2002 and of St. Paul Re for the period from January 1, 2002 through November 1, 2002. Our data as of and for the years ended December 31, 2006, 2005 and 2004 were derived from our consolidated financial statements beginning on page of this Form 10-K. Our data as of and for the year ended December 31, 2003 and as of and for the period from April 19, 2002 through December 31, 2002 were derived from our audited consolidated financial statements not included in this Form 10-K. The data for St. Paul Re for the period ended November 1, 2002 was derived from the audited combined financial statements of St. Paul Re prior to our initial public offering in 2002 (the “Predecessor Business”) not included in this Form 10-K. You should read the selected financial data in conjunction with our consolidated financial statements as of December 31, 2006 and 2005 and for each of the three years in the period ended December 31, 2006 beginning on page of this Form 10-K, and the related “Management’s Discussion and Analysis of Financial Condition and Results of Operations” beginning on page 46 of this Form 10-K.
The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes included on pages through of this Form 10-K and Note on Forward-Looking Statements on page 1. Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).
In November 2002, we completed an initial public offering and entered into several agreements with St. Paul for the transfer of continuing reinsurance business and certain related assets of St. Paul to us. Among these agreements were the Quota Share Retrocession Agreements.
These estimates and assumptions affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. Certain of the estimates and assumptions result from judgments that are necessarily subjective and consequently actual results may materially differ from these estimates. Our critical accounting estimates include premiums written and earned, unpaid losses and LAE, valuation of investments and evaluation of risk transfer.
Due to the nature of reinsurance, ceding companies routinely report and remit premiums subsequent to the contract coverage period. Consequently, reinsurance premiums written include amounts reported by the ceding companies, supplemented by estimates of premiums that are written but not reported (“WBNR”). The premium estimation process considers the terms and conditions of the reinsurance contracts and assumes that the contracts will remain in force until expiration. The estimation of written premiums could be affected by early cancellation, election of contract provisions for cut-off and return of unearned premiums or other contract disruptions. In addition to estimating WBNR, we estimate the portion of premiums earned but not reported (“EBNR”). We also estimate the expenses associated with these premiums in the form of losses, LAE and commissions. The time lag involved in the process of reporting premiums is shorter than the lag in reporting losses. Premiums are generally reported within two years.
When estimating premiums written and earned, we segregate the business of each of our reinsurance subsidiaries into classes by type of coverage and type of contract (approximately 90 classes). Within each class, business is further segregated by the year in which the contract incepted (the “Underwriting Year”), starting with 2002. Estimates of WBNR and EBNR are made for each class and Underwriting Year. Premiums are estimated based on ceding company estimates and our own judgment after considering factors such as the ceding company’s historical premium versus projected premium, the ceding company’s history of providing accurate estimates, anticipated changes in the marketplace and the ceding company’s competitive position therein, reported premiums to date and the anticipated impact of proposed underwriting changes. The net impact on the results of operations of changes in estimated premiums earned is reduced by the losses and acquisition expenses related to such premiums earned.
Had we not made this adjustment, the reinsurance premiums receivable for this class would have been $73,864,000 as of December 31, 2006.
Certain of our reinsurance contracts include provisions that adjust premiums or acquisition expenses based upon the loss experience under the contracts. Reinstatement premiums are the premiums charged for the restoration of the reinsurance limit of a reinsurance contract to its full amount, generally coinciding with the payment by the reinsurer of losses. These premiums relate to the future coverage obtained for the remainder of the initial contract term and are earned over the remaining contract term. Additional premiums are those premiums triggered by losses and not related to reinstatement of limits and are immediately earned. Reinstatement premiums and additional premiums are recognized in accordance with the provisions of assumed reinsurance contracts, based on loss experience under such contracts. Any unearned premium existing at the time a contract limit is exhausted is immediately earned.
While we commenced operations in 2002, the business written is sufficiently similar to the historical reinsurance business of St. Paul Re such that we use the historical loss experience of this business, which is periodically updated by St. Paul Re, to estimate our initial expected ultimate losses and the expected patterns of reported losses. These patterns can span more than a decade and, given our own limited history, the availability of the St. Paul Re data is a valuable asset.
We do not establish liabilities until the occurrence of an event that may give rise to a loss. When an event of sufficient magnitude occurs, we may establish IBNR specific to such an event. Generally, this is done following a catastrophe that affects many ceding companies. Ultimate losses and LAE are based on management’s judgment and reflect estimates gathered from ceding companies, estimates of insurance industry losses gathered from public sources and estimates derived from catastrophe modeling software.
