We write a diversified portfolio of property and casualty insurance and reinsurance internationally through our subsidiaries and branches based in Bermuda, Europe, Hong Kong, Singapore and the United States as well as our Lloyd’s Syndicate 2232. We manage our business through three operating segments: U.S. insurance, international insurance and reinsurance. As of December 31, 2011, we had approximately $11.1 billion of total assets, $3.1 billion of total shareholders’ equity and $3.9 billion of total capital, which includes shareholders’ equity and senior notes.
During the year ended December 31, 2011, we experienced rate increases on property lines that had experienced significant loss activity on a year-to-date basis. We also continued to see rate improvement on our general casualty line of business while rates continued to decline in some of our other casualty lines. We believe these premium rate decreases are generally due to increased competition and excess capacity over the past several years. Despite the challenging pricing environment, we believe that there are opportunities where certain products have adequate premium rates and that the expanded breadth of our operations allows us to target those classes of business. Given these trends, we continue to be selective in the insurance policies and reinsurance contracts we underwrite. Our consolidated gross premiums written increased by $181.1 million, or 10.3%, for the year ended December 31, 2011 compared to the year ended December 31, 2010. Our net income for the year ended December 31, 2011 decreased by $390.5 million, or 58.7%, to $274.5 million compared to $665.0 million for the year ended December 31, 2010. The decrease in net income for the year ended December 31, 2011 compared to the year ended December 31, 2010 was primarily due to lower total return from investments and higher net losses and loss expenses from property catastrophe losses of $171.8 million in the Asia-Pacific region, $53.7 million from the Midwestern U.S. storms, $43.0 million related to the Thailand floods and $23.7 million from Hurricane Irene.
On September 15, 2011, we reached a mutual agreement with Transatlantic to terminate our previously announced merger agreement. Under the terms of the termination agreement, we received a termination fee of $35.0 million plus a $13.3 million partial reimbursement for merger-related expenses. We received an additional fee of $66.7 million from Transatlantic on November 23, 2011, upon its execution of a merger agreement with Alleghany Corporation.
Operating income is an internal performance measure used in the management of our operations and represents after-tax operational results excluding, as applicable, net realized investment gains or losses, net impairment charges recognized in earnings, net foreign exchange gain or loss, impairment of intangible assets and other non-recurring items. We exclude net realized investment gains or losses, net impairment charges recognized in earnings, net foreign exchange gain or loss and other non-recurring items from our calculation of operating income because these amounts are heavily influenced by and fluctuate in part according to the availability of market opportunities and other factors. We exclude impairment of intangible assets as these are non-recurring charges. We have excluded from our operating income the aggregate $101.7 million termination fee received resulting from our previously announced merger agreement with Transatlantic as this is a non-recurring item. In addition to presenting net income determined in accordance with U.S. GAAP, we believe that showing operating income enables investors, analysts, rating agencies and other users of our financial information to more easily analyze our results of operations and our underlying business performance. Operating income should not be viewed as a substitute for U.S. GAAP net income. The following is a reconciliation of operating income to its most closely related U.S. GAAP measure, net income.
We have included diluted book value per share because it takes into account the effect of dilutive securities; therefore, we believe it is an important measure of calculating shareholder returns.
While management believes that our case reserves and IBNR are sufficient to cover losses assumed by us, there can be no assurance that losses will not deviate from our reserves, possibly by material amounts. The methodology of estimating loss reserves is periodically reviewed to ensure that the assumptions made continue to be appropriate. To the extent actual reported losses exceed estimated losses, the carried estimate of the ultimate losses will be increased (i.e., unfavorable reserve development), and to the extent actual reported losses are less than estimated losses, the carried estimate of ultimate losses will be reduced (i.e., favorable reserve development). We record any changes in our loss reserve estimates and the related reinsurance recoverables in the periods in which they are determined.
Expected Loss Ratio Method. To estimate ultimate losses under the expected loss ratio method, we multiply earned premiums by an expected loss ratio. The expected loss ratio is selected utilizing industry data, historical company data and professional judgment. This method is particularly useful for new insurance companies or new lines of business where there are no historical losses or where past loss experience is not credible.
