The combined ratio is the sum of the loss ratio and the expense ratio.
Diluted book value per share is calculated based on total shareholders’ equity, excluding the aggregate value of the liquidation preferences of our preference shares, at December 31, 2004, 2005, 2006, 2007 and 2008, divided by the number of dilutive equivalent shares outstanding of 71,271,170, 98,126,046, 89,876,459, 88,268,968 and 83,705,984 at December 31, 2004, 2005, 2006, 2007 and 2008, respectively. At December 31, 2004, 2005, 2006, 2007 and 2008, there were 1,956,071, 2,917,038, 2,088,084, 2,758,295 and 2,199,481 of dilutive equivalent shares, respectively. Potentially dilutive shares outstanding are calculated using the treasury method and all relate to employee, director and investor options.
Our principal objective in 2008 was to continue to diversify into profitable new lines of insurance business with limited correlation to the existing insurance and reinsurance business, while maintaining a high quality investment portfolio. During 2008, we entered a number of new business lines while scaling back others. We maintained a high quality fixed income portfolio and reduced our investment in funds of hedge funds, while ensuring appropriate levels of liquidity to support the business.
Capital management. During 2008, we continued to execute our strategy to optimize our capital structure. Our total shares outstanding reduced from 85,510,673 at the end of 2007 to 81,506,503 at December 31, 2008 mainly as a result of the purchase and cancellation of 4,080,800 shares on May 13, 2008 for a consideration of $100 million from Candover, the last of our founding shareholders. The repurchase was executed under the share repurchase program authorized by our Board on February 6, 2008 which authorized the purchase of up to $300 million of our ordinary shares in the period to March 1, 2010.
Diversification. During 2008, we established Syndicate 4711 at Lloyd’s, which commenced underwriting for business incepting on or after May 1, 2008. Syndicate 4711 provides an additional distribution platform. In 2008, the business written by Syndicate 4711 covered energy, hull, marine liability, transportation-related liability and aviation.
Investment management. We have reduced our allocation of cash and invested assets in funds of hedge funds from 9.5% in 2007 to 5.0% at December 31, 2008 and in February 2009, we gave notice to redeem all of our remaining hedge fund investments. In the second half of 2008, we also reduced our exposure to financial institutions fixed income securities as part of our investment risk management strategy. The duration of our fixed income portfolio has reduced from approximately 3.4 years at December 31, 2007 to 3.1 years at December 31, 2008 and the book yield on our fixed income portfolio has reduced from 5.1% at December 31, 2007 to 4.6% at December 31, 2008. In 2008, we also recognized other-than-temporary impairment charges of $59.6 million, of which $35.0 million was related to our holdings of Lehman Brothers senior and subordinated debt. At December 31, 2008, approximately 35% by market value of our fixed interest securities comprised asset-backed and mortgage-backed securities, none of which in our opinion falls into the sub-prime category. We had negligible direct exposure to hybrid and preferred securities.
better result than a higher ratio. The loss ratios for our four business segments for the twelve months ended December 31, 2008, 2007 and 2006 were as follows:
The increase in the property reinsurance loss ratio in 2008 was due mainly to $128.3 million of losses, net of reinsurance recoveries and reinstatement costs, associated with Hurricanes Ike and Gustav. These losses increased the loss ratio by 24 percentage points compared to 2007. The combination of limited catastrophe losses during the year ended December 31, 2007 and $11.5 million of reserve strengthening in 2007 compared to a $40.9 million strengthening in 2006, produced a meaningful favorable variance in the property reinsurance loss ratio between 2007 and 2006.
The loss ratio for casualty reinsurance improved to 65.8% from 69.9% in 2007 mainly as a result of favorable development on prior accident years, particularly in our U.S. casualty treaty line. Reserve releases increased from $31.8 million in 2007 to $67.2 million in 2008. This was partially offset by the inclusion in 2008 of $35.0 million of additional reserves related to the global credit crisis. In 2007, we recognized reserves of $20.0 million in addition to $15.0 million of losses resulting from our normal expectations within this segment associated with the global credit crisis.
The U.S. insurance segment suffered in 2008 from $14.0 million of net losses from Hurricanes Ike and Gustav, which increased the loss ratio by 14.9 percentage points. In 2007, U.S. property insurance benefited from improved loss experience and U.S. casualty insurance benefited from prior year reserve releases, when compared to 2006.
Reserve releases. The loss ratios take into account any changes in our assessments of reserves for unpaid claims and loss adjustment expenses arising from earlier years. In each of the years ended December 31, 2008, 2007 and 2006, we recorded a reduction in the level of reserves for prior years. The amounts of these reductions and their effects on the loss ratio in each year are shown in the following table:
The reserve releases in 2008 were $23.9 million lower than in 2007 due predominantly to reserve strengthening in our international insurance segment compared to reserve releases in prior years.
