted stock awards and units, stock options and other equity-based awards to its employees and directors. The fair value of the compensation cost is measured at the grant date and expensed over the period for which the employee is required to provide services in exchange for the award. The expense associated with awards subject to graded vesting is recognized on a straight-line basis. Forfeiture benefits are estimated at the time of grant and incorporated in the determination of stock-based compensation.
We may enter into derivative instruments such as futures, options, interest rate swaps and foreign currency forward contracts as part of our overall foreign currency risk management strategy, to obtain exposure to a particular financial market or for yield enhancement. From time to time we may also enter into insurance and reinsurance contracts that meet the definition of a derivative contract, as defined by the FASB.
We measure all derivative instruments at fair value (see Note 6 - Fair Value Measurements) and recognize them as either assets or liabilities in the Consolidated Balance Sheets. We record the changes in fair value and any realized gains or losses on derivative instruments in the Consolidated Statements of Operations.
We may designate a currency derivative as a hedge of movements in the fair value of certain investment portfolios attributable to changes in foreign exchange rates. This is referred to as a fair value hedge. Changes in the fair value of a designated fair value hedge, along with the changes in the fair value of the hedged asset or liability attributable to the hedged risk, are recorded in net realized investment gains (losses), along with any hedge ineffectiveness.
Certain subsidiaries and branches of the Company operate in jurisdictions where they are subject to taxation. Current and deferred income taxes are charged or credited to net income, or, in certain cases, to AOCI, based upon enacted tax laws and rates applicable in the relevant jurisdiction in the period in which the tax becomes accruable or realizable. Deferred income taxes are provided for all temporary differences between the bases of assets and liabilities used in the Consolidated Balance Sheets and those used in the various jurisdictional tax returns. When our assessment indicates that it is more likely than not that a portion of a deferred tax asset will not be realized in the foreseeable future, a valuation allowance against deferred tax assets is recorded. We recognize the tax benefits of uncertain tax positions only when the position is more-likely-than-not to be sustained upon audit by the relevant taxing authorities.
Common shares repurchased by the Company and not subsequently cancelled are classified as treasury shares and are recorded at cost. This results in a reduction of shareholders’ equity in the Consolidated Balance Sheets.
Effective January 1, 2010, we adopted new guidance issued by the FASB requiring additional disclosures about transfers into and out of Levels 1 and 2 of the fair value hierarchy and separate disclosures about purchases, sales, issuance, and settlements relating to Level 3 measurements. As these new requirements related solely to disclosures, the adoption did not impact our results of operations, financial condition or liquidity. The additional disclosures have been provided in Note 6 - Fair Value Measurements.
Effective January 1, 2010, we adopted amended FASB guidance related to the consolidation of VIEs. This new guidance modifies the approach for determining the primary beneficiary of a VIE by eliminating the initial quantitative assessment and requiring ongoing qualitative reassessments. The adoption of this guidance did not result in the consolidation of additional VIEs.
Effective October 1, 2010, we adopted new guidance issued by the FASB requiring disclosures about the nature of credit risk in financing receivables and how that risk is analyzed in determining the related allowance for credit losses, as well as details on changes in the allowance for credit losses during the reporting period. Additional disclosures with respect to this guidance have been provided in sections (c) and (e) of this note, as well as Note 11 - Commitments and Contingencies.
In October 2010, the FASB issued guidance modifying the definition of the types of costs that can be capitalized in relation to the acquisition of new and renewal insurance contracts. The amended guidance requires costs to be incremental or directly related to the successful acquisition of new or renewal contracts in order to be capitalized as a deferred acquisition cost. Capitalized costs would include incremental direct costs, such as commissions paid to brokers. Additionally, the portion of employee salaries and benefits directly related to time spent for acquired contracts would be capitalized. Costs that fall outside the revised definition must be expensed when incurred. This new guidance is effective for January 1, 2012 and may be adopted either prospectively or retrospectively. Earlier adoption is permitted, provided the guidance is applied at the beginning of the company’s financial year. The transitional provisions of this guidance also indicate that if the application of this guidance would result in the capitalization of acquisition costs that had not previously been capitalized, we may elect not to capitalize those types of costs. We intend to early adopt this guidance prospectively at January 1, 2011 and expect that adoption will not impact our results of operations, financial condition or liquidity.
Our underwriting operations are organized around our two global underwriting platforms, AXIS Insurance and AXIS Re. Therefore we determined that we had two reportable segments, insurance and reinsurance. Except for goodwill and intangible assets, we do not allocate our assets by segment as we evaluate the underwriting results of each segment separately from the results of our investment portfolio.