During 2011, 2010 and 2009, we adjusted our reliance on actuarial methods utilized for certain casualty lines of business and loss years within our U.S. insurance and international insurance segments from using a blend of the Bornhuetter-Ferguson reported loss method and the expected loss ratio method to using only the Bornhuetter-Ferguson reported loss method. We also began adjusting our reliance on actuarial methods utilized for certain other casualty lines of business and loss years within all of our operating segments including the reinsurance segment, by placing greater reliance on the Bornhuetter-Ferguson reported loss method than on the expected loss ratio method. Placing greater reliance on more responsive actuarial methods for certain casualty lines of business and loss years within each of our operating segments is a natural progression as we mature as a company and gain sufficient historical experience of our own that allows us to further refine our estimate of the reserve for losses and loss expenses. We believe utilizing only the Bornhuetter-Ferguson reported loss method for older loss years will more accurately reflect the reported loss activity we have had thus far in our ultimate loss ratio selections, and will better reflect how the ultimate losses will develop over time. We will continue to utilize the expected loss ratio method for the most recent loss years until we have sufficient historical experience to utilize other acceptable actuarial methodologies.
The key assumptions used to arrive at our best estimate of loss reserves are the expected loss ratios, rate of loss cost inflation, selection of benchmarks and reported and paid loss emergence patterns. Our reporting factors and expected loss ratios are based on a blend of our own experience and industry benchmarks for longer tailed business and primarily our own experience for shorter tail business. The benchmarks selected were those that we believe are most similar to our underwriting business.
Our overall change in the loss reserve estimates related to prior years decreased as a percentage of total carried reserves during 2011. On an opening carried reserve base of $3,951.6 million, after reinsurance recoverable, we had a net decrease of $253.5 million, or 6.4%, during 2011, and for 2010 we had a net decrease of $313.3 million, or 8.2%, on an opening carried reserve base of $3,841.8 million, after reinsurance recoverables. We believe that these changes are reasonable given the long-tail nature of our business.
and investments to meet those obligations. We believe showing the impact of an increase or decrease in the expected loss ratios is useful information despite the fact that we have realized only net favorable prior year loss development each calendar year. We continue to use industry benchmarks to supplement our expected loss ratios, and these industry benchmarks have implicit in them both favorable and unfavorable loss development, which we incorporate into our selection of the expected loss ratios.
The following tables provide our ranges of loss and loss expense reserve estimates by business segment as of December 31, 2011:
(1) For statistical reasons, it is not appropriate to add together the ranges of each business segment in an effort to determine the low and high range around the consolidated loss reserves. On a gross basis, the consolidated low estimate is $4,369.0 million and the consolidated high estimate is $5,634.4 million.
(2) For statistical reasons, it is not appropriate to add together the ranges of each business segment in an effort to determine the low and high range around the consolidated loss reserves. On a net basis, the consolidated low estimate is $3,527.5 million and the consolidated high estimate is $4,556.4 million.
Our selection of the actual carried reserves has typically been above the midpoint of the range. As of December 31, 2011, we were 4.5% above the midpoint of the consolidated net loss reserve range. We believe that we should be prudent in our reserving practices due to the lengthy reporting patterns and relatively large limits of net liability for any one risk of our direct excess casualty business and of our casualty reinsurance business. Thus, due to this uncertainty regarding estimates for reserve for losses and loss expenses, we have carried our consolidated reserve for losses and loss expenses, net of reinsurance recoverable, above the midpoint of the low and high estimates for the consolidated net losses and loss expenses. We believe that relying on the more prudent actuarial indications is appropriate for these lines of business.
We cede insurance to reinsurers in order to limit our maximum loss, to protect against concentration of risk within our portfolio and to manage our exposure to catastrophic events. Because the ceding of insurance does not discharge us from our primary obligation to the insureds, we remain liable to the extent that our reinsurers do not meet their obligations under the reinsurance agreements. Therefore, we regularly evaluate the financial condition of our reinsurers and monitor concentration of credit risk. No provision has been made for unrecoverable reinsurance as of December 31, 2011 and 2010 as we believe that all reinsurance balances will be recovered.
When we reinsure a portion of our exposures, we pay reinsurers a portion of premiums received on the reinsured policies. Total premiums ceded pursuant to reinsurance contracts entered into by our company with a variety of reinsurers were $405.8 million, $365.9 million and $375.2 million for the years ended December 31, 2011, 2010 and 2009, respectively.
We had net cash outflows relating to ceded reinsurance activities (premiums paid less losses recovered and net ceding commissions received) of approximately $148.3 million, $128.5 million and $116.0 million for the years ended December 31, 2011, 2010 and 2009, respectively. The net cash outflows in all years are reflective of fewer losses that were recoverable under our reinsurance coverages.
General Casualty: We have purchased variable quota share reinsurance for our general casualty business since December 2002. At year-end 2011, the percentage ceded varied by both location of writing office and by limits reinsured, with a significantly larger cession being effective for policies above $25 million in limits. We also have excess-of-loss cover in place for general casualty business written in our Asian branch offices.