The reserve releases in 2007 benefited from a significant release in our U.K. commercial liability line due to favorable experience. Excluding the impact of deterioration in 2006 of $35.6 million associated with the 2005 hurricanes, net reserve releases were 5.2% of net premiums earned at December 31, 2006.
Further information relating to the release of reserves can be found below under “- Reserves for Loss and Loss Adjustment Expenses - Prior Year Loss Reserves”.
The increases in operating and administrative expenses in 2007 compared to 2006 reflected increased bonus and long-term incentive charges and increased costs in Bermuda, the U.S. and the U.K. due to the hiring of new teams of underwriters and increased investment in support functions and infrastructure.
Other-than-temporary impairments. We review all of our fixed maturities for potential impairment each quarter based on criteria including issuer-specific circumstances, credit ratings actions and general macro-economic conditions. The process of determining whether a decline in value is “other-than-temporary” requires considerable judgment. As part of the assessment process we also evaluate our ability and intent to hold any fixed maturity security in an unrealized loss position until its market value recovers to amortized cost. Once a security has been identified as other-than-temporarily impaired, the amount of any impairment is determined by reference to that security’s estimated fair value and recorded as a charge to realized losses included in earnings.
In light of the recent turmoil in the financial markets, we have recognized other-than-temporary impairment charges of $59.6 million for the twelve months ended December 31, 2008 (2007 - $Nil; 2006 - $Nil), of which $35.0 million is related to our holdings in Lehman Brothers where we wrote our subordinated debt down to a value of zero and our senior debt down to 9.75% of its original par value. Although our holdings in Lehman Brothers are in default, the market value of these securities was derived based on broker-dealer prices. Management believes that this valuation is, in part, based on market expectations of future recoveries from Lehman Brothers’ bankruptcy proceedings.
Taxes. We incurred a tax expense in 2008 of $36.4 million (2007 - $85.0 million), equivalent to a consolidated rate on income before tax of 26.0% compared to 14.8% in 2007 and 19.6% in 2006. The increase in the effective rate of tax in 2008 is due to the distribution of insurance and investment losses
Dividends. The quarterly dividend has been maintained at $0.15 per ordinary share for 2006, 2007 and 2008.
dividend payments to ordinary and preference shareholders totaling $77.9 million in 2008; and
Our preference shares are classified in our balance sheet as equity but may receive a different treatment in some cases under the capital adequacy assessments made by certain rating agencies. Such securities are often referred to as ‘hybrids’ as they have certain attributes of both debt and equity. We also monitor the ratio of the total of debt and hybrids to total capital which was 22.1% as of December 31, 2008 (2007 - 21.8%; 2006 - 25.3%).
Diluted tangible book value per ordinary share at December 31, 2008 was $28.10, an increase of 3.8% compared to $27.08 at December 31, 2007.
In summary, many lines of business are experiencing good levels of rate increase and we believe this trend will continue as 2009 progresses. Our challenge in 2009 is to allocate the appropriate level of capital for each business line and to increase our exposure to those lines that are experiencing the most significant rate increases while moderating our exposure to lines which have not adjusted their rates.
International Insurance. Our international insurance segment achieved an average rate increase of 15% on renewal business reflecting an improving rate environment in a number of our lines of business, in particular marine hull and marine and energy liability for which January 1 is an important renewal period. In marine hull, the rate environment is improving in part due to reduced market capacity and we achieved average effective rate increases of 27% on our book. We achieved significant increases on our marine, energy and construction liability book of on average 44%.
disciplined underwriting approach and we were able to secure renewal orders at rates equivalent to those achieved at the end of 2007.
In respect of our notice of redemption of approximately 40% of our investments in funds of hedge funds, we have received proceeds of $172.3 million in January 2009, with the remaining balance of $4.9 million together with interest earned thereon (if any), to be paid (subject to audit adjustments) promptly after completion of the audit of the Fund’s books for the year in which such redemption occurs.
The reported gross written premiums for treaty pro rata business include estimates of premiums due to us but not yet reported by the cedant because of time delays between contracts being written by our cedants and their submission of treaty statements to us. This additional premium is normally described as pipeline premium. Treaty statements disclose information on the underlying contracts of insurance written by our cedants and are generally submitted on a monthly or quarterly basis, from 30 to 90 days in arrears. In order to report all risks incepting prior to a period end, we estimate the premiums written between the last submitted treaty statement and the period end.