The following table presents our net premiums earned by segment and line of business:
On January 7, 2009, we acquired Dexta Corporation Pty Ltd (“Dexta”), an underwriting agency in Australia. The total purchase consideration to acquire Dexta was not material to our consolidated financial position. This acquisition resulted in the recognition of $15 million and $20 million of goodwill and intangible assets with a finite life, respectively. The functional currency of Dexta is the Australian dollar; accordingly, in the above table goodwill and intangible assets were translated at the exchange rate in effect at December 31, 2010. The acquired intangible assets with a finite life consist primarily of Dexta’s distribution network.
(1) Agency mortgage-backed securities (MBS) include agency residential MBS (RMBS) and agency commercial MBS (CMBS).
(2) Asset-backed securities (ABS) include debt tranched securities collateralized by sub-prime mortgages, auto loans, credit cards, and other asset types. This asset class also includes an insignificant position in collateralized loan obligations (CLOs) and collateralized debt obligations (CDOs).
(4) Represents the non-credit component of the other-than-temporary impairment (OTTI) losses, adjusted for subsequent sales of securities. It does not include the change in fair value subsequent to the impairment measurement date.
maximum exposure to loss on these interests is limited to the amount of our investment. We have not provided financial or other support with respect to these structured securities other than our original investment.
Note: In the absence of an S&P rating, we used the lower rating established by Moody’s or Fitch.
At December 31, 2010, 206 (2009: 312) securities have been in continuous unrealized loss position for 12 months or greater and have a fair value of $410 million (2009: $705 million). At December 31, 2010, the securities in an unrealized loss position were primarily corporate debt, non-agency RMBS, and ABS with a weighted average S&P credit rating of A+, A-, and BBB- respectively while at December 31, 2009, the securities were primarily corporate debt, non-agency RMBS, non-agency CMBS and ABS with a weighted averaged S&P credit rating of BBB+, A, AA and A-, respectively.
At December 31, 2010, 71 securities (2009: 95) were in an unrealized loss position and 12 of these securities (2009: 56) have been in a continuous unrealized loss position for 12 months or greater. Based on our OTTI quarterly review process and our ability and intent to hold these securities for a reasonable period of time sufficient for a full recovery, we concluded that the above equities in an unrealized loss position were temporarily impaired at December 31, 2010 and 2009.
At December 31, 2010 and 2009, we have no unfunded commitments relating to our investments in hedge and credit funds.
Credit losses are calculated based on the difference between the amortized cost of the security and the net present value of its projected future cash flows discounted at the effective interest rate implicit in the debt security prior to the impairment.
The following provides a summary of the credit loss activities by asset class during 2010 and 2009, as well as the significant inputs and the methodology used to estimate these credit losses.
During 2010, we sold some previously impaired corporate debt securities, resulting in a decrease in credit loss impairments of $9 million (2009: $21 million) in the above credit loss table. Additionally, certain previously impaired MTNs matured with realized gains of $29 million in 2010, resulting in a reduction of $85 million in the remaining estimated credit losses in the above table. At December 31, 2010 all the remaining MTNs were in an unrealized gain position.
During 2009, we recognized $263 million of estimated credit losses on MTNs, which are included in the above credit loss table. In response to the credit crisis, the MTN managers reduced their leverage levels which in turn lowered the credit duration of the MTNs. As credit markets recovered and credit spreads tightened in 2009, price appreciation was not as pronounced as the depreciation during 2008 due to the lower credit duration of the MTNs. The tightening of credit spreads was more significant and much quicker than anticipated which hindered the ability of the MTN managers to reinvest the underlying cash flows at wider credit spreads. Consequently, we revised the significant inputs in our projected cash flows for the MTNs (see below), resulting in a significant credit impairment charge in the third quarter of 2009.
For MTNs, our projected cash flows also include significant inputs such as future credit spreads and the use of leverage over the expected duration of each of the medium-term notes. At December 31, 2009, we used the following significant inputs:
During 2009, we recorded credit losses of $14 million on non-agency RMBS. At December 31, 2009, our non-agency RMBS had gross unrealized losses of $35 million, consisting of $13 million of Prime, $16 million of Alt-A and $6 million of Subprime MBS. We used the following weighted average inputs to estimate the credit losses for potentially impaired Prime and Alt-A MBS in an unrealized loss position at December 31, 2009:
Our assumptions on default and loss severity rates are established based on an assessment of actual experience to date for each CLO debt tranche and review of recent credit rating agencies’ default and loss severity forecasts. Based on projected cash flows at December 31, 2010, we do not anticipate credit losses on the CLO debt tranched securities.