The gross liabilities recorded on our consolidated balance sheets as of December 31, 2006 and 2005 for unpaid losses and LAE were $2,368,482,000 and $2,323,990,000 respectively. The following table sets forth a breakdown between gross case reserves and gross IBNR by segment as of December 31, 2006 and 2005 ($ in thousands):
Case reserves are usually based upon claim reports received from ceding companies. The information we receive varies by ceding company and includes paid losses and case reserves and may include an estimated provision for IBNR. Case reserves may be increased or decreased by our claims personnel based on receipt of additional information, including information received from ceding companies. IBNR is based on actuarial methods including the loss ratio method, the Bornhuetter-Ferguson method and the chain ladder method. IBNR related to a specific event may be based on our estimated exposure to an industry loss and may rely on the use of catastrophe modeling software.
Over time, as a greater number of claims are reported, actuarial estimates of IBNR are based on the Bornhuetter-Ferguson and the chain ladder techniques. The Bornhuetter-Ferguson technique utilizes
When estimating unpaid losses and LAE, we segregate the business of each of our reinsurance subsidiaries into classes by type of coverage and type of contract (approximately 90 classes). Within each class the business is further segregated by Underwriting Year, starting with 2002.
Multiple point estimates using a variety of actuarial techniques are calculated for many, but not all, of our 90 classes of coverage for each Underwriting Year. We do not believe that these multiple point estimates are or should be considered a range. Our actuaries consider each class and determine the most appropriate point estimate based on the characteristics of the particular class and other relevant factors such as historical ultimate loss ratios, the presence of individual large losses and known occurrences that have not yet resulted in reported losses. For some classes of business our actuaries believe that a review of individual contract information improves the loss reserve estimate. For example, individual contract review is particularly important for the Finite Risk segment and the accident and health class within the Casualty segment. Our actuaries make their determinations of the most appropriate point estimate of loss for each class. This information is aggregated and reviewed and approved by management and is included in the liability for unpaid losses and LAE.
Generally, North American casualty excess business has the longest pattern of reported losses and, therefore, loss estimates have a higher degree of uncertainty than other reinsurance classes. IBNR for these classes as of December 31, 2006 was $929,671,000, which was 57% of the total IBNR at that date. Because estimates of unpaid losses and LAE related to North American casualty excess business have a higher degree of uncertainty, we would not consider a variance of five percentage points from the initial expected loss ratio to be unusual. As an example, a change in the initial expected loss ratio from 66% to 71% would result in an increase of the IBNR for these classes by $88,135,000. This equates to approximately 8% of the liability for total unpaid losses and LAE for these classes as of December 31, 2006. As another example, if the estimated pattern of reported losses was accelerated by 5% the IBNR for these classes would decrease by $4,904,000, which is less than 1%. We have selected these two inputs as examples of sensitivity analyses because we believe that the two most important inputs to the reserve estimation methodologies described above are the initial expected loss ratio and the estimated pattern of reported losses.
The pattern of reported losses is determined utilizing actuarial analysis, including management’s judgment, and is based on historical patterns of paid losses and reporting of case reserves to us, as well as industry patterns. Information that may cause historical patterns to differ from future patterns is considered and reflected in expected patterns as appropriate. For property and health coverages these patterns indicate that a substantial portion of the ultimate losses are reported within 2 to 3 years after the contract is effective. Casualty patterns can vary from 3 years to over 20 years depending on the type of business.
In property classes, there can be additional uncertainty in loss estimation related to large catastrophe events. With wind events, such as hurricanes, the damage assessment process may take more than a year. The cost of rebuilding is subject to increase due to supply shortages for construction materials and labor. In the case of earthquakes, the damage assessment process may take several years as
buildings are discovered to have structural weaknesses not initially detected. The uncertainty inherent in loss estimation is particularly pronounced for casualty coverages, such as umbrella liability, general and product liability, professional liability and automobile liability, where information, such as required medical treatment and costs for bodily injury claims, emerges over time. In the overall loss reserving process, provisions for economic inflation and changes in the social and legal environment are considered.
In addition to the inherent uncertainty of estimating unpaid losses and LAE, our estimates with respect to the 2005 Hurricanes are subject to an unusually high level of uncertainty arising out of complex and unique causation and coverage issues associated with the attribution of losses to wind or flood damage or other perils such as fire, business interruption or riot and civil commotion. For example, the underlying policies generally do not cover flood damage; however, water damage caused by wind may be covered. Our actual losses from the 2005 Hurricanes may exceed our estimates as a result of, among other things, the attribution of losses to coverages that for the purpose of our estimates we assumed would not be exposed, which may be affected by class action lawsuits or state regulatory actions. We expect that these issues will not be resolved for a considerable period of time and may be influenced by evolving legal and regulatory developments.
Reinsurance accounting is followed for assumed and ceded transactions when risk transfer requirements have been met. Risk transfer analysis evaluates significant assumptions relating to the amount and timing of expected cash flows, as well as the interpretation of underlying contract terms.
