Everest Re’s corporate offices are located in approximately 230,500 square feet of leased office space in Liberty Corner, New Jersey. Bermuda Re’s corporate offices are located in approximately 3,600 total square feet of leased office space in Hamilton, Bermuda. The Company’s other sixteen locations occupy a total of approximately 146,800 square feet, all of which are leased. Management believes that the above-described office space is adequate for its current and anticipated needs.
The following selected consolidated GAAP financial data of the Company as of and for the years ended December 31, 2011, 2010, 2009, 2008 and 2007, were derived from the audited consolidated financial statements of the Company. The following financial data should be read in conjunction with the Consolidated Financial Statements and accompanying notes.
Based on weighted average basic common shares outstanding of 53.8 million, 56.6 million, 60.7 million, 61.7 million, and 63.1 million for 2011, 2010, 2009, 2008 and 2007, respectively.
Based on weighted average diluted common shares outstanding of 56.8 million, 60.8 million and 63.6 million for 2010, 2009 and 2007, respectively. Diluted calculation was not applicable for 2011 and 2008.
Overall, we believe that current marketplace conditions, particularly for catastrophe coverages, provide profit opportunities for us given our strong ratings, distribution system, reputation and expertise. We continue to employ our strategy of targeting business that offers the greatest profit potential, while maintaining balance and diversification in our overall portfolio.
Gross written premiums increased by $71.8 million, or 1.7%, in 2010, compared to 2009, reflecting an increase of $63.7 million in our reinsurance business and $8.1 million increase in our insurance business. The increase in reinsurance premiums was primarily the result of increased writings in our U.S. treaty property and international books of business, driven by a combination of new business, increased participations on renewal contracts, rate increases in select areas, and economic and insurance growth in several regions. The increase in insurance premiums was due to increased writings in professional liability and California workers’ compensation business, partially offset by a reduction in the audit premium accrual for workers’ compensation business. Net written premiums increased $15.8 million, or 0.4%, in 2010 compared to 2009. The lower increase in net written premiums relative to the change in gross written premiums was due to the increased use of reinsurance on several large programs in the insurance book. Premiums earned increased $40.5 million, or 1.0%, in 2010, compared to 2009. The change in net premiums earned is relatively consistent with the increase in net written premiums.
Net investment income increased $105.7 million, or 19.3%, in 2010 compared with net investment income of $547.8 million in 2009, primarily as a result of an $89.7 million increase in investment income from our limited partnerships. Net pre-tax investment income, as a percentage of average invested assets, was 4.5% in 2010 compared to 3.8% for 2009. The variance in this yield was primarily the result of fluctuations in our limited partnership income.
Realized Gain on Debt Repurchase. On March 19, 2009, we commenced a cash tender offer for any and all of the 6.60% fixed to floating rate long term subordinated notes due 2067. Upon expiration of the tender offer, we had reduced our outstanding debt by $161.4 million, which resulted in a pre-tax gain on debt repurchase of $78.3 million.
Net Derivative Gain (Loss). In 2005 and prior, we sold seven equity index put option contracts, which are outstanding. These contracts meet the definition of a derivative in accordance with FASB guidance and as such, are fair valued each quarter with the change recorded as net derivative gain or loss in the consolidated statements of operations and comprehensive income (loss). As a result of these adjustments in value, we recognized net derivative losses of $11.3 million and $1.1 million in 2011 and 2010, respectively, and a net derivative gain of $3.2 million in 2009. The change in the fair value of these equity index put option contracts is indicative of the change in the equity markets and interest rates over the same periods.
Commission, brokerage, taxes and fees increased by $3.5 million, or 0.4%, for the year ended December 31, 2010 compared to the same period in 2009. The change was primarily due to the result of an increase in premiums earned, as the commission ratio, year over year, was comparable.
