The following discussion and analysis reflects the consolidated results of the Company and its subsidiaries for the years ended December 31, 2008, 2009 and 2010, including the results of Paris Re from October 2, 2009 the date of acquisition of controlling interest (Acquisition Date).
The Company’s economic objective is to manage a portfolio of risks that will generate compound annual Diluted Book Value per Share growth of 10% and an average Operating ROE of 13% over a reinsurance cycle. Both of these metrics are defined below in Key Financial Measures.
In its reinsurance portfolio, the Company writes all lines of business in virtually all markets worldwide, and differentiates itself through its risk management strategy and its financial strength. In assuming its clients’ risks, the Company removes the volatility associated with those risks from the clients’ financial statements, and then manages those risks and the risk-related volatility. Through its broad product and geographic diversification, its excellent execution capabilities and its local presence in most major markets, the Company is able to stabilize returns, respond quickly to market needs, and capitalize on business opportunities virtually anywhere in the world.
Overall, the January 1, 2011 renewals saw challenging market conditions with reductions in pricing profitability and increased cedants retentions in most lines of business, with the Company only observing pricing improvements in certain lines of business in response to loss experience. As a result of the reductions in pricing, the Company decided to non-renew or reduce its participations on certain treaties. In addition, the Company actively repositioned its portfolio at the January 1, 2011 renewals, and reduced certain catastrophe exposures, following the integration of Paris Re’s business and underwriting activities into its existing platform. While expected premium volume will decrease due to the factors described above, Management believes it has maintained appropriate diversification in its risk portfolio and maintained a similar priced technical ratio (defined below) to that of the January 1, 2010 renewal. The impact of the Company repositioning its portfolio during the January 1, 2011 renewals is not considered to be indicative of the full year trend given the Company has already repositioned and integrated certain later renewal dates during 2010.
A key challenge facing the Company is to successfully manage risk through all phases of the reinsurance cycle. The Company is confident in its long-term strategy, and believes that by closely monitoring the progression of each line of business, being selective in the business that it writes, and maintaining the
The Company’s profitability is significantly affected by the level of its losses and loss expenses incurred. The Company recognizes losses and loss expenses on the basis of actual and expected claims on business written and earned. The Company’s Non-life and Life net reserve positions at December 31, 2010 were $10.3 billion and $1.7 billion, respectively. Management believes that it follows prudent and consistent reserving policies to maintain a strong financial position. A key challenge for the Company is the accurate estimation of loss reserves for each line of business, which is critical in order to accurately determine the profitability of each line and allocate the appropriate amount of capital to each line in a manner that optimizes profitability.
Within the Company’s Life segment, the reinsurance market is differentiated between mortality and longevity products, with mortality being the larger market. For both the mortality and longevity markets in which the Company writes business, the Company observed improved pricing and conditions and attractive opportunities to grow the portfolio during 2010. Management believes the life business provides the Company with additional diversification benefits and balance to its portfolio. The Company does not write life business in the U.S. market.
In addition to the Consolidated Balance Sheets and Consolidated Statement of Operations and Comprehensive Income, Management uses certain key measures to evaluate its financial performance and the overall growth in value generated for the Company’s common shareholders. The four key measures that Management uses, together with definitions of their calculations, are as follows:
(1) Diluted book value per common shares and common share equivalents outstanding is calculated using common shareholders’ equity (shareholders’ equity less the aggregate liquidation value of preferred shares) divided by the number of fully diluted common shares and common share equivalents outstanding (assuming exercise of all stock-based awards and other dilutive securities).
Diluted book value per common shares and common share equivalents outstanding (Diluted Book Value per Share): Management uses growth in Diluted Book Value per Share as a prime measure of the value the Company is generating for its common shareholders, as Management believes that growth in the Company’s Diluted Book Value per Share ultimately translates into growth in the Company’s stock price. Diluted Book Value per Share is impacted by the Company’s net income, capital resources management and external factors such as foreign exchange, interest rates and equity markets, which can drive changes in unrealized gains or losses on its investment portfolio.
Over the past five years, since December 31, 2005, the Company has generated a compound annual growth rate in Diluted Book Value per Share in excess of 16.0%. The Company’s Diluted Book Value per Share increased by 11% to $93.77 at December 31, 2010 from $84.51 at December 31, 2009, primarily due to comprehensive income and the accretive impact of the share repurchases during 2010 (see Shareholders’ Equity and Capital Resources Management below).
The presentation of Operating Earnings or Loss available to common shareholders is a non-GAAP financial measure within the meaning of Regulation G and should be considered in addition to, and not as a substitute for, measures of financial performance prepared in accordance with GAAP (see Comment on Non-GAAP Measures). The table below provides a reconciliation of operating earnings available to common shareholders to the most comparable GAAP financial measure (in millions of U.S. dollars):
Operating ROE: Management uses operating return on beginning common shareholders’ equity (Operating ROE) as a measure of profitability that focuses on the return to common shareholders. Management has set an average 13% Operating ROE target over the reinsurance cycle, which Management believes provides an attractive return to shareholders for the risk assumed. Each business unit and support department throughout the Company is focused on seeking to ensure that the Company meets the 13% return objective. This means that most economic decisions, including capital attribution and underwriting pricing decisions, incorporate an Operating ROE impact analysis. For the purpose of that analysis, an appropriate amount of capital (equity) is attributed to each transaction for determining the transaction’s priced return on attributed capital. Subject to an adequate return for the risk level as well as other factors, such as the contribution of each risk to the overall risk
level and risk diversification, capital is attributed to the transactions generating the highest priced return on deployed capital. Management’s challenge consists of (i) attributing an appropriate amount of capital to each transaction based on the risk created by the transaction, (ii) properly estimating the Company’s overall risk level and the impact of each transaction on the overall risk level, (iii) assessing the diversification benefit, if any, of each transaction, and (iv) deploying available capital. The risk for the Company lies in mis-estimating any one of these factors, which are critical in calculating a meaningful priced return on deployed capital, and entering into transactions that do not contribute to the Company’s 13% Operating ROE objective.