Catastrophe swap. On August 17, 2004, Aspen Bermuda entered into a risk transfer swap (“cat swap”) with a non-insurance counterparty. During the cat swap’s 3 year term, which ended on August 17, 2007, Aspen Bermuda made quarterly payments based on an initial notional amount of $100 million. In return, Aspen Bermuda was entitled to receive payments of up to $100 million in total if hurricanes made landfall in Florida and caused damage in excess of $39 billion or earthquakes in California caused insured damage in excess of $23 billion. The latest estimate of the insured loss arising from Hurricane Katrina published by PCS on June 8, 2007 was $41.1 billion, which entitled us to a recovery of approximately $26.3 million which has been paid to us. We have decided not to extend the development period under the cat swap and will not be making any further recoveries.
This cat swap falls within the scope of Statement of Financial Accounting Standards (“SFAS”) No. 133 “Accounting for Derivative Instruments and Hedging Activities” and is therefore measured in the balance sheet at fair value with any changes in the fair value shown on the consolidated statement of operations.
Credit insurance contract. On November 28, 2006, the Company entered into a credit insurance contract which, subject to its terms, insures us against losses due to the inability of one or more of our reinsurance counterparties to meet their financial obligations to us. We consider that under SFAS 133 this contract is a financial guarantee insurance contract that does not qualify for exemption from treatment for accounting purposes as a derivative. This is because it provides for the final settlement, expected to take place two years after expiry of cover, to include an amount attributable to outstanding and IBNR claims which may not at that point of time be due and payable to us.
team employs a number of techniques to establish a range of estimates from which they consider it reasonable for management to select a ‘best estimate’ (the “actuarial range”).
Reported claims. For reported claims, reserves are established on a case-by-case basis within the parameters of coverage provided in the insurance policy or reinsurance agreement. In estimating the cost of these claims, we consider circumstances related to the claims as reported, any information available from cedants and loss adjustors and information on the cost of settling claims with similar characteristics in previous periods. In addition, for significant events such as the 2005 and 2008 hurricanes, for example, the detailed analysis of our potential exposures includes information obtained directly from cedants which has yet to be processed through market systems enabling us to reduce the time lag between a significant event occurring and establishing case reserves. This additional information is also incorporated into the analysis used to determine the actuarial IBNR. Reinsurance intermediaries are used to assist in obtaining and validating information from cedants but we establish all reserves. In addition, we may engage loss adjusters and perform on site cedant audits to validate the information provided. Disputes do occur with cedants, but the number and frequency are generally low. In the event of a dispute, intermediaries are used to try to resolve the dispute. If a resolution cannot be reached, then the contracts typically provide for binding arbitration.
For lines of business where early claims experience may not provide a sound statistical basis to estimate the loss reserves, our approach is to establish an initial expected loss and loss expense ratio. This is based on one or more of (a) an analysis of our own claims experience to date, (b) market benchmark data, (c) a contract by contract analysis, and (d) an analysis of a portfolio of similar business written by Syndicate 2020, as available, adjusted by an index reflecting how insurance rates, term and conditions have changed. This initial expected loss and loss expense ratio is then modified in light of the actual experience to date measured against the expected experience. Loss reserves for known catastrophic events are based upon a detailed analysis of our reported losses and potential exposures conducted in conjunction with our underwriters.
Actuarial range of net reserves. In determining the range of net reserves, we estimate recoveries due under our proportional and excess of loss reinsurance programs. For proportional reinsurance we apply the appropriate cession percentages to estimate how much of the gross reserves will be collectable. For excess of loss recoveries, individual large losses are modeled through our reinsurance program. An assessment is also made of the collectability of reinsurance recoveries taking into account market data on the financial strength of each of the reinsurance companies.
The net actuarial range for reserves for losses and loss expenses assuming that net reserves move in proportion to gross would be between $2,403.2 million and $2,896.5 million. The actual net reserves established as at December 31, 2008 were $2,787.0 million.
rise to the claims has happened. Lines of business where the IBNR proportion of the total reserve is high, such as liability insurance, will typically display greater variations between initial estimates and final outcomes because of the greater degree of difficulty of estimating these reserves.
Other investments are accounted for using the equity method of accounting whereby the initial investment is recorded at cost. The carrying amounts of these investments are increased or decreased to reflect our share of income or loss, which is included in net investment income, and are decreased for dividends.