Net realized capital gains were $6.9 million in 2011 compared to net realized capital gains of $101.9 million in 2010 and net realized capital losses of $2.3 million in 2009. In 2011, we recorded $27.5 million of net realized capital gains from sales of fixed maturity and equity securities, partially offset by $16.2 million of other-than-temporary impairments and $4.4 million of net realized capital losses due to fair value re-measurements on fixed maturity and equity securities. The gains and losses on the sales of fixed maturity securities included the impact of selling part of our municipal bond portfolio as credit concerns arose in this market sector. In 2010, we recorded $70.4 million of gains due to fair value re-measurements on fixed maturity and equity securities, $34.5 million of net realized capital gains from sales of fixed maturity and equity securities, partially offset by $3.0 million of other-than-temporary impairments on fixed maturity securities. The gains on the sales of fixed maturity securities included selling securities in foreign currencies, which reduced our exposure to future currency fluctuations. The losses included the impact of selling part of our municipal bond portfolio in the latter part of the year as credit concerns arose in this market sector. We were able to carry these realized losses back for income tax purposes to offset previously realized gains. This carry back availability expired at the end of 2010. In 2009, we recorded $29.4 million of net realized capital losses from sales of fixed maturity and equity securities and $13.2 million of other-than-temporary
During the quarter ended September 30, 2011, we realigned our reporting segments to reflect recent changes in the type and volume of business written. We previously reported the results of Marine & Aviation, Surety, A&H Reinsurance and A&H Primary operations as a separate segment-Specialty Underwriting. The A&H primary business, which is a relatively new line of business for us, has increased significantly, representing approximately 2% of premiums earned and is projected to continue to grow. The A&H primary business is better aligned with the Insurance reporting segment based on the similarities of this business with those businesses already reflected in the Insurance segment. The other operating units included in the Specialty Underwriting segment would have encompassed less than 5% of our premiums earned and their volume is projected to remain less than 5%. As a result of the size of these remaining operating units and their similarity to the business reported within U.S. Reinsurance, they have been reclassified to the U.S. Reinsurance segment. There has been no change to the International and Bermuda reporting segments. We have restated all segment information for prior years to conform to the new reporting segment structure.
The U.S. Reinsurance operation writes property and casualty reinsurance and specialty lines of business, including Marine, Aviation, Surety and A&H business, on both a treaty and facultative basis, through reinsurance brokers, as well as directly with ceding companies primarily within the U.S. The Insurance operation writes property and casualty insurance, including medical stop loss insurance, directly and through general agents, brokers and surplus lines brokers within the U.S. and Canada. The International operation writes non-U.S. property and casualty reinsurance through Everest Re’s branches in Canada and Singapore and through offices in Brazil, Miami and New Jersey. The Bermuda operation provides reinsurance and insurance to worldwide property and casualty markets and reinsurance to life insurers through brokers and directly with ceding companies from its Bermuda office and reinsurance to the United Kingdom and European markets through its UK branch and Ireland Re.
Premiums. Gross written premiums decreased by 3.5% to $1,346.8 million in 2011 from $1,395.4 million in 2010, primarily due to reduced reinsurance premiums for accident and health, crop and marine business partially offset by a $24.4 million increase in reinstatement premiums due to higher catastrophe loss activity in the period. Net written premiums decreased 3.5% to $1,344.3 million in 2011 compared to $1,392.6 million for the same period in 2010, which is in line with the decrease in gross written premiums for the year. Premiums earned decreased 5.4% to $1,312.7 million in 2011 compared to $1,387.0 million in 2010. The change in premiums earned relative to net written premiums is the result of timing; premiums are earned ratably over the coverage period whereas written premiums are recorded at the initiation of the coverage period.