In 2005 an unprecedented level of hurricane losses caused many reinsurers to report significant net losses. Many reinsurers were able to raise additional capital in the third and fourth quarters of 2005 and a number of new reinsurers were formed. Nonetheless, the magnitude of the hurricane losses caused rating agencies to tighten capital requirements and both reinsurers and their insurance company clients to reassess their catastrophe pricing and aggregate loss monitoring parameters and procedures. The result has been an increase in catastrophe pricing, particularly for wind exposures in the U.S. The impact on non-catastrophe pricing has been to mitigate the trend towards rate weakening with many markets experiencing an environment of little or no rate change. We believe that current rates should provide adequate returns.
The most significant factor in the comparison of net income in 2006 with the net loss in 2005 was the difference in underwriting income in 2006 as compared with 2005. Underwriting income, which consists of net premiums earned, less losses and LAE, acquisition expenses and operating expenses related to the reinsurance company subsidiaries, was $218,880,000 in 2006 and was favorably impacted by a low level of major catastrophes. In 2005 we incurred an underwriting loss of $249,506,000 primarily resulting from losses arising out of the 2005 Hurricanes that caused severe damage in the Gulf Coast region of the United States, including the states of Louisiana, Mississippi, Texas and Florida as well as in Mexico and the Caribbean. As a result of losses from the 2005 Hurricanes, certain reinsurance contracts generated additional premiums and adjustments to accrued profit commissions. The aggregate net adverse impact on our net loss for the year ended December 31, 2005 from the 2005 Hurricanes is summarized as follows ($ in thousands):
Net favorable development, which includes the development of prior years’ unpaid losses and LAE and the related impact on premiums and commissions, also contributed to underwriting income. Net favorable development was $55,768,000 in 2006 as compared with $79,256,000 in 2005. The net favorable development in 2006 includes $4,160,000 of net unfavorable development from the 2005 Hurricanes. In addition to the increase in underwriting income, net income in 2006 as compared with the net loss in 2005 was also favorably impacted by an increase in investment income of $58,542,000 and unfavorably impacted by increases in operating expenses related to Platinum Holdings and operating expenses not allocated to segments of $10,036,000 and income tax expense of $55,134,000 in 2006.
The decrease in net premiums written and earned in 2006 as compared with 2005 was attributable to reductions in business written in all three of our segments. These reductions were partially offset by increases in estimates of net written premiums of approximately $68,937,000 in the North American excess casualty classes related to business written in prior periods. We also commenced ceding premiums under a quota share retrocession agreement effective January 1, 2006 (the “Property Quota Share Agreement”) under which Platinum US and Platinum UK ceded 30% of their new and renewal property catastrophe business effective on or after January 1, 2006 to a non-affiliated reinsurer. The decrease in net premiums written and earned in 2006 is also partially due to additional net premiums written and earned in 2005 of approximately $49,451,000 and $46,666,000, respectively, related to losses arising from the 2005 Hurricanes. The reduction in net premiums earned was also affected by changes in the mix of business and the structure of the underlying reinsurance contracts.
Net investment income for the years ended December 31, 2006 and 2005 was $187,987,000 and $129,445,000, respectively. Net investment income increased during 2006 primarily due to increased invested assets attributable to positive cash flow from operations, excluding trading securities activities, which was $525,025,000 in 2006 as well as proceeds from the issuance of common and preferred shares and debt obligations in 2005. The book basis yields on fixed maturity securities were 4.6% and 4.4% as of December 31, 2006 and 2005, respectively. Net investment income included $7,998,000 and $8,172,000 of interest earned on funds held for the years ended December 31, 2006 and 2005, respectively. Net realized gains (losses) on investments were $1,090,000 and ($3,046,000) for the years ended December 31, 2006 and 2005, respectively. Net realized losses in 2006 and 2005 included $255,000 and $1,769,000, respectively, relating to the write-down of our investment in Inter-Ocean Holdings, Ltd. The remaining net realized gains and losses on investments in 2006 and 2005 primarily result from our efforts to manage credit quality, duration, foreign currency exposure, investment sector allocation as well as to balance our investment risk and reinsurance risk.
Net losses and LAE and the resulting loss and LAE ratios for the years ended December 31, 2006 and 2005 were as follows ($ in thousands):
Operating expenses for the years ended December 31, 2006 and 2005 were $95,490,000 and $69,827,000, respectively. Operating expenses include costs such as salaries, rent and like items related to reinsurance operations as well as costs associated with Platinum Holdings. The increase in operating expenses was primarily due to increased incentive-based compensation accruals. In 2006, operating expenses included approximately $17,000,000 of accruals for incentive-based compensation as compared with $1,000,000 in 2005. The increase in incentive-based compensation was the result of the significant increase in net income. The remainder of the increase in operating expenses is primarily due to the expansion of operations in Bermuda, including Platinum Bermuda which has increased its underwriting activity and increased its staff accordingly. The increase is also partially attributable to costs related to equity grants under long term performance based incentive plans.