Professional Liability: For professional liability policies, our reinsurance varied by writing office and by policy type. Professional liability policies written in our Bermuda, European and U.S. offices were quota-
Healthcare: We purchased quota share and excess-of-loss reinsurance protection for our healthcare line of business written by our Bermuda and U.S. offices, respectively. As is the case with general casualty and professional liability, our healthcare business originating in Asia is under an excess-of-loss reinsurance arrangement.
The following table illustrates our reinsurance recoverable as of December 31, 2011 and 2010:
The following table shows our reinsurance recoverables by operating segment as of December 31, 2011 and 2010:
Historically, our reinsurance recoverables related primarily to our property lines of business, which being short tail in nature, are not subject to the same variations as our casualty lines of business. However, during 2011 and 2010 we have increased the amount of reinsurance we utilize for our casualty lines of business in the U.S. insurance and international insurance segments; and as such, the reinsurance recoverables from our casualty lines of business have increased over the past several years. As the reinsurance recoverables are subject to the same uncertainties as the estimate of case reserves and IBNR reserves, if our final casualty insurance ceded loss ratios vary by eight percentage points from the expected loss ratios in aggregate, our required reinsurance recoverable would increase or decrease by approximately $134.6 million. This would result in either an increase or decrease to income before income taxes and shareholders’ equity of approximately $134.6 million. As of December 31, 2011, this amount represented approximately 4% of total shareholders’ equity.
Equity securities: The fair value of the equity securities are priced from market exchanges and therefore included in the Level 1 fair value hierarchy.
Senior notes: The fair value of the senior notes is based on trades as reported in Bloomberg. As of December 31, 2011, the 7.50% Senior Notes and 5.50% Senior Notes (each as defined in Note 9 of the notes to consolidated financial statements) were traded at 114.3% and 100.4% of their principal amount, providing an effective yield of 4.0% and 5.4%, respectively. The fair value of the senior notes is included in the Level 2 fair value hierarchy.
The following table shows the pricing sources of our fixed maturity investments held as of December 31, 2010:
Securities LLC, Deutsche Bank Securities Inc. and other broker-dealers. When broker-dealer quotes are utilized it is primarily due to the fact that the particular broker-dealer was involved in the initial pricing of the security.
International indices: We use international indices, which include the FTSE, Deutche Teleborse and the Scotia Index, to price our non-U.S. government and government agencies securities. The observable inputs used by international indices to determine its prices are based on new issuance and secondary trades and information provided by broker-dealers.
We utilize independent pricing sources to obtain market quotations for securities that have quoted prices in active markets. In general, the independent pricing sources use observable market inputs, including, but not limited to, investment yields, credit risks and spreads, benchmarking of like securities, non-binding broker-dealer quotes, reported trades and sector groupings to determine the fair value. For a majority of the portfolio, we obtained two or more prices per security as of December 31, 2011. When multiple prices are obtained, a price source hierarchy is utilized to determine which price source is the best estimate of the fair value of the security. The price source hierarchy emphasizes more weighting to significant observable inputs such as index pricing and less weighting towards non-binding broker quotes. In addition, to validate all prices obtained from these pricing sources including non-binding broker quotes, we also obtain prices from our investment portfolio managers and other sources (e.g., another pricing vendor), and compare the prices obtained from the independent pricing sources to those obtained from our investment portfolio managers and other sources. We investigate any material differences between the multiple sources and determine which price best reflects the fair value of the individual security. There were no material differences between the prices from the independent pricing sources and the prices obtained from our investment portfolio managers and other sources as of December 31, 2011.
There have been no material changes to any of our valuation techniques from those used as of December 31, 2010. Based on all reasonably available information received, we believe the prices that were obtained from inactive markets were orderly transactions and therefore, reflected the current price a market participant would pay for the asset. Since fair valuing a financial instrument is an estimate of what a willing buyer would pay for our asset if we sold it, we will not know the ultimate value of our financial instruments until they are sold. We believe the valuation techniques utilized provide us with the best estimate of the price that would be received to sell our assets in an orderly transaction between participants at the measurement date.
For debt securities that are in an unrealized loss position that we do not intend to sell, we assess whether a credit loss exists. The amount of the credit loss is recognized in the income statement. The assessment involves consideration of several factors including: (i) the significance of the decline in value and the resulting unrealized loss position, (ii) the time period for which there has been a significant decline in value and (iii) an analysis of the issuer of the investment, including its liquidity, business prospects and overall financial position.
A significant adverse change in legal factors or in the business climate that could affect the value of the intangible asset, including an adverse action or assessment by a regulator;
As a result of our evaluation, we determined that there was no impairment to the carrying value of our intangible assets with finite lives for the year ended December 31, 2011.