Gross written premiums decreased by 0.8% to $1,395.4 million in 2010 from $1,407.1 million in 2009, primarily due to a $40.7 million (48.2%) decrease in the crop hail quota share treaties, a $32.4 million (8.9%) decrease in U.S. treaty casualty volume and a $28.6 million (29.2%) decrease in facultative volume, partially offset by a $73.7 million (11.8%) increase in treaty property volume and a $23.0 million (27.7%) increase in A&H reinsurance. Net written premiums decreased 0.3% to $1,392.6 million in 2010 compared to $1,397.2 million in 2009, which is in line with the decline in gross written premiums. Premiums earned increased 0.2% to $1,387.0 million in 2010 compared to $1,384.9 million in 2009, which are similar to the amount of net written premiums.
Incurred losses were $133.2 million (13.8 points) higher at $1,034.1 million in 2011 compared to $900.9 million in 2010, primarily as a result of the $230.7 million (17.7 points) increase in current year catastrophe losses, largely due to the Japan and New Zealand earthquakes, U.S. Midwest tornadoes, Hurricane Irene and Thailand floods. The current year attritional losses decreased $76.2 million (2.5 points), primarily due to a shift in the mix of business, with a higher level of excess of loss business in the current year, which carries a lower attritional loss ratio than pro rata business, coupled with a decline in earned premiums.
Premiums. Gross written premiums increased by 12.7% to $975.6 million in 2011 compared to $865.4 million in 2010. This was due to strategic portfolio changes with growth in short-tail business, primarily driven by the acquisition of Heartland, which provided $169.6 million of new crop insurance premium in 2011 and $54.0 million growth in A&H primary business, partially offset by the reduction of a large casualty program. Net written premiums increased 32.3% to $820.5 million in 2011 compared to $620.3 million for the same period in 2010 due to higher gross premiums and reduced levels of ceded reinsurance, primarily due to the reduction of the large casualty program. Premiums earned increased 28.1% to $821.2 million in 2011 compared to $641.1 million in 2010. The change in premiums earned is relatively consistent with the increase in net written premiums.
Gross written premiums increased by 2.7% to $865.4 million in 2010 compared to $842.6 million in 2009. This was primarily due to increased writings in A&H primary, professional liability and California workers’ compensation business partially offset by a reduction in audit premiums for workers’ compensation business. Net written premiums decreased 5.5% to $620.3 million compared to $656.2 million in 2009 due to an increase in the use of reinsurance on several large programs. Ceded premiums generally relate to specific reinsurance purchased and fluctuate based upon the level of premiums written in the individual reinsured programs. Premiums earned decreased 4.5% to $641.1 million in 2010 compared to $671.1 million in 2009. The change in premiums earned is relatively consistent with the decrease in net written premium.
Incurred losses and LAE decreased by 0.3% to $536.8 million in 2010 compared to $538.6 million in 2009. The decrease was due to lower net premiums earned, partially offset by an increase in the attritional loss ratio, year over year. Current year attritional losses increased $20.4 million (6.5 points), due to higher expected loss ratios on several programs, reflective of current market conditions. Offsetting the increase in current year losses was a decrease of $22.2 million (3.1 points) in prior years’ loss development compared to 2009. The 2010 prior years’ unfavorable development of $36.8 million was primarily the result of reserve strengthening on several terminated programs.
Incurred losses and LAE increased 30.7% to $1,372.3 million in 2011 compared to $1,050.1 million in 2010. The increase was principally due to a $384.6 million (28.5 points) increase in current year catastrophes in 2011 (Japan and New Zealand earthquakes, the Thailand floods, the Australia floods, and the wildfire loss in Alberta, Canada) compared to the 2010 reported catastrophe losses (Chilean earthquake, New Zealand earthquake and Australia hailstorms). The current year attritional loss ratio, adjusting for prior year attritional reinstatement premiums was down to 52.1% in 2011 from 56.2% in 2010, primarily due to a shift in the mix of business towards property, catastrophe and excess of loss business, which generally carries a lower loss ratio. Prior years’ attritional losses decreased by $66.3 million (5.1 points) due to favorable development on non-catastrophe property business in Singapore and other international markets.