Other-Than-Temporary Impairment in Investments. Our process for identifying declines in the fair value of investments that are other-than-temporary involves consideration of several factors. These primary factors include (i) the time period during which there has been a significant decline in value, (ii) an analysis of the liquidity, business prospects and financial condition of the issuer, (iii) the significance of the decline, (iv) an analysis of the collateral structure and other credit support, as applicable, of the securities in question, (v) expected future interest rate movements, and (vi) our intent
and ability to hold the investment for a sufficient period of time for the value to recover. In addition, EITF 99-20 requires that other-than-temporary impairments for certain asset-backed and mortgage-backed securities are recognized if the fair value of the security is less than its cost or amortized cost and there has been a decrease in the present value of the expected cash flows since the last reporting period. Where our analysis of the above factors results in our conclusion that declines in fair values are other-than-temporary, the cost of the security is written down to fair value and the previously unrealized loss is therefore considered realized in the period such determination is made.
Deferred Tax Assets. We provide for income taxes in accordance with the provisions of SFAS No. 109, “Accounting for Income Taxes” and Financial Interpretation (“FIN”) No. 48, “Accounting for Uncertain Tax Positions” for our subsidiaries operating in income tax paying jurisdictions. Our deferred tax assets and liabilities primarily result from the net tax effect of temporary differences between the amounts recorded in our audited consolidated financial statements and the tax basis of our assets and liabilities. We determine deferred tax assets and liabilities separately for each tax-paying component in each tax jurisdiction.
Our financial statements are prepared in accordance with U.S. GAAP. The discussions that follow include tables and discussions relating to our consolidated income statement and our segmental operating results for the twelve months ended December 31, 2008, 2007 and 2006.
Gross written premiums. The following table analyzes the overall change in gross written premiums in the twelve months ended December 31, 2008, 2007 and 2006. The amounts shown as ‘underlying premiums’ exclude reinstatement premiums and other premiums receivable directly related to losses arising from Hurricanes Katrina, Rita and Wilma (“KRW”) in 2005 or Hurricanes Ike and Gustav (“IG”) in 2008.
Gross written premiums in 2008 increased by 10.1% to $2,001.7 million when compared to the twelve months ended December 31, 2007 as a result of the contribution from new underwriting teams established in the international insurance segment and favorable premium adjustments in our property and casualty reinsurance segments. The decrease in gross written premium in 2007 compared to 2006 was due to several factors including: a less favorable pricing environment in many lines of business, in particular property catastrophe reinsurance, casualty treaty reinsurance and U.K. commercial liability insurance; and the re-positioning of our U.S. excess and surplus lines property insurance business. Gross written premiums in our casualty reinsurance segment were also reduced in 2007 due to the closure of our Marlton, New Jersey office and relocation of our facultative business to Rocky Hill, Connecticut, and a change in our underwriting approach.
Net premiums written. Although total gross written premiums have increased by 10.1%, net premiums written have increased by 14.6% in 2008 compared to 2007. The increase was partly due to a decrease in ceded written premiums by $50.9 million in 2008 compared to 2007 reflecting the purchase of catastrophe cover in 2007 which protected both the 2007 and 2008 wind seasons.
Gross premiums earned. Gross premiums earned reflect the portion of gross written premiums which are recorded as revenues over the policy periods of the risks we write. Therefore, the earned premium recorded in any year includes premium from policies incepting in prior years and excludes premium to be earned subsequent to the balance sheet date. Gross premiums earned in 2008 were $14.2 million lower than in 2007 reflecting the reduction in written premiums in our property and casualty reinsurance segments and due to the gross premium written by the new underwriting teams being written towards the second half of 2008, resulting in a smaller portion of premiums earning through in 2008. Gross earned premium decreased by 4.9% in 2007 compared to 2006 primarily as a result of lower premium production in a softening market.
Net premiums earned. Net premiums earned in 2008 reduced by 1.8% compared to 2007 mainly as a result of the reduction in gross earned premium offset by the recognition of $13.0 million of additional reinstatement premiums associated with Hurricane Ike losses which are earned 100% at the loss date. Net
premiums earned increased by 3.4% in 2007 compared to 2006 predominantly due to our reduction in reinsurance purchases. The changes for each of our segments were as follows:
The underlying changes in net loss ratios by segment for the twelve months ended December 31, 2008, 2007 and 2006 are shown in the following tables:
The prior year adjustment for our international insurance segment is attributable mainly to reserve strengthening for the marine liability line of business and the reserve releases in casualty reinsurance are due to favorable development in U.S. and international treaty business. Losses from Hurricanes Ike and
Prior year adjustments are changes in the reserves for prior year losses and loss adjustment expenses, as described further below. See “- Reserves for Losses and Loss Adjustment Expenses” below.