From 2002 onwards, the Company had eight years of underwriting profitability reflected in combined ratios of less than 100% for its Non-life segment, with the only exception being 2005. In 2005, when the industry recorded its worst year in history in terms of catastrophe losses, with Hurricane Katrina being the largest insured event ever, the Company recorded a net underwriting loss and Non-life combined ratio of 116.3%.
The Non-life combined ratio increased from 81.8% in 2009 to 95.0% in 2010 primarily due to 13.9 points resulting from losses and loss expenses related to the Chile Earthquake, New Zealand Earthquake, Deepwater Horizon and an aggregate contract covering losses in Australia and New Zealand. The combined ratio decreased from 94.1% in 2008 to 81.8% in 2009 primarily due to the absence of large catastrophic losses in 2009 compared to losses and loss expenses related to Hurricane Ike in 2008.
Throughout this filing, the Company’s results of operations have been presented in the way that Management believes will be the most meaningful and useful to investors, analysts, rating agencies and others who use financial information in evaluating the performance of the Company. This presentation includes the use of Operating Earnings or Loss and Operating ROE that are not calculated under standards or rules that comprise U.S. GAAP. These measures are referred to as non-GAAP financial measures within the meaning of Regulation G. Management believes that these non-GAAP financial measures are important to investors, analysts, rating agencies and others who use the Company’s financial information and will help provide a consistent basis for comparison between years and for comparison with the Company’s peer group, although non-GAAP measures may be defined or calculated differently by other companies. Investors should consider these non-GAAP measures in addition to, and not as a substitute for, measures of financial performance prepared in accordance with GAAP. A reconciliation of these measures to the most comparable U.S. GAAP financial measures, net income and return on beginning common shareholders’ equity calculated with net income available to common shareholders, is presented above.
The Company aims to be a reliable and financially secure partner to its cedants. This means that the Company must maintain sufficient liquidity at all times so that it can support its cedants by settling claims quickly. The Company generates cash flows primarily from its underwriting and investment operations. Management believes that a profitable, well-run reinsurance organization will generate sufficient cash from premium receipts to pay claims, acquisition costs and operating expenses in most years. To the extent that underwriting cash flows are not sufficient to cover operating cash outflows in any year, the Company may utilize cash flows generated from investments and may ultimately liquidate assets from its investment portfolio. Management ensures that its liquidity requirements are supported by maintaining a high quality, well balanced and liquid investment portfolio, and by matching the duration of its investments and investments underlying the funds held - directly managed account with that of its net reinsurance liabilities. In 2011, the Company expects to continue to generate positive operating cash flows, absent a series of unusual catastrophic events. The Company also maintains credit facilities with banks that can provide efficient access to cash in the event of an unforeseen cash requirement.
A key challenge in the reinsurance industry is to create economic value through the intelligent assumption of reinsurance and capital markets and investment risk, but also to limit or mitigate those risks that can destroy tangible as well as intangible value. Management believes that every organization faces numerous risks that could threaten the successful achievement of a company’s goals and objectives. These include choice of strategy and markets, economic and business cycles, competition, changes in regulation, data quality and security, fraud, business interruption and management continuity; all factors which can be viewed as either strategic or operational risks that are common to any industry (See Risk Factors in Item 1A of Part I of this report). In addition to these risks, the Company assumes risks and its results are primarily determined by how well the Company understands, prices and manages assumed risk. While many industries and companies start with a return goal and then attempt to shed risks that may derail that goal, the Company starts with a capital-based risk appetite and then looks for risks that meet its return targets within that framework. Management believes that this construct allows the Company to balance the cedants’ need for certainty of claims payment with the shareholders’ need for an adequate return on their capital.
Individual business units manage assumed risks, subject to the appetite and principles approved by the Board, limits approved by the Risk and Finance Committee, and policies established by Executive and Business Unit Management. At an operational level, business units manage assumed risk through risk mitigation strategies including strong processes, technical risk assessment and collaboration among different groups of professionals who each contribute a particular area of expertise.
The major risks to the Company’s balance sheet are typically due to events that Management refers to as shock losses. The Company defines a shock loss as an event that has the potential to materially impact economic value. The Company defines its economic value as the difference between the net present value of tangible assets and the net present value of liabilities, using appropriate risk discount rates, plus the unrecognized value of the Life portfolio. For traded assets, the calculated net present values are equivalent to market values.
There are four areas of risk that the Company has currently identified as having the greatest potential for shock losses: catastrophe, reserving for casualty and other long-tail lines, equity and equity-like investment risk and longevity risk. The Company manages the risk of shock losses by setting risk appetite and limits, as described above and below, for each type of shock loss. The Company establishes limits to manage the maximum foreseeable loss from any one event and considers the possibility that several shock losses could occur at one time, for example a major catastrophe event accompanied by a collapse in the equity markets. Management believes that the limits that it has placed on shock losses will allow the Company to continue writing business should such an event occur.
Other risks such as interest rate risk and credit spread risk have the ability to impact results substantially and may result in volatility in results from period to period. However, Management believes that by themselves, interest rate risk and credit spread risk are unlikely to represent a material threat to the Company’s long-term economic value. See Quantitative and Qualitative Disclosures about Market Risk in
(1) The acquisition of Paris Re’s assets and liabilities involved non-cash share for share transactions, which have been excluded from the Consolidated Statements of Cash Flows.
PartnerRe Ltd. (the Company) provides reinsurance on a worldwide basis through its principal wholly-owned subsidiaries, including Partner Reinsurance Company Ltd. (PartnerRe Bermuda), Partner Reinsurance Europe Limited (PartnerRe Europe) and Partner Reinsurance Company of the U.S. (PartnerRe U.S). Risks reinsured include, but are not limited to, property, casualty, motor, agriculture, aviation/space, catastrophe, credit/surety, engineering, energy, marine, specialty property, specialty casualty, multiline and other lines, mortality, longevity and health and alternative risk products. The Company’s alternative risk products include weather and credit protection to financial, industrial and service companies on a worldwide basis.