For indefinite lived intangible assets we do not amortize the intangible asset but test these intangible assets for impairment by comparing the fair value of the assets to their carrying values on an annual basis or more frequently if circumstances warrant. The factors we consider to determine if an impairment exists are similar to factors noted above. As a result of our evaluation, we determined that there was no impairment to the carrying value of our indefinite lived intangible assets for the year ended December 31, 2011.
We have moved a significant number of employees into and out of the acquired Darwin legal entities. Former Darwin underwriters now underwrite for historical Allied World companies and vice versa.
Any new business written, with a few limited exceptions, is recorded in one underwriting system, which is the legacy Darwin underwriting system.
Based on the above, the lines have blurred to what cash flow streams are related to the acquisition and what are related to our legacy business. We believe this constitutes a reorganization of the reporting structure under U.S. GAAP. In applying the requirements, we have concluded all the goodwill that was originally allocated to the Darwin reporting unit should be allocated to the U.S. insurance segment reporting unit as the assets employed and the liabilities relate to the U.S. insurance operations. All the insurance operations of Darwin are included into the U.S. insurance segment.
Gross premiums written in our U.S. insurance segment increased by $109.3 million, or 15.0%. The increase in gross premiums written was primarily due to increased new business, including from new
Gross premiums written in our international insurance segment increased by $25.5 million, or 5.1%, due to increased premiums in our general property and healthcare lines and new business including new products. This growth was partially offset by the
The table below illustrates our gross premiums written by geographic location for the years ended December 31, 2011 and 2010.
Net premiums written increased by $141.4 million, or 10.2%, for the year ended December 31, 2011 compared to the year ended December 31, 2010. The increase in net premiums written was primarily due to the increase in gross premiums written. During the twelve months ended December 31, 2011, premiums ceded were reduced by $12.4 million due to the commutation of certain variable-rated reinsurance contracts that have swing-rated provisions. A “swing-rated” reinsurance contract links the ultimate amount of ceded premium to the ultimate loss ratio on the reinsured business. It enables the cedent to retain a greater portion of premium if the ultimate loss ratio develops at a level below the initial loss threshold set by the reinsurers, but requires a higher amount of ceded premium if the ultimate loss ratio develops above the initial threshold. In commuting these swing-rated reinsurance contracts, we reduced certain premiums previously ceded and also reduced ceded IBNR by $11.5 million in accordance with the terms of the contracts. During the twelve months ended December 31, 2010, net premiums written included a $9.3 million reduction in premiums ceded for the commutation of certain variable-rated reinsurance contracts.
Net premiums earned increased by $97.5 million, or 7.2%, for the year ended December 31, 2011 compared to the year ended December 31, 2010 as a result of higher net premiums earned for the U.S. insurance and reinsurance segments. This is driven by increased net premiums written in the current and prior periods, as well as the impact of the commutation of the swing-rated reinsurance contracts, which are fully earned.
As of December 31, 2011, approximately 92.6% of our fixed income investments consisted of investment grade securities. The average credit rating of our fixed income portfolio was AA- as rated by Standard & Poor’s and Aa3 as rated by Moody’s, with an average duration of approximately 1.9 years as of December 31, 2011. The average duration of the investment portfolio was 2.7 years as of December 31, 2010.
Net realized investment gains of $285.6 million for the year ended December 31, 2010 were comprised of the following:
Net realized investment gains of $217.7 million from the sale of securities.
Net realized investment gains of $71.9 million related to the mark-to-market adjustments of our other invested assets and fixed maturity investments that are accounted for as trading securities.
The other income of $101.7 million for the year ended December 31, 2011 represented a termination fee from our previously announced merger agreement with Transatlantic.
Net losses and loss expenses increased by $251.3 million, or 35.5%, for the year ended December 31, 2011 compared to the year ended December 31, 2010. The increase in net losses and loss expenses was due to lower prior year net favorable reserve development and higher catastrophe loss activity in the current period totaling $292.2 million, which included estimated net losses and loss expenses incurred of $96.5 million for the Tohoku earthquake and tsunami, $58.6 million for the New Zealand earthquake, $53.7 million for the Midwestern U.S. storms, $43.0 million related to the Thailand floods, $23.7 million for Hurricane Irene and $16.7 million for the Australian storms. During the year ended December 31, 2010, we incurred $98.4 million of catastrophe-related losses, of which $66.8 million was from the Chilean earthquake, $17.0 million from the New Zealand earthquake and $14.6 million from the Australian floods.
The net favorable reserve development is a result of actual loss emergence being lower than anticipated. The unfavorable reserve development in our U.S. insurance segment for the 2006 loss year was primarily due to directors and officers claims within our professional liability line of business related to a class action suit filed against a number of private equity firms alleging collusion. The unfavorable reserve development in our international insurance segment for the 2010 loss year was primarily due to a casualty claim emanating from an oil field service risk.