The gross expense ratio in 2007 increased by 2.8 percentage points when compared to 2006 mainly as a result of the increase in operating and administrative expenses. The increase was attributable to a $14.6 million rise in personnel costs resulting from increased bonus and long-term incentive charges, a $9.9 million increase due to foreign exchange expense principally related to the weakening of the U.S. Dollar against the British Pound, and $7.9 million related to our investment in new business lines. The reduction in the effect of reinsurance by 2.2 percentage points reflects our reduced reliance on reinsurance as we have reduced our exposures in property reinsurance.
Investment income of $139.2 million for 2008 decreased by 53.4% from $299.0 million in 2007, due mainly to the performance of our investments in funds of hedge funds. Losses from our funds of hedge funds investments in 2008 were $97.3 million compared with gains of $44.5 million in 2007. The
Net investment income increased by 46.3% in 2007 compared to 2006, driven mainly by funds of hedge fund contributions, rising interest rates, fixed income sector and asset allocation changes translating into higher book yields and increases in our total cash and investment balances by 13.6% in 2007 when compared to 2006.
During 2008, our fixed income portfolio book yield reduced from 5.1% as at December 31, 2007 to 4.6% as at December 31, 2008. Our fixed income portfolio duration decreased marginally from 3.4 years to 3.1 years during 2008 and the average credit quality of our fixed income portfolio is “AAA,” with 88% of the portfolio being graded “AA” or higher. As at December 31, 2007, the average credit quality of our fixed income portfolio was also “AA+.” As at December 31, 2006, our portfolio book yield was 4.52% and our duration was 3.0 years.
Change in fair value of derivatives. In the twelve months ended December 31, 2008, we recorded a reduction in the fair value of derivatives of $7.8 million (2007 - $11.4 million reduction). This included a reduction of $7.8 million (2007 - $9.0 million) in the estimated fair value of our credit insurance contract. In the twelve months ended December 31, 2007, a charge of $2.4 million for a catastrophe swap which expired on August 20, 2007 was also included. In addition, we hold foreign currency derivative contracts to purchase $18.8 million of U.S. and foreign currencies during 2008. The foreign currency contracts are recorded as derivatives at fair value with changes recorded as a realized foreign exchange gain or loss in our statement of operations. For the twelve months ended December 31, 2008, the impact of foreign currency contracts on net income is a loss of $0.8 million (2007 - loss of $2.4 million). Further information on these contracts can be found in Notes 8 and 9 to the financial statements.
Other-than-temporary impairments. In light of the recent turmoil in the financial markets we have recognized an other-than-temporary impairment charge of $59.6 million in the twelve months ended December 31, 2008, of which $35.0 million is related to our holdings in Lehman Brothers where we wrote our subordinated debt down to a par value of zero and our senior debt down to 9.75% of its original par value. Although our holdings in Lehman Brothers are in default, the market value for these securities was derived based on broker-dealer prices quoted at December 31, 2008. Management believes that this valuation is, in part, based on market expectations of future recoveries from Lehman Brothers’ bankruptcy proceedings.
Net income/(loss). In 2008, we had net income of $103.8 million, equivalent to diluted earnings per ordinary share of $0.89 based on the weighted average number of shares in issue during the period. In 2007, we had net income of $489.0 million, equivalent to diluted earnings per ordinary share of $5.11 based on the weighted average number of shares in issue during the period. In 2006, we had net income of $378.1 million, equivalent to diluted earnings per ordinary share of $3.75 based on the weighted average number of shares in issue during the period. Preference share dividends are deducted from net income for the purpose of calculating earnings per ordinary share.
Our property reinsurance segment is mainly written on a treaty basis and includes catastrophe, risk excess and proportional treaty risks. We also write U.S. and international property facultative risks. Aspen U.K.’s Paris branch writes property facultative business in continental Europe and the Zurich branch writes property and casualty reinsurance in Europe. We also write some structured risks out of Aspen Bermuda. For a more detailed description of this segment, see Part I, Item 1, “Business - Business Segments - Property Reinsurance.”
Gross written premiums. Gross written premiums in this segment decreased by 2.1% compared to 2007 and by 3.5% in 2007 when compared to 2006. The table below shows our gross written premiums for each line of business for the twelve months ended December 31, 2008, 2007 and 2006, and the percentage change in gross written premiums for each line:
The reduction in gross written premiums in the property reinsurance segment in 2007 was principally due to softening rates, in particular in our risk excess line of business, unfavorable pricing and market conditions and the non-renewal of several large contracts which did not meet our pricing conditions. The reduction in gross written premiums in 2006 when compared to 2005 was due to the change in our approach to catastrophe risk management which resulted in the planned non-renewal of, or reduced participation in, certain catastrophe exposed contracts.