Acquisition costs, primarily brokerage fees, commissions and excise taxes, which vary directly with, and are related to, the acquisition of reinsurance contracts, are capitalized and charged to expense as the related premium is earned. Anticipated losses and loss expenses, other costs and investment income related to these premiums are considered in determining the recoverability of deferred acquisition costs. Acquisition costs related to individual
life and annuity contracts are deferred and amortized over the premium-paying periods in proportion to anticipated premium income, allowing for lapses, terminations and anticipated investment income. Acquisition costs related to universal life and single premium annuity contracts for which there is no significant mortality or critical illness risk are deferred and amortized over the lives of the contracts as a percentage of the estimated gross profits expected to be realized on the contracts.
Under some of these contracts, cedants retain the assets on a funds-held basis. In those cases, the Company records those assets as deposit assets and records the related income in net investment income in the Consolidated Statements of Operations.
Effective January 1, 2008, the Company elected the fair value option for all of its fixed maturities, short-term investments, equities and certain other invested assets (excluding those that are accounted for using the cost or equity methods of accounting or investment company accounting). The Company defines fair value as the price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company measures the fair value of financial instruments according to a fair value hierarchy that prioritizes the information used to measure fair value into three broad levels. Following the election of the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in earnings. See Note 3 for additional information on fair value.
The Company elected the fair value option as of the Acquisition Date for all of Paris Re’s fixed maturities and short-term investments and certain other invested assets.
The FASB issued new accounting guidance related to business combinations and noncontrolling interests acquired after December 15, 2008. In April 2009, the FASB issued additional guidance related to accounting for assets acquired and liabilities assumed in a business combination that arise from contingencies. The Company adopted this guidance following the Company obtaining control of Paris Re on the Acquisition Date. The transaction was accounted for as an acquisition method business combination with the purchase price allocated to identifiable assets and liabilities, including certain intangible assets, based on their estimated fair value at the
Acquisition Date. The fair value of noncontrolling interests was also recorded at fair value at the Acquisition Date. The estimates of fair values for assets and liabilities assumed were determined by management based on various market and income analyses and appraisals. All costs associated with the acquisition were expensed as incurred.
In recording foreign currency transactions, revenue and expense items are converted into the functional currency at the average rates of exchange for the period. Assets and liabilities originating in currencies other than the functional currency are translated into the functional currency at the rates of exchange in effect at the balance
As part of its overall strategy to manage its level of currency exposure, from time to time the Company uses forward foreign exchange derivatives to hedge or partially hedge the net investment in certain non-U.S. dollar functional currency subsidiaries and branches. The Company also uses from time to time interest rate derivatives to mitigate exposure to interest rate volatility. These derivatives have been designated as net investment hedges, and accordingly, the changes in fair value of the derivative and the hedged item related to foreign currency are recognized in currency translation adjustment in the Consolidated Balance Sheets.
The Company’s investment strategy allows for the use of derivative instruments, subject to strict limitations. The Company utilizes various derivative instruments such as foreign exchange forward contracts, foreign currency option contracts, futures contracts and credit default swaps, for the purpose of managing overall currency risk, market exposures and portfolio duration and hedging certain investments, or enhancing investment performance that would be allowed under the Company’s investment policy if implemented in other ways. These instruments are recorded at fair value as assets and liabilities in the Consolidated Balance Sheets. Changes in fair value are included in net realized and unrealized investment gains and losses in the Consolidated Statements of Operations and changes in the fair value of foreign currency option contracts and foreign exchange forward contracts are included in net foreign exchange gains and losses in the Consolidated Statements of Operations. Margin balances required by counterparties, which are equal to a percentage of the total value of open futures contracts, are included in cash and cash equivalents.
The majority of the Company’s share-based compensation awards qualify for equity classification. The fair value of the compensation cost is measured at the grant date and is expensed over the period for which the employee is required to provide services in exchange for the award. Forfeiture benefits are estimated at the time of grant and incorporated in the determination of share-based compensation costs. Awards granted to employees who are eligible for retirement and do not have to provide additional services are expensed at the date of grant.
The Company recognizes an asset or a liability in the Consolidated Balance Sheets for the funded status of its defined benefit plans that are overfunded or underfunded, respectively, measured as the difference between the fair value of plan assets and the pension obligation and recognizes changes in the funded status of defined benefit plans in the year in which the changes occur as a component of accumulated other comprehensive income, net of tax.
The Company is involved in the normal course of business with variable interest entities (VIEs) as a passive investor in certain limited partnerships, fixed maturity investments and asset-backed securities, that are issued by third party VIEs. Prior to January 1, 2010, under then effective guidance, the Company performed a quantitative assessment upon initial involvement in a VIE to determine whether it was the primary beneficiary of, and required to consolidate, the VIE. Subsequent to January 1, 2010, in accordance with revised guidance, the Company performs a qualitative assessment at the date when it becomes initially involved in the VIE followed by ongoing reassessments related to its involvement in VIEs. The Company’s maximum exposure to loss with respect to these investments is limited to the investment carrying amounts reported in the Company’s Consolidated Balance Sheets and any unfunded commitments.
The Company monitors the performance of its operations in three segments, Non-life, Life and Corporate and Other. The Non-life segment is further divided into four sub-segments: North America, Global (Non-U.S.) Property and Casualty (Global (Non-U.S.) P&C), Global (Non-U.S.) Specialty and Catastrophe.
During the fourth quarter of 2010, the Company redefined its financial reporting segments following the completion of its integration of Paris Re into its other Non-life sub-segments and changes in management responsibilities for certain lines of business and treaties. As a result, segment data for prior periods has been recast to conform to the current year presentation (see Note 22).
In October 2010, the FASB issued new accounting guidance clarifying that only acquisition costs related directly to the successful acquisition of new or renewal insurance contracts may be capitalized. Those acquisition costs that may be capitalized include incremental direct costs, such as commissions, and a portion of salaries and benefits of certain employees who are involved in underwriting and policy issuance, that are directly related to time spent on an acquired contract. This guidance is effective for interim and annual periods beginning after December 15, 2011, with early adoption permitted at the beginning of an entity’s annual reporting period. The Company is currently evaluating the impact of the adoption of this guidance on its consolidated shareholders’ equity or net income.
Level 2 inputs-Quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in inactive markets and directly or indirectly observable inputs, other than quoted prices, used in industry accepted models.
