The following table sets forth certain of our selected financial data as of and for the years ended December 31, 2011, 2010, 2009, 2008 and 2007. Our data as of December 31, 2011 and 2010 and for the years ended December 31, 2011, 2010 and 2009 were derived from our consolidated financial statements beginning on page of this Form 10-K. Our data as of December 31, 2009, 2008 and 2007 and for the years ended December 31, 2008 and 2007 were derived from our audited consolidated financial statements not included in this Form 10-K. The selected financial data should be read in conjunction with our consolidated financial statements as of December 31, 2011 and 2010 and for each of the years in the three year period ended December 31, 2011 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 31 of this Form 10-K.
Fully converted book value per common share represents total shareholders’ equity, adjusted for the assumed proceeds from exercise of share options, divided by the number of common shares outstanding, adjusted for the assumed exercise or vesting of all outstanding share options and restricted share units. The following summary sets forth the calculation of book value and fully converted book value per common share for the years ended December 31, 2011 and 2010 ($ and amounts in thousands, except per share amounts):
At December 31, 2011, our capital resources of $1.9 billion consisted of $1.7 billion of common shareholders’ equity and $250.0 million of debt obligations. At December 31, 2010, our capital resources of $2.1 billion consisted of $1.9 billion of common shareholders’ equity and $250.0 million of debt obligations. Our net loss was $224.1 million for the year ended December 31, 2011, and our net income was $215.5 million and $383.3 million for the years ended December 31, 2010 and 2009, respectively. Net loss for the year ended December 31, 2011 reflects higher than expected major catastrophe activity partially offset by net investment income and net favorable development. Our net premiums written for the years ended December 31, 2011, 2010 and 2009 were $651.5 million, $760.6 million, and $897.8 million, respectively. The decreases in net premiums written were primarily due to the non-renewal of business that fell below our minimum pricing standards.
Reflecting a continued lack of demand for finite risk covers, we expect to write a relatively small portfolio of business in our Finite Risk segment in 2012.
Assumed reinsurance premiums earned are recognized as revenues, net of any ceded premiums for retrocessional coverage purchased. Both assumed and ceded premiums written are recognized as earned generally on a basis proportionate with the coverage period. Assumed premiums written not yet recognized as revenue are recorded on the consolidated balance sheets as unearned premiums; ceded premiums written not yet earned are recorded on the consolidated balance sheets as prepaid reinsurance premiums.
Due to the nature of reinsurance, ceding companies routinely report and remit premiums subsequent to the contract coverage period. Consequently, premiums written and receivable include amounts reported and billed by the ceding companies, supplemented by our estimates of premiums that are written but not reported. In addition, we estimate the unearned portion of the premiums. Unearned premiums and estimated premiums receivable are estimates based on estimated written premiums and are subject to judgment and uncertainty. Earned premiums, which are recorded in revenues, are the premiums written less the unearned premiums. 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. The time lag involved in the process of reporting premiums is shorter than the lag in reporting losses. Premiums are generally reported in full within two years from the inception of the contract. The potential net impact of changes in premiums earned on the results of operations is reduced by the accrual of losses and acquisition expenses related to such premiums earned. Any adjustments to written and earned premiums, and the related losses and acquisition expenses, are accounted for as changes in estimates and are reflected in the results of operations in the period in which they are made. Any adjustments could be material and could significantly impact earnings in the period they are recorded.
When estimating premiums written and unearned premiums, we segregate the business into classes by reinsurance subsidiary, by type of coverage and by type of contract (resulting in approximately 62 classes). Within each class, business is further segregated by the year in which the contract incepted (the “Underwriting Year”), starting with 2002, our first year of operations. Classes that are similar in both the nature of their business and estimation process may be grouped for purposes of estimating premiums. Estimates are made for each class or group of classes and Underwriting Year. Premiums are estimated based on ceding company estimates and our own judgment after considering factors such as: (1) the ceding company’s historical premium versus projected premium, (2) the ceding company’s history of providing accurate estimates, (3) anticipated changes in the marketplace and the ceding company’s competitive position therein, (4) reported premiums to date and (5) the anticipated impact of proposed underwriting changes. Estimates of ultimate premium are made by our underwriters for each contract and Underwriting Year. Management reviews these estimates with our underwriters and actuaries and selects an ultimate premium estimate. Estimates of premiums written and unearned premiums are based on the selected ultimate premium estimate and the structure of the reinsurance contracts. We evaluate the appropriateness of these estimates in light of the actual premium reported by the ceding companies, information obtained during audits and other information received from ceding companies.
Estimated premiums receivable at December 31, 2011 was lower than at December 31, 2010 due to a decrease in both the property and marine and casualty business written in 2011 as compared with 2010.
Unpaid losses and LAE represent management’s best estimate at a given point in time and are subject to the effects of trends in loss severity and frequency. These estimates are reviewed regularly and adjusted as experience develops or new information becomes available. Any adjustments are accounted for as changes in estimates and are reflected in the results of operations in the period in which they are made. It is possible that the ultimate liability may differ materially from such estimates.