Net foreign currency exchange gains (losses) for the years ended December 31, 2006 and 2005 were $738,000 and ($2,111,000), respectively. We routinely transact business in various foreign
The increase in income tax expense in 2006 as compared with the income tax benefit in 2005 was primarily due to net income in 2006 as compared with a net loss in 2005. The effective tax rate in any given year is based on income before tax expense of our subsidiaries that operate in several jurisdictions with varying corporate income tax rates. Platinum Holdings and Platinum Bermuda are not subject to corporate income tax. The decrease in the effective tax rate was due to several factors. A higher percentage of income before income taxes was generated by Platinum Holdings and Platinum Bermuda in 2006, which are not subject to corporate income tax. In 2006, the combined income before income taxes derived from Platinum Holdings and Platinum Bermuda was approximately 73% of the total income before income tax expense as compared with approximately 45% of the loss before income tax benefit in 2005. Additionally, in 2005, $6,500,000 of income tax was incurred as a result the transfer from Platinum Finance to Platinum Holdings of a portion of the proceeds from the issuance of debt obligations in May 2005. This transfer was considered to be a taxable distribution under U.S. tax law and, accordingly, subject to U.S. withholding tax.
The net unfavorable impact on income before income taxes in 2006 from changes in estimates of the 2005 Hurricanes was $4,160,000. The effect on income before income taxes of net development of the 2004 Hurricanes was immaterial in 2005 and 2006.
The most significant factor in the comparison of net loss in 2005 with the net income in 2004 was the difference in underwriting income in 2005 as compared with 2004. Underwriting income decreased by $296,679,000 in 2005 as compared with 2004 and was primarily due to significantly greater losses arising from the 2005 Hurricanes than the 2004 Hurricanes. The hurricane losses in both 2005 and 2004 were partially offset by growth of profitable business in the Casualty segment and net favorable development. Net favorable development includes the development of prior years’ unpaid losses and LAE and the related impact on premiums and commissions. Net favorable development was $79,256,000 and $55,520,000 in 2005 and 2004, respectively. The net loss in 2005 as compared with net income in 2004 was also favorably impacted by an increase in net investment income of $44,913,000 and a decrease in income tax expense of $55,316,000, partially offset by an increase in operating expenses of $3,494,000 and loss on repurchase of debt of $2,486,000.
The increase in net premiums written in 2005 as compared with 2004 was attributable to growth in Property and Marine and Casualty segments offset by a decline in the Finite Risk segment. Net premiums written and earned in 2005 included approximately $49,451,000 and $46,666,000, respectively, of additional premiums related to losses arising from the 2005 Hurricanes. Net premiums written and earned in 2004 included approximately $29,265,000 of additional premiums related to losses arising from the 2004 Hurricanes. Net premiums written and earned in 2005 also included $2,268,000 of net additional premiums relating loss development of prior years. There were no significant premium adjustments relating to loss development in 2004. The remaining increase in net premiums earned was related to the growth in current and prior periods’ net premiums written and was also affected by changes in the mix of business and the structure of the underlying reinsurance contracts.
Other income (expense) for the years ended December 31, 2005 and 2004 was ($586,000) and $3,211,000, respectively. Other expense in 2005 included ($102,000) of net unrealized losses relating to changes in fair value of fixed maturity securities classified as trading, and ($53,000) of net expense on reinsurance contracts accounted for as deposits. Other income in 2004 included $1,036,000 of net unrealized gains relating to changes in fair value of fixed maturity securities classified as trading, $758,000 of earnings on reinsurance contracts accounted for as deposits and a gain of $1,000,000 on the sale of assets.
The increase in net acquisition expenses in 2005 as compared with 2004 was consistent with the growth in business in the Property and Marine and Casualty segments. Contributing to the increase in the net acquisition expense ratio in 2005 as compared with 2004 were greater reductions of profit commissions under reinsurance contracts that incurred losses from the 2004 Hurricanes as compared with similar reductions of profit commissions in 2005 relating to the 2005 Hurricanes. Profit commission reductions relating to the 2005 Hurricanes were $3,654,000 representing 0.2% of net premiums earned as compared with profit commission reductions relating to the 2004 Hurricanes of $10,243,000 representing 0.7% of net premiums earned. Net acquisition expenses also included increases in adjustable commissions of approximately $15,790,000 in 2005 relating to prior years’ loss development, representing 0.9% of net premiums earned as compared with increases of $1,631,000 of adjustable commissions in 2004, representing 0.1% of net premiums earned. The net acquisition expense ratios in 2005 and 2004 were also affected by changes in the mix of business.