Reinsurance ceded. The purchase in 2007 of a number of reinsurance contracts covering us for a period of greater than 12 months, effectively covering the 2008 windstorm season, has resulted in an $81.6 million reduction in ceded written premiums in 2008. Reinsurance costs in 2007 decreased by $40.1 million compared to 2006 as we reduced our reliance on outwards reinsurance in line with the planned non-renewal of, or reduced participation in, certain catastrophe contracts.
There were no material property reinsurance losses reported in 2006 and the most significant loss reported in the year was the deterioration in the 2005 hurricane loss estimates by $35.6 million.
$178.4 million in 2006 mainly as a result of the increase in operating and administrative expenses associated with personnel costs related to increased bonuses and long-term incentive charges and the weakening of the U.S. Dollar against the British Pound. The reduction in the acquisition ratio for property reinsurance from 25.0% in 2006 to 21.1% in 2007 is mainly due to a $105.9 million reduction in the earned reinsurance cost for the year compared to the same period in 2006.
Gross written premiums. The table below shows our gross written premiums for each line of business for the twelve months ended December 31, 2008, 2007 and 2006, and the percentage change in gross written premiums for each line:
The 3.5% decrease in gross written premiums in 2008 was due to the challenging market conditions in addition to negative prior period premium adjustments in our international treaty business written in London. Premium increased in our facultative business following the reorganization of the business and its relocation from New Jersey to Connecticut in 2007. Gross written premiums decreased by 11.1% in 2007 compared to 2006 due to a general reduction in premium rates, the reorganization of our casualty facultative business and downward revisions on estimated premiums on prior year premium estimates for a number of U.S. and international casualty treaties based on updated information received from cedants. The reduction in premium in 2007 compared with 2006 for the international treaty business line was due to a slight reduction in premium rates in 2007 and the loss of a small number of large contracts.
Losses and loss adjustment expenses. Losses and loss adjustment expenses decreased by 18.0% in 2008 compared to 2007, due to a $35.4 million increase in prior year reserve releases and a 13.4% reduction in gross earned premium. The reserve releases reflected favorable loss experience from the international casualty and U.S. casualty reinsurance business lines. The 2008 year has also been impacted by an additional $35.0 million provision against potential losses as a result of the ongoing financial crisis.
Policy acquisition, operating and administrative expenses. Total expenses were $108.6 million for 2008 equivalent to 26.2% of net premiums earned (2007 - 24.7%). The acquisition expense ratio has increased by 1.2 percentage points due to a greater proportion of business emanating from the U.S. where commission rates are higher. Operating costs have reduced by $4.7 million year on year due to a reduction in accruals for performance-related compensation and favorable movements in the exchange rate between the U.S. Dollar and British Pound applied to Sterling denominated expenses. Policy acquisition expenses decreased by 2.0 percentage points between 2007 and 2006 due primarily to changes in business mix and premium reductions for certain contracts with higher commission rates. The increase in the operating and administrative expense ratio in 2007 compared with 2006 of 1.6 percentage points was mainly due to the increase in personnel costs associated with increased bonus accruals and long-term incentive charges, and the weakening of the U.S. Dollar against the British Pound in 2007.
Not Meaningful - 2007 was the first year of operations for these lines of business.
Overall premiums have increased by $204.8 million in 2008 mainly due to the $207.9 million of premium contributed by our newer lines of business. Written premium for existing lines decreased by
Policy acquisition, operating and administrative expenses. The 2008 acquisition expense ratio has improved by 0.6 percentage points due to an $8.0 million reduction in profit commissions and changes to the business mix following the introduction of new teams. Increases in the acquisition costs for the international insurance segment between 2007 and 2006 are attributable to increases in profit commissions resulting from improved profitability, particularly in the energy line.
We write both U.S. property and casualty insurance on an excess and surplus lines basis. For a more detailed description of this segment, see Part I, Item 1, “Business - Business Segments - U.S. Insurance.”
Gross written premiums. Gross written premiums increased by 4.8% compared to the prior period of 2007 due to increased contribution from the property business following the repositioning of the risks written in that account. Gross written premium for casualty insurance decreased as a result of competition and business being declined due to rate inadequacy.
The table below shows our gross written premiums for each line of business in this segment for the twelve months ended December 31, 2008, 2007 and 2006, and the percentage change in gross written premiums for each line:
Losses and loss adjustment expenses. Losses increased only marginally in 2008 despite the year suffering from $14.0 million of losses associated with Hurricanes Ike and Gustav. The current period benefited from a prior period reserve release of $8.1 million compared to a release of $6.3 million in 2007. The loss ratio for the segment decreased to 55.1% in 2007, from 75.0% in 2006. The decrease was attributable to a combination of reserve releases in 2007 compared to a reserve strengthening of $0.8 million in 2006 and favorable loss experience in the 2007 accident year in our U.S. casualty business. The comparative period suffered from a significant number of medium-sized commercial property losses.