The liabilities recorded on our consolidated balance sheets as of December 31, 2011 and 2010 for unpaid losses and LAE were $2.4 billion and $2.2 billion, respectively. These amounts exclude any amounts we may recover from our retrocessionaires under coverage we purchased for such losses. We record estimates of amounts we expect to recover from retrocessionaires as assets on the consolidated balance sheets. The following table sets forth our case reserves, additional case reserves and IBNR by segment as of December 31, 2011 and 2010 ($ in thousands):
Since we rely on information regarding paid losses, case reserves and sometimes IBNR provided by ceding companies in estimating our ultimate liability for unpaid losses and LAE, we perform certain procedures in order to help determine the completeness and accuracy of such information. Periodically, management assesses the reporting activities of these ceding companies on the basis of qualitative and quantitative criteria. These procedures include conferring with ceding companies or brokers on claims matters. Our claims personnel, or consultants engaged by us, may also conduct periodic audits of our ceding companies to: (1) review and establish validity of specific claims, (2) determine that case reserves established by the ceding company are reasonable, (3) assure that there is consistency in claim reporting from period to period, and (4) assess the overall claims practices and procedures of the ceding company. We also monitor the claims handling and reserving practices of ceding companies in order to help establish the reinsurance premium for reinsurance contracts with such ceding companies.
Non-catastrophe reserves were $1.8 billion as of December 31, 2011, representing 75% of our unpaid losses and LAE. When estimating unpaid losses and LAE, we segregate the business into classes by reinsurance subsidiary, by type of coverage and by type of contract (resulting in approximately 62 classes). Within each class, the business is further segregated by Underwriting Year, starting with 2002, our first year of operations.
Generally, estimates of ultimate losses that are not related to a specific event are initially determined based on the loss ratio method applied to each Underwriting Year and to each class of business. The selected ultimate losses are determined by multiplying the initial expected loss ratio by the earned premium. The initial expected loss ratios are key inputs that involve management judgment and are based on a variety of factors, including: (1) contract by contract expected loss ratios developed during our pricing process, (2) our historical loss ratios and combined ratios (loss plus acquisition cost ratios), and (3) when available, updated and appropriately adjusted, loss information from The Travelers Companies, Inc. on business previously underwritten by the reinsurance division of The St. Paul Companies, Inc., (“St. Paul Re”), for the reasons described below. These judgments take into account management’s view of past, current and future factors that may influence ultimate losses, including: (1) market conditions, (2) changes in the business underwritten, (3) changes in timing of the emergence of claims and (4) other factors that may influence ultimate loss ratios and losses.
While we commenced operations in 2002, the business we write is sufficiently similar to the historical reinsurance business of St. Paul Re such that we review the historical loss experience of this business when we estimate our own initial expected loss ratios and loss development patterns. Loss development patterns can span more than a decade, therefore, the St. Paul Re data is a valuable supplement to our own and industry data. The historical experience of St. Paul Re also included information for the administrative costs of managing claims and the related ULAE factors. In 2010 we conducted a review of our administrative expenses of managing claims that resulted in a $13.2 million reduction of ULAE reserves.
In property lines, the loss development patterns are based on historical reported loss data. For all lines, historical data by effective date and business type is used to determine loss development patterns that reflect each year’s reinsurance contract inception date distribution and the distribution of underlying business written on a losses occurring basis versus on a risk attaching basis. In marine lines, the loss development patterns are primarily based on historical reported loss data. Loss development patterns are analyzed for various reinsurance sub-classes and an overall pattern is determined by the mix of business within each Underwriting Year.
In the North American casualty excess-of-loss classes, the loss development patterns are primarily based on our historical reported loss data and that of St. Paul Re, both of which are supplemented by industry data from the Reinsurance Association of America (“RAA”) and Insurance Services Offices, Inc. (“ISO”). Due to the long loss development pattern in general liability, various sources are used to estimate the end of the loss development pattern referred to as the “tail”. To estimate the tail, we supplement our historical data, and the available St. Paul Re data, with industry data, generally from the RAA.
Generally, an event causing more than $1 billion of property losses to the insurance industry or $10 million of property losses to the Company is considered and tracked as a major catastrophe. Unpaid losses and LAE related to major catastrophes were $607.1 million, which represented 25% of our total unpaid losses and LAE as of December 31, 2011.
As losses from catastrophes mature, our actuaries generally consider losses reported to us relative to loss development patterns from prior catastrophe events. Our estimate of ultimate liability for losses and LAE related to a catastrophe event will generally be based on these development patterns after approximately twelve months following the event. However, since loss development patterns may be inconsistent between events, for very large catastrophes, such as Hurricane Katrina in 2005, we will generally review information on a contract-by-contract basis for a longer period. Ultimate losses for a catastrophe event are typically reasonably well known within 12 to 24 months following the event, although ultimate losses from an earthquake may take longer to develop. As of December 31, 2011, the paid and reported losses as a percentage of the current estimated ultimate loss were 6% and 57%, respectively, for the February 2011 earthquake in New Zealand and 28% and 65%, respectively, for the earthquake in Japan.
In addition to the February earthquake in New Zealand and the earthquake in Japan, in 2011 we established specific reserves for major catastrophes that included U.S. tornadoes, the June earthquake in New Zealand, Hurricane Irene, flooding in Australia, Thailand and Denmark and Cyclone Yasi. The U.S. tornadoes included six catastrophe events referred to by Property Claim Services, a division of ISO, as Catastrophes 42, 43, 44, 46, 48, and 53. In 2010, we established specific reserves for major catastrophes that included the earthquakes in Chile and New Zealand, flooding in Australia, Windstorm Xynthia, and two U.S. catastrophe events referred to by Property Claim Services as Catastrophes 14 and 96. In 2009, we established specific reserves for major catastrophes that included floods in Ireland (“Irish Floods”), Hailstorm Wolfgang, Winterstorm Klaus and three U.S. catastrophe events referred to by Property Claim Services as Catastrophes 63, 68 and 78. We also have established specific reserves for catastrophe events in prior years, including Hurricanes Ike and Katrina.