During the year ended December 31, 2010 we incurred a one-time 1% capital stamp duty of $1.6 million related to a capital contribution of $160.0 million from Allied World Bermuda to Allied World Switzerland.
Our expense ratio was 30.1% for the year ended December 31, 2011 compared to 32.8% for the year ended December 31, 2010 primarily due to a decrease in the general and administrative expense ratio.
The amortization and impairment of intangible assets decreased $0.5 million, or 14.3%, for the year ended December 31, 2011 compared to the year ended December 31, 2010. The decrease was due to the non-compete covenants related to the acquisition of Darwin being fully amortized during 2010. No impairments were recognized during the year ended December 31, 2011.
Interest expense increased $14.8 million, or 36.8%, for the year ended December 31, 2011 compared to the year ended December 31, 2010 primarily as a result of additional interest expense on our 5.5% senior notes that were issued by Allied World Bermuda in November 2010.
Net investment income decreased by $56.6 million, or 18.8%, for the year ended December 31, 2010 compared to the year ended December 31, 2009. The decrease was due to a combination of lower accretion of book value to par value for our fixed maturity investments, lower yields on our fixed maturity investments and an increased allocation to other invested assets, which contribute to our total return but carry no current yield. We increased our other invested assets by $162.9 million between December 31, 2010 and December 31, 2009. In response to new OTTI guidance issued by the FASB in April 2009, we increased the book value of our fixed maturity investments for any non-credit OTTI previously recognized, which resulted in higher book values and
As of December 31, 2010, approximately 96% of our fixed income investments consisted of investment grade securities. The average credit rating of our fixed income portfolio was AA as rated by Standard & Poor’s and Aa2 as rated by Moody’s, with an average duration of approximately 2.7 years as of December 31, 2010. The average duration of the investment portfolio was 3.0 years as of December 31, 2009.
Net realized investment gains of $217.7 million primarily from the sale of fixed maturity securities due to the rebalancing of our portfolio from U.S. Treasury and agency securities into other asset classes and shortening the overall duration of our investment portfolio as discussed above. The realization of gains is not an explicit strategy of the company but a by-product of actively managing the portfolio. During 2010 active management consisted of managing the duration (increasing the duration to 3.5 years as of March 31, 2010 and decreasing the duration for the remainder of the year) and sector exposures of the portfolio in anticipation of potential interest rate movements and sector spread levels. During 2010, we hired an additional fixed income manager. The transition from the existing manager to our newest manager also contributed to the higher turnover and level of realized investment gains. While we expect to continue to actively manage the portfolio during 2011, we would expect somewhat lower turnover.
During the year ended December 31, 2009, we had $49.6 million of net impairment charges recognized in earnings, $7.7 million was due to credit related losses where the anticipated discounted cash flows of various debt securities were lower than the amortized cost, and $41.9 million was due to net impairment charges for those securities in an unrealized loss position where our investment managers had the discretion to sell.
We recorded net favorable reserve development related to prior years of $313.3 million and $248.0 million during the years ended December 31, 2010 and 2009, respectively. The following table shows the net favorable reserve development of $313.3 million by loss year for each of our segments for the year ended December 31, 2010. In the table, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.
The loss and loss expense ratio for the year ended December 31, 2010 was 52.1% compared to 45.9% for the year ended December 31, 2009. Net favorable reserve development recognized in the year ended December 31, 2010 reduced the loss and loss expense ratio by 23.1 percentage points. Thus, the loss and loss expense ratio related to the current loss year was 75.2%. Net favorable reserve development recognized in the year ended December 31, 2009 reduced the loss and loss expense ratio by 18.8 percentage points. Thus, the loss and loss expense ratio related to that loss year was 64.7%. The increase in the loss and loss expense ratio for the current loss year was primarily due to a net increase in loss reserves of $164.6 million from a number of earthquakes, explosions and other weather related events during the year ended December 31, 2010, which contributed 12.1 points to the current loss year’s loss and loss expense ratio.
Increased stock-related compensation of $8.5 million, which included a one-time increase of $4.3 million for performance-based awards granted under the Company’s equity plans in 2009 to recognize expected performance above the target level. For all performance-based awards, we initially recognize the stock compensation expense at 100% of the fair market value of our common shares on the date of grant and reassess, at least annually, the projected growth in book value to determine whether an adjustment to the initial estimate of the expense should be made. During the year ended December 31, 2010, we have
accrued 150% of the fair market value of Allied World Switzerland’s common shares awarded, as we believe it is probable that we will achieve the maximum performance criteria when these performance-based awards vest at the end of 2011. For additional information on our performance-based awards, see Note 13 “Employee Benefit Plans” in our notes to the consolidated financial statements.