Incurred losses and LAE increased 71.2% to $1,050.1 million in 2010 compared to $613.3 in 2009. The increase was principally due to a $417.3 million (35.3 points) increase in current year catastrophes related to the Chilean earthquake, the Australian hailstorms and floods, the New Zealand earthquake and the Canadian hailstorm compared to the absence in 2009 of any similar large events. Attritional losses also increased, primarily due to an increase in premiums earned and higher expected loss ratios which were partially offset by favorable development on prior years’ reserves.
Commission and brokerage increased 8.0% to $288.4 million in 2010 compared to $267.1 million in 2009. The increase was primarily in line with the increases in premiums earned. Segment other underwriting expenses increased to $27.6 million in 2010 compared to $23.1 million in 2009. The increase was consistent with the growth in premiums earned resulting in stable other underwriting expense ratios for the periods.
Premiums. Gross written premiums decreased 1.1% to $725.3 million in 2011 compared to $733.0 million in 2010, primarily due to reduced participations and non-renewal of U.K. property business, where rate increases were not achieved, partially offset by an increase of $11.3 million in reinstatement premiums due to higher catastrophe loss activity in the current period and a $16.0 million favorable foreign exchange impact. Net written premiums decreased 1.0% to $725.5 million for in 2011 compared to $733.0 million in 2010, in line with the decrease in gross written premiums. Premiums earned decreased 2.1% to $723.0 million in 2011 compared to $738.4 million in 2010. The change in premiums earned is in line with the decline in net written premiums.
Incurred losses and LAE decreased 5.4% to $457.9 million in 2010 compared to $484.0 million in 2009. The decrease was primarily due to the favorable development on prior years’ attritional and catastrophe reserves, partially offset by current year catastrophe losses from the Chilean earthquake, New Zealand earthquake and Australian hailstorms. The 2010 prior year favorable development primarily emanated from casualty business written by the Bermuda office.
Segment Expenses. Commission and brokerage increased 1.7% to $174.0 million in 2011 compared to $171.1 million in 2010. The commission variance differs from the premiums earned variance primarily due to changes in the mix of business. Segment other underwriting expenses decreased slightly to $26.3 million in 2011 compared to $26.4 million in 2010.
Our carried reserves at each reporting date are our best estimate of ultimate unpaid losses and LAE at that date. We complete detailed reserve studies for each exposure group annually for our reinsurance and insurance operations. The completed annual reinsurance reserve studies are “rolled forward” for each accounting period until the subsequent reserve study is completed. Analyzing the roll-forward process involves comparing actual reported losses to expected losses based on the most recent reserve study. We analyze significant variances between actual and expected losses and post adjustments to our reserves as warranted.
We believe that these uncertainties continue to render reserves for A&E, and particularly asbestos losses, significantly less subject to traditional actuarial analysis than reserves for other types of losses. We establish reserves to the extent that, in the judgment of management, the facts and prevailing law reflect an exposure for us or our ceding companies.
We have direct relationships with Mt. McKinley policyholders and we attempt to uphold our contractual rights and assert valid defenses to coverage where appropriate. The uncertainties inherent in asbestos coverage and bankruptcy litigations have provided us the opportunity to engage in settlement negotiations with a number of policyholders who have potentially significant asbestos liabilities. Those discussions are aimed at achieving reasonable negotiated settlements that limit Mt. McKinley’s liability to a given policyholder to a sum certain. Because of the risks and uncertainties inherent in litigation, we cannot be certain that this approach will lead to a negotiated settlement in the range expected by us in each or every instance. Between 2004 and 2011, we concluded settlements or reached agreement in principle with 23 of our high profile policyholders. We continue the approach of attempting to negotiate with such policyholders that may have significant asbestos liabilities, in part because their exposures have developed to the point where we and the policyholder have sufficient information to be motivated to settle. We believe that this active approach will ultimately result in a more cost-effective liquidation of Mt. McKinley’s liabilities than a passive approach, although it may also introduce additional variability in Mt. McKinley’s losses and cash flows as reserves are adjusted to reflect the developments in litigation, negotiations and, ultimately, potential settlements.