Policy acquisition, operating and administrative expenses. Policy acquisition expenses have decreased by $5.7 million due mainly to a reduction in earned premiums and a change in business mix between property and casualty insurance. Operating and administrative expenses are broadly in line with 2007 despite 2008 being impacted by costs associated with the repositioning of the property account. Although the policy acquisition expense ratio of 20.1% in 2007 is relatively consistent with 19.8% in 2006, the underlying net earned premiums from U.S. property business and U.S casualty business changed. The change in business mix towards casualty insurance resulted in lower commission levels, however this was offset by an increase in profit commission in 2007 associated with increased profitability in the account. Operating and administrative expenses increased to $24.4 million in 2007 from $17.2 million in 2006 due primarily to $3.7 million of reorganization costs associated with our U.S. operations, in addition to the increase in operating and administrative expenses associated with personnel costs connected with increased bonuses and long-term incentive charges.
At December 31, 2008 and December 31, 2007 total cash and investments, including accrued interest receivable, were $6.0 billion and $5.9 billion, respectively. The composition of our investment portfolio is summarized below:
Other investments. Other investments represent the Company’s investments in funds of hedge funds which are recorded using the equity method of accounting. In 2008, the Company sold share capital in the funds that were held at cost of $198.6 million for proceeds of $177.2 million realizing a pre-tax loss of $21.4 million.
The following tables summaries the fair value of our mortgage-backed securities (“MBS”) by rating and class at December 31, 2008:
Alternative- A securities. We define Alternative-A (“alt-A”) mortgages as those mortgages with lower documentation and loan application standards than prime mortgages. At December 31, 2008 we had $8.7 million invested in alt-A securities.
Valuation of Fixed Income and Short Term Available for Sale Investments. All of the fixed income securities are traded in the over-the-counter market based on prices provided by one or more market makers in each security. In addition, there are readily observable market value indicators such as credit spreads. We use a variety of pricing sources to value our fixed income securities including those securities that have prepayment features such as mortgage-backed securities and asset-backed securities in order to ensure fair and accurate pricing. The fair value estimates of the securities in our portfolio are not sensitive to significant unobservable inputs or modeling techniques.
Valuation of Other Investments. The value of our investments in funds of hedge funds is based upon monthly net asset values reported by the underlying funds to our funds of hedge fund managers. The financial statements of our funds of hedge funds are subject to independent annual audits evaluating the net asset positions of the underlying investments. We periodically review the performance of our funds of hedge funds and evaluate the reasonableness of the valuations.
Gross reserves for the property reinsurance segment in 2008 reflect the continued settlement of 2004 and 2005 related hurricane losses in addition to early claims settlements associated with Hurricane Ike. Gross reserves for the casualty reinsurance segment have continued to increase reflecting the build up of long-tail reserves and the recognition of additional reserves associated with the global credit crisis. International insurance reserves have increased by 11.8% due to the recognition of hurricane-related losses and the reserves associated with the new business lines. The reserves for U.S. insurance have increased reflecting hurricane losses and the higher proportion of casualty business.
U.S. Insurance. This segment had a $6.3 million release driven largely by the casualty account. This was due to the recognition of some favorable experience to date on the account.
specialty reinsurance of $6.7 million, the run-off of quota shares written in 2002 and 2003 of $6.4 million followed by marine hull insurance of $2.4 million and aviation insurance of $1.8 million. These releases were offset by increases in Hurricane Katrina reserves for the energy, liability and worldwide property accounts.
During 2008, we continued to execute our capital management strategy to optimize our capital structure. Total capital decreased marginally during the year and the proportion funded by our ordinary shareholders has also reduced from 78.1% to 77.9%, mainly as a result of the $100 million share repurchase in May 2008.
The following table shows our capital structure at December 31, 2008 compared to December 31, 2007.
Access to capital. Our business operations are in part dependent on our financial strength and the market’s perception thereof, as measured by shareholders’ equity, which was $2,779.1 million at December 31, 2008 (2007- $2,817.6 million). We believe our financial strength provides us with the
flexibility and capacity to obtain funds through debt or equity financing. However, our continuing ability to access the capital markets is dependent on, among other things, market conditions, our operating results and our perceived financial strength. We regularly monitor our capital and financial position, as well as investment and security market conditions, both in general and with respect to Aspen Holdings’ securities. Our ordinary shares and all our preference shares are listed on the New York Stock Exchange.