The frequency and severity of reported losses relative to anticipated frequency and severity of losses is one of the most influential factors and is largely dependent on the loss experience of our ceding companies. Reported loss experience is a key input to our loss estimation process and, if loss experience reported in periods subsequent to estimating the ultimate losses are materially greater or less than anticipated, we may adjust the ultimate loss ratio accordingly. Adjustments to increase or decrease a prior year’s ultimate loss ratio are generally referred to as unfavorable or favorable loss development.
The loss development patterns are also key inputs to our loss estimation process. Loss development patterns reflect the time lag between the occurrence and settlement of a loss. The time lag in reporting can be several years in some cases and may be attributed to a number of reasons, including the time it takes to investigate a claim, delays associated with the litigation process, and the deterioration, in connection with health related claims, in a claimant’s physical condition many years after an accident occurs. As a predominantly broker market reinsurer for both excess-of-loss and proportional contracts, we are subject to potential additional time lags in the receipt of information as the primary insurer reports to the broker who in turn reports to us. As of December 31, 2011, we did not have any significant back-log related to our processing of assumed reinsurance information. All of the foregoing factors can impact the loss development patterns. A key assumption that our estimates are based on is that past loss development patterns are reasonably predictive of future loss development patterns. However, it may be difficult to identify differences in business reinsured from Underwriting Year to Underwriting Year and how such differences can affect loss development patterns. This difficulty adds to uncertainty in estimates that use these patterns.
During the years ended December 31, 2011, 2010 and 2009, we experienced net favorable loss development of $113.0 million, $158.9 million, and $100.8 million, respectively. This net favorable loss development was attributable primarily to a level of cumulative losses reported to us by our ceding companies that was lower than expected and that, in our judgment, resulted in sufficient credibility in the loss experience to change our previously selected loss ratios and reduce estimated ultimate losses, as discussed further in Item 1, “Business - Unpaid Losses and Loss Adjustment Expenses”, in this Form 10-K. During 2011, 2010, and 2009, approximately $107.4 million, $145.7 million, and $94.9 million, respectively, of the total net favorable development was attributable to lower reported loss experience than we expected. Conditions and trends that have affected development of reserves in the past may not necessarily occur in the future. The factors that may result in differences between our current estimates of loss liability and our ultimate loss liability are set forth above under “Uncertainty of Estimates” in this Form 10-K.
As another example of key assumption sensitivity, if we accelerated the estimated loss development patterns related to North American casualty excess-of-loss classes by 5%, we would decrease the IBNR for these classes by $35.2 million, which represents approximately 3% of unpaid losses and LAE for these classes as of December 31, 2011, or if we accelerated the loss development patterns by 10%, we would decrease the IBNR for these classes by $100.3 million, which is approximately 8% of unpaid losses and LAE for these classes as of December 31, 2011.
In order to limit the effect on our financial condition of large and multiple losses, we may buy retrocessional reinsurance, which is reinsurance for our own account. Reinsurance recoverable, also referred to as “ceded loss reserves,” includes estimates of the recoveries from our retrocessional reinsurance that arise from unpaid losses from our assumed reinsurance business. These assets are estimates of future amounts recoverable from retrocessionaires for losses that have occurred at or before the balance sheet date. Each quarter, after estimating the amount of unpaid losses and LAE, our actuaries review all retrocessional contracts. The estimate of the amount recoverable is based on the gross incurred loss and the structure of the retrocessional contracts. In addition, we assess the financial strength of our reinsurers and their willingness and ability to pay our claims. Based on this assessment, we may record an allowance and reduce the reinsurance recoverable and net earnings. We had reinsurance recoverable on unpaid losses and LAE of $4.0 million and $8.9 million as of December 31, 2011 and 2010, respectively. There was no valuation allowance recorded on these amounts.
Fixed maturity securities we own that we may not have the positive intent to hold until maturity are classified as available-for-sale and reported at fair value, with related net unrealized gains or losses excluded from earnings and included in shareholders’ equity as a component of accumulated other comprehensive income or loss, net of deferred taxes. Fixed maturity securities we own and have the intent to sell prior to maturity, or securities for which we have elected the fair value option attributes of the FASB Accounting Standards Codification (“ASC”) 825, “Financial Instruments” (“ASC 825”), are classified as trading securities. Trading securities are reported at fair value, with mark-to-market adjustments included in net realized gains and losses on investments and the related deferred income tax included in income tax expense or benefit in the consolidated statements of operations.
The fair value of our fixed maturity securities and short-term investments is based on prices generally obtained from pricing services, which include index providers, pricing vendors and broker-dealers. Index providers utilize external sources and pricing models to value index-eligible securities across numerous sectors and asset classes. Pricing vendors collect, edit, maintain, evaluate and model data on a large number of securities utilizing primarily market data and observable inputs. Broker-dealers value securities through proprietary trading desks primarily based on observable inputs. As of December 31, 2011, we valued approximately 38% of our investment securities using prices obtained from index providers, 59% using prices obtained from pricing vendors, and 3% using prices obtained from broker-dealers. The number of prices we obtain per instrument varies based on the type of asset class and particular reporting period. Prices are generally obtained from multiple sources when a new security is purchased and a pricing source is assigned to the particular security. A hierarchy is maintained that prioritizes pricing sources based on availability and reliability of information, with preference generally given to prices provided by index providers and pricing vendors. Pricing providers may be assigned to a particular security based upon the provider’s expertise. Generally, the initial pricing source selected is consistently used for each reporting period. We have not adjusted any prices that we have obtained from pricing services. However, if we determine that a price appears unreasonable, we investigate and assess whether the price should be adjusted.