Investment Valuation. Our fixed income investments are classified for accounting purposes as available for sale and are carried at market value or fair value in our consolidated balance sheets. Our equity securities are also held as available for sale and are carried at market or fair value. Most securities we own are traded on national exchanges where market values are readily available. Some of our commercial mortgage-backed securities (“CMBS”) are valued using cash flow models and risk-adjusted discount rates. We hold some privately placed securities, less than 0.14% of the portfolio, that are either valued by brokers or an investment advisor. At December 31, 2011 and 2010, our investment portfolio included $515.5 million and $567.9 million, respectively, of limited partnership investments whose values are reported pursuant to the equity method of accounting. We carry these investments at values provided by the managements of the
At December 31, 2011, we had net unrealized gains, net of tax, of $449.6 million compared to $369.4 million at December 31, 2010. Gains and losses from market fluctuations for investments held at market value are reflected as comprehensive income (loss) in the consolidated balance sheets. Gains and losses from market fluctuations for investments held at fair value are reflected as net realized capital gains and losses in the consolidated statements of operations and comprehensive income (loss) in accordance with FASB guidance. Market value declines for the fixed income portfolio, which are considered credit other-than-temporary impairments, are reflected in our consolidated statements of operations and comprehensive income (loss), as realized capital losses. We consider many factors when determining whether a market value decline is other-than-temporary, including: (1) we have no intent to sell and, more likely than not, will not be required to sell prior to recovery, (2) the length of time the market value has been below book value, (3) the credit strength of the issuer, (4) the issuer’s market sector, (5) the length of time to maturity and (6) for asset-backed securities, changes in prepayments, credit enhancements and underlying default rates. If management’s assessments change in the future, we may ultimately record a realized loss after management originally concluded that the decline in value was temporary. See also ITEM 8, “Financial Statements and Supplementary Data” - Note 1 of Notes to the Consolidated Financial Statements.
Cash and Invested Assets. Aggregate invested assets, including cash and short-term investments, were $15,797.4 million at December 31, 2011, an increase of $432.4 million compared to $15,365.0 million at December 31, 2010. This increase was primarily the result of $659.5 million of cash flows from operations, $106.6 million of unrealized appreciation, $56.5 million in equity adjustments of our limited partnership investments and $13.6 million of unsettled securities, partially offset by $103.8 million paid out in dividends to shareholders, $92.5 million paid for share repurchases, $65.7 million due to fluctuations in foreign currencies, $63.1 million due to the cost of businesses acquired, $50.0 million revolving credit pay off and $4.4 million in fair value re-measurements.
adequacy models. We use investment managers experienced in these markets and adjust our allocation to these investments based upon market conditions. At December 31, 2011, the market value of investments in these investment market sectors, carried at both market and fair value, approximated 57% of shareholders’ equity.
The pre-tax equivalent total return for the bond portfolio was approximately 5.1%, 5.7% and 10.1%, respectively, for 2011, 2010 and 2009. The pre-tax equivalent return adjusts the yield on tax-exempt bonds to the fully taxable equivalent.
The following table below represents the reserve levels and ranges for each of our business segments for the period indicated.
We have exposure to insured A&E losses through our Mt. McKinley operation and reinsured A&E losses and through Everest Re. In each case, our management and analyses of our exposures take into account a number of features of our business that differentiate our exposures from many other insurers and reinsurers that have significant A&E exposures.
At December 31, 2011, the gross reserves for A&E losses were comprised of $145.6 million representing case reserves reported by ceding companies, $102.9 million representing additional case reserves established by us on assumed reinsurance claims, $40.6 million representing case reserves established by us on direct excess insurance claims, including Mt. McKinley, and $210.8 million representing IBNR reserves.