May 2005. In December 2005, we repurchased $94,660,000 of the Remarketed Notes and incurred a loss on repurchase of debt of $2,486,000.
Income taxes (benefit) and the effective tax rate for the years ended December 31, 2005 and 2004 were as follows ($ in thousands):
The income tax benefit in 2005 as compared with income tax expense in 2004 was due to the loss before income tax benefit in 2005. In 2005, approximately 45.0% of the loss before income tax benefit was derived from Platinum Holdings and Platinum Bermuda. In 2004, approximately 16.9% of the income before income tax expense was derived from Platinum Holdings and Platinum Bermuda. Additionally, we incurred approximately $6,500,000 of income tax expense in 2005 associated with the transfer from Platinum Finance to Platinum Holdings of a portion of the proceeds from the issuance of debt obligations in May 2005. This transaction was deemed to be a taxable distribution under U.S. tax law and subject to U.S. withholding tax.
We conduct our worldwide reinsurance business through three operating segments: Property and Marine, Casualty and Finite Risk. In managing our operating segments, management uses measures such as underwriting income and underwriting ratios to evaluate segment performance. We do not allocate assets or certain income and expenses such as investment income, interest expense and certain corporate expenses by segment. Segment underwriting income is reconciled to income before income taxes. The measures we used in evaluating our operating segments should not be used as a substitute for measures determined under U.S. GAAP. The following table summarizes underwriting activity and ratios for the three operating segments for the years ended December 31, 2006, 2005 and 2004 ($ in thousands):
The Property and Marine operating segment includes principally property (including crop), marine, aviation and aerospace reinsurance coverages that are written in the United States and international markets. This business includes catastrophe excess-of-loss treaties, per-risk excess-of-loss treaties and proportional treaties. This operating segment generated 36.1%, 33.5% and 30.6% of our net premiums written in 2006, 2005 and 2004, respectively.
Net premiums written decreased in 2006 in almost all classes within this segment, most notably North American property proportional, property risk excess, crop and aviation classes of business. Contributing to the decrease in net premiums written was our decision to reduce our exposure to North American hurricanes. The reduction in North American property proportional and property risk excess was due to our decision to favor North American catastrophe excess business over North American property proportional and property risk excess catastrophe exposed business. Net premiums written and net premiums earned in 2005 included additional premiums of $45,409,000 and $42,624,000, respectively, from reinsurance contracts that incurred losses arising from the 2005 Hurricanes. Excluding the additional premiums related to the 2005 Hurricanes, gross premiums written in the North American catastrophe excess class increased in 2006. Net premiums written and earned in 2006 as compared with 2005 also decreased in the catastrophe classes as a result of the commencement of the Property Quota Share Agreement under which we ceded approximately $55,455,000 of premiums written. The reductions in the crop and aviation classes were primarily due to the expiration of a significant proportional contract in each class. The decreases of net premiums written were partially offset by increased pricing in the catastrophe exposed classes, primarily in North America.
Net losses and LAE and the resulting loss ratios for the years ended December 31, 2006 and 2005 were as follows ($ in thousands):
The decreases in net losses and LAE and the resulting net loss and LAE ratio in 2006 as compared with 2005 were primarily due to the significant difference in major catastrophe losses. Major catastrophe losses were $5,500,000 representing 1.2% of net premiums earned in 2006 as compared with $573,900,000 representing 100.8% of net premiums earned in 2005. Included in the major catastrophe losses in 2005 were $549,050,000 from the 2005 Hurricanes representing 96.5% of net premiums earned. Net losses and LAE and the resulting net loss and LAE ratios in 2006 and 2005 were also impacted by favorable net loss development of $54,317,000, representing 12.1% of net premiums earned in 2006 and $51,298,000 representing 9.0% of net premiums earned in 2005. Exclusive of the favorable net loss development, effects of the catastrophe losses and additional premiums generated by such catastrophe losses, the net loss and LAE ratio in 2006 improved by approximately 1% as compared 2005. The slight improvement is due to changes in the mix of business.