Generally, pricing services determine prices by maximizing the use of observable inputs to determine the fair value measurement. The inputs used by index providers may include, but are not limited to, benchmark yields, transactional data, broker-dealer quotes, security cash flows and structures, credit ratings, prepayment speeds, loss severities, credit risks and default rates. The inputs used by pricing vendors may include, but are not limited to, benchmark yields, reported trades, broker-dealer quotes, issuer spreads, bids, offers and industry and economic events. Broker-dealers value securities through trading desks primarily based on observable inputs. For further discussion on fair values of investments see “Financial Condition - Liquidity - Sources of Liquidity”.
In 2009, we adopted additional guidance under FASB ASC 320, “Investments - Debt and Equity Securities” (“ASC 320”). In accordance with this additional guidance, we recognize the portion of OTTI related to a credit loss in net income and the portion of OTTI related to all other factors in other comprehensive income or loss. The amount of the credit loss of an impaired debt security is the difference between the amortized cost and the greater of (i) the present value of expected future cash flows and (ii) the fair value of the security. The effect of adoption resulted in a cumulative adjustment to debt securities that were impaired prior to 2009, net of deferred tax, of $14.2 million that was recorded in accumulated other comprehensive income in the consolidated statement of shareholders’ equity.
In accordance with ASC 320, we also consider our intent to sell a security and the likelihood that we will be required to sell a security before an unrealized loss is recovered. Our intent to sell a security is based, in part, on adverse changes in the creditworthiness of a debt issuer, pricing and other market conditions and our anticipated net cash flows. If we determine that we intend to sell a security that is in an unrealized loss position, then the unrealized loss related to such a security, representing the difference between the security’s amortized cost and its fair value, is recognized as a net impairment loss in our consolidated statements of operations at the time we determine our intent is to sell.
Net deferred tax assets were $31.6 million and $47.8 million for the years ended December 31, 2011 and 2010, respectively. At each balance sheet date, we evaluate the recoverability of the deferred tax assets, considering the timing of the reversal of deferred income and expense items as well as the likelihood that we will generate sufficient taxable income to realize the future tax benefits. We believe that it is more likely than not we will generate sufficient taxable income and realize the future tax benefits in order to recover the deferred assets and accordingly, no valuation allowance was established as of December 31, 2011 and 2010. See Note 8 to the “Notes to Consolidated Financial Statements” contained elsewhere in this Form 10-K for additional information on income taxes.
Reinsurance accounting is used for assumed and ceded transactions when risk transfer requirements have been met. Risk transfer analysis involves evaluating significant assumptions relating to the amount and timing of expected cash flows, as well as the interpretation of underlying contract terms. Reinsurance contracts that do not transfer sufficient insurance risk are accounted for as deposits and assets or liabilities are initially recorded for the same amount as assets paid or received. Interest income or expense related to the deposit is recognized as incurred. Profit margins are earned over the settlement period of the contractual obligations. As at December 31, 2011 and 2010, we have deposit liabilities of $9.5 million and $8.8 million, respectively, included in other liabilities related to an assumed transaction that is accounted for as a deposit.
The net loss and diluted loss per common share for the year ended December 31, 2011 as compared with net income and diluted earnings per common share for the year ended December 31, 2010 was primarily due to a decrease in the net underwriting result attributable to an increase in major catastrophe activity and a decrease in net favorable development. In addition, there was a decrease in net realized gains on investments and investment income for the year ended December 31, 2011 as compared with the year ended December 31, 2010. This was partially offset by a decrease in net impairment losses on investments. During a period of loss, the basic weighted average common shares outstanding is used in the denominator of the diluted loss per common share computation.
The Property and Marine operating segment generated 52.9% and 54.3% of our net premiums written for the years ended December 31, 2011 and 2010, respectively. The following table summarizes underwriting activity and ratios for the Property and Marine segment for the years ended December 31, 2011 and 2010 ($ in thousands):
The Property and Marine segment underwriting result decreased by $330.4 million for the year ended December 31, 2011 as compared with the year ended December 31, 2010, primarily due to an increase in net losses arising from major catastrophes. Net losses arising from major catastrophes, net of reinstatement premiums and retrocessional recoveries, were $510.0 million and $214.8 million for the years ended December 31, 2011 and 2010, respectively. Net losses from major catastrophes for the year ended December 31, 2011 were attributable to the February and June earthquakes in New Zealand, the earthquake in Japan, U.S. tornadoes, Hurricane Irene, floods in Australia, Thailand and Denmark, and Cyclone Yasi.
Gross premiums written decreased by $51.1 million for the year ended December 31, 2011 as compared with the year ended December 31, 2010. Gross premiums written included reinstatement premiums related to major catastrophes of $30.6 million and $17.7 million for the years ended December 31, 2011 and 2010, respectively. The decrease in gross premiums written was due to decreases across most classes of business, most significantly in the catastrophe excess-of-loss classes, for the year ended December 31, 2011 as compared with the same period in 2010 and resulted from fewer opportunities that met our underwriting standards and our desire to reduce our exposure to catastrophe events. The increase in ceded premiums written was due to an increase in our purchase of retrocessional coverage on catastrophe business for the year ended December 31, 2011 as compared with the same period in 2010 that resulted from our desire to reduce our exposure to catastrophe events. Net premiums earned decreased by $68.0 million for the year ended December 31, 2011 as compared with the same period in 2010, primarily as a result of decreases in net premiums written in current and prior periods. Net premiums written and earned were also affected by changes in the mix of business and the structure of the underlying reinsurance contracts.