The Company’s financial instruments that it measures at fair value using Level 2 inputs generally include: U.S. Treasury bonds; U.S. Government Sponsored Entities bonds; Organization for Economic
Co-operation and Development Sovereign Treasury bonds; investment grade and high yield corporate bonds; catastrophe bonds; mortality bonds; mortgage-backed securities; asset-backed securities; foreign exchange forward contracts and over-the-counter derivatives such as foreign currency option contracts, equity put and call options, credit default swaps and interest rate swaps.
The Company’s financial instruments that it measures at fair value using Level 3 inputs generally include: unlisted equities including preference shares; unit trusts; inactively traded fixed maturities; real estate mutual fund investments; inactively traded weather derivatives; notes receivable and total return swaps.
During the year ended December 31, 2010, there were no significant transfers between Levels 1 and 2.
At December 31, 2010 and 2009, the aggregate carrying amounts of items included in Other invested assets that the Company did not measure at fair value were $241.0 million and $169.3 million, respectively, which related to the Company’s investments that are accounted for using the cost method of accounting, equity method of accounting or investment company accounting.
At December 31, 2010 and 2009, substantially all of the accrued investment income in the Consolidated Balance Sheets related to the Company’s investments and the investments underlying the funds held - directly managed account for which the fair value option was elected.
During the year ended December 31, 2010, certain fixed maturities with a fair value of $17.9 million were transferred from Level 3 into Level 2. The reclassifications to Level 2 consisted of municipal (included within U.S. government and agencies), corporate and student loans (included within asset-backed securities) fixed maturities. The transfers into Level 2 were due to the availability of quoted prices for similar assets in active markets used for valuation as of December 31, 2010, resulting from the continued recovery of the financial markets. In addition, during the year ended December 31, 2010, certain derivatives with a fair value in a net liability position of $8.2 million were transferred out of Level 3 into Level 2 due to the availability of observable inputs.
U.S. government and agencies-U.S. government and agencies securities consist primarily of bonds issued by the U.S. Treasury, corporate debt securities issued by the Federal National Mortgage Association, the Federal Home Loan Bank and other U.S. agencies as well as bonds issued by U.S. domiciled state and municipality entities. These securities are generally priced by independent pricing services. The independent pricing services may use actual transaction prices for securities that have been actively traded. For securities that have not been actively traded, each pricing source has its own proprietary method to determine the fair value, which may incorporate option adjusted spreads (OAS), interest rate data and market news. The Company generally classifies these securities in Level 2. Certain of the U.S. domiciled states and municipality investments issued by municipal housing authorities are not actively traded and are priced based on internal models using unobservable inputs. Accordingly, the Company generally classifies these securities in Level 3.
Non-U.S. sovereign government, supranational and government related-Non-U.S. sovereign government, supranational and government related securities consist primarily of bonds issued by non-U.S. national governments and their agencies, non-U.S. regional governments and supranational organizations. These securities are generally priced by independent pricing services using the techniques described for U.S. government and agencies above. The Company generally classifies these securities in Level 2.
Residential mortgage-backed securities-Residential mortgage-backed securities primarily consist of bonds issued by the Government National Mortgage Association, the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, as well as private, non-agency issuers. With the exception of private, non-agency issuers, these residential mortgage-backed securities are generally priced by independent pricing services and brokers. When current market trades are not available, the pricing provider will employ proprietary models with observable inputs including other trade information, prepayment speeds, yield curves and credit spreads. The Company generally classifies these securities in Level 2. Bonds issued by private, non-agency issuers are generally inactively traded and are priced based on valuation models using unobservable inputs, including cash flow assumptions and credit spreads. The Company generally classifies these securities in Level 3.
Included in the Company’s Level 3 categorization, in general, are unlisted equities including preference shares, unit trusts, credit linked notes, certain inactively traded weather derivatives, notes and loans receivable and total return swaps. For Level 3 instruments, the Company will generally either (i) receive a price based on a manager’s or trustee’s valuation for the asset; or (ii) develop an internal discounted cash flow model to measure fair value. Where the Company receives prices from the manager or trustee, these prices are based on the manager’s or trustee’s estimate of fair value for the assets and are generally audited on an annual basis. Where the Company develops its own discounted cash flow models, the inputs will be specific to the asset in question, based on appropriate historical information, adjusted as necessary, and using appropriate discount rates. As part of the Company’s modeling to determine the fair value of an investment, the Company considers counterparty credit risk as an input to the model, however, the majority of the Company’s counterparties are highly rated institutions and the failure of any one counterparty would not have a significant impact on the Company’s financial statements.
The other invested assets within the segregated investment portfolio underlying the funds held - directly managed account, which are categorized as Level 3 investments, are primarily real estate mutual fund investments carried at fair value. For the real estate mutual fund investments, the Company receives a price based on the real estate fund manager’s valuation for the asset and further adjusts the price, if necessary, based on appropriate current information on the real estate market.
the fair value of the CENts was calculated using quoted market prices at December 31, 2010 and was based on the present value of estimated discounted future cash flows at December 31, 2009. The fair value of the CENts was based on the aggregate principal amount outstanding from PartnerRe Finance II Inc. of $63 million at December 31, 2010 and 2009; and
the fair value of the current portion of long-term debt as of December 31, 2009 was based on the present value of estimated future cash flows using a discount rate reflective of the current market cost of borrowing under similar terms and conditions. The current portion of long-term debt was repaid in July 2010 (see Note 11).
Disclosures about fair value of financial instruments exclude insurance contracts (other than financial guarantees), investment contracts and certain other financial instruments.
The cost, gross unrealized gains, gross unrealized losses and fair value of investments classified as trading securities at December 31, 2010 and 2009 were as follows (in thousands of U.S. dollars):
The components of the net realized and unrealized investment gains (losses) for the years ended December 31, 2010, 2009 and 2008 were as follows (in thousands of U.S. dollars):
Included in net realized investment (losses) gains on equities in 2009 is a gain of $18.3 million related to the Company’s equity investment in Paris Re prior to the Acquisition Date (see Note 7).