Net acquisition expenses and resulting net acquisition expense ratios for the years ended December 31, 2006 and 2005 were as follows ($ in thousands):
Gross, ceded and net premiums written and earned for the years ended December 31, 2005 and 2004 were as follows ($ in thousands):
Net premiums written and earned increased in 2005 as compared with 2004 due to growth primarily in the North American pro-rata and catastrophe classes. The most significant increase was in the property pro-rata class where we increased our net premiums written in catastrophe exposed business in Florida. Net premiums written and earned in 2005 also included additional premiums of approximately $45,409,000 and $42,624,000, respectively, from reinsurance contracts that incurred losses arising from the 2005 Hurricanes. Net premiums written and earned in 2004 included approximately $16,198,000 of additional premiums resulting from losses arising from the 2004 Hurricanes. Net premiums written and earned in 2005 also included $2,685,000 of additional net premiums relating to unfavorable loss development on the 2004 Hurricanes. There were no significant premium changes relating to loss development in 2004.
The increase in net losses and LAE and the related net loss and LAE ratio in 2005 as compared with 2004 was due to losses of $549,050,000 arising from the 2005 Hurricanes as compared with losses of $169,652,000 arising from the 2004 Hurricanes. Net losses from the 2005 Hurricanes represent representing 96.5% of net premiums earned as compared with net losses from the 2004 Hurricanes that represent 35.0% of net premiums earned. The net losses and LAE from the 2005 Hurricanes and 2004 Hurricanes were partially offset by net favorable loss development of approximately $51,298,000 representing 9.0% of net premiums earned in 2005 and approximately $48,478,000 representing 10.0% of net premiums earned in 2004. During 2005 and 2004, actual reported losses were significantly less than expected for the short-tailed non-catastrophe property lines resulting in reductions in estimated ultimate losses for such lines. The net loss and LAE ratio was also affected by the growth in business and the additional premiums arising from the 2005 Hurricanes and 2004 Hurricanes.
The increase in net acquisition expenses in 2005 as compared with 2004 was consistent with the growth in business. The increase in the net acquisition expense ratio was primarily due to increases in commissions of $6,489,000 in 2005 related to the net favorable development of non-catastrophe net losses and LAE, partially offset by commission reductions of $3,654,000 in 2005 related to reinsurance contracts with catastrophe losses. There were no significant commission adjustments in 2004. The net acquisition expense ratios in 2005 and 2004 were also affected by changes in the mix of business.
Other underwriting expenses for the years ended December 31, 2005 and 2004 were $26,074,000 and $27,827,000, respectively. The decrease in other underwriting expenses was due to cost reductions in the Property and Marine segment in 2005, partially offset by the allocation of a greater percentage of common operating and administrative costs to the Property segment due to a decline in underwriting activity in the Finite Risk segment. Other underwriting expenses for the years ended December 31, 2005 and 2004 included fees of $6,538,000 and $6,396,000, respectively, relating to the RenRe Agreement that provides for a periodic review of aggregate property catastrophe exposures by RenaissanceRe.
The Casualty operating segment principally includes reinsurance treaties that cover umbrella liability, general and product liability, professional liability, workers’ compensation, casualty clash, automobile liability, surety and trade credit. This operating segment also includes accident and health treaties, which are predominantly reinsurance of health insurance products. This operating segment generated 64.4%, 47.1% and 41.2% of our net premiums written for the years ended December 31, 2006, 2005 and 2004, respectively.
The decrease in net premiums written in 2006 was primarily due to reductions of business written across most casualty classes in the 2006 underwriting year, most significantly in the accident and health and trade credit classes. The reduction in business written is primarily due to decreases in price adequacy which caused us to non-renew some contracts. The decrease in net premiums written in the 2006 underwriting year was partially offset by increases in estimates of net written premiums of $68,937,000 in the North American excess casualty classes related to business written in prior underwriting years as compared with similar increases of estimates of $55,500,000 in 2005. Net premiums written and earned were also affected by changes in the mix of business and the structure of the underlying reinsurance contracts.
The increase in net losses and LAE in 2006 as compared with 2005 was primarily due to an increase in the net loss and LAE ratio. The increase in the net loss and LAE ratio in 2006 as compared with 2005 was due to less net favorable loss development in 2006 than in 2005 and higher initial expected loss ratios in certain significant classes reflecting a decline in price adequacy. Net losses and LAE included net favorable loss development of approximately $9,424,000, representing 1.2% of net premiums earned in 2006, and approximately $15,913,000 of net favorable loss development, representing 2.0% of net premiums earned in 2005. The net favorable loss development was primarily in casualty classes with short loss development periods. The net loss and LAE ratio was also affected by the changes in the mix of business within the segment.
Other underwriting expenses for the years ended December 31, 2006 and 2005 were $27,022,000 and $24,690,000, respectively. The increase in other underwriting expenses in 2006 as compared with 2005 was primarily due to an increase in incentive-based compensation. The increase in incentive-based compensation in 2006 as compared with 2005 was due to increased net income in 2006.
approximately $15,913,000, representing 2.0% of net premiums earned in 2005, and approximately $675,000 of net unfavorable loss development, representing 0.1% of net premiums earned in 2004. The decrease in the net loss and LAE ratio in 2005 was also due, in part, to changes in the mix of business toward classes with lower loss ratios.