For the year ended December 31, 2010, net losses and LAE arising from major catastrophes of $232.4 million, excluding reinstatement premiums earned of $17.7 million, related primarily to the 2010 earthquakes in Chile and New Zealand. Net losses and LAE arising from major catastrophes, with related premium adjustments, increased the net loss and LAE ratio by 149.1 points and 54.3 points for the years ended December 31, 2011 and 2010, respectively.
Net favorable loss development was $41.4 million and $36.9 million for the years ended December 31, 2011 and 2010, respectively. Net favorable loss development and related premium adjustments decreased the net loss and LAE ratio by 11.2 points and 9.2 points for the years ended December 31, 2011 and 2010, respectively. Net favorable loss development for the years ended December 31, 2011 and 2010 was primarily attributable to a level of cumulative losses reported by our ceding companies that was lower than expected and that, in our judgment, resulted in sufficient credibility in the loss experience to change our previously selected loss ratios.
Net favorable development in the major catastrophes class arose primarily from the February 2010 earthquake in Chile, the September 2010 earthquake in New Zealand and the December 2010 floods in Australia. Net favorable development in the property per risk excess-of-loss class arose from the 2007 through 2010 underwriting years. Net favorable development in the property proportional class arose primarily from the 2008 and 2009 underwriting years, with a change in the expected loss ratios contributing $0.7 million of the net favorable development. Net favorable development in the crop class arose primarily from North American business in the 2010 underwriting year. Net favorable development in the marine, aviation and satellite class arose primarily from the 2007 and 2008 underwriting years. This was partially offset by unfavorable development in the 2009 underwriting year primarily arising from the loss related to the explosion on the Deepwater Horizon oil rig. Net unfavorable development in the catastrophe excess-of-loss (non-major events) class arose primarily from an increase in loss advices from ceding companies related to fourth quarter 2010 events in Europe and Australia, partially offset by an improvement in North American business and international business prior to 2010.
Net acquisition expenses and related net acquisition expense ratios were $49.3 million and 13.8% , respectively, for the year ended December 31, 2011 and $60.2 million and 14.4%, respectively, for the year ended December 31, 2010. The decrease in net acquisition expenses was primarily due to the decrease in net premiums earned and a decrease in commissions related to prior years as compared with the same period in 2010. The decrease in acquisition expense ratio for the year ended December 31, 2011 was primarily due to a decrease in commissions related to prior years as compared with the same period in 2010. The increase in commissions related to prior years was $0.2 million and $5.4 million for the years ended December 31, 2011 and 2010, respectively. The commissions related to prior years increased the net acquisition expense ratio by 0.1 points and 1.2 points for the years ended December 31, 2011 and 2010, respectively. Net acquisition expenses and related net acquisition expense ratios were also affected by changes in the mix of business.
The Casualty operating segment generated 45.6% and 43.3% of our net premiums written for the years ended December 31, 2011 and 2010, respectively. The following table summarizes underwriting activity and ratios for the Casualty segment for the years ended December 31, 2011 and 2010 ($ in thousands):
The Casualty segment underwriting income decreased by $81.2 million for the year ended December 31, 2011 as compared with the year ended December 31, 2010, primarily due to a decrease in net favorable development. Net favorable development was $59.9 million and $121.1 million for the years ended December 31, 2011 and 2010, respectively. In addition, a review of our administrative costs of managing claims resulted in a reduction of $13.2 million in ULAE reserves in 2010.
Net premiums written decreased by $32.4 million for the year ended December 31, 2011 as compared with the year ended December 31, 2010, primarily due to decreases in the North American casualty excess-of-loss, international casualty and financial lines classes as a result of fewer opportunities that met our underwriting standards. Net premiums earned decreased by $25.1 million as a result of the decreases in net premiums written in current and prior periods. Net premiums written and earned were also affected by changes in the mix of business and the structure of the underlying reinsurance contracts.
Net losses and LAE increased by $59.0 million for the year ended December 31, 2011 as compared with the year ended December 31, 2010, primarily due to a decrease in net favorable loss development. Net favorable loss development was $59.4 million and $113.3 million for the years ended December 31, 2011 and 2010, respectively. Net favorable loss development and related premium adjustments decreased the net loss and LAE ratios by 18.8 points and 33.6 points for the years ended December 31, 2011 and 2010, respectively. Net favorable loss development for the years ended December 31, 2011 and 2010 was primarily attributable to a level of cumulative losses reported by our ceding companies that was lower than expected and that, in our judgment, resulted in sufficient credibility in the loss experience to change our previously selected loss ratios. The net loss and LAE ratios were also affected by changes in the mix of business. In addition, changes in our estimate of the administrative costs of managing claims decreased the net loss and LAE ratio by 3.5 points in 2010.
Net favorable development in the North American claims made class arose primarily from the 2003 through 2007 underwriting years. Net favorable development in the North American occurrence excess-of-loss class arose primarily from the 2002 through 2006 underwriting years. A review of historical results in the North American clash class resulted in a change to the expected loss ratios in all prior underwriting years. This change in expected loss ratios contributed $13.7 million to the net favorable development in this class. Net favorable development in the North American umbrella class arose primarily from the 2003, 2004 and 2006 underwriting years, partially offset by net unfavorable development in the 2008 underwriting year. Net favorable development in the financial lines class arose primarily from the North American surety business in the 2004 through 2008 underwriting years. Net favorable development in the accident and health class arose primarily from the 2005 and 2008 underwriting years. The international casualty class was impacted by net unfavorable development from financial institutions business and utility companies’ exposure to wildfires in Australia in the 2008 underwriting year. This was partially offset by net favorable development in all other underwriting years. This class also benefited by $2.0 million of favorable development from changes in the pattern of expected reported losses and initial expected loss ratios.