The components of net investment income for the years ended December 31, 2010, 2009 and 2008 were as follows (in thousands of U.S. dollars):
Other than the funds held - directly managed account, the Company generally earns investment income on funds held by reinsured companies based upon a predetermined interest rate, either fixed contractually at the inception of the contract or based upon a recognized index (e.g., LIBOR). Interest rates ranged from 3.0% to 6.0% at December 31, 2010 and from 1.0% to 6.0% at December 31, 2009. See Note 5 for additional information on the funds held - directly managed account.
At December 31, 2010 and 2009, approximately $271.2 million and $55.2 million, respectively, of cash and cash equivalents and approximately $1,679.2 million and $1,693.0 million, respectively, of securities were deposited, pledged or held in escrow accounts in favor of ceding companies and other counterparties or government authorities to comply with reinsurance contract provisions and insurance laws.
Following Paris Re’s acquisition of substantially all of the reinsurance operations of Colisée Re (previously known as AXA RE), a subsidiary of AXA SA (AXA), in 2006, Paris Re and its subsidiaries entered into an issuance agreement and a quota share retrocession agreement to assume business written by Colisée Re from January 1, 2006 to September 30, 2007 as well as the in-force business as of December 31, 2005. The agreements provided that the premium related to the transferred business was retained by Colisée Re and credited to a funds held account. The assets underlying the funds held - directly managed account are maintained by Colisée Re in a segregated investment portfolio and managed by the Company. The segregated investment portfolio underlying the funds held - directly managed account is carried at fair value. Realized and unrealized investment gains and
The cost, gross unrealized gains, gross unrealized losses and fair value of investments underlying the funds held - directly managed account at December 31, 2010 and 2009 were as follows (in thousands of U.S. dollars):
The Company also utilizes foreign currency option contracts to mitigate foreign currency risk. The Company uses exchange traded treasury note futures contracts to manage portfolio duration and commodity and equity futures to hedge certain investments.
The Company also assumes credit risk through credit default swaps to replicate investment positions. The original term of these credit default swaps is generally five years or less and there are no recourse provisions associated with these swaps. While the Company would be required to perform under exposure assumed through credit default swaps in the event of a default on the underlying issuer, no issuer was in default at December 31, 2010. The counterparties on the Company’s assumed credit default swaps are all highly rated financial institutions.
The Company has entered into various weather derivatives, weather futures and longevity total return swaps for which the underlying risks reference parametric weather risks for the weather derivatives and weather futures, and longevity risk for the longevity total return swaps.
(1) The Company enters into interest rate swaps to mitigate notional exposures on certain total return swaps. Accordingly, the notional value of interest rate swaps is not presented separately in the table.
The gains and losses in the Consolidated Statements of Operations for derivatives not designated as hedges for the years ended December 31, 2010, 2009 and 2008 were as follows (in thousands of U.S. dollars):
On July 4, 2009, the Company entered into definitive agreements to effect a multi-step acquisition of all the outstanding common shares and warrants of Paris Re, a French-listed, Swiss-based holding company and its operating subsidiaries. In July 2009, the Company purchased approximately 6% of the outstanding Paris Re common shares. On October 2, 2009, the Company closed its block purchase of Paris Re’s common shares and warrants which represented, in the aggregate, approximately 77% of the outstanding common shares of Paris Re, resulting in the Company’s ownership of Paris Re’s common shares increasing to approximately 83%. Subsequent to October 2, 2009, the Company acquired additional common shares of Paris Re and effected a Merger, resulting in the Company obtaining 100% ownership of Paris Re on December 7, 2009. The Company issued its common shares, in exchange for Paris Re common shares and warrants, for all steps of the acquisition.
The aggregate purchase price paid by the Company to acquire 100% of the outstanding Paris Re common shares and warrants was $1,979.7 million for total identifiable net assets acquired, at fair value, of $1,953.7 million. The Company recorded goodwill of $26 million related to the acquisition (see Note 8).
In April 2010, the Company announced a voluntary termination plan available to certain eligible employees in France and, during 2010, the Company integrated Paris Re into its existing Non-life sub-segments (see Notes 18(c) and 22).
The following table shows the Company’s goodwill and intangible assets at December 31, 2010 and 2009 (in thousands of U.S. dollars):
During the year ended December 31, 2010, the Company completed the integration of Paris Re into its other Non-life sub-segments (see Note 22). Following the completion of the integration, the Company reallocated the goodwill related to the Paris Re acquisition, that was previously allocated to the Paris Re sub-segment, to its Catastrophe Non-life sub-segment. The goodwill was reallocated to the Catastrophe Non-life sub-segment based on the Company’s assessment of the future expected benefits. As of December 31, 2010 and 2009, the allocation of the goodwill among the Company’s segments and sub-segments was as follows (in thousands of U.S. dollars):
The table below is a reconciliation of the beginning and ending liability for unpaid losses and loss expenses, excluding policy benefits for life and annuity contracts, for the years ended December 31, 2010, 2009 and 2008 (in thousands of U.S. dollars):
Within the Company’s North America sub-segment, the Company reported net favorable loss development for prior accident years in 2010, 2009 and 2008. The net favorable loss development in 2010 included net favorable development for prior accident years in most lines of business, predominantly in casualty and agriculture, while motor experienced adverse loss development for prior accident years of $8 million. The net favorable loss development in 2009 included net favorable development for prior accident years in most lines of business, predominantly in casualty, while multiline experienced adverse loss development for prior accident years of $8 million. The net favorable loss development in 2008 included net favorable development for prior accident years in all lines of business, except for multiline, which experienced adverse loss development for prior accident years of $3 million. Loss information provided by cedants during each of these years for prior accident years included no individually significant losses or reductions but a series of attritional losses or reductions. Attritional losses are losses that may not be significant on an individual basis, but are monitored on an aggregated basis by the Company to identify trends that may be meaningful from a reserving standpoint.