We used the following valuation technique and assumptions in estimating the fair value of our financial instruments as well as the general classification of such financial instruments pursuant to the above fair value hierarchy.
At December 31, 2010, and 2009, the CLO - equity tranched securities (“CLO - Equities”) were classified within Level 3 as we estimated the fair value for these securities using an income approach valuation technique (internal cash flow model) due to the lack of observable, relevant trades in the secondary markets. The following table presents a range of significant inputs used in our valuation model.
The changes made to the above significant inputs in 2010 did not impact significantly the fair value of the CLO-Equities at December 31, 2010.
Gross and net incurred losses and loss expenses were as follows:
The following table summarizes information on the location and amounts of derivative fair values on the consolidated balance sheets at December 31, 2010 and 2009:
The hedging relationship foreign currency contracts were entered into to mitigate the foreign currency exposure of two available for sale fixed maturity portfolios denominated in Euros. The hedges were designated and qualified as a fair value hedge. The net impact of the hedges is recognized in net realized investment gains (losses).
In September 2007, we issued a policy which indemnified a third party in the event of a non-payment of a $400 million asset-backed note. This security had a 10 year term with the full principal amount due at maturity and was collateralized by a portfolio of life settlement contracts and cash held by a special purpose entity. We concluded that the indemnity contract was a derivative instrument and accordingly we recorded it at its fair value. This contract was cancelled and settled during the fourth quarter of 2009.
We have the option to redeem the Senior Notes at any time and from time to time, in whole or in part, at a “make-whole” redemption price, which is equal to the greater of the aggregate principal amount or the sum of the present values of the remaining scheduled payments of principal and interest. The related indentures contain various covenants, including limitations on liens on the stock of restricted subsidiaries, restrictions as to the disposition of the stock of restricted subsidiaries and limitations on mergers and consolidations. We were in compliance with all the covenants contained in the indentures at December 31, 2010 and 2009.
Interest expense recognized in relation to our Senior Notes includes interest payable, amortization of the offering discounts and amortization of debt offering expenses. The offering discounts and debt offering expenses are amortized over the period of time during which the Senior Notes are outstanding. During 2010, we incurred interest expense of $52 million (2009 and 2008: $29 million).
We monitor and control the aggregation of credit risk on a consolidated basis by assigning limits on maximum credit exposures in certain categories including, but not limited to, single obligors and groups, industry sector, country and region. Such limits are based on a variety of factors, including the prevailing economic environment and the nature of the underlying credit exposures. The credit risk reporting process is supported by an exposure database, which contains relevant information on counterparties and credit risk; we also license third party databases to provide credit risk assessments.
The assets that potentially subject us to concentrations of credit risk consist principally of investments, reinsurance recoverable and insurance and reinsurance premiums receivable balances, as described below:
Our investment portfolio is managed by external investment managers in accordance with our investment guidelines. Specific provisions limit the allowable holdings of a single issue and issuers. In addition, excluding U.S. government and agency securities, we limit our concentration of credit risk to any single corporate issuer to 2% or less of our fixed
Our reinsurers with the three largest balances accounted for 13%, 11% and 11%, respectively, of our total reinsurance recoverable on unpaid and paid losses balance at December 31, 2010 (2009: 13%, 12% and 13%, respectively). Amounts related to our reinsurers with the ten largest balances comprised 70% of December 31, 2010 balance (2009: 70%) and had a weighted average A.M. Best rating of A (2009: A).
The diversity of our client base limits the credit risk associated with our premiums receivable. In addition, for insurance contracts we have contractual rights to cancel coverage for non-payment of premiums and for reinsurance contracts we have contractual rights to offset premiums receivable with corresponding payments for losses and loss expenses. These contractual rights contribute to the mitigation of credit risk, as does our monitoring of aged receivable balances. In light of these mitigating factors, and considering that a significant portion of our premiums receivable are not currently due based on the terms of the underlying contracts, we do not utilize specific credit quality indicators to monitor our premiums receivable balance. At December 31, 2010, we recorded an allowance for estimated uncollectible premiums receivable of $3 million (2009: $2 million). The corresponding bad debts expense charges for 2010, 2009 and 2008 were insignificant.
We lease office space in the countries in which we operate under operating leases which expire at various dates. We renew and enter into new leases in the ordinary course of business as required. During 2010, total rent expense with respect to these operating leases was $19 million (2009: $17 million; 2008: $15 million).