Net acquisition expenses and related net acquisition expense ratios were $72.7 million and 22.8%, respectively, for the year ended December 31, 2011 and $71.5 million and 20.8%, respectively, for the year ended December 31, 2010. The increase in the acquisition expense ratio was due to an increase in commissions related to prior years for the year ended December 31, 2011 as compared with the same period in 2010. The increase in commissions related to prior years was $0.2 million and had no effect on the net acquisition expense ratio for the year ended December 31, 2011. The decrease in commissions related to prior years was $4.8 million and decreased the net acquisition expense ratio by 1.6 points for the year ended December 31, 2010. Net acquisition expenses and related net acquisition expense ratios were also affected by changes in the mix of business.
Net losses, LAE and acquisition expenses decreased by $9.4 million for the year ended December 31, 2011 as compared with the year ended December 31, 2010, primarily due to net favorable development in 2011 as compared with net unfavorable development in 2010. Net favorable development was $4.0 million for the year ended December 31, 2011 compared with net unfavorable development of $2.5 million for the year ended December 31, 2010. Net favorable development for the year ended December 31, 2011 was primarily related to contracts from the 2004 underwriting year offset by net unfavorable development related to a contract from the 2003 underwriting year. Net unfavorable development for the year ended December 31, 2010 was primarily related to a contract from the 2003 underwriting year. The net favorable development decreased the net loss and LAE and acquisition expense ratio by 29.0 points for the year ended December 31, 2011 compared with net unfavorable development increasing the ratio by 14.3 points for the year ended December 31, 2010.
Net realized gains on investments were $3.9 million and $107.8 million for the years ended December 31, 2011 and 2010, respectively. Sales of investments resulted in net realized gains of $1.4 million for the year ended December 31, 2011, primarily from realized gains from U.S. Treasury Inflation-Protected Securities ("TIPS") and corporate bonds partially offset by realized losses from U.S. Government securities. The net gains from mark-to-market adjustments on trading securities of $2.5 million for the year ended December 31, 2011 were related primarily to non-U.S government securities partially offset by insurance-linked securities. Sales of investments resulted in net realized gains of $106.4 million for the year ended December 31, 2010, primarily from U.S. Government securities, U.S. Government agency residential mortgage-backed securities ("RMBS"), and non-U.S. government securities. The net gains from mark-to-market adjustments on trading securities of $1.4 million for the year ended December 31, 2010 were related primarily to non-U.S. government securities.
Net impairment losses on investments were $22.4 million and $36.6 million for the years ended December 31, 2011 and 2010, respectively. The net impairment losses reflect other-than-temporary impairments attributable to credit losses on impaired securities that exclusively relate to investments in securitized mortgages not guaranteed by U.S. government agencies. The net impairment losses recorded for the year ended December 31, 2011 reflect our revised assumptions regarding macroeconomic conditions in the United States, including the outlook for home prices, and included $19.0 million related to non-agency RMBS and $3.4 million related to sub-prime asset-backed securities (“ABS”). The net impairment losses recorded for the year ended December 31, 2010 included $17.7 million related to sub-prime ABS, $11.2 million related to non-agency RMBS and $7.7 million related to commercial mortgage-backed securities (“CMBS”).
Non-underwriting operating expenses were $15.6 million and $25.6 million for the years ended December 31, 2011 and 2010, respectively, and related to costs such as compensation and other corporate expenses associated with operating as a publicly-traded company. The decrease during the year ended December 31, 2011 as compared with the same period in 2010 was primarily attributable to a decrease in performance-based compensation in 2011.
Net income (loss) and diluted earnings (loss) per common share for the years ended December 31, 2010 and 2009 were as follows ($ and amounts in thousands, except diluted earnings (loss) per common share):
The Property and Marine operating segment generated 54.3% and 57.6% of our net premiums written for the years ended December 31, 2010 and 2009, respectively. The following table summarizes underwriting activity and ratios for the Property and Marine segment for the years ended December 31, 2010 and 2009 ($ in thousands):
Net losses and LAE increased by $92.9 million in the year ended December 31, 2010 as compared with the year ended December 31, 2009, primarily due to the increase in losses arising from major catastrophes in 2010. Net losses and LAE arising from major catastrophes were $232.4 million and $42.6 million for the years ended December 31, 2010 and 2009, respectively. The increase in losses from major catastrophes was partially offset by the increase in net favorable loss development. Net favorable loss development was $36.9 million and $14.3 million in 2010 and 2009, respectively. Net losses arising from major catastrophes, with related premium adjustments, increased the net loss and LAE ratio by 54.3 points and 7.5 points for the years ended December 31, 2010 and 2009, respectively. Net favorable loss development and related premium adjustments decreased the net loss and LAE ratio by 9.2 points and 3.2 points in 2010 and 2009, respectively. The resulting loss ratio, excluding catastrophes and development, decreased due to a lower proportion of crop business, which had a higher loss ratio than the remainder of the segment, and a higher proportion of catastrophe business, which had a lower loss ratio than the remainder of the segment. Net favorable loss development for the year ended December 31, 2010 was primarily attributable to a level of cumulative losses reported by our ceding companies that was lower than we expected and that, in our judgment, resulted in sufficient credibility in the loss experience to change our previously selected loss ratios. The change in our estimate of the administrative costs of managing claims in the year ended December 31, 2010 decreased the net loss and LAE ratio by 0.3 points.
Net favorable development was $33.3 million for the year ended December 31, 2010. See "Results of Operations - Year Ended December 31, 2011 as Compared with the Year Ended December 31, 2010 - Underwriting Results - Property and Marine" above for discussion of net favorable development by class of business for the year ended December 31, 2010.