Industry analysts use the “survival ratio” to compare the A&E reserves among companies with such liabilities. The survival ratio is typically calculated by dividing a company’s current net reserves by the three year average of annual paid losses. Hence, the survival ratio equals the number of years that it would take to exhaust the current reserves if future loss payments were to continue at historical levels. Using this measurement, our net three year asbestos survival ratio was 5.8 years at December 31, 2011. These metrics can be skewed by individual large settlements occurring in the prior three years and therefore, may not be indicative of the timing of future payments.
Capital. Our business operations are in part dependent on our financial strength and financial strength ratings, and the market’s perception of our financial strength, as measured by shareholders’ equity, which was $6,071.4 million at December 31, 2011 and $6,283.5 million at December 31, 2010. On March 13, 2009, Everest Re and Everest National, wholly-owned indirect subsidiaries of the Company, received notification of a one level ratings downgrade by Standard & Poor’s. On April 7, 2010, Standard & Poor’s upgraded the Company’s debt ratings one level. On January 24, 2012, Moody’s affirmed the ratings of the Company’s operating subsidiaries but changed the outlook on the ratings from stable to negative reflecting their opinion of the potential direction of the ratings over the medium term (12 to 18 months). Management will continue to work with Moody’s over this time to address their concerns but it is not possible to predict the potential outcome. Management does not believe that a one notch downgrade would have a material adverse affect on the Company’s business. We continue to possess significant financial flexibility and access to the debt and equity markets as a result of our perceived financial strength, as evidenced by the financial strength ratings as assigned by independent rating agencies.
years. Our $1,698.0 million of equity securities are comprised primarily of publicly traded securities that can be easily liquidated. We believe that these fixed maturity and equity securities, in conjunction with the short-term investments and positive cash flow from operations, provide ample sources of liquidity for the expected payment of losses in the near future. We do not anticipate selling securities or using available credit facilities to pay losses and LAE but have the ability to do so. Sales of securities might result in realized capital gains or losses. At December 31, 2011 we had $547.7 million of net pre-tax unrealized appreciation, comprised of $649.2 million of pre-tax unrealized appreciation and $101.5 million of pre-tax unrealized depreciation.
Effective July 27, 2007, Group, Bermuda Re and Everest International entered into a five year, $850.0 million senior credit facility with a syndicate of lenders referred to as the “Group Credit Facility”. Wells Fargo Corporation (“Wells Fargo Bank”) is the administrative agent for the Group Credit Facility, which consists of two tranches. Tranche one provides up to $350.0 million of unsecured revolving credit for liquidity and general corporate purposes, and for the issuance of unsecured standby letters of credit. The interest on the revolving loans shall, at the Company’s option, be either (1) the Base Rate (as defined below) or (2) an adjusted London Interbank Offered Rate (“LIBOR”) plus a margin. The Base Rate is the higher of (a) the prime commercial lending rate established by Wells Fargo Bank or (b) the Federal Funds Rate plus 0.5% per annum. The amount of margin and the fees payable for the Group Credit Facility depends on Group’s senior unsecured debt rating. Tranche two exclusively provides up to $500.0 million for the issuance of standby letters of credit on a collateralized basis.
At December 31, 2011, the Group Credit Facility had no outstanding letters of credit under tranche one and $446.5 million outstanding letters of credit under tranche two. At December 31, 2010, the Group Credit Facility had no outstanding letters of credit under tranche one and $406.4 million outstanding letters of credit under tranche two.
The Holdings Credit Facility requires Holdings to maintain a debt to capital ratio of not greater than 0.35 to 1 and Everest Re to maintain its statutory surplus at $1,875.0 million plus 25% of future aggregate net income and 25% of future aggregate capital contributions after December 31, 2010, which at December 31, 2011, was $1,898.9 million. As of December 31, 2011, Holdings was in compliance with all Holdings Credit Facility covenants.
Costs incurred in connection with the Group Credit Facility and the Holdings Credit Facility were $1.8 million and $1.7 million for December 31, 2011 and 2010, respectively.