On December 9, 2010, our Board of Directors declared a dividend of $0.23 per common share to shareholders of record at the close of business on December 31, 2010 and payable on January 18, 2011. The Board of Directors also declared a dividend of $0.453125 per Series A 7.25% Preferred Share and a dividend of $1.875 per Series B 7.5% Preferred Share. The Series A Preferred Share dividend is payable on January 18, 2011, to shareholders of record at the close of business on December 31, 2010 and the Series B Preferred Share dividend is payable on March 1, 2011, to shareholders of record at the close of business on February 15, 2011.
On November 23, 2005, we issued $250 million of 7.50% series B Preferred shares with a liquidation preference of $100.00 per share. We may redeem the shares on or after December 1, 2015 at a redemption price of $100.00 per share. Dividends on the series B Preferred shares if, as and when declared by our board of directors will be payable initially at a fixed rate per annum equal to 7.50% of the liquidation preference on the first day of March, June, September and December of each year, commencing on March 1, 2006, up to but not including December 1, 2015.
The holders of the series A and B Preferred shares will have no voting rights except as described below. Whenever dividends payable on the series A and B Preferred shares have not been declared by the board of directors and paid for an
At December 31, 2010, 19,787,712 (2009: 19,762,574) warrants were outstanding and exercisable at an average price of $12.31 (2009: $12.36) and will expire on November 20, 2011. These warrants include a “cashless exercise” provision which allows the warrant holder to surrender the warrants with a notice of cashless exercise and receive a number of common shares based on the market value of AXIS Capital’s common shares. The cashless exercise provision will result in a lower number of common shares being issued than the numbers of warrants exercised.
At December 31, 2010, we accrued $85 million (2009: $70 million) of cash dividends relating to the anti-dilution provision in respect of the warrants.
Following our shareholders’ approval at the Annual General Meeting held in May 2007, we amended our bye-laws to permit common shares repurchased to be held in treasury. Our Board of Directors authorized the following share repurchase plans:
on December 10, 2009, our Board of Directors authorized to extend the above repurchase plan until December 31, 2011, and approved a new share repurchase plan to repurchase up to $500 million of our common shares until December 31, 2011; and
on September 24, 2010, our Board of Directors approved a new share repurchase plan to repurchase up to $750 million of our common shares until December 31, 2012.
(3) On November 29, 2010, we privately negotiated with Trident II, L.P. and affiliated entities to repurchase 3,062,824 of our common shares.
We have SERPs for our two senior executives: Chairman, Mr. Butt, and President and Chief Executive Officer (CEO), Mr. Charman. The SERP for Mr. Butt requires us to make annual payments to him upon retirement, or beginning January 1, 2010, even if he has not retired, for a period of ten years. The SERP for Mr. Charman requires us to make annual payments to him starting January 1, 2009, even if he has not retired, for a period of twenty years.
The weighted-average assumptions used to determine our net periodic pension cost and benefit obligations were as follows:
(1) Based on the average return for a hypothetical portfolio of high quality corporate bonds (rated AA or better) over the SERP payment period.
(2) Considered the historical returns of equity and fixed maturity markets in conjunction with current economic and financial market conditions.
We have issued stock options, restricted stocks, restricted stock units, and phantom stock units to our employees and non-management directors but none of these awards were subject to performance and market conditions. At December 31, 2010, 3,871,527 equity-based awards remain available for grant under the 2007 Plan. Subsequent to December 31, 2010 and up to February 8, 2011 we granted a total of 1,749,610 stock awards under the 2007 plan as follows:
100,000 restricted stocks with a grant date fair value of $35.29 to our Chief Financial Officer in connection with his employment agreement; and
28,110 unrestricted stocks with a grant date fair value of $35.29 to our non-management directors.
We have granted stock options under the 2003 Plans. The stock options generally become exercisable over a three-year annual vesting period and expire ten years from the date of grant. We have determined the fair value of each stock option grant at the date of grant. Since 2006 we have not granted stock options.
The following is a summary of stock options outstanding and exercisable at December 31, 2010 and related activity for the year ended:
(1) The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between our closing stock price at December 31, 2010 and the exercisable price, multiplied by the number of in-the-money-options) that would have been received by the stock option holder had all stock option holders exercised their stock options on December 31, 2010.