A one-time increase of $12.5 million in professional fees during the year ended December 31, 2010 primarily related to the establishment and operation of Syndicate 2232 and our efforts to effect our redomestication to Switzerland.
Interest expense increased $1.2 million, or 3.0%, for the year ended December 31, 2010 compared to the year ended December 31, 2009 primarily as a result of additional interest expense on our 5.5% senior notes that were issued in November 2010.
International Insurance Segment. The international insurance segment includes our direct insurance operations in Bermuda, Europe, Singapore and Hong Kong. This segment provides both direct property and casualty insurance primarily to Fortune 1000 North American domiciled accounts and mid-sized to large non-North American domiciled accounts.
The following table summarizes the underwriting results and associated ratios for the U.S. insurance segment for the years ended December 31, 2011, 2010 and 2009.
Premiums. Gross premiums written increased by $109.3 million, or 15.0%, for the year ended December 31, 2011 compared to the same period in 2010. The increase in gross premiums written was primarily due to new business from existing products, $55.1 million in premiums from new products, specifically in our general casualty, environmental and inland marine lines of business and rate increases in our general property and general casualty lines of business. This growth was partially offset by the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions), rate reductions in our other lines of business and increased competition.
The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables.
Overall, our U.S. insurance segment recorded net favorable reserve development of $68.5 million during the year ended December 31, 2010 compared to net favorable reserve development of $70.4 million for the year ended December 31, 2009 as shown in the tables below. The $68.5 million of net favorable reserve development excludes the impact of the commutation of the swing-rated reinsurance contracts of $8.9 million discussed above. In the tables, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.
Premiums. Gross premiums written increased by $25.5 million, or 5.1%, for the year ended December 31, 2011 compared to the same period in 2010. The increase in gross premiums written was primarily a result of new business, including $12.5 million from new products, specifically related to our trade credit line of business and small to mid-sized enterprise (“SME”) insurance products. In addition, we increased premiums in our healthcare line of business and experienced rate increases within our general property line of business. This growth was partially offset by the continued trend of the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) including the non-renewal of one general property policy that was previously written during the year ended December 31, 2010 for $5.1 million and the non-renewal of several policies totaling $15.7 million in our general casualty line of business.
Overall, our international insurance segment recorded net favorable reserve development of $118.5 million during the year ended December 31, 2011 compared to net favorable reserve development of $180.6 million for the year ended December 31, 2010, as shown in the tables below. In the tables, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.
The unfavorable reserve development in our professional liability segment for the 2008 loss year related primarily to a greater reliance on the Bornhuetter-Ferguson reported loss method than on the expected loss ratio
method. The unfavorable reserve development in our international insurance segment for the 2010 loss year was primarily due to a casualty claim emanating from an oil field service risk.
Net losses and loss expenses. Net losses and loss expenses increased by $2.1 million, or 1.3%, for the year ended December 31, 2010 compared to the year ended December 31, 2009. The increase in net losses and loss expenses was primarily due to higher loss activity in the current period partially offset by higher net favorable reserve development recognized. During the year ended December 31, 2010, we experienced net losses and loss expenses of $112.3 million from a number of earthquakes, explosions and weather related events. Overall, our international insurance segment recorded net favorable reserve development of $180.6 million during the year ended December 31, 2010 compared to net favorable reserve development of $139.5 million for the year ended December 31, 2009, as shown in the tables below. In the tables, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.
** Includes our workers compensation catastrophe reinsurance and accident and health reinsurance
Net premiums written increased by $47.2 million, or 9.0%, consistent with the increase in gross premiums written. Net premiums earned increased $53.4 million, or 10.6%. Premiums related to our reinsurance business generally earn at a slower rate than those related to our direct insurance business. Direct insurance premiums typically earn ratably over the term of a policy. Reinsurance premiums under a quota share reinsurance contract are typically earned over the same period as the underlying policies, or risks, covered by the contract. As a result, the earning pattern of a quota share reinsurance contract may extend up to 24 months, reflecting the inception dates of the underlying policies. Property catastrophe premiums and premiums for other treaties written on a losses occurring basis earn ratably over the term of the reinsurance contract.