For the Global (Non-U.S.) P&C sub-segment, the Company reported net favorable loss development for prior accident years in 2010, 2009 and 2008. The net favorable loss development in 2010 included net favorable development for prior accident years in all lines of business, but was most pronounced in the property line. The net favorable loss development in 2009 included net favorable development for prior accident years in all lines of business, but was most pronounced in the motor and casualty lines. The net favorable loss development in 2008 included net favorable development for prior accident years in all lines of business, but was most pronounced in the property line. Loss information provided by cedants during each of these years for prior accident years included no individually significant losses or reductions but a series of attritional losses or reductions.
For the Global (Non-U.S.) Specialty sub-segment, the Company reported net favorable loss development for prior accident years in 2010, 2009 and 2008. The net favorable loss development in 2010 included net favorable development for prior accident years in all lines of business, except for specialty casualty, which experienced adverse loss development for prior accident years of $37 million. The net favorable loss development in 2009 included net favorable development for prior accident years in most lines of business, predominantly in aviation and engineering, while agriculture and credit/surety experienced combined adverse loss development for prior accident years of $4 million. The net favorable loss development in 2008 included net favorable development in all lines of business, except for energy and specialty casualty, which experienced combined adverse loss development for prior accident years of $9 million. Loss information provided by cedants during each of these years for prior accident years included no individually significant losses or reductions but a series of attritional losses or reductions.
Favorable or adverse development related to the guaranteed reserves is recorded as a change in unpaid losses and loss expenses in the Consolidated Balance Sheets and as a change in the Reserve Agreement payable or receivable balance to/from Colisée Re, which is included within Other reinsurance balances payable in the Consolidated Balance Sheets. Accordingly, the reconciliation of the beginning and ending liability for unpaid losses and loss expenses for the years ended December 31, 2010 and 2009 includes the change in the Reserve Agreement. As of December 31, 2010 and 2009, the Company’s net liability for unpaid losses and loss expenses includes $1,239 million and $1,500 million, respectively, of guaranteed reserves and Other reinsurance balances payable includes $128 million and $116 million, respectively, payable to Colisée Re related to the Reserve Agreement.
The impacts of the global financial and economic crisis on the Company’s reinsurance underwriting operations abated in 2010. The Company has continued to review its loss estimates and has decreased its reserves during 2010 in certain affected lines of business for certain underwriting years, reflecting actual claims activity being less than anticipated based on information provided by cedants.
Based on information currently available and the range of potential estimated ultimate liabilities, the Company believes that the unpaid loss and loss expense reserves for North America and Global (Non-U.S.) specialty casualty, North America and Global (Non-U.S.) credit/surety lines of business and other potentially exposed classes of business contemplate a reasonable provision for exposures related to the effect of increased financial stress in the world economies. The Company is unaware of any specific issues that would materially affect its unpaid loss and loss expenses estimates related to this exposure.
development being subject to the Reserve Agreement. Of the remaining $78 million and $80 million, respectively, in gross reserves, the majority of the reserves relate to casualty exposures in the United States arising from business written by PartnerRe SA and PartnerRe U.S.
The Life segment reported net adverse development for prior accident years of $12 million and $24 million for the years ended December 31, 2010 and 2008, respectively, and net favorable development for prior accident years of $15 million for the year ended December 31, 2009.
The net favorable development in 2009 and the net adverse development in 2008 was mainly driven by the GMDB business. Such development was $16 million favorable and $33 million unfavorable for the years ended December 31, 2009 and 2008, respectively.
The Company uses retrocessional agreements to reduce its exposure to risk of loss on reinsurance assumed. These agreements provide for recovery from retrocessionaires of a portion of losses and loss expenses. The Company remains liable to its cedants to the extent that the retrocessionaires do not meet their obligations under these agreements, and therefore the Company evaluates the financial condition of its reinsurers and monitors concentration of credit risk on an ongoing basis. The Company actively manages its reinsurance exposures by generally selecting retrocessionaires having a credit rating of A- or higher. In certain cases where an otherwise suitable retrocessionaire has a credit rating lower than A-, the Company generally requires the posting of collateral, including escrow funds and letters of credit, as a condition to its entering into a retrocession agreement. The selection of retrocessionaires follows a precise qualitative and quantitative process. The Company regularly reviews its reinsurance recoverable balances to estimate an allowance for uncollectible amounts based on quantitative and qualitative factors. The allowance for uncollectible reinsurance recoverable was $6.9 million and $6.8 million at December 31, 2010 and 2009, respectively.
Paris Re reinsured property catastrophe and per risk excess-of-loss business for its 2008 and 2007 accident years through a 24% quota share treaty to Triomphe Re Ltd. (Triomphe Re), a special purpose reinsurance company domiciled in Bermuda. Reinsurance balances recoverable from Triomphe Re at December 31, 2010 and 2009 are $16.8 million and $28.4 million, respectively. Triomphe Re’s obligations under this agreement are collateralized by cash and other liquid assets held in a trust, including Triomphe Re’s capital, as well as premiums. At December 31, 2010 and 2009, Triomphe Re’s capitalization is approximately $19 million and $33 million, respectively.
The Company incurred interest expense of $1.2 million, $3.9 million and $15.2 million and paid interest of $1.6 million, $6.3 million and $16.1 million for the years ended December 31, 2010, 2009 and 2008, respectively, in relation to this loan.
On March 10, 2010, PartnerRe Finance B LLC (PartnerRe Finance B), an indirect wholly-owned subsidiary of the Company, issued $500 million aggregate principal amount of 5.500% Senior Notes (2010 Senior Notes, or collectively with the 2008 Senior Notes defined below referred to as Senior Notes). The 2010 Senior Notes will mature on June 1, 2020 and may be redeemed at the option of the issuer, in whole or in part, at any time. Interest payments on the 2010 Senior Notes commenced on June 1, 2010 and is payable semi-annually at an annual fixed rate of 5.500%, and cannot be deferred.
For the year ended December 31, 2010, the Company incurred interest expense of $21.8 million and paid interest of $19.6 million in relation to the 2010 Senior Notes issued by PartnerRe Finance B.
The 2008 Senior Notes are ranked as senior unsecured obligations of PartnerRe Finance A. The Company has fully and unconditionally guaranteed all obligations of PartnerRe Finance A under the 2008 Senior Notes. The Company’s obligations under this guarantee are senior and unsecured and rank equally with all other senior unsecured indebtedness of the Company. The proceeds from the 2008 Senior Notes were used to redeem an outstanding bank loan and the remaining net proceeds were used for general corporate purposes.