Net acquisition expenses and resulting net acquisition expense ratios for the years ended December 31, 2005 and 2004 were as follows ($ in thousands):
The increase in acquisition expenses was due primarily to the increase in net premiums earned in 2005 as compared with 2004. The acquisition expense ratios were comparable for the years ended December 31, 2005 and 2004.
The Finite Risk operating segment includes principally structured reinsurance contracts with ceding companies whose needs may not be met efficiently through traditional reinsurance products. In exchange for contractual features that limit our downside risk, reinsurance contracts we classify as finite risk provide the potential for significant profit commission to the ceding company. The classes of risks underwritten through finite risk contracts are generally consistent with the classes covered by traditional products. The finite risk contracts that we underwrite generally provide prospective protection, meaning coverage is provided for losses that are incurred after inception of the contract, as contrasted with retrospective coverage, which covers losses that are incurred prior to inception of the contract. The three main categories of our finite risk contracts are quota share, multi-year excess-of-loss and whole account aggregate stop loss. The ongoing industry-wide investigations by legal and regulatory authorities into potential misuse of finite products have curtailed demand for finite risk products in 2006 and 2005. This operating segment generated (0.5%), 19.4% and 28.2% of our net premiums written for the years ended December 31, 2006, 2005, and 2004, respectively.
Other underwriting expenses for the years ended December 31, 2006 and 2005 were $4,387,000 and $4,905,000, respectively. The decrease in other underwriting expenses was due to the allocation of a greater percentage of direct and common operating costs to the other two segments due to a decline in underwriting activity in the Finite Risk segment.
Other underwriting expenses for the years ended December 31, 2005 and 2004 were $4,905,000 and $6,224,000, respectively. The decrease in other underwriting expenses was due to less direct expenses and the allocation of a greater percentage of common operating costs to the Casualty segment due to a decline in underwriting activity in the Finite Risk segment.
Cash and cash equivalents and investments as of December 31, 2006 and 2005 were as follows ($ in thousands):
Premiums receivable include significant estimates. Premiums receivable as of December 31, 2006 of $377,183,000 included $315,243,000 that is based upon estimates. Premiums receivable as of December 31, 2005 of $567,449,000 included $496,603,000 that is based upon estimates. An allowance for uncollectible premiums is established for possible non-payment of such amounts due, as deemed necessary. As of December 31, 2006 and 2005, no such allowance was made based on our historical experience, the general profile of our ceding companies and our ability in most cases to contractually offset premiums receivable with losses and LAE or other amounts payable to the same parties.
Gross unpaid losses and LAE as of December 31, 2006 of $2,368,482,000 include $1,648,635,000 of IBNR. Gross unpaid losses and LAE as of December 31, 2005 of $2,323,990,000 includes $1,812,245,000 of IBNR. IBNR decreased in 2006 as losses related to the 2005 Hurricanes and 2004 Hurricanes were reported and paid. Gross losses paid in 2006 related to the 2005 Hurricanes and 2004 Hurricanes were approximately $287,040,000. There remains approximately $312,173,000 of gross unpaid losses related to the 2005 Hurricanes and the 2004 Hurricanes, of which
In November 2002, we issued the ESU’s each of which consisted of a contract to purchase our common shares in 2005 and an ownership interest in a Senior Guaranteed Note. On August 16, 2005, Platinum Finance successfully completed the remarketing of $137,500,000 aggregate principal amount of the Senior Guaranteed Notes due November 16, 2007 at a price of 100.7738% with a reset interest rate of 6.371%, referred to as the Remarketed Notes. The remarketing was conducted on behalf of holders of the ESU’s and neither Platinum Holdings nor Platinum Finance received any cash proceeds from the remarketing. Proceeds from the remarketing were used to purchase a portfolio of U.S. Treasury securities to collateralize the obligations of the holders of the ESU’s under the related common share purchase contract and to pay the remarketing fee. There were no excess proceeds distributed to holders of the ESU’s in connection with the remarketing. On November 16, 2005, Platinum settled the common share purchase contract component of the ESU’s by issuing 5,008,850 common shares, which generated cash proceeds to us of $137,500,000, less related fees and expenses. As a result of the settlement of the purchase contract component, the ESUs ceased to exist and are no longer traded on the New York Stock Exchange.