The loss and loss expense ratio for the year ended December 31, 2011 was 65.8%, compared to 49.8% for the year ended December 31, 2010. Net favorable reserve development recognized during the year ended December 31, 2010 reduced the loss and loss expense ratio by 20.1 percentage points. Thus, the loss and loss expense ratio related to the current loss year was 85.9%. In comparison, net favorable reserve development recognized in the year ended December 31, 2010 reduced the loss and loss expense ratio by 12.8 percentage points. Thus, the loss and loss expense ratio related to that loss year was 62.6%. The increase in the loss and loss expense ratio for the current loss year was primarily due to the $176.3 million of global catastrophe losses discussed above, which contributed 31.7 percentage points to the loss and loss expense ratio for the year ended December 31, 2011. Earthquakes and other weather related events discussed above during the year ended December 31, 2010 contributed $26.6 million or 5.3 percentage points to the prior year’s loss and loss expense ratio.
ratio was 17.1% for the year ended December 31, 2011, slightly lower than the 18.3% for the year ended December 31, 2010. The decrease in the acquisition cost ratio is due to more business written on an excess-of-loss basis, which typically carries a lower acquisition cost ratio than quota share business.
Net premiums written increased by $57.1 million, or 12.3%, which is consistent with the increase in gross premiums written. Net premiums earned increased $46.1 million, or 10.1% due to earnings on prior writings.
Net losses and loss expenses. Net losses and loss expenses increased by $15.6 million, or 6.6%, for the year ended December 31, 2010 compared to the year ended December 31, 2009. The increase in net losses and loss expenses was primarily due to the growth of the reinsurance operations and higher loss activity of $26.6 million from a number of earthquakes and other weather related events, partially offset by higher net favorable prior year reserve development. Overall, our reinsurance segment recorded net favorable reserve development of $64.2 million and $38.1 million during the years ended December 31, 2010 and 2009, respectively, as shown in the tables below. In the tables, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.
General and administrative expenses. General and administrative expenses increased $15.4 million, or 31.8%, for the year ended December 31, 2010 compared to the year ended December 31, 2009. The increase in general and administrative expenses was primarily due to an increase in salary and related costs included stock-based compensation. The 2.1 percentage point increase in the general and administrative expense ratio from 10.6% for the year ended December 31, 2009 to 12.7% for the year ended December 31, 2010 was due to higher general and administrative expense partially offset by higher net premiums earned.
and liquid investment portfolio in order to meet our short term liquidity needs. As discussed in Item 1 “Business,” our total investments and cash totaled $8.1 billion at December 31, 2011, the main components of which were investment grade fixed income securities and cash and cash equivalents.
As of December 31, 2011 and December 31, 2010, our shareholders’ equity was $3.1 billion.
The payment of dividends from Holdings’ Bermuda domiciled operating subsidiary is, under certain circumstances, limited under Bermuda law, which requires our Bermuda operating subsidiary to maintain certain measures of solvency and liquidity. Holdings’ U.S. domiciled operating subsidiaries are subject to significant regulatory restrictions limiting their ability to declare and pay dividends. In particular, payments of dividends by Allied World Assurance Company (U.S.) Inc., Allied World National Assurance Company, Allied World Reinsurance Company, Darwin National Assurance Company, Darwin Select Insurance Company and Vantapro Specialty Insurance Company are subject to restrictions on statutory surplus pursuant to the respective states in which these insurance companies are domiciled. Each state requires prior regulatory approval of any payment of extraordinary dividends. In addition, Allied World Assurance Company, AG is subject to Swiss financial and regulatory restrictions limiting its ability to declare and pay dividends and Allied World Assurance Company (Europe) Limited and Allied World Assurance Company (Reinsurance) Limited are subject to regulatory restrictions limiting their ability to declare and pay any dividends without the consent of the Central Bank of Ireland. We also have branch operations in Canada, Hong Kong and Singapore, which have regulatory restrictions limiting the ability to declare and pay dividends. We also have insurance subsidiaries that are the parent company for other insurance subsidiaries, which means that dividends and other distributions will be subject to multiple layers of regulations in order to dividend funds to Holdings. The inability of the subsidiaries of Holdings to pay dividends and other permitted distributions could have a material adverse effect on Holdings’ cash requirements and our ability to make principal, interest and dividend payments on the senior notes and common shares.
Allied World Assurance Company, Ltd uses trust accounts primarily to meet security requirements for inter-company and certain reinsurance transactions. We also have cash and cash equivalents and investments on deposit with various state or government insurance departments or pledged in favor of ceding companies in order to comply with relevant insurance regulations. In addition, Allied World Assurance Company, Ltd currently has access to up to $1.7 billion in letters of credit under two letter of credit facilities, $900 million with Citibank Europe plc and $800 million with a syndication of lenders described below. These facilities are used to provide security to reinsureds and are collateralized by us, at least to the extent of letters of credit outstanding at any given time. The letters of credit issued under the credit facility with Citibank Europe plc are deemed to be automatically extended without amendment for twelve months from the expiry date, or any future expiration date unless at least 30 days prior to any expiration date Citibank Europe plc notifies us that they elect not to consider the letters of credit renewed for any such additional period. If Citibank Europe plc no longer provides capacity under the credit facility it may limit our ability to meet our security requirements and would require us to obtain other sources of security at terms that may not be favorable to us.