On March 2, 2009, the Company announced the commencement of a cash tender offer for any and all of the CENts. Under the terms of the tender offer, PartnerRe Finance II paid holders $500 per $1,000 principal amount of CENts tendered. In addition, holders of the CENts were paid any accrued and unpaid interest on the purchased CENts from the last interest payment date.
On March 13, 2009, PartnerRe Finance II purchased approximately 75% of the issue, or $186.6 million, for $93.3 million. Contemporaneously, under the terms of a cross receipt agreement, PartnerRe U.S. Holdings paid PartnerRe Finance II consideration of $93.3 million for the extinguishment of $186.6 million of the principal amount of PartnerRe U.S. Holdings’ 6.440% Fixed-to-Floating Rate promissory note due December 1, 2066. All other terms and conditions of the remaining CENts and promissory note remain unchanged. A pre-tax gain of $88.4 million, net of deferred issuance costs and fees, was realized on the foregoing transactions. The aggregate principal amount of the CENts and promissory note outstanding at December 31, 2010 was $63.4 million and $71.0 million, respectively.
At December 31, 2010 and 2009, the total authorized shares of the Company were 200 million shares, par value $1.00 per share, as follows (in millions of shares):
During 2009, no shares were repurchased. During 2008, the Company repurchased 1.5 million of its common shares pursuant to its repurchase program at a total cost of $110.0 million, representing an average cost of $71.79 per share.
During 2009, and pursuant to the acquisition of Paris Re, the Company issued 25.7 million common shares, of which 1.3 million common shares were reissued from treasury.
During 2008, under a maturing forward sale agreement, the Company delivered 3.4 million common shares to the forward counterparty over a 40 day valuation period for total proceeds of $211.6 million. The value received per share was the average daily market price per share over the valuation period, subject to a minimum price per share of $59.37 (see Note 19).
In November 2004, the Company issued 9.2 million of 6.5% Series D cumulative redeemable preferred shares (Series D preferred shares) for a total consideration of $222.3 million after underwriting discounts and commissions totaling $7.7 million. The Company may redeem the Series D preferred shares at $25.00 per share plus accrued and unpaid dividends without interest. Dividends on the Series D preferred shares are cumulative from the date of issuance and are payable quarterly in arrears. In the event of liquidation of the Company, the holders of outstanding preferred shares would have preference over the common shareholders and would receive a distribution of $25.00 per share, or an aggregate value of $230 million, plus accrued and unpaid dividends.
(1) Net income and net income available to common shareholders include $4.3 million, and basic net income per share and diluted net income per share include $0.07 per share related to the noncontrolling interests’ share of Paris Re’s net income for the period from October 2, 2009 to December 7, 2009.
with the relevant statutory accounting practices. As of December 31, 2010, there were no significant restrictions on the payment of dividends by the Company’s reinsurance subsidiaries that would limit the Company’s ability to pay common and preferred shareholders’ dividends and its corporate expenses.
The following table summarizes the statutory shareholders’ equity of the Company’s reinsurance subsidiaries as of December 31, 2010 and 2009 (in millions of U.S. dollars):
At December 31, 2010 and 2009, the Company has Swiss and French operations that are branches of PartnerRe Europe and are regulated by the Irish Financial Regulatory Authority, as prescribed by the EU Reinsurance Directive.
the United States and 2008-2010 in France. As a global organization, the Company may be subject to a variety of transfer pricing or permanent establishment challenges by taxing authorities in various jurisdictions. Management believes that adequate provision has been made in the Consolidated Financial Statements for any potential assessments that may result from tax examinations for all open tax years.
The net tax assets and liabilities and their components at December 31, 2010 and 2009 were as follows (in thousands of U.S. dollars):
At December 31, 2010 and 2009, the deferred tax assets (after valuation allowance) of $2.9 million and $17.2 million, respectively, related to capital loss carryforwards in the United States, which can be carried forward for five years.
In May 2005, the shareholders approved the PartnerRe Ltd. 2005 Employee Equity Plan (EEP). The EEP permits the grant of share options, RS, RSUs, SSARs or other share-based awards to employees of the Company. The EEP is administered by the Compensation and Management Development Committee of the Board (the Committee).
In May 2008 and in September 2009 (in connection with the acquisition of Paris Re), the shareholders approved an allocation of an additional 0.6 million shares and 0.4 million shares, respectively, to the EEP. Currently, the plan permits the grant of up to 3.3 million shares, of which a total of 1.7 million shares can be issued as either RS or RSUs and 1.6 million shares can be issued as share options or SSARs. If an award under the EEP is cancelled or forfeited without the delivery of the full number of shares underlying such award, only the net number of shares actually delivered to the participant will be counted against the EEP’s authorized shares. Under the EEP, the exercise price of the award will not be less than the fair value of the award at the time of grant. The fair value is defined in the EEP as the closing price reported on the grant date. Awards issued under the EEP generally vest over 3 years of continuous service, either ratably or with a cliff-vest provision, are expensed ratably over the vesting period and have a ten year contractual term. Participants in the EEP are eligible to receive dividends, which the Company records as an expense, on RSUs that are unvested. Shares available for grant under the previous plan at the time of replacement were transferred and became available for grant under the EEP. At December 31, 2010, 0.9 million shares remained available for issuance under this plan.
The activity related to the Company’s share options for the year ended December 31, 2010 was as follows:
The Company values share options issued with a Black-Scholes valuation model and used the following assumptions for the years ended December 31, 2010, 2009 and 2008:
During the years ended December 31, 2010, 2009 and 2008, the Company issued 374,366 RSUs, 607,173 RSUs and 241,458 RSUs with a weighted average grant date fair value of $79.18, $75.09 and $77.19, respectively. The Company values RSUs issued under all plans at the fair value of its common shares at the time of grant, as defined by the plan document.
Of the 868,002 RSUs outstanding at December 31, 2010, 54,221 are subject to a five year delivery date restriction from the grant date and were not released for conversion into shares.