We believe that our greatest worldwide 1 in 100 year exposure to a single catastrophic event is to a hurricane affecting the U.S. southeast coast, where we estimate we have a gross PML exposure of $913 million. See also table under ITEM 1, “Business - Risk Management of Underwriting and Retrocession Arrangements”.
If such a single catastrophe loss were to occur, management estimates that the economic loss to us would be approximately $629 million. The estimate involves multiple variables, including which Everest entity would experience the loss, and as a result there can be no assurance that this amount would not be exceeded.
For the period from July 1, 2011 to July 1, 2012, we have catastrophe loss reinsurance in place of 75% of $100 million in excess of $215 million, excluding the territories of the U.S., Japan, Europe and Caribbean wind. See ITEM 1, “Business - Risk Management of Underwriting and Retrocession Arrangements” for further details.
Financial Accounting Standards Board Launched Accounting Codification. In June 2009, FASB issued authoritative guidance establishing the FASB Accounting Standards CodificationTM (“Codification”) as the single source of authoritative U.S. GAAP recognized by the FASB to be applied by non-governmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The Codification supersedes all existing non-SEC accounting and reporting standards. All other non-grandfathered, non-SEC accounting literature not included in the Codification have become non-authoritative.
GAAP is not intended to be changed as a result of the FASB’s Codification, but it will change the way the guidance is organized and presented. As a result, these changes have a significant impact on how companies reference GAAP in their financial statements and in the accounting policies for financial statements issued for interim and annual periods ending after September 15, 2009. The Company’s adoption of this guidance impacts the way the Company references U.S. GAAP accounting standards in the financial statements and Notes to Consolidated Financial Statements.
Intangibles-Goodwill or Other. In September 2011, the FASB amended the authoritative guidance for disclosures on Goodwill Impairment. The amendment allows an entity first to assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis in determining whether it is necessary to perform the two-step goodwill impairment test. This guidance is effective for periods beginning after December 15, 2011. The Company will adopt this guidance as of January 1, 2012.
Treatment of Insurance Contract Acquisition Costs. In October 2010, the FASB issued authoritative guidance for the accounting for costs associated with acquiring or renewing insurance contracts. The guidance identifies the incremental direct costs of contract acquisition and costs directly related to acquisition activities that should be capitalized. This guidance is effective for reporting periods beginning after December 15, 2011. The Company will adopt this guidance as of January 1, 2012 and estimates that $13.5 million of acquisition costs will no longer be capitalized during 2012.
Other-Than-Temporary Impairments on Investment Securities. In April 2009, the FASB revised the authoritative guidance for the recognition and presentation of other-than-temporary impairments. This new guidance amends the recognition guidance for other-than-temporary impairments of debt securities and expands the financial statement disclosures for other-than-temporary impairments on debt and equity securities. For available for sale debt securities that the Company has no intent to sell and more likely than not will not be required to sell prior to recovery, only the credit loss component of the impairment would be recognized in earnings, while the rest of the fair value loss would be recognized in accumulated other comprehensive income (loss). The Company adopted this guidance effective April 1, 2009. Upon adoption the Company recognized a cumulative-effect adjustment increase in retained earnings and decrease in accumulated other comprehensive income (loss) as follows:
The overall investment strategy considers the scope of present and anticipated Company operations. In particular, estimates of the financial impact resulting from non-investment asset and liability transactions, together with our capital structure and other factors, are used to develop a net liability analysis. This analysis includes estimated payout characteristics for which our investments provide liquidity. This analysis is considered in the development of specific investment strategies for asset allocation, duration and credit quality. The change in overall market sensitive risk exposure principally reflects the asset changes that took place during the period.