We have granted restricted stock under both our 2003 Plans and the 2007 Plan. The nature and general terms of these plans are materially consistent. Restricted shares are entitled to vote and to receive dividends but may not be transferred during the period of restriction and are forfeited if the employee’s employment terminates prior to vesting. Prior to 2009, the vesting of restricted stock or restricted stock units (“RSUs”) awards were generally subject to a three year cliff vesting provision after the date of grant or upon the employee’s retirement eligibility, death, permanent disability or a qualifying change in control of the Company, if earlier. The restricted stock and RSUs granted in 2009 and 2010 were subject to a vesting period of four years with 25% of the award to be vested annually and has the same accelerated vesting provisions as noted above, excluding the vesting on the employee’s retirement eligibility. Prior to 2008, restricted stock and phantom stock units granted to our non-management directors generally vested six months after the date of grant or upon the director’s earlier retirement, death, permanent disability or a change in control of the Company. Starting in 2008, under the 2007 Plan, we granted common stock and phantom stock units with no vesting restriction to our non-management directors.
The following table provides a reconciliation of the beginning and ending balance of nonvested restricted stock (including restricted stock units) for the year ended December 31, 2010:
during 2010 was $56 million (2009: $57 million; 2008: $24 million). At December 31, 2010, we had 3,882 (2009: 4,555) nonvested restricted stocks outstanding with $61 million (2010: $63 million) of unrecognized compensation cost. These are expected to be recognized over the weighted average period of 2.6 years (2009: 2.4 years).
The collateral manager of four of our CLOs is Blackstone Debt Advisors L.P., who is entitled to management fees payable by the collateralized obligations in the ordinary course of business. We also have investments in three hedge funds and a credit fund that are managed by Blackstone Alternative Asset Management, LP, who is entitled to management fees in the ordinary course of business. During 2010, total management fees to the Blackstone Group were $2 million (2009: $1 million; 2008: $2 million).
Under current Bermuda law, we are not required to pay any taxes in Bermuda on income or capital gains. We have received an undertaking from the Minister of Finance in Bermuda that, in the event of any taxes being imposed, we will be exempt from taxation in Bermuda until March 2016. Our Bermuda subsidiary has a branch operation in Singapore, which is subject to the relevant taxes in that jurisdiction. The branch is not under examination in this tax jurisdiction, but remains subject to examination for tax years 2008 through 2010.
Although realization is not assured, management believes it is more likely than not that the tax benefit of the recorded net deferred tax assets will be realized. Other than the deferred tax assets provided for in the valuation allowance, the remaining gross deferred tax assets relate to ordinary income items. Substantially all of these deferred tax assets relate to our U.S. operations. In evaluating our ability to recover our deferred tax assets within the jurisdiction from which they arise, we consider all available positive and negative evidence, including historical results, operating loss carryback potential and scheduled reversals of deferred tax liabilities. Our U.S. operations have produced significant taxable income in prior periods and have deferred tax liabilities that will reverse in future periods such that we believe sufficient ordinary taxable income is available to utilize all remaining deferred tax assets. There were no unrecognized tax benefits at December 31, 2010 and 2009.
Our U.S. operations required statutory capital and surplus is determined using risk based capital tests, which is the threshold that constitutes the authorized control level. If a company falls below the control level, the commissioner is authorized to take whatever regulatory actions considered necessary to protect policyholders and creditors. The maximum dividend that may be paid by our U.S. insurance subsidiaries is restricted by the regulatory requirements of the domiciliary states. Generally, the maximum dividend that may be paid by each of our U.S. insurance subsidiaries is limited to unassigned surplus (statutory equivalent of retained earnings) and may also be limited to statutory net income, net investment income or 10% of total statutory capital and surplus. At December 31, 2010, the maximum dividend that our U.S. insurance operations could pay without regulatory approval was approximately $101 million.
relevant margins is required. At December 31, 2010, the maximum dividend/distribution AXIS Specialty Bermuda could pay, without a signed affidavit, having met minimum levels of statutory capital and surplus requirements, was approximately $1 billion.
Total statutory net income of our operating subsidiaries was $921 million, $685 million, $408 million for 2010, 2009, and 2008, respectively. The difference between statutory financial statements and statements prepared in accordance with U.S. GAAP vary by jurisdiction; however, the primary difference is that statutory financial statements do not reflect deferred acquisition costs, certain net deferred tax assets, goodwill and intangible assets, unrealized appreciation on debt securities or certain unauthorized reinsurance recoverables.
During January 2011, severe flooding occurred in and around Brisbane, Australia. In addition, Tropical Cyclone Yasi made landfall in northern Queensland, Australia on February 3, 2011. We have exposure to these Australian events, primarily through our reinsurance segment, and are currently assessing our potential claims. At February 18, 2011, the available information is insufficient to arrive at reasonable estimates for our net exposure.