Net premiums written decreased by $27.1 million in the year ended December 31, 2010 as compared with the year ended December 31, 2009, primarily due to decreases in business underwritten in 2010 and 2009 across most casualty classes as a result of fewer opportunities that met our underwriting standards. Net premiums earned decreased by $45.1 million as a result of the decreases in net premiums written in current and prior underwriting years. Net premiums written and earned were also affected by changes in the mix of business and the structure of the underlying reinsurance contracts.
Net favorable development was $121.1 million for the year ended December 31, 2010. See "Results of Operations - Year Ended December 31, 2011 as Compared with the Year Ended December 31, 2010 - Underwriting Results - Casualty" above for discussion of net favorable development by class of business for the year ended December 31, 2010.
Other underwriting expenses were $23.1 million and $25.6 million for the years ended December 31, 2010 and 2009, respectively. The decrease in 2010 as compared with 2009 was primarily due to a decrease in performance-based compensation in 2010.
The Finite Risk segment generated 2.4% and 2.7% of our net premiums written for the years ended December 31, 2010 and 2009, respectively. The following table summarizes underwriting activity and ratios for the Finite Risk segment for the years ended December 31, 2010 and 2009 ($ in thousands):
During the years ended December 31, 2010 and 2009, the Finite Risk portfolio consisted of one in-force contract. Due to the decline in premium volume in recent years, current year ratios may be significantly impacted by relatively insignificant adjustments of prior years’ reserves. The decreases in net premiums written and net premiums earned for the year ended December 31, 2010 as compared with the year ended December 31, 2009 were primarily attributable to a decrease in the underlying premiums written relating to the one in-force contract.
Net investment income was $134.4 million and $163.9 million for the years ended December 31, 2010 and 2009, respectively. Net investment income decreased in 2010 as compared with 2009 primarily as a result of lower new money yields on invested assets and cash and cash equivalents.
Net realized gains on investments were $107.8 million and $78.6 million for the years ended December 31, 2010 and 2009, respectively. Sales of investments resulted in net realized gains of $106.4 million for the year ended December 31, 2010, primarily from U.S. Government securities, U.S. Government agency RMBS and non-U.S. Government securities. The net gains from mark-to-market adjustments on trading securities for the year ended December 31, 2010 included net gains of $1.4 million primarily related to non-U.S. Government securities. Sales of investments resulted in net realized gains of $80.9 million for the year ended December 31, 2009, primarily from TIPS, U.S. Government agency securities, corporate bonds and non-agency RMBS. The net losses from mark-to-market adjustments on trading securities for the year ended December 31, 2009 were comprised of $2.1 million related to non-U.S. dollar denominated securities and $1.2 million related to TIPS, which were partially offset by net gains of $1.0 million related to insurance-linked securities.
Income tax expense was $43.2 million and $4.3 million for the years ended December 31, 2010 and 2009, respectively. Our effective tax rate was 16.7% and 1.1% for the years ended December 31, 2010 and 2009, respectively. Income tax expense or benefit is primarily driven by the taxable income or loss generated by our U.S.-based subsidiaries. The income tax expense or benefit rate is driven by the portion of taxable income or loss generated by our U.S.-based subsidiaries relative to the income or loss generated by our Bermuda-based operations, which are non-taxable. Premiums earned by our U.S. and Bermuda-based subsidiaries generally do not bear a proportionate relationship to their respective pre-tax income for a variety of reasons, including the significant impact on pre-tax income of the different mixes of business underwritten by the particular subsidiary, the presence or absence of underwriting income or loss attributable to such business, and the investment results experienced by the particular subsidiary.
Platinum Bermuda is not licensed, approved or accredited as a reinsurer in the United States and, therefore, under the terms of most of its contracts with U.S. ceding companies, it is required to provide collateral to its 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. See “Sources of Liquidity - Credit Facilities” below for additional information on our credit facilities and the collateral required by us.
Platinum Bermuda and Platinum US have reinsurance and other contracts that also require them to provide collateral to ceding companies should certain events occur, such as a decline in our financial strength rating by A.M. Best or S&P below specified levels or a decline in statutory equity below specified amounts, or when certain levels of assumed liabilities are attained. Some reinsurance contracts also have special termination provisions that permit early termination should certain events occur. As of December 31, 2011 and 2010, we held investments with a carrying value of $61.1 million and $69.8 million, respectively, and cash and cash equivalents of $9.3 million and $9.9 million, respectively, in trust to collateralize obligations under various reinsurance contracts.
The laws and regulations of Bermuda and the United States include certain restrictions on the amount of dividends that can be paid by Platinum Bermuda and Platinum US to their respective parent companies, Platinum Holdings and Platinum Finance, without the prior approval of the relevant regulatory authorities. Based on regulatory restrictions, the unaudited maximum amount available for payment of dividends by our reinsurance subsidiaries during 2012 without prior regulatory approval is as follows ($ in thousands):
During the year ended December 31, 2011, dividends of $300.0 million were paid by the reinsurance subsidiaries of Platinum Holdings, of which $255.0 million was paid by Platinum Bermuda to Platinum Holdings and $45.0 million was paid by Platinum US to Platinum Finance.
During the year ended December 31, 2011, Platinum Holdings repaid loans from Platinum Finance of $75.0 million, due February 1, 2011. In March 2011, Platinum Holdings contributed an additional $120.0 million in capital to Platinum Bermuda.
Platinum Holdings also may require cash to pay for share repurchases. See “Sources of Liquidity - Share and Debt Repurchases” below for additional discussion on share repurchases.