The following shows our trust accounts on deposit, as well as outstanding and remaining letter of credit facilities and the collateral committed to support the letter of credit facilities:
Cash flows from financing activities consist primarily of capital raising activities, which include the issuance or repurchase of common shares or debt and the payment of dividends or the repayment of debt. Cash flows used in financing activities were $162.1 million for the year ended December 31, 2011 compared to net cash used in financing activities of $486.1 million and $450.0 million for the year ended December 31, 2010 and 2009, respectively. During the year ended December 31, 2011 we paid dividends of $28.6 million, repurchased $86.7 million of our common shares and repurchased $53.6 million in warrants. During the year ended December 31, 2010, we paid dividends of $47.7 million, repurchased $674.7 million of our common shares, which included the repurchase of all the common shares owned by Goldman Sachs, and repurchased $70.0 million in warrants to purchase our common shares from Chubb and Goldman Sachs. The reduction in share repurchases was impacted by the previously pending merger agreement with Transatlantic. During 2010, we issued 5.50% Senior Notes for net proceeds of $298.6 million, which we used for share repurchases and other general corporate purposes.
maturity investments were $14.5 million and $57.1 million, respectively. The decrease in net unrealized gains resulted from the sale of certain available for sale securities during the year ended December 31, 2011 and reinvesting the proceeds in fixed maturity investments where mark-to-market changes are reflected in the consolidated income statement. The maturity distribution of our fixed income portfolio (on a fair value basis) as of December 31, 2011 and December 31, 2010 was as follows:
We have investments in various other invested assets, the market value of which was $540.4 million as of December 31, 2011. Each of these funds has redemption notice requirements. For each of our funds, liquidity is allowed after certain defined periods based on the terms of each fund. See Note 4(d) “Investments - Other Invested Assets” to our consolidated financial statements for additional details on our other invested assets.
We do not believe that inflation has had a material effect on our consolidated results of operations. The potential exists, after a catastrophe loss, for the development of inflationary pressures in a local economy. The effects of inflation are considered implicitly in pricing. Loss reserves are established to recognize likely loss settlements at the date payment is made. Those reserves inherently recognize the effects of inflation. The actual effects of inflation on our results cannot be accurately known, however, until claims are ultimately resolved.
For additional information on our financial strength ratings refer to Our Financial Strength Ratings in Item 1 “Business”.
In July 2006, Allied World Bermuda issued $500.0 million aggregate principal amount of 7.50% senior notes due August 1, 2016, with interest payable August 1 and February 1 each year, commencing February 1, 2007. Allied World Bermuda can redeem the senior notes prior to maturity, subject to payment of a “make-whole” premium; however, Allied World Bermuda currently has no intention of redeeming the notes.
The investment commitments outstanding represent unfunded commitments related to our other invested assets.
As part of the acquisition of Darwin, we assumed the Darwin LTIP that Darwin had implemented for certain of its key employees. Initially, the Darwin LTIP allocated 20% of the underwriting profit for each year (premiums net of losses and expenses) plus 20% of the investment income based on average net assets outstanding in each year (at a deemed interest rate equal to the 10 year U.S. Treasury note rate) to the Darwin LTIP participants, based on their assigned percentage interests. Effective January 1, 2006, the Darwin LTIP was modified to reflect changes in the calculation of the underwriting profitability allocated to the participants of the Darwin LTIP. For 2006 and later years, the amount allocated to the participants is calculated as an amount equal to 20% of the underwriting profit less an amount equal to 5% of net premiums earned. In addition, imputed investment income will no longer be credited to the pool participants. Interests in these profit pools vest over a four-year period. The payments due are made in increments over the fourth, fifth and sixth years. This plan is in run-off.
The amounts included for reserve for losses and loss expenses reflect the estimated timing of expected loss payments on known claims and anticipated future claims as of December 31, 2011 and do not take reinsurance recoverables into account. Both the amount and timing of cash flows are uncertain and do not have contractual payout terms. For a discussion of these uncertainties, refer to “ - Critical Accounting Policies - Reserve for Losses and Loss Expenses.” Due to the inherent uncertainty in the process of estimating the timing of these
payments, there is a risk that the amounts paid in any period will differ significantly from those disclosed. Total estimated obligations will be funded by existing cash and investments.