The tables below display the potential impact of market value fluctuations and after-tax unrealized appreciation on our fixed maturity portfolio (including $685.3 million of short-term investments) for the period indicated based on upward and downward parallel and immediate 100 and 200 basis point shifts in interest rates. For legal entities with a U.S. dollar functional currency, this modeling was performed on each security individually. To generate appropriate price estimates on mortgage-backed securities, changes in prepayment expectations under different interest rate environments were taken into account. For legal entities with a non-U.S. dollar functional currency, the effective duration of the involved portfolio of securities was used as a proxy for the market value change under the various interest rate change scenarios.
We had $10,123.2 million and $9,340.2 million of gross reserves for losses and LAE as of December 31, 2011 and 2010, respectively. These amounts are recorded at their nominal value, as opposed to present value, which would reflect a discount adjustment to reflect the time value of money. Since losses are paid out over a period of time, the present value of the reserves is less than the nominal value. As interest rates rise, the present value of the reserves decreases and, conversely, as interest rates decline, the present value increases. These movements are the opposite of the interest rate impacts on the fair value of investments. While the difference between present value and nominal value is not reflected in our financial statements, our financial results will include investment income over time from the investment portfolio until the claims are paid. Our loss and loss reserve obligations have an expected duration of approximately 3.6 years, which is reasonably consistent with our fixed income portfolio. If we were to discount our loss and LAE reserves, net of $0.6 billion of reinsurance receivables on unpaid losses, the discount would be approximately $1.4 billion resulting in a discounted reserve balance of approximately $8.1 billion, representing approximately 61.9% of the market value of the fixed maturity investment portfolio funds.
Foreign Currency Risk. Foreign currency risk is the potential change in value, income and cash flow arising from adverse changes in foreign currency exchange rates. Each of our non-U.S./Bermuda (“foreign”) operations maintains capital in the currency of the country of its geographic location consistent with local regulatory guidelines. Each foreign operation may conduct business in its local currency, as well as the currency of other countries in which it operates. The primary foreign currency exposures for these foreign operations are the Canadian Dollar, the Singapore Dollar, the British Pound Sterling and the Euro. We mitigate foreign exchange exposure by generally matching the currency and duration of our assets to our corresponding operating liabilities. In accordance with FASB guidance, we translate the assets, liabilities and income of non-U.S. dollar functional currency legal entities to the U.S. dollar. This translation amount is reported as a component of other comprehensive income.
We sold six equity index put option contracts, based on the S&P 500 index, for total consideration, net of commissions, of $22.5 million. At December 31, 2011, fair value for these equity index put option contracts was $62.4 million. These equity index put option contracts each have a single exercise date, with maturities ranging from 12 to 30 years and strike prices ranging from $1,141.21 to $1,540.63. The S&P 500 index value at December 31, 2011 was $1,257.60. No amounts will be payable under these equity index put option contracts if the S&P 500 index is at, or above, the strike prices on the exercise dates, which fall between June 2017 and March 2031. If the S&P 500 index is lower than the strike price on the applicable exercise date, the amount due would vary proportionately with the percentage by which the index is below the strike price. Based on historical index volatilities and trends and the December 31, 2011 S&P 500 index
We sold one equity index put option contract based on the FTSE 100 index for total consideration, net of commissions, of $6.7 million. At December 31, 2011, fair value for this equity index put option contract was $7.3 million. This equity index put option contract has an exercise date of July 2020 and a strike price of ₤5,989.75. The FTSE 100 index value at December 31, 2011 was ₤5,572.30. No amount will be payable under this equity index put option contract if the FTSE 100 index is at, or above, the strike price on the exercise date. If the FTSE 100 index is lower than the strike price on the exercise date, the amount due will vary proportionately with the percentage by which the index is below the strike price. Based on historical index volatilities and trends and the December 31, 2011 FTSE 100 index value, we estimate the probability that the equity index put option contract of the FTSE 100 index will fall below the strike price on the exercise date to be less than 44%. The theoretical maximum payout under the equity index put option contract would occur if on the exercise date the FTSE 100 index value was zero. At December 31, 2011, the present value of the theoretical maximum payout using a 6% discount factor and current exchange rate was $30.8 million.