Insurance Subsidiaries to ensure that they are able to meet their insurance and other liabilities as they become due and was satisfied that there was a comfortable margin of liquidity as at December 31, 2008 and for the foreseeable future.
These letters of credit are not secured by cash or securities, though they are secured by a pledge of the shares of certain of the Company’s subsidiaries under a pledge agreement.
As of December 31, 2008, the Company had funds on deposit of $604.6 million and £25.3 million (December 31, 2007 - $367.2 million and £49.3 million) as collateral for the secured letters of credit.
Funds at Lloyd’s. AUL operates in Lloyd’s as the corporate member for Syndicate 4711. Lloyd’s agrees Syndicate 4711’s required capital principally through the syndicate’s annual business plan. Such capital, called Funds at Lloyd’s, comprises: cash, investments and a fully collateralized letter of credit. The amounts of cash, investments and letter of credit at December 31, 2008 amount to $200.3 million (December 31, 2007 - $Nil).
The amounts provided as Funds at Lloyd’s will be drawn upon and become a liability of the Company in the event of the syndicate declaring a loss at a level that cannot be funded from other resources, or if the syndicate requires funds to cover a short term liquidity gap. The amount which the Company provides as Funds at Lloyd’s is not available for distribution to the Company for the payment of dividends. AMAL is also required by Lloyd’s to maintain a minimum level of capital. As at December 31, 2008, the minimum amount was $584,000 (December 31, 2007: $Nil). This is not available for distribution by the Company for the payment of dividends.
U.S. surplus lines trust fund. Aspen U.K. has also established a U.S. surplus lines trust fund with a U.S. bank to secure liabilities under U.S. surplus lines policies. The balance held in the trust at December 31, 2008 was $78.8 million (2007 - $75.5 million).
U.S. regulatory deposits. As at December 31, 2008, Aspen Specialty had a total of $6.8 million (2007 - $6.9 million) on deposit with U.S. states in order to satisfy state regulations for writing business in those states.
Under the credit facilities, we must maintain at all times a consolidated tangible net worth of not less than approximately $1.1 billion plus 50% of consolidated net income and 50% of aggregate net cash proceeds from the issuance by the Company of its capital stock, each as accrued from January 1, 2005. On June 28, 2007, we amended the credit agreement to permit dividend payments on existing and future hybrid capital notwithstanding a default or an event of default under the credit agreement. On April 13, 2006, the agreement was amended to remove any downward adjustment on maintaining the Company’s consolidated tangible net worth in the event of a net loss. The Company must also not permit its consolidated leverage ratio of total consolidated debt to consolidated tangible net worth to exceed 35%. In addition, the credit facilities contain other customary affirmative and negative covenants as well as certain customary events of default, including with respect to a change in control. The various affirmative and negative covenants, include, among others, covenants that, subject to important exceptions, restrict the ability of the Company and its subsidiaries to: create or permit liens on assets; engage in mergers or consolidations; dispose of assets; pay dividends or other distributions, purchase or redeem the Company’s equity securities or those of its subsidiaries and make other restricted payments; permit the rating of any insurance subsidiary to fall below A.M. Best financial strength rating of B++ or S&P financial strength rating of A-; make certain investments; agree with others to limit the ability of the Company’s subsidiaries to pay dividends or other restricted payments or to make loans or transfer assets to the Company or another of its subsidiaries. The credit facilities also include covenants that restrict the ability of our subsidiaries to incur indebtedness and guarantee obligations.
Letter of Credit Facility. We also have a $450 million letter of credit facility with Citibank which is available to Aspen Bermuda for the provision of collateral to its cedants.
claims loss payment patterns. The total amount of payments in respect of our reserves, as well as the timing of such payments, may differ materially from our current estimates for the reasons set out above under “- Critical Accounting Policies - Reserves for Losses and Loss Expenses.”
For our U.K.-based reinsurance and insurance operations, on April 1, 2005, Aspen U.K. signed an agreement for under leases (following our entry in October 2004 into a heads of terms agreement) with B.L.C.T. (29038) Limited (the landlord), Tamagon Limited and Cleartest Limited in connection with leasing office space in London of approximately a total of 49,500 square feet covering three floors. The term of each lease for each floor commenced in November 2004 and runs for 15 years. In 2007, the building was sold to Tishman International. The terms of the lease remain unchanged. We began paying the yearly basic rent of approximately £2.7 million per annum in November 2007. The basic annual rent for each of the leases will each be subject to 5-yearly upwards-only rent reviews. We also license office space within the Lloyd’s building on the basis of a renewable twelve-month lease.