We filed an unallocated universal shelf registration statement with the SEC, which the SEC declared effective on November 8, 2005. Under this shelf registration statement we may issue and sell, in one or more offerings, up to $750,000,000 of debt, equity and other types of securities or a combination of the above, including debt securities of Platinum Finance, unconditionally guaranteed by Platinum Holdings. To affect any such sales from time to time, Platinum Holdings and/or Platinum Finance will
Our principal consolidated cash requirements are the payment of losses and LAE, commissions, brokerage, operating expenses, dividends to our preferred and common shareholders, the servicing of debt, the acquisition of and investment in businesses, capital expenditures, purchase of retrocessional contracts and payment of taxes. The catastrophe losses of 2005 may result in a surge of loss payments over the next year that could adversely affect net cash flows from operations.
Platinum Bermuda and Platinum UK are not licensed, approved or accredited as reinsurers anywhere in the United States and, therefore, under the terms of most of their contracts with United States ceding companies, they are required to provide collateral to their ceding companies for unpaid ceded liabilities in a form acceptable to state insurance commissioners. Typically, this type of collateral takes the form of letters of credit issued by a bank, the establishment of a trust, or funds withheld. Platinum Bermuda and Platinum UK provide letters of credit through the credit agreement described above and through other commercial banks and may be required to provide the banks with a security interest in certain investments of Platinum Bermuda and Platinum UK.
We believe that the net cash flows generated by the operating activities of our subsidiaries in combination with cash and cash equivalents on hand will provide sufficient funds to meet our liquidity needs over the next twelve months. Beyond the next twelve months, cash flows available to us may be influenced by a variety of factors, including economic conditions in general and in the insurance and
reinsurance markets, legal and regulatory changes as well as fluctuations from year to year in claims experience and the occurrence or absence of large catastrophic events. If our liquidity needs accelerate beyond our ability to fund such obligations from current operating cash flows, we may need to liquidate a portion of our investment portfolio, borrow under the credit facility described above or raise additional capital in the capital markets. Our ability to meet our liquidity needs by selling investments or raising additional capital is subject to the timing and pricing risks inherent in the capital markets.
Our contractual obligations by estimated maturity are presented below ($ in thousands):
See note 5 of the Notes to the Consolidated Financial Statements.
See note 12 of the Notes to the Consolidated Financial Statements.
In addition, we achieved average rate increases of approximately 10% on our marine renewal business. Per risk excess rates were approximately equal to expiring in both our U.S. and non-U.S. renewal business.
During 2006 we wrote more property catastrophe excess-of-loss business and less property per risk excess-of-loss and proportional business. Property per risk excess-of-loss and proportional business typically generates relatively more premium than property catastrophe excess-of-loss business having a similar catastrophe risk level. However, we believe property catastrophe excess-of-loss business generally provides more quantifiable catastrophe exposure and is currently priced more attractively. During the January 1 Renewal Season we wrote approximately 15% more U.S. catastrophe excess-of-loss premium than we had during the January 1, 2006 renewal season. We elected not to renew the collateralized quota share contract that covered our catastrophe excess of loss portfolio in 2006. As a consequence of reducing our use of retrocession and writing a larger gross portfolio of catastrophe excess-of-loss business at January 1, our net retained risk and expected profit has increased for 2007. For 2007 we plan to deploy capacity such that up to approximately 22.5% of our total capital could be exposed to an event with a probability of 1 in 250 years.
The lack of significant catastrophe activity in 2006 contributed to excellent financial results and stronger balance sheets for many reinsurers. In January 2007, there were a number of government initiatives in Florida designed to decrease insurance rates in the state. Of most significance to reinsurers was the large increase in the capacity of the Florida Hurricane Catastrophe Fund (“FHCF”), a state-run reinsurer. We believe the increase in capacity of private reinsurers and the FHCF will cause downward pressure on windstorm catastrophe rates for the remainder of the 2007, particularly for Florida residential exposures. We believe that most other classes within the Property and Marine segment will also experience some rate deterioration for the remainder of 2007.
For the Casualty segment, although we believe that the market generally offers adequate returns, pricing has been softening. Ceding companies are willing to increase retentions and reinsurers are competing for participation on the best treaties. During the January 1 Renewal Season rate changes by class of business ranged from an increase of approximately 5% to a decrease of approximately 10%. The overall average remained close to expiring, losing some ground against upward trending loss costs. As a result, we believe the business underwritten in 2007 will have a slightly lower level of expected profitability as compared with the business underwritten in 2006.
During the January 1 Renewal Season we wrote approximately the same amount of casualty business as we had during the January 1, 2006 renewal season. We expect market conditions to continue to weaken through the remainder of 2007 and that fewer casualty opportunities will be attractive. We believe that financial security remains a significant concern for buyers of long-tailed reinsurance
protection who typically seek reinsurers with strong balance sheets, quality ratings, and a proven claims-paying record. We believe that our rating, capitalization and reputation as a lead casualty reinsurer position us well to write profitable business as the opportunities arise.