The Company values SSARs issued with a Black-Scholes valuation model and used the following assumptions for the years ended December 31, 2010, 2009 and 2008:
At December 31, 2010 and 2009, the funded status at the end of the year was included in accounts payable, accrued expenses and other in the Consolidated Balance Sheets. The total amounts recognized in accumulated other comprehensive (loss) income at December 31, 2010 and 2009 were $15.2 million (net of $4.1 million of taxes) and $8.8 million (net of $2.3 million of taxes), respectively.
The assumptions used to determine the pension obligation and net periodic benefit cost for the years ended December 31, 2010, 2009 and 2008 were as follows:
The Company does not believe that any plan assets will be returned to the Company during 2011.
million, or 11.7% of the Company’s total shareholders’ equity, of AAA rated debt securities issued by the government of France. As of December 31, 2009, the Company’s fixed maturity investments included $814 million, or 10.6% of the Company’s total shareholders’ equity, of AAA rated debt securities issued by the government of France. The Company keeps cash and cash equivalents in several banks and may keep up to $500 million, excluding custodial accounts, at any point in time in any one bank.
The Company monitors the performance of the notes receivable based on the type of underlying collateral and by assigning a “performing” or a “non-performing” indicator of credit quality to each individual receivable. As of December 31, 2010, the Company’s notes receivable of $55.6 million were all performing and were collateralized by residential property and commercial property of $28.9 million and $26.7 million, respectively.
The Company has exposure to credit risk related to reinsurance balances receivable and reinsurance recoverable on paid and unpaid losses. The credit risk exposure related to these balances is mitigated by several factors, including but not limited to, credit checks performed as part of the underwriting process, monitoring of aged receivable balances and the contractual right to offset premiums receivable or funds held balances against unpaid losses and loss expenses. The Company regularly reviews its reinsurance recoverable balances to estimate an allowance for uncollectible amounts based on quantitative and qualitative factors. As of December 31, 2010 and 2009, the Company has recorded a provision for uncollectible premiums receivable of $12.6 million and $10.3 million, respectively. See also Note 10 for discussion of credit risk related to reinsurance recoverable on paid and unpaid losses.
Rent expense for the years ended December 31, 2010, 2009 and 2008 was $36.1 million, $30.9 million, and $28.8 million, respectively.
On July 12, 2010, the Company announced certain changes in its executive management group. Related to these changes, on July 28, 2010, the Company entered into a separation agreement (Letter Agreement) with a member of executive management.
During the year ended December 31, 2010, the Company recorded a pre-tax charge of $50.0 million related to the aggregated costs of the voluntary plan and the Letter Agreement within other operating expenses. The continuing salary and other employment benefits costs related to employees participating in the voluntary plan will be expensed as the employee provides service and remains with the Company.
The Company has entered into service agreements and lease contracts that provide for business and information technology support and computer equipment. Future payments under these contracts amount to $27.7 million through 2016.
On July 31, 2008, the Company amended its existing forward sale agreement. Under the terms of the amendment, half the contract matured according to its original term beginning on September 26, 2008, while the
remaining half was extended to April 2010. Under the terms of the unamended half of the forward sale agreement, in 2008 the Company delivered 3.4 million common shares to the forward counterparty for total proceeds of $211.6 million (see Note 12).
Under the terms of the extended forward sale agreement, contract fees of approximately $8.1 million were recorded against additional paid-in capital in 2008 and were paid over the contract period.
This transaction had no other impact on the Company’s common shareholders’ equity, and the Company calculated the dilutive impact related to the forward sale agreement, if any, using the treasury stock method. The diluted net income per share for the years ended December 31, 2010, 2009 and 2008 did not include any dilutive effect related to this agreement.
In the normal course of its operations, the Company enters into agreements with financial institutions to obtain unsecured and secured credit facilities. As of December 31, 2010, the total amount of such credit facilities available to the Company was $1,359.4 million, with each of the significant facilities described below. These facilities are used primarily for the issuance of letters of credit, although a portion of these facilities may also be used for liquidity purposes. Under the terms of certain reinsurance agreements, irrevocable letters of credit were issued on an unsecured and secured basis in the amount of $459.9 million and $243.2 million, respectively, at December 31, 2010, in respect of reported loss and unearned premium reserves.
In the normal course of its underwriting activities, the Company and certain subsidiaries entered into reinsurance contracts with Atradius N.V. The activity included in the Consolidated Statements of Operations related to Atradius N.V. for the years ended December 31, 2010, 2009 and 2008 was as follows (in thousands of U.S. dollars):
Included in the Consolidated Balance Sheets at December 31, 2010 and 2009 were the following balances related to Atradius N.V. (in thousands of U.S. dollars):
The following table provides the distribution of net premiums written by line of business for the years ended December 31, 2010, 2009 and 2008:
The following table provides the geographic distribution of gross premiums written based on the location of the underlying risk for the years ended December 31, 2010, 2009 and 2008:
The following table summarizes the percentage of gross premiums written through these two brokers by segment and sub-segment for the years ended December 31, 2010, 2009 and 2008:
The Company’s results include the results of Paris Re from October 2, 2009, the date of acquisition.
During January 2011, torrential rain and widespread flooding impacted large areas of Australia, including Queensland and Victoria. Additionally, on February 3, 2011, Tropical Cyclone Yasi made landfall as a Category 4 storm in North Queensland, Australia, causing widespread property damage and flooding across the region. The Company’s initial total net loss estimate for these events is expected to be in the range of $80 to $110 million, pre-tax, net of retrocession and reinstatement premiums, and primarily recorded within the Company’s Global (Non-U.S.) P&C and Catastrophe sub-segments. The Company is continuing to assess its exposure related to these 2011 events.
In January and February 2011, the Company repurchased 2.7 million of its common shares at a total cost of $220 million, representing an average cost of $81.54 per share. Following these share repurchases, the Company had approximately 3.8 million common shares remaining under its current share repurchase authorization and approximately 16.7 million shares held in treasury.
We have audited the accompanying consolidated balance sheets of PartnerRe Ltd. and subsidiaries (the Company) as of December 31, 2010 and 2009, and the related consolidated statements of operations and comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.