Our sources of funds consist primarily of cash and cash equivalents held by us, cash from operations, proceeds from sales, redemption and maturity of investments, borrowings from our credit facilities and the issuance of securities. As at December 31, 2011, we had cash and cash equivalents of $792.5 million and Platinum Holdings had cash and cash equivalents of $47.8 million. We expect that our liquidity needs for the next twelve months will be met by our cash and cash equivalents, short-term investments, cash flows from operations, investment income and proceeds from the sale, redemption or maturity of our investments.
Net cash flows used in operating activities were $33.7 million, or $65.1 million excluding trading securities, for the year ended December 31, 2011. Net cash flows provided by operating activities were $24.7 million, or $68.3 million excluding trading securities, for the year ended December 31, 2010. Our reinsurance subsidiaries have liquidity from premiums, which are generally received in advance of the time losses are paid. The period of time from the occurrence of a claim through the settlement of the liability may extend many years into the future. However, due to the nature of our reinsurance operations, cash flows are affected by claim payments that can fluctuate from year to year. The amount and timing of actual claim payments can vary based on many factors, including the severity of individual losses, changes in the legal environment, and general market conditions. During the year ended December 31, 2011, unpaid losses and LAE increased by $172.2 million primarily as a result of significant major catastrophe activity during 2011. We anticipate that our future operating cash flow may be negatively impacted by the payment of these losses.
Net cash flows used in financing activities were $153.1 million and $457.0 million for the years ended December 31, 2011 and 2010, respectively. Net cash flows used in financing activities in 2011 primarily related to repurchases of common shares and the purchase of common share options of $94.7 million and $47.9 million, respectively, and the payment of dividends to common shareholders of $11.7 million. Net cash flows used in financing activities in 2010 primarily related to repurchases of common shares and the purchase of common share options of $379.7 million and $98.5 million, respectively, and the payment of dividends to common shareholders of $13.4 million.
Our investable assets totaled $4.2 billion as at both December 31, 2011 and 2010. Investable assets include investments, cash and cash equivalents, accrued investment income and net balances due to and from brokers and had a duration of 3.6 and 4.1 years as of December 31, 2011 and 2010, respectively.
Our investment portfolio consists primarily of diversified, high quality, predominantly investment grade fixed maturity securities. See Note 3 to the “Consolidated Financial Statements” in this Form 10-K for additional discussion of fair values. The following table sets forth the fair values, net unrealized gains and losses and credit quality of our investments as of December 31, 2011 ($ in thousands):
The following table provides additional detail on the fair value and amortized cost of our portfolio of non-U.S. government fixed maturity available-for-sale securities, fixed maturity trading securities and short-term investments converted to U.S. dollars as of December 31, 2011 ($ in thousands):
When investing in a local or foreign currency it is for purposes of hedging our net foreign currency reinsurance liabilities. All of our investments in debt issued by Eurozone financial institutions are guaranteed by their respective governments and are included in the table above.
In addition to the investments noted above, we hold non-U.S. dollar denominated cash and cash equivalents of $242.2 million that are also held for the purpose of hedging our net foreign currency reinsurance liabilities.
The net unrealized gain position of our municipal bond and corporate bond portfolios was $150.1 million and $20.3 million, respectively, as of December 31, 2011 as compared with an unrealized loss position of our municipal bond portfolio of $3.3 million and an unrealized gain position of our corporate bond portfolio of $17.5 million at December 31, 2010. The improvement in the net unrealized position in our municipal bond portfolio was primarily attributable to a decrease in U.S. Government treasury yields. We analyze the creditworthiness of our municipal bond and corporate bond portfolios by reviewing various performance metrics of the issuer, including financial condition, credit ratings and other public information.
On October 12, 2011, S&P issued a press release stating that it lowered its counterparty credit rating on Platinum Holdings from “BBB+” to “BBB” with a stable outlook and lowered its counterparty credit and financial strength ratings on our reinsurance subsidiaries, Platinum US and Platinum Bermuda, from “A” to “A-” with a stable outlook. S&P’s press release followed our announcement on October 11, 2011 that we expected a net negative impact of approximately $112.4 million on our third quarter 2011 results due to catastrophe losses in the first nine months of the year. This action by S&P has not had a significant impact on our portfolio of existing contracts or collateral obligations, and we do not currently anticipate that it will have a material adverse impact on our business prospects, financial condition or results of operations. Our A.M. Best ratings have not changed and remain at a financial strength rating of “A” (Excellent) with a stable outlook for each of our reinsurance subsidiaries.
See Item 1, “Business - Ratings” for additional discussion on our ratings.
Our Board of Directors has authorized the repurchase of our common shares through a share repurchase program. Since the program was established, our Board of Directors has approved increases in the repurchase program from time to time, most recently on February 16, 2011, to result in authority as of such date to repurchase up to a total of $250.0 million of our common shares. The following table summarizes our repurchases of common shares for the years ended December 31, 2011, 2010 and 2009 ($ in thousands, except share and per share data):
Since 2007, we have repurchased 34,791,744 shares and purchased 8,500,000 share options for a total of $1.2 billion and $146.4 million, respectively.
The timing and amount of the repurchase transactions under our repurchase programs depends on a variety of factors, including market conditions, our liquidity requirements, contractual restrictions, corporate and regulatory considerations and other factors.
Our contractual obligations as of December 31, 2011 by estimated maturity are presented below ($ in thousands):
Our consolidated financial statements as of December 31, 2011 and 2010 and for each of the years in the three-year period ended December 31, 2011, together with the reports thereon by KPMG our independent registered public accounting firm for the years ended December 31, 2011, 2010 and 2009, are set forth on pages through hereto.